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The world can’t afford to relax about oil security

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Authors: Tim Gould and Tae-Yoon Kim*

The recent attacks in Saudi Arabia were a sharp reminder that the world can’t take oil security for granted, even when markets are well supplied. But there have also been suggestions that this kind of disruption to oil supply could have less impact in the future, either because of changes in oil markets or because oil itself is set to be side-lined by accelerated transitions to other energy sources.

The International Energy Agency’s World Energy Outlook (WEO), which will be released on 13 November, addresses this question directly: do changing energy dynamics to 2040 mean that the world can afford to become more relaxed about oil security?

The short answer is that there’s little room for complacency. The market and policy environment may be changing, rapidly in some areas, but oil security concerns don’t disappear in any of the scenarios examined in the report. Whether we like it or not, what happens in oil markets will still matter for all of us – for decades to come.

Oil is under pressure, but is it resistant to change?

Oil is not the force in the global economy and energy mix that it once was. It is still the largest fuel in the global energy mix, but its share is 31% today down from 45% in 1974, when the IEA was founded. The amount of oil consumed per unit of economic output has also fallen by one-third since 2000. This means that economic growth doesn’t drive oil consumption growth as much as it did in the past.

These trends are set to continue as oil is used more efficiently and consumers and policy makers seek cleaner alternatives for transport. In the WEO-2019, a scenario based on today’s policy settings and ambitions sees a marked slowdown in oil demand growth from the late 2020s, mainly because of dramatic changes in the passenger car sector that accounts for one-quarter of global oil demand. More concerted efforts to tackle climate change and air pollution would further accelerate these changes.

Changes on the supply side are also easing some concerns. The remarkable rise of US shale oil production has brought greater diversity to global supplies and reduced dependence on some traditional producers and exporters. The short investment and production cycle of US shale oil also makes it more responsive to price movements, offering something of a safety net for markets in the event of an imbalance between global demand and supply.

These shifts in oil markets are profound, but their effects need to be kept in context. A peak in oil use for passenger cars is clearly visible on the horizon, but this is not yet the case for many other areas of oil demand such as shipping, aviation, freight trucks and the petrochemicals sector.

Even in a scenario where a shared determination to meet the goals of the 2015 Paris Agreement on climate change in full leads to a sharp reduction in oil consumption worldwide, there would still be an oil market of 67 million barrels per day (mb/d) in 2040. That is comparable in size to the market of the early 1990s.

On the supply side, traditional oil producers are being challenged by the shale boom in the United States, but not eclipsed. The Middle East remains by far the largest net provider of crude oil to international markets. And as the US position in global markets evolves, new potential vulnerabilities emerge.

For example, oil analysts had typically watched the hurricane season in the Gulf of Mexico for its implications for US domestic supply, as with Hurricanes Katrina and Rita in 2005. Now, extreme weather in this region also cuts across one of the world’s main oil export routes.

Import dependence and chokepoints

Our projections suggest that dependence on oil, particularly imported oil, is unlikely to disappear quickly. In a scenario based on today’s policy settings and ambitions – which include some ambitious goals for making transport more efficient and more reliant on electricity – oil use continues to grow across much of the developing world. Demand shifts markedly towards Asia, where leading economies’ imports and import bills rise significantly.

In this scenario, Asian importers tap into a wider variety of supply sources, and there is a major increase in flows from North and South America to Asia. However, despite the major changes in oil markets over the period to 2040 and the rise in US output, seaborne crude oil trade from the Middle East to Asia remains critical.

This means that the Strait of Hormuz – the narrow stretch of water that connects oil producers around the Gulf with global markets – remains a vital artery of global oil trade. At present, the strait carries some 16 mb/d of crude oil and 4 mb/d of oil products (around one-third of global seaborne oil trade), largely to consumers in Asia. In 2018, around 80% of crude oil imports to Japan came through the strait, as did 40% of China’s oil imports and more than one-quarter of global LNG trade. Any impediment to shipments through the Strait of Hormuz would materially tighten markets.

The Strait of Hormuz is not the only potential chokepoint: the Strait of Malacca between Malaysia and Indonesia connects exporters in the Middle East and Africa with Asian importers. Around 19 mb/d of crude oil and oil products pass through the Strait of Malacca today. It is also a crucial location for fuel storage, blending and ship refuelling. Growing traffic through the narrow strait increases the risks of congestion, collision or attacks, which could have major implications for global oil and LNG markets. As in the case of Hormuz, finding alternative routes is not a straightforward task.

Some barrels are more equal than others

Crude quality is another important consideration. Crude oil exported from the Middle East consists mainly of light and medium sour crude. Asian refiners have been importing Middle Eastern oil for many years and many of their refineries are configured precisely to process these grades. For example, over 70% of the crude oil processed in refineries in Japan and Korea is light and medium sour crude. There is also a large appetite for these grades from refiners in China and India, although they process a slightly more diverse range of different grades. A potential supply disruption either in the Middle East or in one of the major chokepoints would have a particularly large impact on the global supply of the oil most in demand by Asian refiners.

In such a situation, these supplies could in theory be replaced by increased output from other regions. A key candidate would be the United States where shale production could likely ramp up relatively quickly in the event of a prolonged disruption. But because of differences in crude quality, using US production to offset a sudden drop in the supply of medium sour grades would come with additional challenges. It would take time and could well incur additional costs as refiners adjusted.

Producer economies matter for consumers

A changing energy system is also posing critical questions for many of the world’s traditional oil producers and exporters, raising the prospect of sustained pressure on economies that rely heavily on hydrocarbon revenues. As we highlighted in a WEO special report last year, fundamental changes to the prevailing development model in resource-rich countries look unavoidable.

The rollercoaster ride in oil prices in recent years has brought into sharp relief some structural weaknesses in many producer countries, prompting a number of governments to renew a commitment to reform and diversify their economies. How these producers respond to a changing policy and market environment is critical not only for their own future prospects, but also for oil markets and security.

Inaction or unsuccessful reform efforts would compound future risks, particularly given the need to create employment opportunities for growing, youthful populations in many cases. These risks would multiply in an environment where global demand and prices are lower. Indeed, in the absence of reforms, the risks of disruption and volatility may be significantly greater in scenarios in which major producers have to cope with sustained pressure on hydrocarbon revenues.

No country is an energy island

There are plenty of reasons for policy makers to continue to pay close attention to oil market security, even as they pursue a range of other important energy and environmental goals. A marked slowdown in the pace of overall oil demand growth is seen from the mid-2020s, but demand continues to grow briskly in much of Asia. And these supplies flow through major chokepoints. Rising output from the United States offers Asian importers opportunities for supplier diversification. But it also increases the pressure on producer economies, some of whom are in regions facing escalating geopolitical tensions.

No country is immune from these developments. The risks associated with a physical disruption to supply may change over time, but all are affected by price movements in an interconnected global market.

Against this backdrop, the role of emergency oil stocks to help cope with sudden supply disruptions remains vital, and the effectiveness of such stocks will be greater with broader participation and with increased attention to changes in crude quality and product demand.

It will also be important for refiners to improve the flexibility of their operations; for importing countries to remove fossil fuel consumption subsidies and promote energy efficiency and alternative technologies to moderate their vulnerabilities; and for producer economies to expedite their efforts to reform and diversify their economies.

Founded 45 years ago, the IEA was initially designed to help countries coordinate a collective response to major disruptions in the supply of oil. The IEA’s work has evolved and expanded significantly since then and its expertise across the full spectrum of energy issues puts it at the heart of global dialogue on energy security and sustainability. But the founding mission remains as relevant as ever, and oil security continues to be a core issue for the IEA.

*Tae-Yoon Kim, WEO Energy Analyst

IEA

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China’s Unorthodox Intervention in the Global Oil Market

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Apparently, China has been the talk of the town for quite some time. While the entire yesteryear passed in a flurry of blame game over the pandemic, this year has been nothing short of a blessing for Xi’s regime. However, while China rapidly compensated for the drastic slump last year, the bustling economy has now cooled down – though a bit prematurely. Due to the expansive outbreak of the delta variant, China – like most countries around the world – now faces surging inflation and a crippling shortage of raw materials. However, while one might get a bolder vibe from China’s recent crackdown on industrial giants, the supposed Second Cultural Revolution’ seems on a divergent path from the government’s latest aspirations for the domestic industry.

China seems to be on a path to harness growth that appears to be slowing down as the global economy battles uncertainty. However, while many expected China to take orthodox measures to prolong growth, hardly anyone expected a drastic change of strategy: intervening in a close-knitted global market like never before.

China recently posted its most robust trade surplus in history, with a record rise in exports jumping 25.6% from last year to stand at $294.3; $10 billion more than any previous month. However, while the glowing figures imply sturdiness, the underlying fragility of the Chinese economy is not disguised. In the past few months, China’s production engine has taken a toll as surging energy costs have inhibited production capacity. The factory-gate inflation stands at a 13-year-high which has forced factories to cut output. Amid declining domestic demand due to covid restrictions, manufacturing surveys show that China’s export orders are eroding as supply bottlenecks coupled with energy costs have weighed heavily on the production function. To counter the problem, China recently supplied its reserves into the domestic market; undercutting the surging global price tag dictated by the petroleum giants.

Last Thursday, China’s National Food and Strategic Reserves Administrator made a press release, confirming that the world’s second-largest economy tapped into its crude reserves – estimated at 220 million barrels – to “ease the pressure of rising raw material prices.” While China is known to intervene in commodity markets by using its strategic reserves, for example, Copper, Aluminium, or even grains.

Recently, China tapped into its national reserves to intervene in the global commodity market of industrial metals for the first time since 2010. The intervention was situated as a release to normalize surging metal prices and retain domestic manufacturers’ margins. However,  it is a novelty that a national agency confirmed an active supply of petroleum buffer via an official press conference. And while no additional details were offered, it is presumed by global strategists that the press release referred to the 20-30 million barrels allegedly poured into the domestic industry around mid-July: when Xi’s government offered to supply crude to the OPEC.

Furthermore, China’s Stockpile Agency claimed that through open auctions, China’s reserve crude was intended to “better stabilize the domestic demand and supply.” It was apparent that as China ventured through a supply crunch when Brent Crude – Global Crude Index/Benchmark – breached the $76 bpd mark, the country instead resorted to utilizing its own stockpile instead of relying on expensive imported petroleum. Thus, it shapes a clear picture of how China managed to clock a phenomenal trade surplus despite not importing its usual crude quota.

While it is common knowledge that economies like the US and Europe maintain strategic petroleum reserves, the buffers held by China were utilized to actively manipulate the price in a ‘normalized’ oil market instead of their designated usage in supply crunches or wars. The situation today is anything but critical for the oil market to warrant such an intervention. As OPEC+ has boosted its output by 400,000 bpd starting August, output has bloomed beyond its peak since the price war back in April 2020. While the oil market is still well below the output capacity, mutually curbed by the OPEC+ alliance, the demand is still shaky and an equilibrium seems set. Yet, when we observe China – the world’s largest oil importer – we extricate reason that despite a growing economy, China continues to experience massive shortages: primarily in terms of oil, gas, coal, and electricity.

Furthermore, with the ensue of Hurricane Ida, massive US crude reserves have been wiped which has majorly impacted China as well. The US and China rarely stand on the same page on any front. However, even the White House recently asked OPEC to pump more crude into the market due to the rising gasoline prices in America. The same scenario is panning in China as energy shortages have led to surging costs while domestic demand is diminishing. The brunt is thus falling on the national exchequer: something China is not willing to haggle. While it is highly unorthodox of China to explicitly announce its intervention, many economists believe that it was a deliberate move on part of China’s communist brass to amplify the impact on the market. The plan seemingly worked as Brent fell by $1.36 to stand at $71.24 on Thursday.

If China’s commitment to normalize domestic energy prices is this significant, it is highly likely that another intervention could be pegged later in the fourth quarter. Primarily to counteract the contraction in export orders by cutting imports further to maintain a healthy trade surplus. In my opinion, it is clear that both the US and China are not willing to let Brent (and WTI) breach the $70-$75 bracket as key industries are at stake. However, while one takes a passive approach, the other is touted to go as far as pouring another 10-15 million barrels of crude by the end of 2021. Yet revered global commodity strategists believe that the downturn in prices is “short-lived” just like any other Chinese intervention in a variety of other commodity markets globally. And thus, experts believe that the pump is simply “not enough physical supply” to quite strike a permanent dent in an inherently flawed market mechanism.

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Energy Forum Seeks To Analyze Africa’s Energy Potentials And Utilization

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African Energy Week (AEW) 2021 in Cape Town, fully endorsed by the Government of South Africa, is committed to accelerating Africa’s energy growth with the aim of establishing a secure and sustainable energy future for every individual on the continent. Accordingly, AEW 2021 firmly believes in the role that oil and gas will continue to play in Africa and will emphasise the continent’s upstream market through a collaborative, International Oil Company (IOC) forum. Led by IOC executives, as well as government representatives from notable energy markets in Africa, the IOC forum aims to address the upstream challenges faced in Africa, providing solutions and strategies to drive exploration and make Africa more competitive for investment.

With the discovery of sizeable oil and gas reserves across the continent in recent years, regional and international explorers are turning an eye to the world’s final frontier market – Africa. Nigeria’s 200 trillion cubic feet (tcf) of gas reserves and 37.2 billion barrels of oil (bbl); Mozambique’s 11 tcf of gas; Senegal’s 450 billion cubic meters of gas; Libya’s 48 billion bbl and 53.1 tcf; and Egypt’s 77.2 tcf of gas have all made Africa the ideal destination for hydrocarbon exploration. What’s more, with many African countries making significant steps to enhance their regulatory environments, implementing legislation to create an enabling environment for investment, the continent has become a highly competitive market for exploration and production. Nigeria’s recently implemented Petroleum Industry Bill, Gabon’s new Hydrocarbon Code, and Angola’s inclusive petroleum regulation, to name a few, have all ensured a competitive and highly attractive market.

With the world’s six oil ‘supermajors’ – BP, Chevron, Eni, ExxonMobil, Royal Dutch Shell and TotalEnergies – all actively present in mature and emerging markets across Africa, the continent has become an upstream hotspot. AEW 2021 aims to accelerate this trend, promoting new upstream opportunities and ensuring both National Oil Companies (NOC) and IOCs drive the continent into a new era of energy and economic success. Accordingly, Africa’s premier energy event will host an upstream-dedicated IOC forum in Cape Town, led by IOC executives and government representatives. The IOC forum aims to address key challenges in Africa’s upstream market, whereby the diverse speaker panel will offer up solutions to expand exploration and production, while ensuring the continent remains competitive for investment in a post-COVID-19, energy transition era.

In addition to the discussion on upstream activities, the forum aims to highlight the role of IOCs in enhancing capacity building, whereby emphasis will be placed on IOC-NOC collaboration. IOCs have a critical role to play in Africa, not only regarding resource development, but human capital and local business development. In order for the continent to become truly sustainable and competitive, NOCs require support from IOCs. Accordingly, the forum aims to identify strategies to enhance cooperation and partnerships, with IOCs taking the lead in Africa’s energy development.

“AEW 2021 in Cape Town will offer a real discussion on Africa. Oil and gas are critical in Africa’s development and the African Energy Chamber (AEC) will not succumb to the misguided narrative that Africa should abandon its potential. The IOCs in Africa have demonstrated the continent’s potential, and by sharing strategies to enhance growth, address challenges, and accelerate upstream activities, they will be key drivers in Africa’s energy future. The IOC forum will not only offer a description of African reserves, but will provide clear, attainable solutions to exploitation, exploration and production with the aim of using energy to enact stronger economic growth. By coming to Cape Town, attending the IOC forum, and interacting with African ministers from across the continent, you will be able to be a part of Africa’s energy transformation,” stated NJ Ayuk, Executive Chairman of the AEC.

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Nord Stream 2: A Geopolitical Tension between Russia and Ukraine and the European Dependence

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nord stream

Nord Stream 2 gas pipeline is a 1,230-kilometer direct linkage between the Russian natural gas producers and the consumer market of Europe. The model was made keeping in mind the successful operation of the existing Nord Stream pipeline after a thorough analysis by Nord Stream AG. The main aim of NS2 is said to be the increase in the annual capacity of the existing pipeline up to 110 billion m³. The pipeline starts from the Russian region of Ust-Luga then stretches through the Baltic Sea and ends at the area of Greifswald in Germany. It is due to this route that the project is mainly considered to be controversial. Bypassing directly through the Baltic Sea, the importance of Ukraine for Russia for exporting natural gas to the European market would reduce significantly which will end the $3 billion transit fees gained by the Ukrainian government in the year 2018 alone, causing a sudden and huge strain on the GDP of the country.

This project worth $11 billion would double the market of Russia in Germany which is the largest market in Europe, possessing a key position in international politics. It is said by the Russian officials that the pipeline has almost been completed and it may get operational by the end of August in the year 2021. Some analysts and International Relations experts have considered this as a geopolitical weapon that gives leverage to Russia to influence future events in the region particularly the ones related to the Crimean annexation.

Threat to Ukraine

Recently in a meeting with German Chancellor Angela Merkel, the President of Ukraine appeared to be displeased by the Western recognition of the NS2 pipeline. He called it a “dangerous political weapon” in the hands of the authoritative regime of Russia which has already annexed an integral part of their country to fulfill their geopolitical and economic desires. The desperate opposition of this project by the Ukrainian government has several underlying factors which are very important to discuss.

Firstly, the transit fees earned by Ukraine just by giving passage to the gas going from Russia to Europe make up a fine amount of the GDP of the country. If projects like NS2 get operational then the importance of Ukraine will decline, causing an end to the $3 billion transit fee. Although Russia has ensured to still use Ukrainian passage for the export of their gas, this does not seem to be happening in the future. States are after their national interests and Russia would prefer the direct linkage with the European market instead of paying billions to the Ukrainian government. Currently, out of the quarter of natural gas transported to Europe, around 80% has to pass through the Ukrainian territory.

Secondly, after the expiry of the transit deal between Russia and Ukraine in 2024, it would depend upon the negotiations between the two parties to revive the fate of this deal. Although Kremlin’s Spokespersons have ensured the revival of this deal after its expiry in 2024, debates still exist about the prospects. No one can claim with certitude about the future of this deal between the two states.

Thirdly, Ukraine is intimidated by the future of the country if the Russian gas pipeline bypasses its territory. There already exist many gas-related disputes between the two states which resulted in the cut-off of the gas supply in 2014 and later on in 2015. Russia can pressurize Ukraine for accepting their demands to get their gas supplies back. Recently, Ukraine has started to reduce its dependence on Russian natural gas by switching back to European gas. But this would not be beneficial in any sense if the Russian monopoly over the gas market increases through the NS2 pipeline.

And lastly, the dependence of European markets on Russian gas can undermine the Crimean cause. Once a state has to depend on the other state for the necessities, it has to let go of many important causes and decisions. As Angela Merkel has repeatedly called the NS2 pipeline a geo-economic project rather than a geopolitical “weapon” that can be used by the Russian government as a decisive tool at times of disputes and crises, this already shows the drowning picture of the cause. In addition to this, previously the US administration was very aggressive towards the pipeline but the current government despite its opposition, is unable to do much for stopping the project which can get operational very soon.

Role of US and NS2 Pipeline

The United States of America is well aware of the changing dynamics of the region and the intentions of resurgent Russia. The Republican government under Trump proved to be very destructive for the project. The US did not only oppose the gas pipeline openly but also imposed sanctions on entities aiding Russia in the development of this gas pipeline. In January 2021, Trump imposed sanctions on the gas-pipeline laying ship, “Fortuna” and its owner under the Counter American’s Adversaries Through Sanctions Act (CAATSA). Previously, work on the pipeline had to be suspended as the US imposed sanctions on the main company, Allseas. President Biden was one of the many policy-makers who opposed this pipeline and considered it dangerous for the US and its allies. Although it was not clear what Biden’s policies would be, Blinken ensured to use “persuasive tools” against the pipeline, after acquiring the office. President Biden indeed imposed sanctions on the Russian ships and other companies involved in the laying of pipeline, but analysts think this would not cause any impact on the project as it is almost running towards completion. Rather, anti-sanction policy-makers consider it more important to waive off these sanctions and get into formal negotiation talks with the Russian government.

In May 2021, the President of the US and the Chancellor of Germany gave a joint statement for the agreement signed between the two countries related to the NS2 project. Some of the main features incorporated in the agreement are the announcement of sanctions on Russia in case it violates the peaceful use of the pipeline and utilizes it as a weapon against Ukraine. Germany would not only oppose such a step but would also press on the EU to take counter-measures. Similarly, it was decided to revolutionize the energy sector of Ukraine by the creation of a Green Fund for Ukraine by Germany worth $1 billion. Initially, it was decided that Germany would contribute an amount of $175 million. Also, it is said that Germany would use all its leverage to ensure an extension of the current transit agreement (which is going to expire in 2024) between Russia and Ukraine for at least up to 10 years. This would continue the role played by Ukraine as a transit state, helping its GDP and putting off the security threat over it. There is a sharp criticism on the Biden administration over this agreement which did not involve Poland and Ukraine while deciding their future. Also, the deal does not put any process of hindering the pipeline which is against the aspirations of all Americans and most of its allies.

In addition to limiting the role and influence of Russia in the European continent, the US is also looking forward to the opportunities of fulfilling its national interest. If the US becomes successful in hindering the operation of NS2, it can expand its gas buyers in the European countries. This way, like the post-war era the US can get a strategic and decisive role in this part of the world which can ultimately help it to counter the threats related to the rise of China and the Sino-Russian nexus. We can say that the US cannot only use this as an economic incentive but also utilize its importance in the future of great power rivalry.

Why states are against this Pipeline Project?

Along with the direct impacts of this project on Ukraine and Poland (to some extent). The major concerns of the states which oppose the NS2 pipeline include the additional leverage which Russia will gain when its national gas firm would directly export gas supplies between Russia and the European continent. This may result in a sudden disruption of the supplies, influenced by the changing dynamics of the region. The Russian authorities had cut off the gas supplies of Europe in the winters of 2006 and 2009, leaving millions without gas for days. Similarly, the increased dependence of Europe on Russian gas can be counter-productive and may hinder the interests of the states and the US soon. This situation can be utilized by both Russia and China to exploit the bonding between the US and its allies.

From the security perspective, the presence of Russia and its naval forces can cause a security threat to the states surrounding the Baltic Sea. The unsettled conditions may lead to chaos and problems in the region.

If Russia was to get a high stake in the energy market of Europe, this would also allow it to exploit the situation and create a monopoly over the market. This may not also lead to political outcomes and consequences but can also end the game of local and international gas market players in the continent. This is the biggest threat that is encouraging the US to make NS2 a security threat for itself and its allies.

Way Forward

Keeping in view the nature of international politics and changing economic dimensions to the project, the only possible way forward is an agreement between Russia and the US related to the pipeline and the future of Ukraine. If developments can be made over the existing US-Germany agreement then concerns of the states can be mitigated to a huge degree. The options of imposing sanctions on the pipeline are no more practical and can be counter-productive for the US concerning its allies especially Germany.

Conclusion

The Nord Stream 2 Pipeline despite its economic benefits cannot be separated from its geopolitical aspects and consequences. In international politics, the hardest thing to do is to trust the intentions of the other state, especially when it was a superpower previously and has several examples of violating the sovereignty and rights of neighboring states. But presently, all those who oppose the pipeline have no other option than to allow its proper functioning under certain terms and conditions.

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