OIL PRICE AND GEOPOLITICAL SHIFTS

Author : Admin | Wednesday, May 24, 2017
Posted in category Eurasia, Special Analysis
Comments Off

Geopolitics experts, as well as stock market analysts agree about the complex relationship between the developments on the world stage and those in the field of oil production and trade.

While continuing to influence and be directly influenced by geopolitics, the fossil fuel industry, especially the oil sector’s importance is also challenged by the rapid evolution of the alternative (or renewable) energies that contribute to a decline of the world’s oil demand.

Recent developments

a) Observers analyzing the impact of the first summit between U.S. President Donald Trump and his Chinese counterpart Xi Jinping pointed out that the summit will affect fossil fuel and related energy policy for Asia and the world more than the actions of the Organization of Petroleum Exporting Countries (OPEC) or the prices set by major oil producers.

China, the largest buyer of US oil exports, has recently blocked North Korean coal imports to sanction Pyongyang for its nuclear and ballistic missile programs, and is buying US coal instead. The coal blockade indirectly helps U.S. President Donald Trump fulfill his promise of “putting US coal miners back to work.” China’s economy is still dependent on the country’s coal-fired power plants, and the move to buy more U.S. coal in support of UN sanctions against North Korea illustrates how geopolitics will drive energy policy.

In fact, rather than the U.S. “pivot” to Asia during the administration of President Barack Obama, the oil prices were affected mainly by China’s economic slowdown, lower demand after decades of record growth, and debt accumulation. Analysts assess that the Trump administration will attempt to exploit these economic and geopolitical factors and energy policy will become a weapon for the U.S., in a way that is not far from how it is used by Russia. President Trump’s pro-fossil fuel energy agenda benefiting U.S. shale oil producers, major energy firms and coal companies is an opportunity to use oil sales as an economic weapon to deal with global foreign policy uncertainty.

At the beginning of this year, the White House published on its website President Trump’s “America First Energy Plan” which significantly mentions that “In addition to being good for our economy, boosting domestic energy production is in America’s national security interest. President Trump is committed to achieving energy independence from the OPEC cartel and any nations hostile to our interests. At the same time, we will work with our Gulf allies to develop a positive energy relationship as part of our anti-terrorism strategy.”

Significantly, Saudi Arabia was the first country President Trump visited during his first overseas trip, and during the visit, Saudi national oil firm Aramco said it signed $50 billion worth agreements with U.S. firms. Saudi energy minister Khalid al-Falih said deals involving all companies totaled over $200 billion.

Shortly before the visit, Saudi Aramco announced that it has become a 100-percent owner of Port Arthur (Texas), the biggest oil refinery in North America, with a capacity of 600,000 barrels per day, as well as of 24 distribution terminals. Aramco previously owned 50 percent in the refinery before acquiring the full stake from Royal Dutch Shell, after the two companies decided to separate their assets.
b) Saudi Arabia is attempting a similar tactic by stimulating an oil price war in Europe against Russia, Iraq and Iran, who have been cutting into Saudi’s lucrative European markets. The Saudis, moreover, are slashing oil export prices in Asia to maintain market share and have a geopolitical counter against the Shiite Iranian government that is waging a war against Sunni Middle Eastern governments backed by Saudi Arabia. Oil has become a weapon of choice in economics and geopolitical nation state conflict.
It was also during President Trump’s visit in Saudi Arabia – just ahead of the May 25 OPEC meeting – Saudi Arabia’s energy minister said that extending the current agreement on global oil supply cuts nine month instead of six, until March next year, as Saudi Arabia has suggested, and adding one or two small producers to the pact, should be enough to reduce oil inventories.

OPEC, together with participating non-member countries, meets to set policy on May 25 in Vienna. Turkmenistan, along with Egypt and the Ivory Coast, are due to attend the meeting.

c) Other recent examples of geopolitical moves that influenced directly the oil market are the U.S. airstrike in Syria, as well as the U.S. Navy’s cancellation of the planned port calls to Australia for the USS Carl Vinson carrier group which was instead sent toward the Korean Peninsula in the wake of recent missile tests by North Korea.

In the case of Syria, which is only a marginal oil producer, it was not the production factor that counted, but the concerns of possible retaliation against the U.S. move from Iran and Russia, which both support President Bashar al-Assad’s regime.

These events generated a slight increase in the price, notwithstanding other factors such as the 12-straight weeks of rising U.S. oil-rig counts that should have brought oil prices lower.

This trend of increasing production even as prices come down is due to the marginal cost of production, which in the Middle East is around $10 and in Russia is $20, so even at $50 there is a profit. And an authoritarian regime that needs $100 oil to balance the country’s budget would pump as much as it can.

d) Historians also noted that if between 1900 to the late Sixties the oil prices fluctuated in a range between $15 a barrel to just above $30 a barrel – even through two world wars, population growth and a revolution in transport and industry – geopolitical events caused oil prices to surge to more than $100 a barrel following the Middle East oil embargoes of the late sixties and early seventies. The Middle East events at that moment combined with a surge in China’s demand for oil that fuelled the country’s rapid economic growth (for a period of time, China doubled its economy every seven years).

The prices collapsed back to $20, with a current level between $50 and $55 a barrel. However, the economic drive to keep producing even as the industry shifts to a low carbon future means prices may continue to fall.

e) According to Dieter Helm, economics professor at the Oxford University and a long-time industry observer, the oil market downturn is only getting started. The burn out of the oil industry is approaching quicker than was first thought.

Last March, the International Energy Agency (IEA) warned oil and gas companies that failing to adapt to the climate policy shift away from fossil fuels and towards cleaner energy would leave a total of $1 trillion in oil assets and $300bn in natural gas assets useless. For the big oil companies, this means they have to adopt an aggressive slashing of capital expenditure, pumping of remaining oil reserves while keeping costs to the floor and paying out very high dividends.

Until then, fossil fuels are severely affected by falling prices and, more recently, declining investment. It started with coal, with richer OECD (Organization for Economic Co-operation and Development) countries reducing demand for almost a decade. In China, coal power has also flattened.

Oil and gas woes are driven less by renewables than by a mismatch of too much supply and too little demand. But with renewable energy expanding at record rates and with more efficient cars, including all-electric vehicles, a growing number of companies in the fossil-fuel sector are driven to the insolvency zone.

 

Oil and current geopolitical trends

Political events can have a significant influence on the price of oil, but the price of oil also has a strong influence on political events. In 2016, the rapid decrease in the price of oil had significant geopolitical consequences. Low oil prices combined with other socio-economic factors have been responsible for severe food shortages in Venezuela and an ongoing recession in Nigeria. Even in traditionally oil-rich countries such as Saudi Arabia, there have been cutbacks to public subsidies for water and electricity to counterbalance lost oil revenue.

The U.S. shale factor

With the technological advancements in hydraulic fracturing (also known as “fracking”), the average breakeven price for shale oil producers has fallen by more than 40%. The days when oil was selling at US$120 per barrel are long gone, with shale oil currently being extracted in US states such as North Dakota and Montana for as little as US$29 a barrel. The shale industry brought a major change in the U.S. world strategy, a strategy that is less and less driven by its energy needs.

The U.S. shale industry includes some of the world’s largest integrated oil producers alongside independent drillers, for whom unconventional drilling is a way to get quicker returns with lower costs on shorter horizon projects. The industry also has new vigor, with President Donald Trump setting a pro-hydrocarbon agenda and encouraging more drilling and construction of energy infrastructure. The U.S. is seen to surpass Saudi Arabia to become the world’s leading source of oil, which will re-shape the geopolitical landscape of the energy industry for years to come.

According to Rosneft, the Russian major oil company, U.S. shale oil output has become and will remain a new global oil price regulator for the foreseeable future. Moreover, Rosneft even warned, last March, that the United States might not want to join in the foreseeable future any deals aiming to stabilize or increase the oil price. Rosneft said the only guaranteed route to balance the market was for all producers to limit supplies, but this would not happen because U.S. shale producers would not join any such pact, since the U.S. law bars them from such action.

The “Grand bargain”: a new qualitative relationship Russia U.S.

What is already called “the shale revolution” and the new position of the U.S. as a major player in the oil and gas market generated qualitative changes in the relationship between the United States and Russia, the features of which had appeared first with regard to the issue of Syria.

As oil and gas giants, the U.S. and Russia both want understanding and cooperation between them. The United States has discovered the size of its own oil and gas wealth, as a result of the discovery of underground shale oil and gas deposits on its territory. On the other hand, one of the main reasons for which Russia has waged its war in Syria was to prevent the passage of natural gas pipelines from Qatar through Syria to Turkey then Europe, since this would have the potential to shatter Russia’s monopoly on natural gas distribution in the European market.

Part of the “Grand Bargain” that is taking shape involves the relationship between the United States and Russia, in light of the fact that the two of them together control the largest and most important oil and gas reserves in the world.

Part of what has been happening recently is that Qatar has withdrawn from the battle over Syria, and that the war of gas pipelines between Russia and Qatar has thus come to a stop. Some say that the United States inspired, or endorsed, the transformation in Qatar’s stance, which was accompanied by change at the highest level of power in Qatar. At any rate, Russia views this as a victory for itself in terms of the future of its own natural gas wealth. Indeed, Qatar had the ability to obstruct Russia due to the amount of natural gas at its disposal, and pipelines to Europe would have had the potential to dwarf Russia’s natural gas wealth.

Iran also benefitted from the renewed relationship between the United States and Russia. Tehran had been at the forefront of opposition to natural gas pipelines stretching across Syria and Turkey and it fought in Syria also for reasons that fall under oil and gas considerations. Iran is exporting its oil mainly to China and India, having been apparently allowed an “exception” from U.S. imposed sanctions. Iran continues to pump oil at a rate of two million barrels a day and China is comfortable with this, especially as it is paying discounted prices.

One of the main losers of the “Grand Bargain” is Europe, which is likely to lose the most as a result of the “shale revolution”. This is mainly due to the fact that natural gas prices in Europe remain three times higher than they are in the United States, and that the cost of electricity is more than twice what it is in America. That makes very difficult a process of re-industrialization, which is a major issue for the Europeans. While American energy independence is not likely to help Europe, Russia with its unlimited resources of gas, is in need for a big customer and seeks to become “Europe’s Texas.”

Russia vs. Saudi Arabia

Since Russia’s economy depends significantly on oil (according to the Russian finance minister, in 2016 Russia could balance its budget if oil reached $82 a barrel), analysts’ estimates show that Russia needs an increase in the oil prices by about 30 percent from the current position to maintain its current levels of spending.

That is one of the main factors that generated the unexpected cooperation between OPEC and non-OPEC countries, instigated by the full support of Saudi Arabia (OPEC) and Russia (non-OPEC) which brought stabilization to the crude markets for almost half a year.

The effects of the “shale revolution” have been mostly mitigated by the compliance of OPEC and non-OPEC members to the agreed upon cuts, while geopolitical and security issues have prevented Libya, Iraq, Venezuela and Nigeria, from producing quantities that might have affected the balance.

Notwithstanding the optimism about the results of the 25 May OPEC meeting, fears are growing that OPEC’s leading producer, Saudi Arabia, is no longer happy to bear the burden of the production cuts while other OPEC members, such as Iran and Iraq, are looking at production increases.

Saudi Arabia’s other rival, Russia, is also not sitting idle. Even if Moscow is still behind the official production cuts, Russian oil companies have been fighting for additional market share in Saudi Arabia’s main client markets, China, India and even Japan. Iraq and Iran, in contrast, have been cutting away share in Europe.

Saudi Arabia is sometimes seen as having lost its grip on the largest oil markets. U.S. shale oil is increasing its market share, while addressing European options at the same time. Russia, Iran and Iraq have been pushing for market share in Asia, while taking up Saudi share in Europe.

In an unexpected move, Saudi Arabia has reported that it will try to regain some market share in Europe, one of its former main markets. In a move to increase the attractiveness of Saudi crude, the Kingdom plans to change the way it prices oil for Europe from July. The new pricing plans could be effective from July 1, mainly to increase the appeal of Saudi crude. Aramco, the Saudi oil company also has lowered prices for some Mediterranean and Asian clients, while U.S. clients will have higher prices.

If Aramco, in addition to Iraq and Iran, is entering the European market, this would affect Russia’s position as the largest supplier in the European oil markets and a confrontation between Russia and Saudi Arabia in Europe could destabilize not only the market but also lead to a new price war.

Both Russia and Saudi Arabia are unwilling for the moment to risk a real price war. Presidential elections in Russia are coming up in 2018, while the future of the young Saudi elite depends on Aramco’s moves. When taking a smarter approach, both nations could redirect their aggressive market strategies to the new incumbents in Europe. Iraq and Iran have been very smart by attempting to take market share from both sides. Combining Moscow and Riyadh’s power, a price war against the Iran-Iraq axis would be more feasible and would also have the advantage of not threatening the OPEC and non-OPEC production cut.

Iraq: conquered and abandoned for oil

The case of Iraq is significant for the complex relationship between geopolitics and oil prices. Even before the intervention against the Saddam Hussein regime, analysts opposed to the war pointed out that the upcoming intervention in Iraq was about hydrocarbons at the geo-strategic level, and the macroeconomic threats to the U.S. dollar from the Euro.

According to these analysts, the real reason for the intervention in Iraq was to prevent the OPEC countries to adopt the Euro as an oil transaction currency standard. In order to pre-empt OPEC, the U.S. needed to gain strategic control of Iraq and its second largest proven oil reserves.

Iraq had made the switch from a dollar standard to a Euro standard in November 2000, when the euro was worth around 80 cents, so the U.S. corporate-military-industrial network wanted a government in Iraq that would revert back to a dollar standard, while also hoping to veto any wider OPEC momentum towards the euro, especially from Iran, the second largest OPEC producer. Iran also required, in 2003, Euro in payment of exports toward Asia and Europe, and the Tehran government opened an Iranian Oil Bourse on the free trade zone on the island of Kish for the express purpose of trading oil priced in other currencies, including Euros. Between 2006 and January 2016, Iran was also under severe economic sanctions imposed by the UN.

According to several analysts, one of the main reasons for which the United States rushed to withdraw from Iraq without leaving a foothold for itself in the form of military bases or otherwise, after it had heavily invested in a costly war was the fact that at that time the Americans discovered the size of their own wealth of oil and gas, and decided that they had no need for Iraq’s oil and for its reserves. The plans for withdrawal from Iraq were drawn up at the end of the Bush era, and the Obama administration implemented them hastily and with unusually great speed.

Since the end of the war, Iraq’s political class, military leaders and some senior religious figures have led a 13-year pillage that has left Iraq consistently rated as one of the top five least transparent and most corrupt countries in the world. Moreover, the recent years’ decline of the oil price added to the difficulties generated by the war, the change of the regime and the need to confront the Daesh terrorist group. If, as projected, global oil prices remain at historic lows, Iraq will be unable to pay some of its civil servants, or honor pledges to build roads and power stations.

The anti-terror war against Daesh recently prompted a “coming back” of the U.S. in Iraq, after the Department of Defense was asked by U.S. President Donald Trump to provide a strategy to accelerate the fight.

The order was followed by a visit in Iraq, last February, of U.S. Defense Secretary Jim Mattis, who first had to reassure the Iraqi government that a plan announced by President Trump to seize Iraqi oil fields in order to pay for the US military’s role in defeating Daesh would not be put in action. Mattis also declared that he has been assured that the announced inclusion of Iraq in the Administration’s travel ban currently stalled by a legal challenge would not affect Iraqis who have fought alongside U.S. forces.

Soon after the visit, at the beginning of May, several reports mentioned negotiations to keep American troops in Iraq even after the end of the multinational campaign against Daesh. An on-going U.S. military presence would protect the effort to rebuild Mosul, thwart further insurgency, and stabilize the region.

U.S. forces in Iraq would be stationed inside existing Iraqi bases in at least five locations in the Mosul area and along Iraq’s border with Syria. The forces would help control security in the city and oversee the transition to a political administration of Mosul. They would continue to be designated as advisers to dodge the need for parliamentary approval for their presence.

Bad times for “petro-states”: the case of Venezuela

As in the case of Iraq, a crude oil price level below $50 is estimated to be catastrophic for many of the so-called petro-states, countries that rely on oil and natural gas exports to balance budgets, with undiversified infrastructure and a tendency to use oil money to alleviate social problems. They often struggle to improve their own human capital and to combat corruption, both of which are worsened from the effects of the relatively easy money of oil production.

While countries like Norway, Canada, Mexico, and the United States all produce oil, they are not petro-states because these are not dominating sectors of the economy.  While oil is just 5% of total U.S. exports, it is 50% for the United Arab Emirates, 54% for Russia, and 89% of all Venezuelan exports. For anyone relying on oil to make up 50% or more of their exports, a fall in oil prices is catastrophic. According to a Wall Street Journal estimate for 2016, while the oil price averaged slightly more than $50, the price needed by some petro-states was as follows:

  • Libya: $207.60
  • Venezuela: $111.30
  • Saudi Arabia: $95.80
  • Russia: $84.90

Low oil prices have humbled great powers before.  In the 1980s, a chute in energy prices shocked the Soviet system. Historians point out that one of the most effective ways in which Reagan’s economic policies weakened the Soviet Union was by helping bring about a drastic fall in the price of oil in the 1980s, thereby denying the Soviet Union large inflows of hard currency.

Venezuela: a crisis with geopolitical implications

The current crisis in Venezuela offers a significant example of the petro-states’ fate. The state-owned oil company, Petróleos de Venezuela SA (PDVSA), has struggled with declining production for years, as revenues have been diverted for funding the government and social programs and not for reinvestment in company operations.

The collapse of oil prices in 2014 thrust the country into a full-blown economic crisis that has steadily grown worse in the ensuing years. This is having a crippling effect on Venezuela and the oil market, altering long-standing trade flows and hollowing out the country’s oil-producing assets.

According to some estimates, Venezuela has the largest oil reserves in the world, but much of those reserves are extra-heavy crude that requires a considerable amount of refining and upgrading. As conventional fields decline, PDVSA has become more reliant on more costly heavy oil, further cutting into its revenue base. Importing from abroad the necessary substances for diluting its oil obliges PDVSA to pay market prices for the imports, but sell some of the refined product at a loss domestically. By mid-2016, news reports showed the company struggling to come up with the cash needed to pay for imports, leading to an involuntary decline in purchases. Oil tankers sat off Venezuela’s coast, refusing to unload cargoes because of missed payments.

Enter Rosneft

In order to obtain some much needed money, PDVSA reportedly offered Russian state-owned oil company Rosneft, Russia’s top oil producer, a 10 percent stake in a heavy oil project in the Orinoco Belt called Petropiar. PDVSA has a 70 percent share, and U.S. oil company Chevron Corp holds 30 percent of the venture, which includes an oil field and a 210,000 barrel-per-day oil upgrader.

For Chevron, the U.S. partner in Petropiar, the Russian deal would also mean working alongside Rosneft, which has been affected by U.S. sanctions against Russia.

The Petropiar offer is part of a larger package offered to Rosneft and it would mean further gained ground in Venezuela for the Russian company. Last year, Rosneft paid $500 million to increase its stake in the Petromonagas joint venture, from 16.7 percent to 40 percent, the maximum foreign partners are allowed to have under oil sector regulations created under late leader Hugo Chavez.

According to most estimates, Rosneft has lent PDVSA between $4 billion and $5 billion, but the details of those deals have not been disclosed.

The Rosneft deal prompted the Venezuelan National Assembly to accuse the government of President Nicolás Maduro of trying to sell off state assets without legislative approval. “Any deal of national interest must be approved by the National Assembly,” tweeted lawmaker Jose Guerra, head of congress’ finance commission. “If PDVSA sells 10 (percent) of Petropiar to Rosneft, that sale is null and void.”

In its turn, the Supreme Court, which is under the control of President Maduro, attempted to take power away from the National Assembly, issuing a ruling on March 29 that all but dissolved the legislature. Presumably President Maduro’s government could sell national oil assets, such as the deal under negotiation with Rosneft. The dissolving of the legislature was widely denounced as an attempted “self-inflicted coup” both domestically and abroad because the Assembly is one of the few remaining institutions not under control of the President. The Supreme Court backed off the pronouncement days later due to the outcry. Still, it provoked national protests, which are ongoing, deepening the country’s political crisis.

The Citgo deal: implications for the United States

In another controversial move, in 2016 PDVSA used 49.9 percent of its shares in its U.S. subsidiary Citgo as collateral for a loan financing from Rosneft. PDVSA said in April that it had received $1.985 billion from an unnamed client in return for future oil shipments, with Citgo shares used as a guarantee. Citgo owns three refineries in the U.S., along with pipelines and retail gas stations.

In the United States, the Citgo deal prompted several warnings from the U.S. Congress to the Administration.

Such warnings were sent by several members of the Congress to the U.S. Secretary of Treasury Steven Mnuchin, stressing that if Venezuela defaults on its debt obligations, it could result in Russia taking control over U.S. refining assets, leading to more Russian ”control over oil and gas prices worldwide,” which would ”inhibit U.S. energy security, and undermine broader U.S. geopolitical efforts.” The Congressmen are worried that if PDVSA defaults, Rosneft will seize the U.S.-based refineries and “the Russian government could readily become the second-largest foreign owner of U.S. domestic refinery capacity,” which would be “to the detriment of U.S. interests.” The members of the Congress also expressed concerns that Russia could use its control of Citgo to counter sanctions imposed by the Obama administration after Russia annexed Crimea in March 2014.  

Since U.S. Treasury Secretary Steven Mnuchin missed the deadline to respond, at the beginning of May a bipartisan group of U.S. Senators introduced a wide-ranging bill aimed at the crisis in Venezuela, calling for sanctions and demanding President Donald Trump step in to prevent the Citgo deal.

The bill calls for the State Department to coordinate an international response to the crisis in Venezuela; requires the U.S. intelligence community to prepare an unclassified report on the involvement of Venezuelan government officials in corruption and the drug trade; and would provide $10 million in humanitarian aid for the country.

The bill effectively bypasses the Treasury Department, calling on the President to take all necessary steps to prevent Rosneft from gaining control of U.S. energy infrastructure.

The political crisis: complicating the picture

Complicating the picture in Venezuela is the escalating political turmoil challenging President Nicolás Maduro, who wants to retain power in the elections scheduled for next year. Consumers have to endure long lines for food and other necessities, and hunger is spreading. With Venezuela’s refineries in disrepair, even gasoline is in short supply. A monthly inflation rate of 20 percent is shrinking the value of paychecks.

In the past two years, Venezuela was mined of corruption and failed political leadership: a long list of shortages, rampant poverty, incrimination of the opposition, and steps of Nicolás Maduro’s regime closer to dictatorship. Also, according to some sources, the country is confronting a so-called homicide epidemic that goes “unreported” due to the country’s scrapping of crime statistics reporting over a decade ago.

The Venezuelan government and the state oil company owe $8.5 billion in payments this year, and at least an additional $7.9 billion in 2018, amounts that economists say will further erode international reserves that form the last defense against default. According to financial experts, Venezuela’s ability to avoid a disastrous default will probably require much higher oil prices than appear likely in the next year or two. According to financial experts, the global oil price will have to rise to $70 a barrel in order to improve the financial situation for Venezuela.

A change in government in Venezuela could send, primarily via the oil markets, a wave of consequences across the global economy, with three possible scenarios:

1. An extended political uncertainty in Venezuela could cause massive production disruptions and raise oil prices. This would allow OPEC and its partners to produce at more natural rates, while watching Venezuelan unrest do their job for them. It would also benefit American shale producers, which have been waiting for months for oil prices to rise a little higher to make production profitable.

2. If a new leader with the same policies as Maduro takes over, it will essentially stall the situation. Nothing will be settled in Venezuela, and the oil markets will continue to wait and see.

3. If Maduro is replaced by a politician who offers increased free-market opportunities and negotiates oil agreements with foreign companies, it could improve Venezuela’s oil revenues but also contribute to global oversupply and a depressing effect on prices.

OPEC’s diminishing power

Despite all of this, Venezuela is expected by OPEC to play a major role in the cartel’s plan to curb global supply. In OPEC’s November 2016 agreement, Venezuela accounted for almost 10 percent of the net supply cut from member nations (calculated as cuts minus allotted increases). As OPEC is discussing the extension of the cut, they need to convince a financially weak quasi-dictatorship to slow down the production of its country’s primary economic asset.

The case of Venezuela is also illustrating the diminishing power of OPEC, the cartel of oil producing nations that, for several decades, had the power to effectively set the price of oil in the global market and, in using that power, could alter the economic conditions in all of the world’s major powers.

In political terms, OPEC’s ability to cause “oil shocks” in the last part of the last century gave them political as well as economic clout and as the Middle Eastern cartel members hinted at using that, so the push back started.

OPEC is also hindered by the fact that it includes several Middle East nations, some of whom were sworn enemies, united only in their attempt to maximize oil revenues. That was always a precarious balance to maintain and as politics has moved to the extremes it has become even more so. Saudi Arabia and Iran, for example, continue to fight proxy wars while negotiating together at OPEC meetings. It is little wonder that the cartel members increasingly distrust one another. As the most recent round of supply cuts were being proposed, former Saudi oil minister Ali Al Naimi said that cuts were pointless as nobody actually stuck to them. He was relieved of his duties shortly thereafter…

There are several theories as to why OPEC’s power has been so severely reduced and the reason is probably a combination of all of them. First, the U.S. and other nations have been able to increase production due to new technologies and techniques, in particular horizontal fracking.

Another reason for the change is the rise of alternative energy. As technology will advance solar, wind and other renewable energy sources to the point where they become commercially viable, the pressure to preserve oil has lessened. The world is still dependent on oil and using it up at an alarming rate, but the day when that is no longer the case is clearly in sight.

While undoubtedly many factors have combined to make OPEC less formidable, the cartel is far from being completely irrelevant. The fact that their ability to control prices through action is reduced will increase the likelihood that they will aggressively try to oppose such a trend.

The renewables’ challenge

While the prices for oil and other fossil fuels crashed in the last two years, the renewable energy sector have been thriving, with investments in the sector scoring new records in 2015 and seeing twice as much global funding as fossil fuels.

Renewable energy is energy that is derived from natural processes (e.g. sunlight and wind). Solar, wind, geothermal, hydropower, bioenergy and ocean power are sources of renewable energy. Currently, renewables are used in the electricity, heating and cooling and transport sectors. Renewable energy collectively provides only about 7 percent of the world’s energy needs. Fossil fuels, along with nuclear energy (a non-renewable energy source) are supplying 93% of the world’s energy resources. Nuclear energy (controversial among public opinion) currently provides 6% of the world’s energy supplies.

According to a report of the U.S. Department of Energy, in 2016, solar energy employed 43 per cent of the Electric Power Generation sector’s workforce, while traditional fossil fuels combined made up just 22 per cent. Solar energy accounts for the largest proportion of employers in the Electric Power Generation sector, with wind energy the third largest, while the coal industries have declined in the past 10 years. 6.4 million Americans now work in the energy industry and 2016 added 300,000 new net jobs, which made up 14 per cent of the entire job growth of the US for that year.

Already many countries throughout the world are committing to a future that will be powered by renewables. For example:

  • Germany currently generates 25 percent of its electricity from renewables and is aiming for 80 percent by 2050;
  • Spain’s top source of electricity in 2013 was wind power, ahead of nuclear, coal and gas. Renewables supplied 42 percent of mainland Spain’s electricity in the same year;
  • In 2012 China’s wind power generation increased more than generation from coal;
  • The Philippines produce 29 percent of its electricity with renewables, targeting 40 percent by 2020;
  • Denmark is aiming to produce 100 percent of its heat and power with renewable energy by 2035 and all energy by 2050.

Emerging economies, like South Africa, China and Brazil, invested in renewables US$112 billion in 2012, which is close to the US$132 billion that developed countries invested.

Another advantage for the emerging economies is the fact that they can “leapfrog” over fossil fuel energy, right to affordable clean energy. Many have already taken advantage of the benefits of renewable energy and recognized the long-term benefits.

Declining costs for clean energy

Renewable energy is becoming ever cheaper to produce. Recent solar and wind auctions in Mexico and Morocco ended with winning bids from companies that promised to produce electricity at the cheapest rate, from any source, anywhere in the world.

The cost of solar power has fallen to 1/150th of its level in the 1970s, while the total amount of installed solar has soared 115,000-fold. Also, the price of batteries to store solar power is falling with a similar speed.

A February 2017 report from Bloomberg New Energy Finance (BNEF) and the Business Council for Sustainable Energy (BCSE) stresses the growth of the renewable energy, favored by the declining cost of wind and solar power, largely due to advances in technology. The cost of building large utility-scale solar photovoltaic power plants for example has been fallen by 50% in just five years.

In Western Europe, the cost of a 4 kW solar panel system, sufficient for a family household, has dropped from over $22,000 in 2009 to $7,500 by early 2016, which makes a solar energy system cost-efficient for most households in Germany.

The Tesla Revolution

The global energy transformation is best embodied by Tesla, which itself has gone from being a small electric car company in 2007 to an integrated renewable electricity and mobility business just 10 years later.

In the “Secret Tesla Motors Plan (just between you and me),” a blog post written in 2006, CEO Elon Musk described his vision on transforming Tesla into more than a car company: “…the overarching purpose of Tesla Motors (and the reason I am funding the company) is to help expedite the move from a mine-and-burn hydrocarbon economy towards a solar electric economy, which I believe to be the primary, but not exclusive, sustainable solution,” wrote Musk.

In their recent book “The Tesla Revolution: Why Big Oil is Losing the Energy War”, new energy researchers Rembrandt Koppelaar and Willem Middelkoop point out that Tesla’s corporate mission to accelerate the world’s transition to renewable energy is at the heart of this energy revolution.

In the words of Elon Musk, “Since we have to get to a renewable future, it is better to get there as soon as we can”, and the transition is envisaged to pass through the following phases:

- Phase 1: The world undergoes the first large growth in the production of clean energy such as wind and solar (20002020).

- Phase 2: Growth in global energy needs is now met predominantly by renewable energy sources rather than fossil fuels (20202050).

- Phase 3: Clean energy becomes dominant in the energy mix globally, surpassing the amount generated from gas, coal and oil (20502080).

- Phase 4: The end point of the transformation of the global energy system when virtually all energy generated comes from renewable sources complemented with nuclear (20802100).

The Gigafactories

A key element in the process of adopting the renewable energy is the storage component, with Tesla producing, in the “Gigafactory”, lithium ion batteries, supporting the Tesla vehicles and providing low-cost batteries using alternative energy sources. In a recent video, Elon Musk was quoted as saying: “We actually did the calculations to figure out what it would take to transition the whole world to sustainable energy. You’d need 100 Gigafactories.”

One main goal of the Gigafactory is to reach and maintain net zero energy. A leader in advancement and innovation, they claim that “By 2018, the Gigafactory will reach full capacity and produce more lithium ion batteries annually than were produced worldwide in 2013.” The Gigafactory also aims to continue to drive down the price of these batteries, financially stimulating the use of clean energy sources.

The offensive of the electric car

Almost two decades have passed since Toyota launched the world’s first mass-produced hybrid vehicle, the Prius, in 1997. By 2015, the hybrid vehicle market had grown to 2 million units. According to a report by Goldman Sachs in 2016, the electric vehicle (EV) market could grow to over 2 million cars in 2020 and 4 million in 2025. Hybrid sales could rise to almost 14 million units. By 2030, those numbers could reach 10 million (EV) and perhaps 20 million (hybrid), by the combined forces of car companies and a boost from government incentives.

The multi-government efforts to rapidly scale up electric vehicles are united via the 15-country global Electric Vehicles Initiative (EVI), which covers 90 percent of all car markets. Jointly, their ambitious aim is to sell 6 million EVs per year by 2020 with 20 million on the road. For that target to happen, all current plans for scale-up from all electric car providers have to be achieved. Even reaching half that target will lead to a new phase of this revolution, where global annual growth in additional passenger vehicles sold of 3 million is fully met by electric cars.

In terms of electric vehicles (EV), it is estimated that by 2022, electric cars without any subsidies or tax credits will cost the same as equivalent internal combustion cars, but win out financially on cost savings. The key to this will be the launch of models that boast both range and low cost, as mass-market all-electric cars need at least a 200-mile range and a price far below $50,000. Already, models like GM’s Chevrolet Bolt and Tesla Model 3 have a 200-plus mile capability at a $30,000 to $35,000 starting sales price.

The EV and its other clean energy projects brought Tesla’s market value to some $51 billion, which is just below General Motors’ market value. Tesla Motors’ value has risen more than 40 percent in 2016.

The advance of the electric cars is being reckoned by major oil companies, such as BP and Royal Dutch Shell, which are making more tentative steps in the direction of low-carbon energy. In its latest annual report on future energy trends, BP admitted that it is bracing itself for a revolution in electric car use that could halve the demand of drivers for oil.

In previous years the oil major has downplayed the potential of electric cars, but in its most recent reports it increased its estimation the number of electric vehicles it expects on the world’s roads in 2035 from 57 million to 100 million.

The islands adventure

According to a recent report from Bloomberg New Energy Finance (BNEF), island microgrids currently represent 36 percent of Tesla’s total power storage capacity deployed to date. Since November 2016, the company has deployed first- or second-generation versions of its grid-scale Powerpacks on five islands: Ta’u in American Samoa, Monolo island in Fiji, and Kauai and Oahu islands in Hawaii. The fifth project was on an island in North Carolina.

BNEF’s Energy Storage Project Database tracked a total of 157 megawatt-hours (MWh) of energy storage capacity installed by Tesla in 2016 and 17 MWh in the first quarter of 2017, a total of 174 MWh deployed in recent months.

Tesla is not the only company targeting the island microgrid market. Energy storage players Fluidic Energy and Electro Power Systems also deployed new microgrid projects in the first quarter of 2017, according to BNEF. In addition, the International Renewable Energy Agency (IRENA) and the Abu Dhabi Fund for Development (ADFD) recently committed $44.5 million for four projects in the Pacific and Africa, including 30 MW of new capacity for islands announced in January. BNEF tracked 48 MW of new generation assets commissioned or announced in the first quarter of this year in the Pacific and Indian oceans regions alone.

Internet tech giants are also getting in on the action. Last month, Facebook and Microsoft joined with investment firm Allotrope Partners to launch the Microgrid Investment Accelerator, which will mobilize roughly $50 million between 2018 and 2020 to expand energy access in parts of India, Indonesia and East Africa, with an estimated addressable market of 212 million people.

Royal players

The alternative energy sector is strongly supported by the informal business groups that united under the patronage of the Prince of Wales, mainly the Corporate Leaders Group on Climate Change (CLG).

The CLG is a group of major European business leaders working together under the patronage of the Prince of Wales to advocate solutions on climate change to policymakers and business peers within the EU and globally. It has currently 23 members and brings together business leaders from a cross-section of UK, EU and international businesses, including service providers, retailers and consumer goods companies, infrastructure operators, energy generators, energy producers, energy intensive industries, advanced manufacturing, and technology suppliers.

CLG members, among which Lloyds Banking Group, Tesco and Unilever, employ 2 million people across 170 countries and represent combined revenues of more than $170 billion. The University of Cambridge Institute for Sustainability Leadership (CISL) provides the CLG secretariat.

The CLG acts as a strategic advisory body to the Green Growth Platform (GGP) that brings together ministers from European governments, businesses and the European Parliament to discuss and debate the economic opportunities and challenges involved in the transition to a low carbon, resilient economy. This notable and influential platform is made up of ministers from 16 governments, 18 members of the EU parliament and some 40 major businesses.

The CLG also plays a fundamental role within the “We Mean Business” coalition, a group of organizations working with many of the world’s most influential businesses and investors, which recognize that the transition to a low carbon economy is essential to secure sustainable economic growth and prosperity for mankind and works to accelerate this transition. Eliot Whittington, CLG’s Acting Director, sits on the Board of Directors of the “We Mean Business” coalition.

On 26 April, CLG published a report titled “21st century energy: Business reflections on renewables in Europe”, in which it urges the EU to strengthen its proposed renewable energy target in order to mobilize investment in increasingly cost effective clean energy sources.

The report criticizes the “inconsistent, vague and unambitious EU policies” in the field of renewable energy that are discouraging investment and slowing the transition towards a cleaner energy future.

At present, the European Commission is proposing a non-binding EU-level target of 27 per cent renewable energy by 2030. The majority of companies interviewed for the CLG report think the EU should raise this target in addition to establishing better arrangements for an EU-wide energy market. Currently, only seven of the 28 EU Member States have targets in place beyond 2020. A new Renewable Energy Directive is due to be agreed later this year.

Some sobering facts

While renewable energy technologies could play a significant role in the global transformation, “vision projects” such as eliminating the use of all fossil fuels in the world by 2050, are seen as over optimistic by many researchers, who point out that they are based on unrealistic assessments of the market readiness of a wide range of key technologies.

The financial costs of building the 100% renewable energy world are still enormous, as is the land area needed to accommodate the new sources of energy supply. For example, the necessary surface for the 46,480 solar photovoltaic (PV) plants envisioned for the U.S. in one of the projects is close in size to the combined areas of Texas, California, Arizona, and Nevada.

To meet 8% of the UK’s energy needs, one would have to build 44,000 offshore wind turbines; these would have an area which would fill the entire 3000 km coastline of the UK with a strip 4 km wide.

To replace 440 MW of U.S. fossil fuel generation (expected to be replaced in the next 25 years), it would take 29.3 billion solar photovoltaic panels and 4.4 million battery modules. The area covered by these panels would be equal to that of the state of New Jersey. To produce this many panels, it would take several centuries, assuming they could be built at the pace of one per second.

In the case of the electrification of all transportation uses, with all the progress made, it is still very difficult since there are still no technologies for battery storage applicable to heavy-duty trucks, marine vessels and aircraft.

Another aspect that needs to be taken into account is the fact that the manufacturing of all renewables also requires massive amounts of fossil fuels and natural resources with proportionately little energy return. On the other hand, hydrocarbons (oil, natural gas, coal) are energy dense, portable and storable, and they have many useful by-products that create thousands of spin-off industries.

The partisans of the “traditional” energy accuse the proponents of the renewable energies of the so-called “Apollo Fallacy”, that is of not taking into account costs and commercial considerations, as was the case of the Apollo program, which spent billions of dollars only to demonstrate the U.S. engineering prowess during the Cold War.

Conclusions

Until the renewable energies grow enough to compensate fossil fuels in the world’s consumption, oil market analysts assess that the 2020s could be a “decade of disorder” for the oil markets. Taking into account the historical review, oil prices seem “volatile”, with periods of stability, followed by huge increases, followed by the almost inevitable downturn coming off the big spike. Busts in the oil market tend to sow the seeds of the next cycle. Consequently, a price spike in a few years’ time might be expected, because of the drastic cut back in drilling and investment over the past three years.

The latest energy outlook issues by British Petroleum (BP) points to another looming battle for market share, where low-cost producers may try to boost market shares before oil demand peaks. It estimates that there is an abundance of oil resources, and “known resources today dwarf the world’s likely consumption of oil out to 2050 and beyond”. According to Spencer Dale, BP group chief economist, “In a world where there’s an abundance of potential oil reserves and supply, what we may see is low-cost producers producing ever-increasing amounts of that oil and higher-cost producers getting gradually crowded out.

Oil demand growth is expected to slow down in the years to come. BP pegs the cumulative oil demand until 2035 at around 700 billion barrels, “significantly less than recoverable oil in the Middle East alone”. Both OPEC’s Middle East members and the U.S. are seen increasing oil and liquids production in the next two decades.

As always, any geopolitical crisis in some country (as Venezuela, for example) might suddenly take off the market a couple million barrels per day, which can only add to the market’s disorder.

Taking into account that influential U.S. think tanks believe that Europe should have additional nuclear weapons to deter Russian and Iranian influence, such geopolitical moves would cause oil prices to rise significantly if every European country in NATO acquired the so-called nuclear triad: land-based intercontinental ballistic missiles, strategic bombers, and submarine-launched ballistic missiles.

The Trump Administration’s policy of having energy, national security and geopolitics combined will help U.S. shale oil firms to increase output and lower prices. On the other hand, if President Xi, who doesn’t want a war between the US and North Korea with China caught in the middle, decides to support harsher sanctions against North Korea, then millions of barrels of oil sold to the Chinese at below-market prices from the U.S. and Saudi Arabia could solve one of the deadliest geopolitical standoffs in the world.

Geopolitical events are now interlocked and could move oil prices in ways that were not seen since the OPEC oil embargo in 1973. Those who ignore oil’s economic importance, its impact on growth, and the reciprocal relationships between oil and geopolitics, do so to the detriment of their commercial and security interests.

 

Both comments and pings are currently closed.