Month: June 2016
Continued dependence on Gulf oil
Doug Hengel, formerly at the State Department and now at the German Marshall Fund (and also teaching at SAIS), allowed me to republish his excellent notes for his talk at Woodrow Wilson last week, already posted here:
There is a great deal of uncertainty in oil markets at the moment. The big questions, beyond when the market will rebalance, include:
- Are we in the midst of another boom and bust cycle in the oil market or are there structural changes that define a new paradigm? Has U.S. tight oil changed market dynamics forever?
- Has the Saudi/Iranian rivalry evolved to the point where geopolitics now dominates Riyadh’s approach to oil? Are the Saudis using oil as a weapon?
- Is the Saudi 2030 Vision OPEC’s “obituary notice” as some have declared? Will the Saudis continue to invest in oil or are they pumping all out now due to concerns that oil demand is going away?
- Are we in a “lower for longer” scenario for oil prices? Or have the large cuts in investment by oil companies in the past couple years simply planted the seeds for the next price spike?
As we think about these questions, and more importantly what the future of oil geopolitics might look like, it is helpful to ground ourselves with a few facts. It is important to remember:
- The countries of the Persian Gulf account for almost 1/3 of global oil production and hold roughly 50% of proven oil reserves. They generally have the lowest cost oil to produce.
- About 17 million barrels a day (mbd) of crude oil and refined products move through the Strait of Hormuz, only a small fraction of which could get to market via alternative routes if the strait was blocked.
- Oil fields have a natural decline rate averaging 3-6 percent a year, much higher for U.S. tight oil. This means that every year investment in existing or new fields is needed to bring to market about 4 mbd of additional oil just to keep global production at current levels (not including any increase in demand). Those 4 mbd are equivalent to the total surge in U.S. tight oil production over the 2011-14 period. It also means we need to add the equivalent of a new Saudi Arabia to the market every 3 years.
By one estimate, global upstream project cancellations could create a 4 mbd ‘‘hole” in global oil supplies by 2020. Estimates of production in Brazil, Canada, Mexico and elsewhere in coming years have been revised downwards. There is growing concern that the large reduction in investment by the international and national oil companies will lock in the world’s reliance on OPEC, and in particular on the lower-cost supplies from the Persian Gulf, for decades. The International Energy Agency (IEA) and the U.S. Energy Information Administration (EIA) have pointed to this risk in their most recent global energy outlooks.
Are there structural issues that might mitigate against greater reliance on OPEC and the Persian Gulf? Two are often cited – the U.S. tight oil boom and climate change.
U.S. TIGHT OIL: While U.S. tight oil production jumped by an average 1 mbd per year from 2011 through 2014, over the past year U.S. tight oil production is down about 1 mbd. In the meantime U.S. gasoline consumption has increased sharply and is expected to hit a record in 2016. So U.S. oil imports are growing again. Last year U.S. net crude oil imports dropped to only a quarter of U.S. consumption, the lowest level since 1970. This year it looks like we will need to import one-third of our oil. Some believe that with prices of $50 or more per barrel there could be a renewed surge of U.S. production this year adding perhaps as much as 1 mbd to U.S. output by the end of the year. But that is a very optimistic scenario. And after that? There is no doubt U.S. production could resume an upward climb with higher prices, but almost certainly not enough to offset reduced output elsewhere in the world.
CLIMATE: All scenarios that would reduce carbon emissions enough to keep global warming to 2 degrees or less require a huge shift away from petroleum for transportation. Both Statoil and the IEA have modeled what very aggressive introduction of electric vehicles (EVs) might do to oil demand, in the case of Statoil’s “renewal” scenario new car sales would be 90 percent EVs or hybrids by 2040. Even with such an enormous change in how light duty vehicles are powered global oil demand would still be in the range of 75-80 mbd by 2040 — as much as 20 mbd below today’s consumption but still requiring very large investments to compensate for the decline of existing fields. Supply could well decline much faster than demand.
So what does this all mean for the U.S. and the world?
- We are not in a new paradigm. Oil is not going away and the world’s dependence on the Persian Gulf for global supplies is very likely to increase going forward. Therefore the U.S. will need to play an active role in the region to ensure the oil keeps flowing, including protection of sea lanes.
- U.S. “energy independence” remains a chimera even if we were self-sufficient in oil, which is very unlikely to happen in any case.
- OPEC is not dead. Notwithstanding the Saudi/Iranian rivalry, they are likely to be able to and want to work together to influence the oil market once markets are more in balance. Recent statements by the new Saudi oil minister indicate they will continue to invest heavily in maintaining their production capacity.
- We need to keep our eye on the ball regarding constraining oil demand – continued progress on more efficient vehicles, facilitating the move to EVs, to natural gas for trucking, etc.
- Innovation is essential (e.g., autonomous vehicles), ideally in cooperation with international partners.
- We should continue to encourage and assist new and non-OPEC oil producers seeking to boost their output, in particular Mexico and emerging suppliers in Africa.
- We should not be treating our Strategic Petroleum Reserve as a piggy bank – selling off oil to meet other budgetary requirements. We may need the SPR to cushion a supply disruption, U.S. tight oil is not a substitute. At the same time we should continue to promote cooperation by China and India with the IEA on a coordinated response to an oil supply disruption given their increasing importance to the market (and since they are building their own strategic reserves).
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The Gulf’s still risky future
Wednesday the Middle East Program at the Wilson Center hosted The Gulf, Iran, and Future Oil Geopolitics, featuring David Goldwyn, President of Goldwyn Global Strategies; Douglas Hengel, Senior Resident Fellow at the German Marshall Fund; Elizabeth Rosenberg, Senior Fellow and Director of the Energy, Economics, and Security Program at the Center for New American Security; and Jean-Francois Seznec, Non-Resident Senior Fellow and Director at the Atlantic Council’s Global Energy Center. Jan Kalicki, Global Fellow at the Wilson Center and Senior Fellow at the Watson Institute for International and Public Affairs at Brown University, moderated the discussion.
Rosenberg discussed how lifting most sanctions on Iran has influenced Iranian politics. While the economy has opened up considerably since January, there are still many obstacles to doing international business in Iran. The prohibition on doing business with the Iranian Revolutionary Guard Corps (IRGC) leaves much of the economy untouchable by foreign investors. Many of the remaining sanctions are secondary, which requires Iranian companies to cut ties to groups like the IRGC that control 20-60% of the Iranian economy.
Iran is currently producing 3.5-3.8 million barrels per day and exporting 2 million. Iran could get up to 4 million per day. Beyond that, Iran would have to make substantial infrastructure investments. Several international oil companies have signed exploratory contracts, but there are still a lot of unknowns. With Iran upping the ante in Syria and around the region, the future of the broader Middle East is in question.
Goldwyn said that Iraqi oil production had recently reached 1.8 million barrels per day, its highest level ever. This is Iraq’s peak. It will not even be able to maintain this level. Iraq suffers chronic problems:
- the government is weak and unable to make plans or execute them;
- failure to resolve ethnic and sectarian conflicts opened the door to the Islamic State (ISIS) and maybe worse in the future;
- the government is spending a huge portion of its budget on the war effort: $33 billion between 2009 and 2014.
The Iraqi army’s progress in retaking Fallujah is promising, but Fallujah has been liberated many times—each time escalating ethnic tensions to still higher levels.
Iraq will barely be able to maintain production in the coming months. The Iraqi government is spending all of its diminished oil revenue on its military, and low oil prices have limited the government’s ability to function on a basic level—let alone invest in infrastructure to boost oil production. Iraq’s near future looks grim.
Seznec commented on how Saudi Arabia’s deputy Crown Prince Mohammed bin Salman is transforming his country in dramatic ways. His new “Vision 2030” intends to wean Saudi Arabia off oil dependence and diversify its economy. Saudi Arabia intends to maintain its current production of 10.2 million barrels per day, while growing its private sector. To accomplish this, King Salman bin Abdulaziz Al Saud appointed Khalid al-Falih as minister of the newly revamped Ministry of Energy, Industry, and Mineral Resources.
A major component of “Vision 2030” is selling 5 percent of the government’s shares in Aramco. Aramco is currently valued at 2 trillion dollars, so this will likely be the biggest IPO (initial public offering) in history. Part of Mohammed bin Salman’s plan is to revolutionize the workforce. By 2030, the government hopes that women will fill 45 percent of public and private sector positions. There are big changes on the way for the Kingdom, and we will have to wait and see what else the young deputy crown prince has in store for us.
Hengel addressed major factors that will affect all the countries discussed. His bottom line is that dependence on the Gulf will continue. The natural decline in current production means that continued investment in existing oil fields and new discoveries are essential. Hengel predicts that the United States and the world will continue to be dependent on OPEC. There is much uncertainty about the future of consumption. Many countries have started shifting towards electric vehicles and are moving away from their dependence on oil. But the United States continues to lead in consumption with the lion’s share, 10%, of global consumption. Gulf oil supplies are likely to remain important for the foreseeable future.
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Surprise!
Yes, the “leave” vote surprised me. I expected economic rationality and political equanimity to prevail over distaste for immigrants and flag-waving England firsters. Identity politics has triumphed once again. Let it be a lesson to me.
The immediate economic implications are already clear: a sharp fall in the British pound, a sell-off in stock markets worldwide, an even shakier euro, and more than likely renewed recession in Europe as well as a sharp slowdown elsewhere. The US may be the exception for a while, as many people will seek safe haven in the dollar, but that will drive it up, weaken exports, and slow already slow growth. Uncertainty will persist: Scotland will proceed with a second referendum, Wales may follow suit, and Catalonia will try to do so. Will the Netherlands or France put the EU to a vote?
What about the Balkans and Middle East, where my attention is focused?
In the Balkans, both the immediate and longer term effects are dire. The region is heavily dependent on European trade and investment, which are going to be hit hard right away. But perhaps more important will be the political impact. Balkanites (that’s what I call people who live in the Balkans) have already been finding it hard to believe in their European prospects, which seem farther away than they did five years ago. Now they would be fools not to doubt the willingness of Europe minus UK to accommodate their membership.
These doubts will open the door to increased Russian influence, not only in the Balkans but also in Ukraine. No one gains more politically than Putin does from the UK referendum: it weakens his antagonists in the UK and the EU, makes his annexation of Crimea and occupation of southeastern Ukraine look more acceptable, and validates his ethnic nationalism. The vodka should be flowing freely at the Kremlin today. It will also flow into the Balkans. Putin will no doubt intensify his efforts in Serbia, in Bosnia’s Republika Srpska and in Macedonia to wean Slavs from their EU and NATO dreams.
The Middle East is a harder call. There are a lot of wealthy Gulf sheikhs with money and property in Britain. They won’t like seeing the pound collapse, and some may already be so strapped by low oil prices that they panic and get out. But my guess is that most will hang on. Slowed world economic growth will however crimp oil prices once again, after their recent rise to $50 and change. So the future of Gulf money in Britain is likely dimmer than it was in the past.
Britain’s role in the Middle East may also change. It has been a major European contributor to intervention not only in Iraq but also in Libya and Syria. A more inward-looking and reduced Britain is not going to have the same resources and will to underwrite such efforts.
Britain will of course raise its barriers to Middle Eastern immigrants, but it hasn’t been taking many of them in any event. The main focus of resentment has been against East Europeans and the threat of immigration from the Balkans. Young Albanians, Serbs, Bosniaks and Macedonians are going to lose both education and job opportunities that many have been enjoying in recent years.
Ironically, one of the many problems that need to be resolved during the two-year negotiation to implement Brexit, will be Brits abroad living in the rest of Europe, who number 1.2 million. Three million people from other EU countries live in the UK. If no accommodation is reached to allow these people to stay, we could see a massive population movement with unpredictable implications. Even if they are allowed to stay, this kind of migration is finished. The next British government will have to do everything it can to prevent foreigners from reaching its soon to be diminished shores.
Net net: Brexit is bad news for the UK, the EU, the US, the Balkans and the Middle East. It is good news for Vladimir Putin. My friends and I will not be celebrating.
PS: It took a couple of days, but John Oliver did a great, if pretty gross, explainer:
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Dear Russian friends,
Moscow is apparently again using incendiary weapons against civilian areas, according to the Syrian opposition delegation to the UN talks:
HNC Letter to Ban Ki-Moon
UNOFFICIAL TRANSLATION
H.E. Mr. Ban Ki-moon
United Nations Secretary-General
New York
23 June 2016
Your Excellency,
It is with great concern that I report to you, in your capacity as the depositary for the Convention on Conventional Weapons (CCW), regarding a dangerous escalation in the illegal use of air-delivered incendiary weapons by Russian forces against civilian objects and in areas with a strong concentration of civilians across Syria, including most recently in Syria’s largest city, Aleppo.
Article 2 of Protocol III of the Convention on Conventional Weapons prohibits parties in all circumstances from “making the civilian population as such, individual civilians or civilian objects the object of attack by incendiary weapons.” Protocol III of the CCW also prohibits parties from making a “military objective located within a concentration of civilians the object of attack by air-delivered incendiary weapons.” Security Council resolutions 2139 (2014) and 2254 (2015) prohibit parties from deploying indiscriminate weapons in populated areas or engaging in methods of warfare of a nature to cause superfluous injury or unnecessary suffering.
Since the start of its intervention in Syria, Russian air forces have repeatedly deployed incendiary weapons and cluster munitions to kill, main and terrorize Syrian civilians, including in at least 10 documented incidents as described in Annex I. Recent incendiary aerial attacks by Russian forces have been documented in Aleppo, including in DaratAzza, Anadan, Ein Jara, Kafr Hamrah and Haritan. Recent video footage taken in Aleppo shows incendiary weapons likely to be thermite mounted in a Russian Su-34 fighter-ground attack aircraft. Thermite, which ignites while falling, has been likened to ‘mini nuclear bombs’ and was deployed repeatedly by Russian forces in residential areas.
Incendiary weapons rank among the world’s most powerful explosives and are known to have devastating effects on civilians. They cause immensely painful burns and prompt fires that are hard to extinguish. Yet Russian forces have systematically and deliberately used such weapons to kill innocent civilians, including women and children. In so doing, they have violated the CCW and breached international humanitarian law.
Your Excellency, as the depositary for the Convention on Conventional Weapons, we urge you to:
(i) Launch an investigation into the use of incendiary aerial weapons by Russia in Syria;
(ii) Demand the protection of Syrian civilians from the use incendiary aerial weapons in Syria;
(iii) Call on Member States to impose consequences for repeated breaches on international humanitarian law by Russian and Syrian forces.
Your Excellency, the failure to impose consequences for the Syrian regime and Russia’s repeated breaches of international humanitarian law has allowed the Syrian crisis to worsen—costing Syrian lives, encouraging a global refugee crisis, and giving new life to extremist terrorist groups. The whole world is less safe because the world has failed to act on our people’s behalf. Syrian civilians need protection. We rely on you to demand it.
Please accept, Your Excellency, the assurances of my highest consideration.
Dr. Riyad Hijab
General Coordinator, High Negotiations Committee
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Rebuilding Syria
Launching the American Security Project’s new white paper Syrian stabilization and Reconstruction, ASP hosted a panel to discuss the prospects for rebuilding Syria after the end of its tragic civil war. Mathew Wallin, Fellow for Public Diplomacy at the American Security Project, presented a summary of the white paper, highlighting the need to go into Syria with defined goals and a clear understanding of how to achieve them. In order to learn from our mistakes in Iraq and Afghanistan, Wallin emphasized an approach to reconstruction that focuses on the local level to establish security and create a new unified vision for Syria’s future.
Hani Masri, a member of the ASP Board of Directors and Founder of Tomorrow’s Youth Foundation, stressed the role that women and children play in post-war reconstruction. Masri noted that if we do not invest in Syria’s youth today, in twenty or thirty years the new generation of Syrians will not be ready to take on the challenges of governance in the new Middle East. Betty Bernstein-Zabza, Senior Advisor and Director of Operations for Global Women’s Issues in the Office of the Secretary of State, then addressed the reconstruction efforts undertaken in Iraq. Tragically, many women have become heads of households in Iraq and Syria, and because of that, any effort to provide security and economic prosperity in liberated areas must take women and children into account.
Kaufman Fellow and Director of Project Fikra at the Washington Institute for Near East Policy David Pollock proposed a bold plan for future engagement in Syria. He argued that given that Assad and his partners—Iran and Russia—are not seeking a political solution any time soon, the international community must start rebuilding Syria today. He claimed that reconstruction could commence in Opposition-controlled areas in Idlib, Deraa, and al-Hasakah, and stressed how the immediate needs of places such as Kobane and Manbij underline the urgency of acting now. An audience member questioned this proposal on grounds that Idlib, in particular, is under constant aerial bombardment. Any infrastructure rebuilt would be instantly destroyed. Among his other proposals,
Pollack responded emphasizing the need for a no-fly zone. He added that while this and other proposed measures will not solve the whole of the Syrian crisis, we have to start somewhere. The United States and international community have an opportunity to do the right thing, backed by moral and strategic reasoning.
Wallin commented that in the policy community many people advocate that we need to “do something” without sufficient thought to what comes after. We can provide humanitarian aid now, but that policy has no foreseeable end. A no-fly zone in Syria might have to be maintained for twenty years.
Wallin’s strategic concerns noted, it’s hard to argue against doing something to help the 6.6 million internally displaced Syrians that have fled their homes and the remaining millions that are living in constant peril.
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Counting on the census
A: I doubt that is the path President Ivanic wants to go down. But the way Bosnia and Herzegovina works he has to always appear to be protecting Serb interests. The problem is constitutional. The Dayton constitution provides no incentives for politicians to gain support across ethnic lines. This is just the latest exemplar.
The political controversy around the census results is a serious embarrassment for anyone who is concerned about the country as a whole, which is what a president would normally be concerned about. A census should be a technical exercise with political implications, not a political exercise that affects the techniques used.
Q: At the same time Dodik is calling the Assembly of Republika Srpska (RS) to reject the census results as irrelevant.
A: I assume the RS Assembly will do as Dodik commands.
I doubt the crisis has peaked. Dodik will take any opportunity he is offered to reject whatever the state government decides. He seems to me quite determined to take RS down a road that keeps himself in power right now but leads to disaster for his constituents in the longer term.
Q: Can the international community tolerate manufacturing crisis from RS officials in such an important moment for BiH?
A: Can Bosnians tolerate it?
So long as Dodik continues to be reelected you will face crises of this sort. The international community has a lot bigger problems right now than publication of the census results in Bosnia and Herzegovina. The EU has delineated a clear path for Bosnia and Herzegovina towards reform. It also pays a lot of the country’s bills. The war ended over 20 years ago. Isn’t it time Bosnians accepted responsibility for their own census?
Q: At the same time we have a meeting of [Serbian Prime Minister] Vucic and [Croatian President] Grabar-Kitarovic who signed a declaration on relations between Serbia and Croatian, but problem child is against – RS! Their leaders obviously do not want reconciliation. Your comment?
A: RS under Dodik defines itself as opposed to Croat and Bosniak interests. Why would it welcome reconciliation?
It seems to me the divide between Belgrade and Banja Luka is getting bigger. What Dodik is doing is clearly not in Serbia’s interest. He is damaging Serbia’s EU prospects and championing a diehard Serb nationalist cause that has been defeated repeatedly both in war and in peacetime elections, except in RS.
I imagine Vucic will try to rein Dodik in, but I am not certain he’ll succeed. Dodik likes EU hard currency, but he is bent on making RS a Russian satellite. He has no serious interest in EU membership, unless he can achieve it as an independent and sovereign state. That isn’t going to happen.
I think the census results should be published, along with all the technical issues and how they have been resolved. Let the chips fall where they may.
Erol Avdo, also of Avaz, followed up with some additional questions later today:
Q: In today’s interview you are quoted to say that Aleksandar Vučić “will try to curb Dodik.” In what way and with which instruments Mr. Vučić can really curb Dodik, and does the Serbian leader want to do that? Or could it be that there is a change of mood in Belgrade (could they become more openly pro-Russian, with pro-Russian position (Šešelj radicals and others) in Serbian parliament?
A: You’ll have to ask Prime Minister Vucic whether he is comfortable with the Russophiles in Belgrade and whether he feels the pressure coming from them. It seems to me that giving in to them is a sure way of blocking his goal of EU membership.
As for curbing Dodik, the reasons to do so are clear: Dodik’s advocacy of RS independence puts Serbia in a lose-lose position. I’ll leave it to the Prime Minister to figure out what instruments to use, but I suspect that money is the prime leverage that would work with RS right now. Dodik is pretty desperate.
Q: Also, could Mladen Ivanic, who is an experienced and old politician, actually have a new assessment of that “change of heart” in Belgrade — and — in the worst case scenario — decide to show more resistance to all this EU accession process?
A: Ask him, not me, whether he has had a change of heart. In my way of thinking, he is not going to be able to outflank Dodik on the nationalism side, so he may as well stick with the EU.
Q: Or this is only all about census? Could Ivanic become more pro-Russian as well?
A: Russia is a declining regional power. Anyone who wants to tie the future of his country to a petro-state that lacks enough revenue to fund its budget is welcome to do so. Just don’t expect the U.S. or the EU to pay your bills or welcome you into their clubs if that is the choice you make.
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