Report_53915778_Oil Politics and Currency.docx

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Seminar: Oil Politics and Currency Speaker: Prof. Albert Kwong Student: RIZVI, Syed Hassan Tallal ID: 53915778 Programme: MSF Course: EF5063 Professional Seminars Report: Semester A

Transcript of Report_53915778_Oil Politics and Currency.docx

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Seminar: Oil Politics and Currency

Speaker: Prof. Albert KwongDate: 4, October 2014

Student: RIZVI, Syed Hassan Tallal

ID: 53915778

Programme: MSF

Course: EF5063 Professional Seminars

Report: Semester A

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Table of Contents

Part 1: Oil Politics and Currency..............................................................................2

Effect of Oil on Different Currencies....................................................................3

Part 2........................................................................................................................5

Current Landscape and Politics in International Oil Market.................................5

Will Saudi Arabia Cut Production to Stabilize Prices?.........................................6

China and Oil Politics...........................................................................................7

Conclusions..............................................................................................................9

References..............................................................................................................11

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Part 1: Oil Politics and Currency

The modern world has an almost insatiable appetite for energy. From the smallest of mobile

phones in our hands to jumbo jets roaring through skies, in every product or service, energy

plays an integral role. No wonder then that energy plays a key role in economic growth of

nations in the modern world. In the energy spectrum, fossil fuels remains the dominant force and

expected to remain the most important fuel type for the world economy, despite the rise of

alternative fuel. This is because the changing the fuel type would require technology and

structural changes in the economic infrastructure of the world.

Within fossil fuels, oil is one of the most important, given its integral role in the modern

economy. Nations devise prudent policies which to serve to bring about energy security, and

since oil plays such an expansive role in world economy, politics and oil are often mixed

together. For this reason, I found the seminar by Prof. Albert Kwong titled “Oil Politics and

Currency” very pertinent. The speaker shed light on a very relevant issues these days and I

agreed with most of his ideas. Following from this, countries around the global have prioritized

energy security. Energy security has many dimensions, but may be loosely defined as

construction of policy incentives to acquire access to appropriate energy sources and reasonable

prices (International Energy Agency, 2014). The policy has both long term and short term

objectives. Short term objectives relate to normalizing demand and supply while long term

objectives seek energy independence and sustainability. Therefore, the absence of energy

security will adversely impact a country’s economic outlook and may have long-lasting social

impact.

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Oil is spread around the world unequally, with some regions having a disproportionate share of

oil reserves. Saudi Arabia, for example, alone having 16 per cent of the world’s proven oil

reserves (U.S. Energy Information Administration, 2014). A list of the top 5 oil producers is in

the table below. US is the not far behind Saudi Arabia in terms of production, but is the world’s

largest consumer of oil in the world, consuming 18.6 million barrels per day in 2012 (Zhou,

2014).

Table 1:

Country Production (000s barrel per day)

Saudi Arabia 11,726

US 11,119

Russia 10,397

China 4,372

Canada 3,856

Source: U.S. Energy Information Administration

Moreover, Prof. Albert Kwong explained how currencies of major oil producers are highly

correlated to fluctuations in the oil. As a student of finance, I found the linkages fascinating.

Furthermore, the speaker elaborated the important of energy security for China, one of the largest

consumers of oil.

Effect of Oil on Different Currencies

There is abundant research, analyzing the effect of crude oil prices movements on currencies

around the world. At a micro level, a long position in a commodity such as WTI crude oil, has an

effective counter short position in the US dollar (because the WTI crude oil is quoted in US

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dollars) (Active Trader, 2014). Hence, most of the time we witness inverse relationship between

US dollar and WTI crude oil prices. Apart from US, impact of changes in crude oil prices on

currencies depend on how big of a role oil plays in the economy. For example, Canada is one of

the largest oil producers and net exports of oil in the world (U.S. Energy Information

Administration, 2014). Consequently, upward movements in the price of oil would be beneficial

for the Canadian economy, which in turn would be eventually reflected in the appreciation of the

Canadian dollar (see figure 1 below). In Figure 1 we see that the CAD/USD exchange rate has

closely followed the oil prices. Same is the case with Norwegian Kroner in figure 2. In fact, one

of the most compelling reasons for Norway not to join the common currency bloc of Euro, was

to continue to reap benefits of a strong economy supported by oil, as pointed out by the speaker

during the seminar.

Figure 1:

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CAD/USD vs WTI Crude Oil

Oil CAD/USD

Source: (OANDA, 2014)

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Figure 2:

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Source: (OANDA, 2014)

Part 2

Current Landscape and Politics in International Oil Market

While the importance of oil in the global economy has not been significantly dented, the current

landscape of the global oil industry has undergone dramatic shift since the innovation of shale

oil. The industry of this technology fundamentally changed the way the industry now operates.

Shale oil, also known as tight oil, is extracted from rock formations which do not allow the oil to

flow freely (Financial Times, 2014). Hence, until recent advances in extraction methods such as

horizontal drilling and hydraulic fracturing, shale oil was very difficult and costly to extract.

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While it is still more difficult to extract than conventional oil, the innovative technology has

made the production of shale a commercially viable undertaking.

In the US, shale oil production skyrocketed from a mere 111,000 barrels a day in year 2004 to

553,000 barrels a day by 2011. The success of shale oil has immense implications for the energy

security of US, a country which has relied on the Middle East for a major chunk of the oil

imports. Constant political and social unrest in the volatile region of Middle East exposed US to

energy security risks. While shale oil production in the US has not completed substituted Middle

Eastern oil, the production is constantly rising. The production has already resulted in fall in US

crude oil imports to 16 year lows (Zhou, 2014). Furthermore, as of current estimates, US oil

import levels from OPEC (organization of petroleum exporting countries) are now at 30-year

lows.

Several factors can be cited to explain the current situation of the oil market. Firstly, the boom in

shale oil extraction has flooded markets worldwide. Secondly, OPEC, which produces about

33% of the world’s oil has maintained its production levels. Lastly, demand for fuel in Europe

and some parts of Asia is forecasted to be low. The net result of these factors has been a dramatic

fall in oil prices (Anjli Raval, 2014). Brent prices, for example, have fallen by 30% to date since

June 2014. I intend to explain each factor is a fair bit of detail

Will Saudi Arabia Cut Production to Stabilize Prices?

Before I address the question, I believe it is important to shed some light on OPEC. OPEC is a

cartel of one the world’s largest oil producers and include the following countries: Algeria,

Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, UAE, and Venezuela.

All together, these countries produce roughly above 40% of total world supply. Hence, changes

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in production levels of OPEC have significant effect on the world oil prices. A complicating

factor in the equation is that most of the countries in OPEC have been hotbeds of instability,

especially Iraq, Libya, and Iran. Its significance in the oil markets may be evaluated from the fact

that in 1970s, the then Organization of Arab Petroleum Exporting Countries (OAPEC), the

precursor of OPEC, imposed an oil embargo which shot up price by almost 300% in a matter of

three months (History Channel, 2014).

Currently, OPEC still retains immense clout in the oil market but would be reluctant to resort to

measures such as oil embargos. However, it plays an active role in managing the supply levels in

the market and maintain profitable price levels for its member countries. For example, during the

recent financial crisis of 2008, when oil prices fell to $40 per barrel from highs of $140, OPEC

cut its production levels drastically to prop up prices to $80 (Mouawad, 2008).

As mentioned before, the fact that OPEC includes several politically unstable countries, regional

politics regularly impacts decisions of OPEC. Even in the 1970s oil embargo, conflict with Israel

was the reason behind the cut back in production. Currently, low oil prices should have ideally

prompted a production cut from OPEC. However, the organization, led by Saudi Arabia, has

failed to reach a consensus on the most feasible way to react to the scenario. Saudi Arabia, in

particular, has remained adamant that it would not cut production. Analysts are of the view that

Saudi Arabia wants to put pressure on Iran by keeping the price lowers. Saudi Arabia and Iran

are regional and ideological rivals: Saudi Arabia adheres to the Sunni school of thought whereas

Iran belongs to the Shia school of thought. Another view is that Saudi Arabia wants to maintain

its large market share by not increasing the price levels. Yet another opinion is the country wants

to fight off competition from the shale oil producers, primarily in US, by keeping prices low and

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hurting the profitability of companies there. I believe there is confluence of all the

aforementioned factors that explain the current situation in the oil market.

China and Oil Politics

According to reports by the US Energy Information Administration (EIA), China is now the

world’s largest net importer of petroleum and other liquid fuels (U.S. Energy Information

Administration, 2014). China’s oil demand growth has far outpaced the growth in its domestic

oil output, leading to the current situation. Consequently, EIA expects China to import 66% of its

oil in 2020 and 72% by 2040. This was a natural outcome of a rapidly growing economy that at

times averaged in the double figures. This fact however also has implications for China’s energy

security policy.

The Middle East has historically been and continues to be the largest source of oil for China.

While China has made efforts in diversifying its sources, the region retains its importance. This

means that the Indian Ocean, for example, has an important place in China’s energy security

policy. Roughly 70% of the world petroleum products are channeled through this ocean

(Rasgotra, 2014). Since oil plays such a major role in China’s economic growth, oil supply

security is top priority for the Chinese government. The importance of the Strait of Malacca can

be highlighted here. It is narrow and congested waterway in South-East Asia that provides the

shortest route between the Indian Ocean and the Pacific Ocean, channeling approximately 25%

of world trade each year (The Jamestown Foundation, n.d.). In order to promote a more reliable

and safer route for ships carrying oil for China, it has strengthen it naval force and increased its

presence in the sea. China often has disputes with the US, who in turn has often increased its

presence in the seas under the pretext of providing security in the region.

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In response to the volatile nature of sea routes in Asia, China has embarked upon strategies to

secure stable oil supplies through land routes. One of the most feasible land routes for China is

through Pakistan, a country with which China maintains cordial relations. This particular trade

route involved the port city of Gwadar in Pakistan. Over the years, the Chinese government has

made substantial investments in the city (Subohi, 2013) . The entire process would involve the

off-loading tankers at Gwadar, transferring it to the capital Islamabad up north some 900 miles

and then would be passed into the Xinjiang province into China. While this would provide a

more efficient route of China’s energy supplies, Pakistan’s internal security issues complicate the

matter. Gwadar is located in Pakistan’s volatile province of Balochistan, which is home to

several separatists movements. Furthermore, China’s Xinjiang province has its own problems of

its Uyghurs.

Conclusions

In conclusion, I agree with most of Prof. Albert Kwong’s views in his seminar. Oil has and

continues to play an important role in the modern world economy. Despite the adverse impact on

the environment through its use, it is impossible to immediately turn away from this fossil fuel.

The entire oil industry, from upstream to downstream, has made substantial investments in the

oil infrastructure, making rapid shift to another fuel infeasible. Since oil is so important, nations

have made the stable and secure access to the fuel a top priority. This is all the more true for fast

developing nations such as China, which are growing rapidly and demand for oil is increasing.

Developed countries too have immense vested interests in securing oil. This prominence of oil

has earned it a special place in global politics as well. China for example has propped up

financial support for countries such as Pakistan, to gain short and secure route for oil imports

from the Middle East.

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However, Prof. Albert Kwong did not mention some critical features of the shale oil production.

Definitely shale oil has revolutionized the oil industry and U.S. one of the largest importer of oil,

has seen its imports shrinking. Nevertheless, according to my research, the shale oil wells have a

more rapid depletion rate than conventional oil wells such as those in Saudi Arabia (Wile, 2013).

So while oil importers such as U.S. has exuberant that their dependence of imported oil is falling

with increasing production of shale oil, they must also consider factor in the life of the wells. If

the wells do deplete fast, how long can the independence from oil imports last?

Furthermore, although alternative energy forms such as solar, biomass, and wind are fast being

implemented to replace our dependence on oil, we are still technologically far away from fully

replacing oil. This miracle fuel will continue to play an important role in our lives. The seminar

was most pertinent for aspiring financial analysts who may eventually work for institutions

which specialize in the trading and research of the commodity oil and the industry as well. The

seminar has thus helped me identify some of the core issues currently facing the oil industry and

pushed me to further investigate the matter. This will not only help broaden my current

understanding of the oil industry, but enhance my understanding of the financial markets in

general.

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References

Active Trader. (2014). Crude Oil and Currencies. Active Trader.

Anjli Raval, N. H. (2014, November 23). Oil markets: A new chapter for Opec? Retrieved from

Financial Times: http://www.ft.com/intl/cms/s/0/64c2485e-70a4-11e4-8113-

00144feabdc0.html#slide0

Financial Times. (2014, November 21). Lexicon. Retrieved from Financial Times:

http://lexicon.ft.com/term?term=shale-oil

History Channel. (2014, November 23). Energy Crisis (1970s). Retrieved from History:

http://www.history.com/topics/energy-crisis

International Energy Agency. (2014, November 21). What is energy security. Retrieved from

IEA: http://www.iea.org/topics/energysecurity/subtopics/whatisenergysecurity/

Mouawad, J. (2008, December 17). OPEC Agrees to Another Cut in Production. Retrieved from

The New York Times:

http://www.nytimes.com/2008/12/18/business/worldbusiness/18opec.html?_r=0

OANDA. (2014, November 21). Historical Exchange Rate. Retrieved from OANDA:

http://www.oanda.com/currency/historical-rates/

Rasgotra, D. (2014, March 32). India-China competition in the Indian Ocean. Retrieved from

IISS Voice: http://www.iiss.org/en/iiss%20voices/blogsections/iiss-voices-2014-b4d9/

march-2014-cd5b/china-india-ocean-c0d6

Subohi, A. (2013, February 25). Gwadar deal: business optimism, Baloch reservations.

Retrieved from Dawn: http://www.dawn.com/news/788568/gwadar-deal-business-

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optimism-baloch-reservations

The Jamestown Foundation. (n.d.). China's Malacca Dilemma. Retrieved from The Jamestown

Foundation: http://www.jamestown.org/single/?no_cache=1&tx_ttnews%5Btt_news

%5D=3943#.VHaVmjGUdfM

U.S. Energy Information Administration. (2014, September 30). Canada. Retrieved from EIA:

http://www.eia.gov/countries/cab.cfm?fips=ca

U.S. Energy Information Administration. (2014, November 21). Saudi Arabia. Retrieved from

EIA: http://www.eia.gov/countries/country-data.cfm?fips=SA&trk=m

U.S. Energy Information Administration. (2014, March 24). Today in Energy. Retrieved from

EIA: http://www.eia.gov/todayinenergy/detail.cfm?id=15531

Wile, R. (2013, May 19). Why America's Shale Boom Will Last For Years. Retrieved from

Business Insider: http://www.businessinsider.com/fracking-shale-extraction-and-

depletion-2013-3?op=1

Zhou, M. (2014, January 4). U.S. Crude Imports Fall to Lowest Level Since 1998. Retrieved

from Bloomberg: http://www.bloomberg.com/news/2014-01-03/u-s-crude-imports-fall-

to-lowest-level-since-1998.html

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