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Geopolitics and WorldEnergy Markets

1. Price swing due to the Arab Spring

• In early 2011, the price of crude oil rose by 62percent in a single month, rocketing from $75 to$120 per barrel as protests and revolts shook anarc of Arab countries.

• The price of crude jumped 6 percent on a singleday, February 21, in response to sudden anddramatic unrest in Libya.

• This strong price reaction occurred even thoughLibya accounts for only about 2 percent ofannual world oil production.

The large influence of troubles in this relativelyminor producer stemmed from two mainsources.1. Unrest across the oil-producing countries of

the Middle East, accompanied by fears thatother nations would soon be inflamed,raised market doubts about the ability ofother producers to surge their production tocompensate for the withdrawal of Libyan oilfrom the market.

2. Second, Libya produces a light (high API),sweet (low sulfur) crude that is especiallyvalued in some market segments.

• An expansion of Saudi production could notsubstitute for the missing Libyan oil.

• Saudi Arabia, a supplier capable of a surge inproduction, pumps a heavier more sour(higher sulfur) crude.

• Many refineries in Europe and Asia are notequipped to handle higher-sulfur crude,

2. Imminent strike against Iran

• In 2012, continuing sanctions against Iran andthe fear of an imminent strike against Iraniannuclear capabilities contributed to near-record world oil prices and extremely highgasoline pump prices in the United Statesand around the world.

• Energy prices have always been subject toshocks from events that occur in singlecountries, and this will remain true as long asmajor sources of energy are concentrated in afew countries.

• However, looking back as well as forward, largergeopolitical considerations go beyond theimpact of any single nation, and thosetransnational and more enduring factors are thefocus here.

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ENERGY GEOPOLITICS FOR THE NEXT GENERATIONS:DEMAND, MIX, AND INTERNATIONAL MOVEMENTS

• The overall contours of energy geopolitics are ratherstraightforward and understood by most people atleast on a casual level.

• First, there are several basic types of energy sources:– fossil fuels (including coal, oil, and natural gas), nuclear

energy, and renewables (including hydroelectric power,wind energy, biomass, waste products, and solar).

• Each of these resources is best suited to particularuses.

• For example, hydroelectric power can generateelectricity quite well, but it would be a poor choice fora transportation fuel.

• Further, these various energy resources aredistributed across the world not necessarilywhere the demand is.

• The response to this situation is twofold.• First, one can adapt a geographically

convenient energy source to a use for whichit less well suited.

• For example, near the end of World War II, thealmost-defeated axis powers were driven tonear-desperate expedients.

• Oil-starved Japan converted some automobilesto burn wood as fuel.

• After failing to capture oil fields in Romania andin the Caucasus, Germany, having developed theworld’s first jet-propelled aircraft, used oxen totow planes onto the runway in order to conservejet fuel.

• As a second approach, one can move a fuelfrom its source to where it will be used.

• The contemporary world economy, built onfossil fuel, has developed and elaborated thismodel for almost a century, starting with theconversion of the British Navy from coal to oilin the first decades of the twentieth century.

• The mismatch between the geographicallocation of energy resources and their pointsof consumption drives the geopolitics of oil.

• If oil must be transported from the nationswhere it originates to the countries where itwill be consumed, the energy must crossnational boundaries, international waters, andsometimes-contested borderlands as well.

• Three more general factors complete thegeopolitical stage setting.

• First, virtually all experts expect worldwideenergy demand to increase markedly overthe next generation or so, focusing on ahorizon out to 2030–2050.

• Energy demand will grow faster in someregions (most notably China and Indiaaccording to most expectations) whiledemand in other regions may stagnate orexpand at a much slower rate (North Americaand the European Community).

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• Second, the energy mix—the proportion of fossilfuels, nuclear, and renewables—will change onlyslowly.

• Thus, the energy mix of today is essentially theenergy mix of 2030–2050.

• Third, the largest energy-consuming regions ofthe next generation will gather an increasingportion of their energy from outside their ownborders.

• Exhibit 2.3 also draws on estimates for 2030by ExxonMobil and BP, and shows thepercentage of each type of energy sourceprevailing in 2010 and the distribution thatthese energy firms expect to hold in 2030.

• Interestingly, there are some distinctdifferences in the assessment of the 2010situation by these two firms.

Exhibit 2.3 Percentage of Consumption by FuelTypes, Estimates of ExxonMobil and BP

• For example, the two predictions for the role of hydroelectricitydiffer by a factor of at least 100 percent.

• They both agree that oil will provide 25–30 percent of all energy in2030 and that natural gas will contribute about 25 percent, withfossil fuels all considered (coal, oil, and natural gas) togetheraccounting for 75–80 percent of all energy the world will consumein 2030.

• Further, in a subsequent analysis, Exxon extended its forecast to2040 in which it forecasts that oil will still account for more than30 percent of world energy and that hydrocarbons will alsoconstitute 77 percent of world energy, with renewables rising towhat will still be a less than 5 percent share.

• Even with some important differences, however, the two forecastsare in broad agreement, especially regarding the categories thatare likely to be most important from a geopolitical perspective.

• Of the six categories of energy shown in Exhibit 2.3,some types are consumed where they originate, whilelarge portions of other types of energy are shippedgreat distances.

• Hydroelectricity, energy produced from renewables,and nuclear energy have virtually no shipping ortransmission across national boundaries.

• Not only has this been true historically, but it isprojected to remain true for the next generation.

• Thus, the principal energy sources that are shippedtrans-regionally are all fossil fuels—oil, natural gas,and coal—as Exhibit 2.4 shows.

Exhibit 2.4Fossil FuelDemandedfor Importand Availablefor Export,2010 and2030,Projected

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• Of these, not all three are shipped equally.• For example, in 2010, North America, Asia

Pacific, Europe, and Eurasia imported 1,296million metric tons of oil, but total world importsof coal in 2010 totaled only 91 million tons.

• This difference isn’t surprising for three reasons:1. Oil has much more value per unit of weight,2. oil is easier to ship, and3. coal deposits are more widely distributed

than oil, so that coal is consumed near itspoint of production.

• BP, expects trans-regional oil shipments toincrease by about 50 % by 2030, and coalremaining unchanged.

• Natural gas occupies a middle ground betweenoil and coal in terms of shipments.

• Traditionally, natural gas moved only throughpipelines, with an almost negligible shipment ofgas in the form of liquefied natural gas (LNG).

• However, shipments of LNG have become morecost competitive with other energytransportation methods recently, and LNGshipments have accelerated rapidly in recentyears.

• To ship LNG requires that natural gas beliquefied by cooling the gas to -260oF -162oC.

• In this process, natural gas is first transportedby pipeline to a liquefaction facility.

• After liquefaction, the LNG is pumped onto aship or into railroad tank cars, which thencarry the LNG to its destination, a facility atwhich it can be re-gasified and shipped on viaa natural gas pipeline.

• Obviously this transmission cycle requires thedevelopment of an elaborate infrastructure, whichhas been developing quite rapidly.

• The growth of LNG is one of the reasons thatconsumption of natural gas is expected to grow morerapidly than either coal or oil (see Exhibits2.1 and 2.2).

• In addition, natural gas is increasingly popular as afuel for electrical generation, due in no small measureto its lower emission of greenhouse gases.8

Exhibit 2.1 ExxonMobil’s Analysis of WorldEnergy by Type (Quadrillion BTUs)

Exhibit 2.2 BP’s Analysis of World EnergyConsumption by Type (Million Metric Tonsof Oil or Equivalent)

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• With the advance of LNG as a method for shippingnatural gas, one might expect the long-term result tobe a world in which both oil and natural gas in theform of LNG have a similar pattern of internationalshipment.

• Previously, with no way to transport natural gas acrossgreat ocean distances, much of it was stranded.

• With the development of a robust LNG infrastructure,natural gas seems poised to fully enter the worldenergy market.

• However, a potentially extremely importantdevelopment for the availability andgeopolitical significance of natural gas lies inthe future of shale gas—gas trapped in deepsedimentary layers of shale that has beenunrecoverable in a commercially viablemanner until quite recently.

• Massive shale gas deposits around the world,including the United States, promise to makenatural gas much more abundant near thepoint of ultimate consumption.

• Thus, the future of shale gas can dramaticallyaffect the future geopolitical significance ofnatural gas and even have a dramatic effecton markets for other forms of energy.

• Setting aside the emerging importance ofshale gas, oil and natural gas are the twoforms of the world’s energy that dominateinternational energy shipments.

• As a result, the geopolitical implications ofenergy turn on the acquisition of oil andnatural gas from abroad and the shipment ofoil and gas around the world.

THE WORLD MARKET FOR ENERGY

• Oil today trades in a mature worldwidemarket, which has developed from alongstanding and mostly successful U.S.policy.

• Metaphorically at least, recent decades haveseen the financialization of oil.

• With the operation of this worldwide market,oil has become essentially fungible, with oilin one location being readily convertible intooil in another.

• Of course, not all oil is the same.• The importance of Libyan oil and sweet

versus sour types of crude oil have alreadybeen noted , so oil may be largely fungible,but different kinds of oil are not quite asfungible as cash.

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• Nonetheless, to a large extent, the oldaccounting law that “all sources support alluses” has become true of oil in the worldmarket, and the promise of LNG may soonmake the same true of natural gas.

• This is an extremely important geopoliticaldimension of the world energy market.

• Speaking of the diversity of supply, WinstonChurchill noted almost 100 years ago,

• “Safety and certainty in oil lie in variety andvariety alone,”11 and the same remains truetoday.

• That variety of supply depends on robustworld energy markets.

• Further, it seems evident that talk of “energyindependence” for the United States is a fancifulnotion, in spite of longstanding claims by a successionof presidents that we are working toward such energyautarky.

• As Exhibit 2.4 makes clear, the location of supply anddemand for energy makes evident the future of aninterdependent world of energy.12

• For the United States, the best outcome is for energyto be traded in a free worldwide market, with thehope that new technologies can lessen dependenceon foreign energy sources.