The changing face of energy geopolitics

International Futures Programme
Anyone trying to forecast oil prices twenty or twenty-five years ago would have noticed that the world economy was slowing down. It would have seemed reasonable then to predict that oil prices would start to drop. Of course, the opposite happened.
The 1973 Arab-Israeli war and the 1979 Iranian revolution were followed by "oil shocks" as prices rose suddenly and significantly. And the 1991 Gulf War led to all sorts of price predictions, mostly pointing upwards. Today, prices are hovering around historically low levels -- oil is actually cheaper now in real terms than before the shocks. Still, it is important to remember that energy prices are determined by geopolitics, not just by economics. Two regions, the Middle East and the Caspian Basin, hold the key to understanding that geopolitics and, not surprisingly, they are watched closely by industry and government everywhere, not least at the OECD.Middle East will be more importantThe shared perception of those experts is that the importance of the Middle East producers will grow, not decline. And as in the past, politics could prove to be every bit as important as geology and resource sustainability, at least in the next 50 years.Let's take the question of Islamic fundamentalism. It is often quoted as a potential threat to oil supplies, but experience with the fundamentalist regimes in Iran and Saudi Arabia suggests that their need for oil revenue will keep them tied to the market. The absence during the Gulf war of Arab solidarity (as expressed previously in the use of the "oil weapon" in the 1973 war with Israel) supports arguments that pan-Arabism is a tired force politically and unlikely to gain sufficient strength to provoke further price shocks.Paradoxically, the Gulf region could be the source of new shocks, not because of sudden price hikes, but rather if the oil price collapses. If prices continue to decline, many non-Gulf producers would become uneconomic, causing serious problems in countries that are highly dependent on energy exports for hard currency. At the same time, world dependence on the Gulf would grow. While this would guarantee an in-flow of cash to the petro-monarchies in the long term in the medium term revenues would suffer, and the social pact that is financed by oil money could break down. Civil strife could follow, leading to the disruption of oil supplies. Eventually, the oil would come back on-stream again, but it is worth remembering that the 1979 shock came after Iran's production was disrupted for only a few months. Oil companies (and the governments of countries that rely on oil imports) are thus faced with a dilemma. Depending on a region as volatile as the Gulf is hardly ever going to be risk-free, but investing heavily in developing non-Gulf reserves will probably not be necessary for the next decade or so.A Caspian delicacyContinuing low oil prices could have particularly serious consequences for Russia, most of whose hard-currency earnings come from oil and gas exports sales. Oil revenues from traditional customers would fall. This would have the dual effect of hurting incomes and undermining the argument that customers should switch to natural gas. And that would make it harder for Gazprom, the Russian authority, to meet its European export target of 190 billion cubic metres by 2010, versus 98 billion in 1991.To have any chance of achieving that target, money would have to be found to build pipelines to carry the extra 100 billion cubic metres, and this may prove difficult given the uncertain outlook for the investment and the crowding out by the investment commitments elsewhere in the former Soviet Union, notably the Caspian Sea area.Proven reserves in the Caspian basin are 15-31 billion barrels of oil. That's 2.7% of world reserves. Some 230-360 trillion cubic feet of gas are also estimated, which is 7% of world reserves. Estimates of possible oil reserves vary from as little as 20 to as much as 200 billion barrels. Assuming that optimistic assessments of 20 to 30 billion barrels in the shallow waters of the Kazakh offshore sector are correct, total regional production could reach 3.5 million barrels a day (mbd) in 2010, with 2.5 to 2.8 mbd exported. In 1997 production was 0.9 mbd, with 0.3 mbd exported.Oil demand in 2010 is projected to be 94 to 103 mbd, depending on assumptions for demand growth. This implies that OPEC may have to shut capacity to defend prices. More-over, if the projection model assumes that technologies will promote convergence towards energy-saving processes, world demand would only be 89 mbd in 2010.Given that Caspian reserves are unlikely to have a great influence on world markets, and will face enormous difficulties in even getting out to these markets, it is worth asking why so much attention is being focused on this region. Part of the explanation lies in the instability of the Middle East: Caspian energy supplies could bridge any gap that would open up if supplies from another major producer were interrupted for a certain time. The Caspian Basin is also important geographically and politically. The restrictions on Iraqi capacity may offer Iran an opportunity to yield renewed influence in the region, especially as it could also be a key player in opening up the Caspian's oil and gas fields to international exploitation. With Iran, the coming years may thus see Western governments moving away from sanctions and towards "constructive engagement". United States oil companies would encourage such a strategy, especially since their competitors are already strengthening their position on the ground.Moreover, the US and Europe are not alone in wanting to build links with the region. China sees it as part of its plans to resurrect the Silk Road, which could re-awaken old rivalries in a new "Great Game", similar to the power struggles of the 19th century. This puts Russia in a difficult position. If it seeks revenue from investment in the Caspian and transit taxes on pipelines crossing Russian territory, it would encourage a rival to its indigenous industries. If it takes an aggressive stance, it risks opening its sensitive southern flank to influence from its political and economic rivals.A disturbance in the Caspian region would thus have repercussions far beyond its immediate shores. For example, if oil companies lose money due to political upheavals, they will be more reluctant to fund new projects in other areas of perceived instability, including those that could have provided the extra capacity that will be needed early in the 21st century. More directly, if pipelines crossing this region are cut for whatever reason, the shortfall in supplies to major markets could have drastic consequences for those countries which have decided to run down, or even eliminate, their strategic reserves.The Caspian is thus important not only because of a potential contribution it can make to world energy markets, but also because the competition for its reserves reflects a wide-ranging network of interrelated domestic, regional and global-scale rivalries, all of which are helping to draw the geopolitical energy map of the 21st century.Bibliography"Caspian Oil and Gas" IEA, Paris, 1998."Unlocking the Assets: Energy and the Future of Central Asia and the Caucasus", James A. Baker Institute for Public Policy, Rice University, Houston, Texas, 1998.Bahgat, Gawdat, "Oil Security in the New Millennium: Geo-Economy vs. Geo-Strategy" Strategic Review, Vol. 26, No. 4, 1998. Other stories on this Spotlight on the 21st century©OECD Observer No 217-218, Summer 1999

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