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The Impact of Pricing Regulations on Argentina’s Energy Sector

23 Monday May 2016

Posted by V. Markov in Argentina, Fracking, Natural Gas, Oil, Vaca Muerta

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Argentina, Economics, energy, Energy Independence, Energy Security, fracking, gas, Kirchner, LNG, Macri, natural gas, oil, oil and gas, peronism, peronismo, Politics, security, shale, unconventional, unconventional resources, Vaca Muerta

Introduction

Since 2001, Argentina has tried to achieve the goals of promoting domestic production and supporting consumption of energy simultaneously. In a departure from the deregulation of the 1990s, Argentina’s government imposed a pricing regime to maintain the stability and affordability of consumer energy prices in order to stimulate economic growth and preempt the possibility of hyperinflation. Exports of energy were curtailed through a system of capital controls and export duties. As consumption rebounded following the 2001 economic crisis, producer prices remained below the prices for energy imports, thereby discouraging investment and volume growth. In response, the government instituted a system of producer price controls and subsidies to encourage investment, making up the difference between producer prices and controlled prices through federal budget outlays. Argentina’s regulatory system accomplished its goal of stimulating demand and limiting exports, however, in doing so it introduced distortions in the market that prevented the market from balancing with domestic production. The Argentina case study provides a lesson for countries seeking to accomplish contradictory goals through regulation, establishing a need for professional technocratic regulation, rather than regulation by decree, and flexibility in overcoming the interaction effects caused by intervention in the markets.

Energy Regulation between 1989 and 2015

            Following a period of liberalization and deregulation in the 1990s, Argentina’s energy sector has been increasingly regulated since the 2001 economic crisis. The energy sector operates under the basic 1967 Ley de Hidrocarburos (Law No. 17.319),[1] which establishes hydrocarbon reserves as the patrimony of the nation and grants the Executive wide powers to grant concessions and regulate energy. The energy sector became heavily regulated until the Menem administration (1989-1999) pursued a vast liberalization of the economy. During this time, the Congress promulgated the Ley de Reforma del Estado (Law No. 23.696)[2] in 1989 with the aim of privatization and deregulating industry. The Menem reforms enabled private participation in oil and gas, deregulated prices, and culminated in the full privatization of YPF, a process that started with Law No. 24.145 of 1992.[3] During this time, Argentina’s economy and energy sector underwent rapid growth. Despite the oversupply in the international oil markets and the weakness of Brent prices, Argentine oil production increased 76% between 1990 and 2001, while gas production more than doubled as presented in Figure 1.

Figure 1

1

Following the 2000-2001 economic crisis, the Argentine government took a much more interventionist role in the energy sector and economy in general. Seeking to stimulate economic growth and prevent a return to hyperinflation, the short-lived Duhalde administration (2002-2003) issued Decrees 310/2002 and 809/2002, which established export restrictions on oil and oil products, including a 20% export duty.[4] Export duties were extended to gas in 2004. The administration further began controlling energy prices, particularly freezing rates in the electricity sector.[5] Law 25.561, passed in 2002, established emergency control measures over the exchange rate and prices.[6] Further clarifying its role through Resolution 1104/2004, the Ministry of Energy and Mines established formulaic pricing for energy.[7] Both the Nestor Kirchner (2003-2008) and Cristina Fernandez de Kirchner (CFK, 2008-2015) administrations maintained the price controls. Although export duties were introduced as temporary emergency measures, they were effectively made permanent in 2007 through Law 26.217.

Consumer Prices and the Impact on Demand

While the price controls did appear to stimulate economic growth and promote stability in the early 2000s, the lack of political will to raise consumer prices stimulated demand beyond what would have been commensurate with economic growth. As a result of the price control legislation coming into force after 2001, energy prices were denominated in pesos and remained nearly fixed, in spite of wide fluctuations in the USD prices of commodities. Natural gas prices, as presented in Figure 2, remained close to their 2003 level until 2013, despite peso inflation averaging 17% per year between 2000 and 2014.[8] Figure 3 shows vehicle fuel prices at the official exchange rate, representing an unreactive pricing system. Faced with punitive export terms and pressure from the government to maintain prices, producers had no choice but to direct domestic production to the market at low prices.

Figure 21.png

Figure 31

Demand for controlled products, gasoline and transportation fuels, natural gas, and electricity, grew faster after 2001 than over the period 1990 – 2001. Compound annual growth rates for fuel and product demand are presented in Figure 4. As presented in Figure 5, demand for oil products, gas, and electricity grew rapidly in relation to its 2002 level, in total reaching 150% of 2002 demand by 2013. Consumers expanded structural demand for energy, leading to a large growth in residential energy demand per capita, as show in Figure 6.  The low fixed costs for products disrupted the distribution business, garnering complaints from the Argentine gas distributors trade group, citing the inability of distributors to maintain operations at current prices; GasNatural Fenosa, for example, depended on federal assistance of 515 million pesos for operation and maintenance in 2015.[9]

Figure 4

Growth in Demand by Product and Sector CAGR 1990-2013 CAGR 1990-2001 CAGR 2002-2013
Transport – Oil Products 1.5% 0.8% 3.2%
Residential – Gas 3.9% 4.1% 4.2%
Residential – Electricity 5.7% 6.4% 5.9%
Commercial – Gas -1.2% -5.0% 2.9%
Commercial – Electricity 6.5% 9.3% 4.6%
Industry – Oil Products 5.4% 12.9% -0.2%
Industry – Gas 2.3% 1.7% 2.8%
Industry – Electricity 3.7% 4.4% 3.6%

Figure 5

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Figure 6

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Regulatory Impact on Industry

            The regulation of the wider economy and energy sector in particular created large distortions in supply and demand that led to a severe decline in the upstream sector, in terms of investment, production, and wells drilled. Figure 7 presents private investment in the energy sector over the 2000s. Since consumer prices were fixed and could not react to increasing demand, prices in the upstream sector remained depressed, depriving the market of signals to raise production and seek new supply. The aforementioned export duties were introduced as a measure to maintain domestic supply for the market, yet only served to extinguish exports. Over the five year period following the 2002 introduction of export restrictions on oil, crude oil exports declined by 79%, despite production only falling by 12% over the period, as shown in Figure 8. Similarly, gas exports collapsed five years after export duties were introduced in 2004, falling 87% while production only decreased 7% (Figure 9). Imports of gas rose 36% during the period. The inability of producers to sell at realistic market prices, in either the domestic or international markets, disincentivized investment and production. Restrictions on repatriations for foreign firms, currency controls, and denomination of energy prices in pesos made Argentina even more unattractive as an upstream market.

Figure 7

1.png

Figure 8

1.png

Figure 9

1.png

Regulation of Production

Seeking to address the deteriorating energy balance and decrease the outlays of foreign reserves to purchase energy in the international markets, the government sought to stimulate domestic production through a complex system of subsidies and producer pricing regulations. Wellhead prices for natural gas prices remained below $2.30/MMBtu until 2012 as a result of import competition and fixed consumer prices. Relative to international benchmarks, wellhead oil prices were also depressed as a result of an autarkic market and consumer price controls.

During the CFK administration, the Ministry of Energy and Mines declared Resolution 24/2008,[10] introducing the Gas Plus program, which enabled producers to receive prices greater than the controlled prices agreed to between the Ministry and producers. Similarly, the oil market received tax credits through the Oil Plus program, as part of Decree 2014/2008. Seeking to eliminate gas exports to keep the domestic market supplied, Resolution 127/2008 further raised the gas export tax to 100% of the highest price between Bolivian and LNG imports. Natural gas was subject to greater taxation as a result of its systemic importance to the Argentine economy, penetrating all sector including transport, and thus was deemed more important for retaining for the domestic market. This taxation stands in contrast to oil, which was taxed to a lesser degree and provided foreign currency export revenues for the government.

As the problem of domestic production became more acute by 2012, the government took more drastic steps through Decree 1277/2012, establishing the Commission for Planning and Strategic Coordination, and Law 26.741, nationalizing YPF-Repsol. The Commission gained pervasive powers to regulate the energy sector, including price-setting and approvals of private investment plans. The ultimate intention of the Commission was to ensure that firms were investing in the upstream sector in accordance with government plans for production. The expropriation of YPF similarly sought to bring greater control over the largest E&P player in the country in order to develop resources more quickly, particularly prolific unconventional reserves.

Production Subsidy Structure

The Commission, acting under a series of decrees, laws, and resolutions passed between 2012 and 2015, created a complex series of pricing regulation that sought to simultaneously subsidize both producers and consumers. In particular, Resolution 1/2013 set the wellhead price of natural gas to $7.50/MMBtu for production exceeding levels planned by the Commission. The federal budget covered the difference between the $7.50 price and the market price, which typically remained below $3/MMBtu, leading to large expenditures on energy. The remaining resolutions are summarized in Figure 10. The Commission established differential pricing for producers based on the final use of the gas, the date of operation, and the resource basin. Wells operating before 2013 may receive a price between USD $4/MMBtu and $7.5/MMBtu, depending on the production curves and whether or not the gas is reinjected. Projects streaming after 2013 sell into the market and receive the difference from the government to equal a wellhead price of $7.5/MMBtu.[11] Basins make a further difference, with the highest prices reserved for Neuquén Basin shale. Production for CNG networks receives a price of 0.89 ARS/m3.  The complexity of the subsidy structure, not only introduces uncertainty over its maintenance by political forces and added transaction costs, but also ensures that only large producers are able to meet their investment targets and field the legal expertise to capture the subsidy rents.

Figure 10

Law Effect
Decree 929/2013 New E&P projects can export up to 20% of production tax-free
Resolution 60/2013 Price range for incremental volumes for small gas producers set to between USD $4.00 and $7.50/MMBtu.
Law 27.007 Amends 1967 law extending length of concessions and lowers investment requirements
Resolution 139/2014 Defines rights of acquired companies to subsidies
Resolution 123/2015 Better defines participation in subsidy program
Resolution 185/2015 More firms eligible for production subsides

The oil sector, historically offering terms similar to international oil prices, attained a large degree of support following the 2014 oil price collapse. The CFK government retained pricing support at $77.5/bbl[12] at the wellhead in order to encourage investment and prevent an increase in unemployment in sensitive provinces. The Macri administration, coming into power at the end of 2015, lowered price support to USD $67.5/bbl for light Neuquén crude and $54.90/bbl for heavier San Jorge basin crude.

The combined total of energy subsidies, for both the upstream and consumer segments, began to take up an increasing portion of the federal budget. The budgetary cost in 2015 amounted to $18.4 billion USD, primarily requiring servicing through foreign reserves. After the accession of the Macri administration, Decree 272/2015 abolished the Commission and its duties were transferred to the Ministry of Energy and Mines. The Macri government began to unwind the subsidy structure, lowering guaranteed prices at the wellhead as previously mentioned and permitting free exports and imports and repatriation of 70% of export revenues. The pro-market agenda has already attracted investment, though years are likely to pass before the investment materializes into production growth.

Argentina: A Case Study in Regulation

Argentina’s energy regulations are the result of a series of incremental regulatory measures seeking to react to the problems caused by the initial energy price controls. The primary regulations of 2001 intended to stabilize prices and stimulate economic growth were successful, while export taxes did diminish exports, providing the domestic market with stranded supply intended for export markets. However, the temporary measures became permanent in practice and began to severely distort the market. Fear of political unrest ensured that only additional regulation, rather than amendments and rollbacks of previous measures, were possible. In accordance with basic economic principles, the price ceilings on energy resulted in a supply shortage as producers found it uneconomical to continue investments. Subsequent regulations sought to spur investment through a series of command-and-control measures and subsidies. However, each incremental regulation failed to bring about a balanced energy market.

Argentina provides a case for the need of an independent, institutionalized, and professional regulator that can balance the interests of consumers, producers, and the social goals of the government. In Argentina’s centralized political system, in which the Executive retains large powers to regulate and issue emergency decrees, requiring a 2/3 vote in the Congress to overturn, regulations were easy to issue and difficult to lift without checks and balances. Regulation by decree is inherently subject to political whims and only provides broad solutions to a particular problem. As such, the Argentine system continually introduced uncertainty into the energy market, preventing firms from modeling financial performance and investing, while constant changes precluded the institutionalization of a professional regulatory body. The complex multi-tiered pricing structure also added unnecessary opacity, complicating investment decisions and leaving room for patronage and moral hazard. An independent regulator, with formulaic, rather than set prices, would serve to introduce stability, particularly through cost-plus pricing. In particular, targeting bands of prices, rather than fixed prices, would allow limited price signals to give producers, consumers, and regulators insights into market developments. The top-down Argentinian regulatory model has not brought the energy market to balance, only eroded energy security, and its failures demonstrate the need for professional regulatory capacity for other countries seeking to manage the energy market.

Beyond the regulator itself, Argentina demonstrates the interaction effects of intervention in the markets. Additional regulation, rather than simply causing its intended effect, can often interact with preexisting market distortions to cause unintended consequences. Argentina’s government consistently sought to correct problems through additional regulation, which begot further issues and regulations. Often, the impact of a particular regulation is unpredictable, especially for energy, which impacts every sector of the economy. The interaction effects call for recognition of problems and the flexibility to address them, even at political cost. Argentina’s particular form of political populism may preclude the possibility of addressing such issues quickly and early, but the lesson may be applicable elsewhere. The economic impact of additional regulation makes a strong case for a technocratic regulatory body, with the power to reverse decisions as necessary; it is not expected that all regulations are correct or achieve their desired outcome each time. Maintaining simple, transparent, and flexible regulations can better achieve social goals than crystallized controls, even if it takes some power away from politicians.

Conclusion

            Argentina’s energy regulations throughout the 2000s demonstrate that even well-intentioned regulation can be subverted by top-down political processes and interaction effects, creating the need for an independent regulator and the ability to reexamine regulations, rather than introduce new ones to correct prior measures. In response to the 2001 crisis, Argentina enacted price controls to protect consumers from rising prices and stimulate economic growth. After a return to growth, price controls became fixed and permanent as the government feared political unrest resulting from their abolition. Low and fixed consumer prices, coupled with export restrictions, translated into producer prices that were insufficient to enable investment in the country, particularly given the general volatility of economics and politics. The government turned to making the energy market more autarkic before resorting to command-and-control measures and subsidies to correct the low producer prices caused by the initial regulations. Ultimately, the Argentine government oversaw a vast increase in federal energy subsidies while the country became a net importer of hydrocarbons. The Argentine case shows the inefficacy of broad centralized regulation by decree, necessitating an independent regulator to balance the interests of the government and market participants. The interaction effects of various decrees and controls further show that flexibility in implementing regulations is necessary to correct for unintended consequences. Argentina’s energy regulations evolved into capricious decrees that only worsened problems in the energy market, rather than solving them, demonstrating the need for pragmatic flexibility and a professional regulatory apparatus that can be applied beyond Argentina.

 

[1] Government of Argentina. “Ley de Hidrocarburos.”  23 June 1967

[2] Government of Argentina. “Reforma del Estado”  17 August 1989

[3] Government of Argentina. “Federalización de Hidrocarburos” 24 September 1992

[4] Government of Argentina. “Exportaciones” 13 May 2002

[5] David Mares. Political Economy of Shale Gas in Argentina. (Cambridge, MA: Belfer Center 2013).

[6] Government of Argentina. “Emergencia Publica y Reforma del Regimen Cambiario” 6 January 2002

[7] Ministry of Energy and Mines. “Aclaraciones y recomendaciones” 10 April 2016

[8] World Development Indicators. (Washington, DC: World Bank Group, 2016).

[9] GasNatural Fenosa. Interim Report January – September 2015 Results. 4 November 2015.

[10] Government of Argentina. “Gas Natural” 3 June 2008

[11] YPF. Form 20-F 2015. December 31, 2015.

[12] “Argentina Cuts Wellhead Prices” ArgusMedia. 6 January 2016.

1973 Oil Crisis in Context

03 Wednesday Dec 2014

Posted by V. Markov in History, Oil, OPEC, United States

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Tags

Eisenhower, Embargo, europe, Israel, James Akins, middle-east, Nixon, oil, oil consumption, Oil Crisis, Oil Weapon, OPEC, Politics, security, united states, US, Western Europe, Zamani

Gas Shortage

Introduction

On October 17th, 1973, the industrialized world woke up to a sudden and unprecedented threat to its own growth and prosperity; never before had it faced such a constraint to its growth nor had it ever been so dependent on a resource it no longer had unlimited dominion over, overturning a system in place since 1860. Price shocks and crises of supply were nothing new within the oil market. However, it was the utter helplessness to alleviate the crisis given the dependence on and inelasticity of oil consumption. The US invited the 1973 oil shock through its complacency and revealed the rigidity of the oil supply-demand system. Although elements within the policymaking establishment sounded the alarm in the years prior to 1973, there was no action to prevent or mitigate the blow of a supply crisis. The direct event leading to the embargo was clear – US support for Israel during the 1973 war. The systemic issues were longstanding and pushed the oil supply-demand system in that direction for years. Despite the confluence of events that suggested a high probability of an effective and sustained oil embargo against the West, the US failed to understand the oil supply-demand system and its elements, misreading both the quantitative risk and immeasurable uncertainty, allowing itself to blunder into the crisis and forgo preventative measures.

1973 Crisis in Context

The oil crisis of 1973 presented the industrialized world with a radical departure from its collective experience in the previous oil crises of 1956 and 1967. An easy escape from consequences in the previous crises altered the calculus in the US, forming biases in the evaluation of risk and uncertainty. The outcome of these crises prevented an evaluation of the systemic changes had accrued between 1956 and 1973. Thus, a brief description of the 1956 and 1967 crises is necessary for understanding biases against action before October 1973.

In addition to the historical events, understanding the complex system that brought oil from well to consumer is crucial. In an economics system framework of Meadows, the stock of the system is the available supply of oil. The inflow into this stock comes from the producers, the supply-side, and the internal mechanisms that allowed this production. Up until 1973, the major producers of the world were the US and the countries of the Persian Gulf, North Africa, Indonesia, and Venezuela. The Eastern Bloc was generally autarkic and remained outside of this inflow. Within that, it was the Western oil companies that had the expertise and technology to extract oil effectively. Through this power, the companies were able to negotiate the terms of royalties agreements and dictate prices to the world markets through posted, rather than floating, prices. The entrance of smaller independent companies into the market gave host governments leverage to negotiate with them by the late 1960s. Within each producer, there was a different mixture of domestic politics that influenced production – regulatory bodies and environmental legislation in the US and authoritarian and popular politics that influenced production in the remainder. Of the US regulatory bodies, the Railroad Commission of Texas (RRC) was the most powerful, stewarding oil production to encourage conservation and maintain prices in a “situation of chronic potential oversupply,”[1] creating the easily employable spare production capacity in the US. Indeed, it controlled more oil production than all other major producers. The RRC served as both a buffer for the system and a regulatory feedback loop that regulated prices around a band to avoid the volatility that characterized the oil market in its early years. The main objective of the supply side of the oil market system was to provide abundant oil at relatively cheap prices; it was produced these exact results, much to its own detriment.

The demand side of the system, to which the stock outflowed, consisted of the major industrial economies, the US, Western Europe, and Japan and the subsystems that defined their level of oil consumption. Fueled by both economic expansion and preference against polluting coal, these economies expanded their use of oil for power generation, spurred on by seemingly endless cheap oil prices. As these countries became ever more reliant on oil for transportation and electricity, their demand increased and became more inelastic, making the system more rigid and precariously balanced on an oversupply of oil. This created an unsustainable reinforcing feedback loop that oversupply of oil kept prices low, which encouraged profligate oil use, which further tightened supply. Eventually, prices had to increase in accordance with supply and demand, or the rigid system would suffer a shock.

1956 – The American Oil Weapon

By the time Gamal Nasser finished excoriating erstwhile European colonial powers in his speech in Alexandria on July 26, 1956, the Egyptian army had already moved forward and seized the Suez Canal. The Canal was the crucial supply line to Middle East oil, and the British and French governments decided to bring it back under Western control. British Prime Minister Anthony Eden complained to Eisenhower that “Nasser can deny oil to Western Europe and we shall be at his mercy.”[2] Ironically, Eisenhower would be the one denying oil to Western Europe in short order.

US contingency plans for an oil shortage among the European allies centered on the Middle East Emergency Committee, which was tasked with coordinating the resources to draw on American spare oil capacity and reroute the tanker lines to supply the Europeans. The French and British, assuming they would have American support, coordinated with the Israelis to launch a joint intervention and seize the Suez Canal on October 24th, 1956. Eisenhower, fearing that military action could generate instability in the Middle East and open an opportunity for Soviet gains in the region, was furious with the Europeans. Nasser scuttled several ships in the Canal as a result of the war, shutting it down and forcing the oil supply lines to go around Africa and thus constricting supply to Europe.

With Britain and France in the middle of an oil supply crisis, Eisenhower refused to activate the emergency resupply committee and actually imposed oil sanctions on them until they accepted his demands for withdrawal. Meanwhile, Saudi Arabia also embargoed Britain and France to little effect. Under political and economic pressure, Britain and France fully withdrew from Egypt, at which point the US finally activated its emergency committee to make up the oil shortfall. The lesson was clear; the US was able to impose its will through its abundant oil resources. Although a European crisis, the 1956 oil shock confirmed US energy security.

1967 – The US Rescues Europe

By 1967, the global oil market was changing but was not a radical departure from 1956.  OPEC had come into existence in 1960, but it was still an ineffective coordinating body. The industrialized world consumed ever greater quantities of oil, averaging 35.5 million barrels each day in 1967, accounting for 45.7% of all domestic energy consumption.[3] On the eve of the Six-Day War, Europe imported 75% of its oil from the Arab exporters, leaving it vulnerable in the short term.

On June 5, 1967, Israel preempted an attack by the Arab states of Egypt, Syria, and Jordan, quickly overrunning their positions. For their support of Israel, the Arab exporters imposed an oil embargo against the US, UK, and West Germany on June 8, reducing production by 60% and precipitating an immediate oil crisis in Europe.[4] The US set into action, with the RRC allocating an additional million barrels of production to make up the shortfall, resupplying Europe and saving it from the crisis. By July, the oil weapon and the embargo had failed; the Arab exporters gave up revenues while continuously subsidizing the Arab belligerents. The Arab producers had to increase production to maintain their market share, thus Arab production was 8% higher after in August than just before the war.[5]  Once again, the US, as described by the National Security Council in 1960, was “Europe’s principal safety factor in the event of denial of Middle East oil.”[6] However, it took a mere six years for this margin of safety to erode.

The US Invites the Wolf

By 1973, the confluence of several factors eroded the energy security of the industrialized world, even if the perceptions of security remained. The US passed a significant milestone in March, 1971, when the RRC  allowed full production for the first time under normal circumstances; the spare capacity of 4 million barrels a day during the period of 1957 to 1963 had been whittled down to 500,000 barrels in 1973, only 1% of industrial world consumption.[7] As a result, the US was importing 36% of daily consumption by 1973. As early as 1968, the US State Department had informed the OECD countries, much to their surprise, that the US would soon be left with no spare capacity and unable to provide emergency relief. Contemporaneously, the industrialized nations were undergoing an economic boom, with 1973 GNP growing at 10.4% in Japan, 5.9% in the US, and 5.4% in Western Europe.[8] The oil glut of the previous 20 years kept prices low, incentivizing the switch from coal to oil electricity generation for economic and environmental reasons. Compounding the issue, the ordinary consumers became accustomed to boundless cheap energy; efficiency and conservation became an afterthought. Oil thus constituted 46% of all energy consumption in 1972, up from 28.9% in 1950.[9] These changes added not only demand but short-run inelasticity to the system of demand. On the supply-side, low oil prices made more expensive production uneconomical, an issue further compounded by increased environmental regulation. A victim of its own success, the cheapness of oil encouraged profligate use, which fed back into the system, making it even more rigid and vulnerable.

Just as the demand was becoming more inelastic, the major oil companies came under pressure from independent producers, which were offering host countries better royalties agreements. Nascent revolutionary regimes in Libya, Algeria, and Iraq seized upon the opportunity, isolating the companies and gaining concessions. Once Qaddafi wrested a 55% share of the profit from oil sales in 1970, the event changed the entire supply-side dynamic; 55% became the minimum acceptable to host governments. With profit sharing altered, the issue of price became the main negotiating point. The abandonment of the Bretton Woods System and relaxation of the gold standard devalued the US dollar in the early 1970s, bringing down the real posted price of oil. Suddenly, the oil companies came under further pressure to raise posted prices, which had remained nominally the same since 1961.[10] The US government was unconcerned with this development at the time, as the pressure to increase prices “did not immediately seem threating to a range of interests broader than those of the corporations immediately involved.”[11] These events significantly increased quantifiable risk in the system as a function of import dependence, tight supplies, and inelastic demand, suggesting a higher probability of a shock.

As the US ignored the risk, it also misread the uncertainty of the situation and gauge the probability of an impending disaster. Warnings did come from within the government. A 1970 State Department report recognized the changes in the oil market, warning that producing countries will be able to collude in raising prices and determining production, yet “no one in Washington paid any serious attention to the message.”[12] Contrarily in the same year, the president’s Task Force on Oil Imports predicted “only five million barrels per day would need to be imported, and most of this could come from the Western Hemisphere” by 1980.[13] The projection was already exceeded by 1971. Another alarming State Department report by James Akins, a senior Foreign Service Officer, encouraging “the development of alternative energy sources, and controlling [American] consumption”[14] to reduce dependence. Akins published his concerns publicly in his article “The Oil Crisis: This Time the Wolf is Here” in Foreign Affairs in 1973. Akins was able to separate the signal from the noise, recognizing the changing dynamics of US spare capacity, demand inelasticity, and changes in the Middle East that put OPEC in “[control of] a product which is irreplaceable in the short run, and is vitally necessary.”[15] The view of Akins and the State Department were controversial, particularly the projections of price increases seen as impossible, while opposing viewpoints, those of an impending oil glut, proliferated in Washington. In a sense, the “warning flags were up, but there was no particular response, nor…was there the requisite consensus either in the United States or among the industrial countries as a group that would have been needed for more concerted prophylactic action.”[16] Indeed, “before 1973, there was no policy at all envisaging a serious confrontation with OPEC.”[17] Understandably, in the 1960s, it was assumed that spare capacity of two million barrels would still prevail in 1975[18] and the US even rejected an offer from the Shah of Iran in 1969 to deliver “1,000,000 daily barrels of oil for ten years at $1.00 per barrel in order to establish a stockpile”[19] as a buffer in the system. The risk was in place; the uncertainty was made difficult by the multitude of opinions and misunderstanding of the supply and demand system.

The Arab Exporters

As the US entered the oil market as a major importer, market prices for oil began to exceed those of posted prices. In the tight market, some Arab leaders, particularly Sadat, were insisting that the oil weapon be used to realize political goals. King Faisal of Saudi Arabia, historically dovish, rejected this use of oil, preferring American favor as a counteracting force against instability and communist incursions into the region. However, Faisal was vulnerable to public perceptions; he had to maintain solidarity with Egypt and the Palestinians or risk suffering terrorist attacks on oil infrastructure. Faisal genuinely did not want conflict with the US, but continued support for the US would isolate Saudi Arabia from the other Arabs. In light of recent devaluations of the dollar, Faisal began to reconsider his position and warn that the Saudis would “not increase their oil production capacity to meet rising demand, and that the Arab oil weapon would be used in some fashion, unless the United States moved closer to the Arab viewpoint and away from Israel.”[20] This reality was impressed upon the oil executives at Aramco, the Western firm responsible for extracting Saudi oil, who conveyed the message to an unconcerned US government: there was “a large degree of disbelief that any drastic action as imminent or that any measures other than those already underway were needed to prevent such from happening.”[21] The Saudis continued to message that King Faisal is “one hundred percent determined to effect a change in US policy and to use oil for that purpose.”[22] Although such messaging was designed to convince the US of the seriousness of the threats, and even Nixon announced at a press conference that the use of the oil weapon to change US policy “was a subject of major concern,”[23] there was little “contingency planning relating to possible OPEC and producer country actions” or more overt messaging to assuage Arab concerns. Despite the use of the embargo in previous crises, the administration took no action.

As the Arabs prepared to launch the 1973 war against Israel, Western and Israeli intelligence indicated that the event was unlikely. As a result, the October 6 surprise attack on Israel worked as planned, with Egypt and Syria scoring several initial victories. Meanwhile, the negotiations over posted prices between exporting governments and the companies were at a standstill. The countries decided to unilaterally raise prices to those of the spot market, instantly increasing oil prices by 70% to $5.11 a barrel. This event changed the entire supply-demand radically from its structure in 1967. At this point, unaccustomed to high oil prices, the US was already facing an energy crisis.

The US only wanted to avoid involvement in the 1973 war. However, given Soviet supply shipments to Syria and Egypt, the US decided to resupply Israel and keep it in the war, thereby confirming its favor of Israel over the Arabs. Henry Kissinger tried to frame the actions as anti-Soviet rather than anti-Arab, erroneously still believing that the Arabs would not use the oil weapon. On October 17, the OPEC oil ministers agreed to cut overall production by 5% each month until their political objectives were realized and the US ended support for Israel. The cuts in absolute supply pushed prices to $11. The US then announced a $2.2 billion aid package to Israel. Thus everything was in place, a tight market, organization, a willingness to use oil for political ends and no emergency supply; the wolf was at the door and the US all but invited it into the house.  On October 20th, this final public action prompted the immediate embargo of oil exports to the US from the Arab states. Thus the US was caught almost totally by surprise by the imposition of the Arab oil embargo, which it had consistently assumed would not materialize. The effects were disastrous for the US economy, which had grown so reliant on cheap oil, and it went into recession, spending the better part of the 1970s dealing with stagflation and unemployment.

[1] Daniel Yergin, The Prize: The Epic Quest for Oil, Money, and Power. (New York: Free Press, 2008): p. 549

[2] Yergin, The Prize, p. 467.

[3] Data derived from British Petroleum. BP Statistical Review of World Energy June 2014. (London: BP, 2014).

[4] Yergin, The Prize, p. 537

[5] Ibid, p. 539.

[6] Ibid, p. 538.

[7] BP, Statistical Review.

[8] Darmstadter, Joel and Hans Landsberg. “The Economic Background.” The Oil Crisis. (New York: W.W. Norton & Company, 1976. 15-39): p. 18

[9] Ibid, 19

[10] BP, Statistical Review.

[11] Philip, George. The Political Economy of International Oil. (Edinburgh: Edinburgh University Press, 1994): p. 156.

[12] Yergin, The Prize, p. 569.

[13] Akins, James. “The Oil Crisis: This Time the Wolf is Here.” Foreign Affairs. April 1973.

[14] Akins, “The Oil Crisis.”

[15] Akins, “The Oil Crisis.”

[16] Yergin, The Prize, p. 573.

[17]  Parra, Francisco. Oil Politics: A Modern History of Petroleum. (New York: I.B. Tauris & Co., 2004): p. 168

[18] Lovejoy, Wallace and Paul Homan. Economics Aspects of Oil Conservation Regulation. (Baltimore: The Johns Hopkins University Press, 1967): p. 112.

[19] Ibid, 157.

[20] Yergin, The Prize, p. 577.

[21] Ibid, p. 578.

[22] Ibid, p. 579.

[23] Ibid, p. 580

Keystone XL – Canada Looks to Asia

13 Thursday Feb 2014

Posted by V. Markov in Canada, Keystone, Oil, United States

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asia, canada, China, harper, keystone, keystone xl, obama, oil, pipeline, Politics, state, state department, stephen, tar, tar sands, The Keystone XL, transcanada, xl

The Keystone XL has been a topic of much contention and frustration for several years. With the US State Department’s release of its Final Supplemental Environmental Impact Statement report on January 31st, 2014, the pipeline has become no less controversial though recent developments suggest that the project will be approved. The primary contention has been the safety and environmental impact of the pipeline, though it is important to recognize the situation from a Canadian context as well as an American. 

All figures below are derived from BP’s Statistical Review of World Energy 2013, unless otherwise noted.

Canadian Oil Reserves

About 98% of Canada’s oil is concentrated in Alberta, and 99% of that oil is in the form of unconventional oil sands. These Albertan reserves amount to 170.2 billion barrels, though this oil is heavy, with a low API gravity, and sulfurous. US refineries have been increasingly equipped to handle such oil, making it suitable for the US market.

In 2012, Canada exported 3.056 million bpd and imported about 700,000 bpd. Of these exports, 2.955 million bpd went to the US, comprising 96.6% of all Canadian exports. As such, the US holds a near monopoly on Canadian oil, which has given the refining and transportation system its present structure.

Canadian oil sands are particularly sensitive to oil prices, requiring “$40-70/bbl for new in-situ projects and $80-100/bbl for new surface mining projects” according to the Energy Information Administration. Understandably, the surge in oil prices in the 2000s has led to a boom in Canadian oil sands extraction.

Avoiding a needlessly in-depth discussion of the characteristics of Canadian bitumen here, the EIA notes that “many objections to oil sands development center upon the relatively energy-intensive and carbon-intensive extraction and processing methods required. Calculations of the climate impacts of oil sands development are complicated and often yield different results but, caveats and exceptions aside, well-to-tank greenhouse gas emissions are typically higher for oil produced from the oil sands than oil produced through conventional means. The potential to exacerbate climate change is merely one of the environmental costs that accompany the development of Canada’s oil sands.”

Effectively, producing oil from Canadian oil sands requires a much larger expenditure of capital and energy, in addition to greater carbon emissions. One might expect this of an unconventional energy source, and it remains a large point of contention for environmentalists.

Canadian Exports to the US and Integration

At present, Canada suffers from bottlenecks in pipeline and rail capacity to bring its oil to the US market, resulting in losses of “$47 million a day on average, implying $17 billion a year,” according to the Fraser Institute. Essentially, Canadian oil trades at a discount to the world price because it cannot reach world markets and remains bound to the US pipelines in the Midwest, creating a glut and forcing a $37 price discount to Brent crude prices as a result. Obviously, the Canadian government is pushing to resolve the situation and decrease the discount for Canadian oil. As such, it is pushing for the approval of the Keystone XL pipeline, which will help bring more of this oil to market at a cheaper transportation rate than rail.

The result of the large price differential, coupled with pipeline bottlenecks, has been the rise of crude by rail. Even though rail is more expensive as a method of transportation, the price differential is large enough that transporting crude by rail is still profitable. If that price differential were to narrow, it would be no longer worthwhile to transport crude by rail. However, for now, the expansion of rail networks continues. The State Department’s most recent reports notes the rise of rail infrastructure in recent years and the accompanying rise in transportation, which has increased from nearly none in 2011 to 180,000 bpd in 2013. According to the report, rail loading facilities are expected to increase by 57% to a capacity of 1.1 million bpd from the present 700,000 bpd. As more crude by rail is brought to US refiners, bypassing the pipelines, the price differential will narrow, perversely, making rail less competitive. In any case, more oil will come southward to the US.

As such, Canadian oil from Alberta will continue to come into the US, albeit at a higher price, with or without the Keystone XL pipeline.

The pipeline itself will add 830.000 bpd of capacity, of which, 100,000 bpd will be reserved for the Bakken shale. This will help alleviate some of the bottlenecks and provide Canadian producers with a narrower differential for their oil, placating some concerns.

US Domestic Politics and Pipeline Approval  

The primary point of contention has been the safety and environmental impact of the pipeline on both greenhouse emissions and aquifers in Nebraska, as well as continued dependence on oil. As the project crosses the US-Canadian border, it requires approval from the State Department and, ultimately, the president to begin construction. The State Department report takes into account revised routing and additional precautions taken on the pipeline. The report appears favorable to the project, noting that “approval or denial of any one crude oil transport project, including the proposed Project, remains unlikely to significantly impact the rate of extraction in the oil sands, or the continued demand for heavy crude oil at refineries in the United States.” It also notes the bypassing of important aquifers in Nebraska and the lowered incidence of high volume spillage through the use of pipelines. The greenhouse emissions from the project are insubstantial, though the greater fear remains the US dependence on the particularly energy and carbon intensive oil sands of Canada. The much-lauded job creation aspect of the pipeline will be minimal and only temporary construction work, for the most part. 

The report itself appears to be a necessary piece of information for the administration to make a defensible decision on the pipeline. US domestic politics come into play as the administration, which has long-courted environmentalist constituents has to decide on the pipeline, especially when vulnerable Democrats have to win reelection and are under local pressure for and against the pipeline. 

Canada – Looking East

The more interesting effects of the Keystone pipeline are actually taking place in Canada. Canadian PM Stephen Harper has been repeatedly on the record as frustrated with American delays of the project. Even in early 2012, Harper was quoted saying “Canada will continue to work to diversify its energy exports.” With no land outlets other than through the US, Canadian energy can only by shipped by sea. As most Canadian oil is located in Alberta, shipping the crude westward to British Columbia makes the most sense. There are already pipelines to Vancouver and the Trans Canada pipeline is being reviewed for expansion. British Columbia and Alberta are already cooperating on allowing Enbridge to construct additional pipelines with a specific aim of exporting to Asian markets, pending environmental and safety concerns. Even just recently, Harper’s statements have echoed a feeling of frustration “this administration may continue to be difficult for reasons of internal politics, but I do believe that one way or another these decisions will go ahead at some point.”

The US clearly does not want Canadian oil to be exported elsewhere when it receives nearly all Canadian exports; the US National Oceanic and Atmospheric Administration released a report warning of the dangers of transporting crude to British Columbia. The timing of the report coincides with increased calls for outlets other than the US, especially when the Enbridge pipeline is expected to carry about 500,000 bpd, constituting a substantial portion of Canadian production. 

In short, the Canadian government is frustrated with the pace of developments in the US over the Keystone XL. It will begin looking for other outlets for its oil, ones that will pay the world price and minimize the discount on Canadian crude. This move would be advantageous to Canada and detrimental to the US as competition is introduced into the system. Moreover, the system of refineries and conduits depends on a constant stream of Canadian oil and would be disturbed as a result, unless US sources can make up the difference. The Keystone pipeline is about more than just environmental concerns; it underscores a systemic arrangement that is not static and unchanging; the Canadians have the option to reorient the arrangement to their benefit and to American disadvantage.

The US enjoys a monopolist’s position; political diffidence may squander this advantage for US refiners and consumers. Keystone may not lower gasoline prices in the US, but it may just prevent them from rising as it enables the current energy arrangement between the US and Canada to continue.

Iraq, Kurdistan, Oil, and Sovereignty

26 Sunday Jan 2014

Posted by V. Markov in Iraq, Oil

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Erdogan, Iraq, KRG, Kurdistan, Maliki, middle-east, oil, Politics, Saddam Hussein, security, Turkey

Maliki

Kurdistan within Iraq has proven to be a surprising island of stability in the region and the country. Its success has cascading repercussions for Iraq and the wider region and, of course, energy developments. Although Kurdistan is unlikely to realize a significant impact on worldwide oil markets in the short term, the developments there, in both politics and oil, could produce significant changes and difficulties in the Middle East.

The Last Hurrah of Easy Oil

Kurdistani oil has been described as “the last easy oil” in the world, where one can “put a pipe in the ground and the oil starts flowing” according to the International Energy Agency’s executive director Maria van der Hoeven. Under Saddam Hussein, the region remained a target for oppression and underdevelopment. Hussein’s central government sought to divide and conquer the Kurds politically and settle traditionally Kurdish areas with Sunni Arabs. Upon the Kurdish cooperation with Iran during the Iran-Iraq War, Hussein exacted his vengeance, resulting in the infamous attacks on the Kurds in the late 1980s. Following the Gulf War, Kurdistan remained a victim in the general UN sanctions program against Iraq, although it did receive some revenues from the oil-for-food program. It also maintained a level of autonomy in the 1990s as the West imposed a no fly zone and central government troops withdrew from the region. In terms of oil, Iraq developed the oil fields near Kirkuk, yet they remained under central control despite their proximity to Kurdistan. After the 2003 invasion, Kurdistan was spared much of the chaos and managed to emerge as the most stable part of Iraq. The Kurdistan Regional Government (KRG) has focused on branding itself as different from the rest of the country and seeking foreign investors through economic liberalization and political stability.

Proven reserves in the territory under KRG administration figures at about 45 billion barrels. This accounts for about 30% of Iraq’s 150 billion barrels of proven reserves.  

It’s no surprise that major oil companies are looking to develop oil plays under the suzerainty of the KRG. Exxon, Chevron, and Total and an assortment of smaller E&P firms are trying to operate in the area. According to KRG figures,  Kurdistan itself exported 100,000 barrels a day in 2011, constituting about 3.5% of total Iraqi production. According to Ashti Hawrami, the KRG’s Minister of Natural Resources, Kurdistan presently produces 300,000 barrels daily, an increase amounting to 9.6% of total Iraqi production (BP figures). However, oil industry sources put the KRG’s total export capacity at 225,000 bpd.  Of these exports, Kurdistan has relied on trucks to transport it about 50,000 bpd into Turkey. 2014 appears to be set to see oil production increase by 33% to 400,000 bpd through the use of newly built pipelines. Hawrami, ever optimistic, predicts 1 million bpd in 2014, though previous KRG projections from 2009 wildly overestimated production figures, expecting 400,000 bpd by 2011 and 1 million bpd by 2014. Naturally, the KRG has a vested interest in being optimistic about its own prospects to attract foreign investment in an unstable region.

In terms of the deals themselves, the KRG has taken a markedly liberalized approach to E&P, offering favorable terms to oil firms. For example, DNO, a Norwegian independent, secured a production sharing agreement (PSA) with the KRG, giving it a 40% share of the first 50 million barrels produced from the Tawke oil field.  These terms are more favorable than those offered by the central government, no doubt intended to attract much-needed investment and provide a risk discount to foreign firms.

The Trials of Federal Governance

As foreign firms move into Kurdistan to build the production and export infrastructure, the central government in Baghdad is seeking to reassert its dominion over the KRG and force it to seek its approval for exporting crude oil. The Shiite Iraqi prime minister, Nouri al-Maliki, faces two restive regions, Kurdistan itself and the mainly Sunni west of the country. The primary goal of his administration, supported in this respect by both the US and Iran,  is to prevent the fragmentation of the country. The latent divisions in the country, repressed during the time of Saddam Hussein, have been a persistent issue since the 2003 invasion. 2013 has proven to be the worst year for sectarian violence since 2007, prompting a centralizing push by Maliki. 

Following the US departure in 2011, Maliki has had a free hand to secure the power of his Shiite coalition. The Washington Post has a great synopsis of the political dealings in Iraq. In a few words, the US failed to broker a political power sharing agreement in 2010 and backed Maliki’s Shiite coalition for the sake of stability. The US and Iraqi administrations also failed to establish a security agreement, contingent on prosecution immunity for US troops, similar to the current dealings with Afghanistan. Thus, following the American departure in 2011, Iraq was denied a cohesive professional American security force and the US lost additional influence in the country. Maliki took advantage of the American departure to begin persecuting his Sunni political rivals, inciting protests and sectarian violence.

Since 2011, the neighboring Syrian civil war has displaced large numbers of people and produced hardened and, often, radicalized fighters. Iraq is now feeling the secondary effects of this development. The Al Qaeda affiliate group, Islamic State of Iraq and Syria (ISIS). has begun encroaching on Iraqi sovereignty, coming into the western Al-Anbar province from Syria. The group seized Fallujah in late December 2013, forcing out the agents of the central government. However, it is uncertain if the local Sunni tribes in the province are cooperating with or confronting ISIS, with some receiving support from the Iraqi army and others remaining opposed to both ISIS and the central government. Any support for ISIS has resulted from Sunni feelings of disenfranchisement since the 2010 elections. Maliki fears losing this city, and thus his legitimacy, and has sent the army to surround Fallujah and wrest control from ISIS. As of this publication, the city remains under siege by the army.

Kurdistan in Context

Within the context of Maliki and the central government’s slipping control, comes the issue of KRG autonomy and oil exports. Understandably, losing either Kurdistan or Fallujah and the Anbar province to ISIS will deal a heavy blow to central legitimacy. Losing just one of these battles for political dominance will strengthen the resolve of political opponents in the other. As such, Maliki is put in an unenviable position of fighting a two-front political battle. Moreover, as more time passes and a section of the country remains out of his control, not only does ISIS entrench itself, but his governance appears ineffectual, giving both the KRG and local Sunni tribes in Anbar additional political maneuverability.

Maliki is making some overtures to appeal to the Sunnis, preferring to have them drive out Al Qaeda rather than risk a full assault on Fallujah. Meanwhile, he has attempted to clamp down on the KRG over the issue of oil exports. These exports fall within the purview of the central government, independent Kurdish oil exports remain an affront to Baghdad’s supremacy while denying it Kurdish oil revenues. This has resulted in Maliki threatening to reduce the share of the national budget the KRG receives under the guise of balancing the budget. The KRG is supposed to receive 17% of the budget, though, as the previously cited Economist article mentions, it frequently receives about 12%. The central government maintains that the KRG cheats the system by exporting oil independently through its own pipelines to Turkey and retaining the proceeds, thus it does not deserve its allotted budget. More than a budgetary issue, for Maliki, this is one of sovereignty. Allowing the KRG to retain oil export earnings undermines his own legitimacy while bolstering that of the KRG, which simultaneously receives funding to build up its governmental, security, and energy infrastructure.

Maliki cannot be heavy handed with his treatment of either issue, especially with elections looming in April. Yet, he must act lest his consolidated power slip away. The ISIS threat is clearly more urgent, though it buys time for the KRG to continue establishing itself. The KRG issue could be addressed by sending federal assets, judiciary, military, and police, to ensure that oil is not exported without central sanction. However, this would pull assets away from fighting ISIS and further alienate the Kurds. Alternatively, the central government could attempt to buy the loyalty of the Kurds and the Sunnis by increasing federal provisions, but that would result in a large budget deficit with the parameters of the present budget.

Ultimately, a federal Iraq can only be maintained by amicable relationships between Sunni Arabs, Shiites, and Kurds working towards a single commonwealth. This model can be made to work through the largesse of oil revenues, however, that would require additional stability and a single-minded focus on increasing exports while distributing them where most needed. Political ambitions, pettiness, rivalries, and outside influence all work against this model. Alternatively, it could be preserved through repression as it was during the time of Saddam Hussein. It appears as if Maliki may continue along his path of attempting to retain consolidated Shiite control of the central government through ham-fisted efforts that not only undermine Iraqi federalism and aggravate sectarian tensions, but also reduce the attractiveness of Iraq as a destination for foreign investment into its oil.

Kurdish Independence

As Kurdistan builds its institutions, the ambition of independence edges closer to realization. Interestingly enough, the KRG exports oil through Turkey, which has historically persecuted Kurds in its territory. However, energy concerns appear to be more important as Turkey attempts to diversify away from Russian and Iranian energy. Turkey’s prime minister Erdogan recently began reconciliation efforts with the Kurds, as Syrian Kurds have begun carving out their own part of Syria. Perhaps Erdogan is trying to push the Kurds away from the radical Kurdish parties in Turkey and into their own independent state, one that does not remove present Turkish territory. Pushing the Kurds to an independent Syrian or Iraqi Kurdistan may help alleviate the issue of Kurdish actions against the Turkish state, though, alternatively, they could press for pieces of Turkey with a Kurdish majority. Turkey is simultaneously attempting to build relations with Baghdad, which could provide a major source of hydrocarbons for Turkish growth. It appears that in the long-run, it can only accomplish cordial relations with either Kurdistan or Baghdad, given the former’s separatist intentions. Furthermore, it is important to note that many other players in the region have their own restive regions clamoring for independence and a successfully independent Kurdistan would legitimize these ambitions further. Iran, Syria, Israel, Russia, and, of course, Iraq would all prefer the status quo. The second and third order effects in these countries could be far-reaching, potentially resulting in shocks to energy markets and the regional military balance.

A fully independent Kurdistan with cordial relations with Turkey, and thus secured export lanes, would not likely shift oil markets very much in the near term. Even if exports rise to 1 million bpd, a potential fracturing of Iraq would result in higher oil prices as markets react to instability and the government loses additional ability to combat ISIS and other separatist factions. This could have multiple consequences for the region as a whole, which is likely why the US continues to support a unified federal Iraq. The future of the country remains in Maliki’s hands, he will either sacrifice its future stability and prosperity on the alter of sectarian politics or begin the reconciliation process to include Sunnis and Kurds in the spoils of Iraq’s oil wealth. He has not been this magnanimous in the past, and it remains likely that violence will increase as the central government loses its grip on different provinces. Though this likely remains positive for the KRG in the near term, the instability in Iraq will prove debilitating to its recent upward trajectory in oil exports.

France, Nuclear Dependence, and West Africa

14 Friday Jun 2013

Posted by V. Markov in France, Nuclear

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Africa, Algeria, electricity, energy, europe, France, Libya, Mali, Niger, Nigeria, nuclear, Politics, security, West Africa

In light of the recent attack on a Nigerien uranium mine in Arlit, Niger, it is worth taking a step away from fossil fuels to examine the nuclear side of energy.

French Nuclear Ambitions

France is known for, amongst other things, its reliance on nuclear power to deliver electricity to its citizens. Électricité de France exists as a public company with majority ownership by the French state and manages most French electricity production.

According to the EIA, France generated 530 billion kWh in 2011. Of this, the majority came from nuclear, and the rest from a mixture of fossil fuels and renewables. This is the breakdown:

  • 420 billion kWh from nuclear – 79.24%
  • 45 billion kWh from all fossil fuel sources – 8%
  • 44 billion kWh from hydroelectric – 8%
  • 22 billion kWh from renewables – 4%

French installed capacity for electricity generation, meaning total capacity of currently installed generators, expressed in kilowatts (kW), totaled 124 million kW in 2010. If the entirety of French capacity operated 24/7 for a full year, it would be capable of generating 1.086 trillion kWh. For comparison, the world consumed 18 trillion kWh in 2010.

The following list shows the breakdown of French installed capacity in 2010:

  • 63 million kW of nuclear – 50.8%
  • 27.4 million kW of fossil fuels – 22.09%
  • 18 million kW of hydroelectric – 14.51%
  • 8.5 million kW of renewables – 6.8%
  • 6.9 million kW of pumped storage hydro – 5.5%

If all French nuclear plants operated at 100% capacity for a full year, they would be able to generate 551,880 million kWh, which is more than French consumption in 2011. In this sense, France is very secure in electricity production as long as it can continue operating its nuclear reactors and retain the other sources of energy

Compiling data from the International Atomic Energy Agency, French nuclear reactors operated at a capacity factor of 73.73% in 2012. For comparison, US reactors operated at a capacity factor of 91%.

Giving some attention to the systemic issues with French energy, it is important to note that France achieves its high level of nuclear power generation because it is able to export to neighboring countries. According to the French General Commission on Sustainable Development, France exported 56.4 billion kWh in 2011.

The following list shows French net electricity exports by country in 2011:

  • Germany – 20.2 billion kWh
  • Italy – 13.3 billion kWh
  • Switzerland – 10.7 billion kWh
  • UK – 5.8 billion kWh
  • Belgium and Luxembourg – 4.9 billion kWh
  • Spain – 1.7 billion kWh

According to the World Nuclear Association, France will require 9254 tons of uranium in 2013 or roughly 13% of world demand. The uranium markets operate on a contractual basis of 3-15 years, and as a spot market, which constitutes less than 20% of supply.  According to Reuters, France received about 18% of its uranium from Niger in 2008.

Uranium mining provides the primary supply, but the secondary supply, resulting from “commercial stockpiles, nuclear weapons stockpiles, recycled plutonium and uranium from reprocessing used fuel, and some from re-enrichment of depleted uranium tails” provides additional energy security. These stockpiles are difficult to quantify due to commercial confidentiality, but they are estimated to be near 154,000 tons of uranium.

Uranium Mine Attacks in Niger

Although the event was not covered very well in the US, extremists attacked two towns in Niger on May 23, 2013.  One attack occurred at a military base in Agadez and another at a uranium mine in Arlit. The attacks were coordinated, occurring simultaneously. According to NPR, Moktar Belmoktar, the extremist behind the Algerian attacks in January, claimed responsibility for the attack on Arlit, while the Movement for Oneness and Jihad in West Africa (MUJAO), an affiliate of Al Qaeda, claimed responsibility for both attacks. The attacks on Algeria already had potential effects, which have been described here before. 

Africa Map.

Legend:

  • Red represents areas in Mali outside of government control. 
  • Green represents Niger
  • Black dots represent recent terrorist attacks. 

Effectively, large swathes of the Sahara lays ungoverned and provide a base of operations for extremists in the area. French intervention in Mali has halted further gains, but the French presence in Niger, limited to special forces allowed to secure mining operations, is hardly a full commitment, allowing the extremists to become bolder in their attacks.

Implications of Uranium Production Disruption

Although France depends on nuclear power for its electricity at the present, supply shocks from Niger will not definitively endanger France. France is diversified enough to withstand such a shock, being capable of generating as much power from non-nuclear sources as from nuclear. The country focuses on energy security, and its stockpiles of uranium, though the numbers are confidential, are likely to be ample enough to withstand a disruption in Nigerien uranium production. One must note that Germany and Japan are decreasing their use of nuclear, driving down prices and making more uranium available. Simultaneously, Chinese growth in nuclear pushes up demand and prices. Furthermore, France could tap into other countries’ secondary supplies if necessary and possibility import electricity if absolutely necessary. As a result, the threat to France is only minimal at this point.

However, the main threat rests with increased energy and commodity prices as a result of diminished supply and shift to other fuels for power generation. The market tends to react to such events;  the attack on Arlit on May 23 caused a small spike in uranium prices. However, spot prices are somewhat difficult to gauge because of the limited market. Electricity prices in Europe will likely rise in the case of a Nigerien supply shock because the French electricity export market affects  neighboring countries, especially Germany as it decreases its own capacity for nuclear power. This carries both political and economic risk as several governments face uncertainty and unpopularity at home while economies are teetering on the brink of recession. As a result of these woes, the effect of additional pressures in the form of a uranium supply shock is multiplied. Furthermore, Russia becomes relatively more powerful as it has the potential to supply natural gas to mitigate the effects of such a shock. Given Gazprom’s history of monopolistic pricing, it would likely take advantage of the situation for both political and economic gain. Gazprom is slowly succumbing to the pressure of mismanagement and seeks to reverse its decline; a disruption in the normal energy order within France would provide a lucrative opportunity.

Political and Military Security Risks of Expanding Extremist Influence

If the extremists in West Africa are able to continue carrying out such attacks and gain unmolested safe havens in the vast lawless areas of the region, then both Europe and West Africa will suffer. Successful attacks are inherently legitimizing to a group such as MUJAO, even if they fail to cause catastrophic damage; they are used as a tool of recruitment for the decentralized networks of fighters. Furthermore, the countries in the region are hardly developed and are lacking in capacity to withstand such incursions. Even oil-rich Nigeria can scarcely contain the fomenting insurgency within its own borders. In a positive feedback loop, successful attacks beget additional followers and cells, which culminate in additional attacks and further reach, especially into Chad and down into the energy rich coastal region. These safe havens also allow for the opportunity to plan attacks against Europe for further legitimization. However, the West African desert is not like Afghanistan in that it is much more inhospitable. If the terrorist threat is not addressed, the risk of collapse, coups, and political instability is heightened while Europe becomes exposed to low-level terrorist attacks if the extremists gain a foothold there.

Future of Energy Panel

01 Wednesday May 2013

Posted by V. Markov in Future

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alternative, future, gas, middle-east, natural gas, nuclear, oil, Politics, renewable, renewables, unconventional resources, united states, US, USA

I’ve got an interesting update rather than full post on a particular issue. I attended a discussion panel on the Future of Energy at Georgetown University which included several figures from both academia and local think tanks. It was an interesting discussion followed by a Q&A session. I have summarized the main points of the discussion below:

Oil is still the primary commodity in energy and remains the world’s most traded commodity, in both value and volume. However, the US is probably past peak demand for crude oil, while energy demand is shifting to other sources, such as cheap natural gas. The energy infrastructure, to include electricity, transportation, industry, and supply lines, is slowly changing to accommodate these changes. The large capital costs prevent a rapid shift.

The United States will likely become energy independent, possibly by 2020, as technology improves. Hydrocarbons will still dominate the energy solution, in the US as well as around the world. Renewables and alternatives to hydrocarbons are not viable at the moment and will remain more expensive than hydrocarbons for the foreseeable future. The technology that has made the exploitation of shale gas and oil and other unconventional resources has driven down their costs and has made alternatives uncompetitive economically. Currently, renewable cannot compete with such cheap sources of oil and gas.

The technological advances in the US and the vastly expanded supply of hydrocarbons in the country will alter the dynamic behind the worldwide energy trade on both the supply and demand side. This will change the system upon which the Middle East and Russia rely for export earnings and maintaining their systems of governance.

Middle East wealth distributions are too skewed towards the top causing resentment and instability with the majority of citizens in these countries. The rulers, to whom the oil and gas wealth flows, have no incentive to change as they enrich themselves and would be unable to do so if the government were to adopt stronger and fairer rule of law or any further changes. As a result, there will be more turmoil in the region, especially as the US increases its own oil and gas production and disrupts supply and demand in the markets. It is possible that Iran and Iraq descend into chaos or suffer upheavals that present opportunities for the countries to attack smaller, but rich countries, such as Kuwait and Qatar, to bolster incomes and provide a common enemy for the people.

Nuclear power will likely continue to grow as countries, especially those in the Middle East seeking to sell rather than burn oil and operate water desalination plants, try to meet their electricity demands. However, the infrastructure and regulatory bodies for these industries are difficult and time-consuming to implement at the level of desired competence and authority. The capital costs behind these projects, barring small modular nuclear plants, are prohibitive for most countries. Moreover, stakeholders in nuclear, such as students studying the science behind it and regulators, would need assurances and guarantees of completion of these projects to commit themselves to the nuclear path. Such guarantees are, however, only viable in specific cases in countries with adequate capital at hand. Many of the countries considering this route, such as those in the Middle East, are notorious for wasteful public budgets and many are indebted and retain budget deficits despite their enormous hydrocarbon wealth. This effectively prevents a simple transition to nuclear power.

These are the basic ideas I gathered from the panel. Overall, it was bullish on hydrocarbons and pessimistic about the viability of alternatives in the face of cheaper oil and gas. Turmoil in the Middle East also appeared to be a given in the near to medium term. I will likely expand upon these issues in future posts, but I wanted this to serve as a quick update rather than a protracted explanation.

The Venezuelan Bounty and the Political Future

18 Thursday Apr 2013

Posted by V. Markov in Natural Gas, Oil, Venezuela

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Capriles, Chavez, Economics, energy, gas, Hugo, Maduro, natural gas, oil, PDVSA, Politics, PSUV, Venezuela

Dilma_Rousseff_receiving_a_Hugo_Chávez_picture_from_Nicolás_Maduro (1)In light of Hugo Chavez’s passing on March 5th, it is useful to explore this ever salient topic and Venezuela’s plentiful hydrocarbon reserves.

As usual, any figures cited below come from the BP Statistical Review 2012, unless otherwise stated.

Oil

Venezuela is, of course, known for its oil reserves, which stood at a staggering 296.5 billion barrels at the end of 2011, compared to Saudi Arabia’s 264.5 billion barrels.

In 2009, the  Oil and Gas Journal cited Venezuelan reserves as 99.4 billion barrels of conventional reserves. In 2011, this figure was revised to 211 billion barrels. BP figures put Venezuelan reserves at 296.5 billion barrels, of which 220 billion are extra heavy crude from the Orinoco Belt. Extra heavy oil is usually considered to be unconventional oil. 

However, as mentioned in other blog posts, all oil is not created equal. Most Venezuelan oil is particularly dense and viscous, giving it the appellation of extra heavy crude. The American Petroleum Institute (API) ratings for this viscosity are referred to as API Gravity and measured in degrees.

From United States Geological Survey (USGS) reports, the following list describes the different viscosities of oil. Less viscous oil, meaning that it is less dense and flows more freely, is more desirable as it can produce more oil products

  • Conventional Oil – Gravity of 20 degrees or more. The lightest crudes stand at about 46 degrees and can be found in Algeria and Malaysia. 
  • Heavy Oil – Gravity between 10 and 20 degrees
  • Extra Heavy Oil – Gravity between 4 and 10 degrees
  • Bitumen/Asphalt – Gravity less than 4. Natural bitumen is immobile and mostly found in Canada, Kazakhstan, and Russia.


Venezuelan oil production has declined from a high of 3.517 million bbl in 1997 (EIA) to 2.72 million bbl in 2011. It is important to remember that, although Venezuela has reserves rivaling Saudi Arabia’s, they are unconventional and require additional expertise, infrastructure, and investment to exploit. As a result, the correlation between reserves and production is not as straightforward as it might appear initially.

Oil, Politics, and PDVSA

Venezuela’s national oil company, PDVSA (Span. Petróleos de Venezuela, Sociedad Anónima), came into existence with the nationalization of the oil industry in 1975. Even at inception, PDVSA was intended as a revenue source to fund industrialization and government spending. However, the collapse of oil prices in the 1980s and 1990s and increasing liberalization of the oil industry allowed PDVSA to shed many of its political shackles and focus on producing increasingly larger quantities of oil. With the rise of Chavez to the presidency, the state began reasserting its power over the oil industry. In 2006, exploration and production were further nationalized, resulting in joint ventures with foreign oil companies, who were only allowed minority stakes in projects. PDVSA was mandated to take a minimum of 60% ownership in projects.

As a result, PDVSA operates as a monopoly on the basis of politics rather than economics. An example of this limitation is the failure of PDVSA to take advantage of increased commodity prices in the 2000s to increase both reinvestment into wells and oil production in general. PDVSA oil production actually declined while prices increased. The opposite phenomenon occurred in other major oil exporting countries. For example, Saudi Arabian oil production increased by 22.39% from production of 8.809 million bbl in 2002 to 10.782 million bbl in 2008, when prices reached a higher peak than previous high point in 1980. Similar production increases can be found in other major oil producers.

According to the CIA, oil exports account for 95% of Venezuelan export earnings and provide about 45% of federal budget revenues. Although PDVSA has been able to fund expensive social programs, it neglects to reinvest windfalls into maintaining existing wells. The EIA estimates that Venezuela must spend at least $3 billion each year to maintain production at its mature existing fields. Coupled with the political risk for foreign energy companies, Venezuela’s infrastructure does not receive the investment or expertise required to maintain oil production at constant levels. 

Hugo Chavez was not one to hide his political leanings, proudly proclaiming himself a socialist and expanding social spending, subsidies, and programs in accordance.  According to the Council on Hemispheric Affairs, Chavez implemented “missions” to reduce illiteracy, provide education, healthcare and housing. According to the report, these initiatives have met with some success, especially in promoting literacy, and reduced poverty by more than half, from 54% to 26%, while extreme poverty fell by 72%. Chavez also implemented fuel and food subsidies, which are both draining to the government’s budget. Government spending reached 45% of GDP in 2012. However, these successes have come at an extraordinary cost, subsidized by oil prices and devaluations, rather than organic poverty alleviation through development of industry. As a result, inflation remains an issue, as does the crime and corruption associated with largess and a weak justice system. Corruption is endemic, placing Venezuela at 165/176 according to Transparency International. 

In accordance with the resource curse, Venezuela fell victim to capricious government spending, which proved itself unsustainable once oil prices retreated. Debt to GDP reached about 71.9% in 1995 and a restructuring period followed in the late 1990s with IMF loans of 350 million SDR (Special Drawing Rights, essentially used as an internal currency based on a basket of currencies for the IMF) in 1996. One should note that this austerity may have fueled discontent and allowed Chavez to gain power. By 1998, Debt to GDP had reached 40.1%. Debt to GDP stabilized afterward, before surging to 49.3% in 2004 and dropping down to 26.3% in 2009 on the heels of record oil prices. A combination of high oil prices, which are denominated in USD and not cheap Bolivars, and currency devaluation, which occurred in 2002, 2003, 2004, 2005, 2010, 2011, and 2013, helped minimize the debt the GDP ratio. During Chavez’s presidency from 1999 to 2013, the Bolivar has been devalued by 992 percent. Even with such a cheap currency, Venezuelan exports outside of the energy sector are virtually nonexistent and the country remains dependent on imports and plagued by shortages. 

Natural Gas

Venezuela has substantial natural gas reserves as well as oil. These numbered 195 tcf or about 2.7% of the world’s proven reserves. However, the country only produces 31.2 bcm in 2011, (1.1 tcf) a figure which has remained relatively constant during the 2000s. Venezuela consumed 33.1 bcm in 2011, meaning that it also imports natural gas despite its reserves. As a result of its consumption and production patterns, Venezuela remains mostly insulated from the global gas markets and forgoes a potential source of revenue. Once again, the expertise and capital required to export natural gas would ensures that such a possibility remains years in the future.

Political Future

In April 2013, Nicolas Maduro was elected president of Venezuela following the death of Hugo Chavez. As the former foreign minister under Chavez and reportedly his “anointed successor,” he is expected to carry out or expand the policies started under Chavez. Maduro secured the state apparatus to aid him in electoral victory, including the “unconstitutional use of state resources,” such as the army, to assist in campaigning, and the extensive cult of personality cultivated by Chavez. In addition, many Venezuelans, if not most, benefit directly from the patronage mechanisms instituted by Chavez. Henrique Capriles, the centrist opposition candidate, who appears to be warm towards the US, was defeated in an election marred by electoral irregularities, that were enough to “render Mr Maduro’s victory margin moot.”

With such a turn of events, it can be reasonably expected that the political and economic situation will remain somewhat static in the future. PDVSA will remain a political asset intended to contribute to government revenues, which in turn provide subsidies and patronage for the ruling party, the United Socialist Party of Venezuela (PSUV) in this case. Coupled with oil spot prices likely to hover around $100 per bbl, PDVSA may be able to carry on as an ineffective, yet stable, monopoly. Enough Venezuelans remain unsatisfied with the status quo as to merit a tempering of previous policies, but the government still finds itself in a position to increase pressure on opposition forces. Regardless, government involvement in the economy, coupled with growing inflation and uncompetitive exports, high levels of crime and corruption, and a partially dissatisfied populace will force the ruling party to come to terms with the economic reality. Maduro will have to make the politically difficult choice of coming closer to the center and liberalizing the economy, or remain a Chavista and preside over worsening economic conditions and increasing inflation that will further degrade popularity. He already lacks the charisma and authority of his predecessor, leaving him with few options. A sudden liberalization will be very unpopular, especially as many ordinary citizens stand to lose some benefits, while increasing repression or even resorting to violence, puts Venezuela in a very precarious position. Such a situation would likely affect worldwide oil spot prices, if the markets sense an increasing likelihood of diminished Venezuelan production; oil production never occurs in a vacuum. The most preferable development would be a steady, but not sudden, political and economic liberalization that would avoid the ire of citizens losing benefits, but also allow industry, markets, and opposition parties to adjust to the new conditions. Maduro would have to be ready to pay the political costs and compete more fairly with the opposition.

Header Image: Image by  Agência Brasil – Used under Creative Commons Attribution License. The image may be found here.

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