THE POLITICS OF OIL : WELLS OF ANXIETY / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

The politics of oil: Wells of anxiety

By Javier Blas

Published: March 29 2011 22:42

Surrounded by gigantic sand dunes, el-Sharara oil field is one of Libya’s biggest. Perched on the edge of the Sahara south of Tripoli, the installation was smoothly pumping about 300,000 barrels a day of high-quality crude down an 800km pipeline to the Mediterranean coast until a few weeks ago.


Operated by Repsol YPF of Spain, the multibillion-dollar project was seen as a sign that the Libyan energy sector, after 20 years of underinvestment and isolation, was enjoying a revival.


But as political unrest broke out in the north African country in late February, foreign workers at the field rushed to a remote desert airstrip and left, having halted output from the wells. As one executive puts it, the last man, literally, shut down the field.


Thousands of other foreign workers at fields such as Waha and Amal – workhorses of the country’s industry since oil was discovered in the 1950s – did the same, bringing Libya’s output to a halt. In the oil trading hubs of London, New York and Singapore, dealers awoke to a familiar foe: a crisis in the Middle East. As in the past, they reacted by buying. Oil prices jumped to $115 a barrel, a two-and-a-half year high.


But the current crisis goes beyond the geopolitically inspired short-term supply disruptions to which the market is fairly accustomed. The changes sweeping the Middle East and north Africa, which account for one-third of the world’s oil output, are redrawing the region’s politics and will have a deeper impact in the oil market than the loss of Libyan oil for a few months. In dozens of interviews with analysts, consultants, government officials and traders, a consensus emerges: the geopolitics of oil have rarely loomed larger than today.


“We are going through a definitive transformation of Middle East oil politics,” says David Kirsch, a consultant at PFC Energy, echoing a widely held view on the market.


The current events are akin to other turbulent periods in the intersection between oil markets and Middle East politics, including the nationalisations of the 1950s and 1960s, the Arab oil embargo of 1973-74 and the Iranian revolution of 1979. Then – like today – the events had a common characteristic: they were open-ended, leaving the market facing uncertainty. The result, in the words of one trader, is that “it is not safe to be sure any longer”.


Yet the latest chain of events, still unfolding, has shattered beliefs that the oil market thought were set in stone. Decades-old regimes have collapsed, leaving traders asking who is next in the domino game of regime change. Trouble is knocking at the door of Saudi Arabia, the “central bank” of world oil, with unrest for the first time in almost every country bordering the kingdom: Bahrain, Oman, Iraq, Yemen and Jordan.


The wave of discontent has shown that the oil industry can no longer ignore the region’s problems: booming population growth, high unemployment, rising inflation, lack of freedom in the age of the internet, and violent repression of dissidence. Few see a rapid end to the upheavals. “The genie is out of the bottle and there is no way to put it back,” says an executive at a top oil trading house.


In short, the cost of oil will be higher than before, as traders will demand a geopolitical price premium to compensate for the perception of higher risk. Even when the unrest settles and supply disruptions end, the emerging populism evident in the region is thought likely to push countries towards policies that imply high oil prices as they need to fund higher spending to buoy popular support.


Regime change and democracy could solve problems over time, bringing prices down. But not much of that stable new order is in sight within the next few months or even years. Worse, some regimes are resisting reform, notably in the Gulf, so unrest will continue to lurk in the background, like a volcano, with periodic eruptions that will push up prices, followed by periods of calm.


Oil is the world’s most important traded commodity and its significance will only increase as developing nations, from China to Brazil, demand more energy. The move to higher prices will have a profound impact on the global economy, acting as a tax in consuming countries, depressing growth worldwide and pushing inflation higher.


The most immediate concern is supply disruptions. Before the recent unrest, Libya was the world’s 12th-largest oil exporter, producing about 1.6m b/d of high-quality crude – enough to meet, say, the demands of Belgium and the Netherlands. Saudi Arabia and other leading members of the Opec cartel, including Kuwait and the United Arab Emirates, have rushed to offset the shortfall.


But as Riyadh and others boost their production, Opec’s spare capacity shrinks. It is now less than 4m b/d – well below the peak of more than 7m b/d in 2009, though still well above the 500,000 b/d of 2004 after Iraq went offline following the US invasion a year earlier. Still, the cumulative effect of several disruptions in the Middle East could drain all the cushion. Michael Wittner, head of oil research at Société Générale in New York, says that after experiencing a true supply disruption this year, even if no further such events occur, “the market will see such events as real possibilities rather than abstract scenarios”. The list of countries under watch is lengthening almost by the day as unrest spreads. Oman, Syria, Yemen and Bahrain may be small producers but collectively they amount to a meaningful bloc of some 1.5m b/d.


Moreover, as Opec’s spare capacity shrinks, the market demands a bigger and bigger price premium to offset the risk that another big disruption – say a hurricane in the Gulf of Mexico – forces the system to run at full capacity. Supply disruptions also matter beyond lost volume. Although oil is a commodity, each producing country pumps a variety that is slightly different to the rest, making interchangeability difficult – in some cases impossible. Take Libya: the country produces one of the highest-quality types of oil in the world, light and with a low sulphur content. Although Saudi Arabia has acted to replace the number of barrels lost, it has been unable to match the quality.


European refiners are paying record premiums over the Brent crude benchmark in the physical market to secure supplies of high-quality, low-sulphur crude oil after the loss of Libya’s production. The price premium for similar crudes to those supplied by the north African nation – including BTC Blend of Azerbaijan, Algeria’s Bonny Light, Saharan Blend from Algeria and Kazakhstan’s Kumkol – has soared to multi-year highs.


Another concern is when production will recover. In the case of Libya and to a lesser extent Yemen, violence needs to end to allow the return of both domestic and international workers to the oil fields. But even when staff come back, the task of restarting the fields will not be easy.


Antoine Halff of Columbia University says that the history of oil production disruption is not encouraging: countries struggle to return to their pre-crisis output levels. “It happened in Iran after 1979, Iraq after the invasion of Iraq in 1990, in Venezuela after the oil strike of 2002-03,” he says. “Even if there is no war damage, the emergency shut-in of the fields will cause problems.”


Apart from the short-term outages and difficulties in restarting production, the oil market could suffer bigger problems over the longer run. Analysts, consultants and industry executives fear that governments in the region – both new and old ones – are set to adopt fresh policies that would result in higher oil prices. The concern, says Bill Farren-Price of Petroleum Policy Intelligence, a consultancy, is that “when the tectonic shift in Middle East politics subsides, we are likely to see more populist energy policies in the region”.


The clearest manifestation of the fresh populism is the hand-outs and boost to public spending announced by King Abdullah of Saudi Arabia. The policies, at a total cost of $129bn – equal to more than half the country’s oil revenues last year – vary from one-off bonuses for public sector workers to the promise of half a million homes at affordable prices. All in all, says John Sfakianakis, chief economist of Banque Saudi Fransi in Riyadh, “the total bill of measures is a substantial fiscal undertaking” on top of a budgetary trend in which actual spending has exceeded what had been announced over the past five years.


Edward Morse, a veteran oil watcher, argues that the extra spending will lift Saudi Arabia’s oil revenue needs closer to those of Venezuela and Iran, arch-hawks on price. Riyadh is likely to pay for King Abdullah’s largesse by tapping the country’s reserves, worth an estimated $450bn. Even so, prices will need to average $80 a barrel this year for Riyadh to balance its budget. Only a decade ago, it achieved that with prices at about $20 a barrel. “The main concern is that the hand-outs, which are at the moment discretionary spending, evolve into non-discretionary spending, boosting permanently the budgetary requirements,” says Mr Morse.


Saudi Arabia is not alone. Other members of the six-nation Gulf Co-operation Council have been announcing extra spending. Kuwait, for example, has proclaimed a one-off bonus of $4,000 for each citizen and promised free food staples for more than a year.


Higher social spending will not only put upward pressure on oil prices but will reduce the funds available for state-owned oil companies to invest in future production capacity, analysts and executives say.


As long as governments feel under threat from social discontent, they are likely to delay any cut in hefty energy subsidies and stick with measures that make petrol cheaper than water. This financial support has led to runaway domestic growth in oil demand, which over the past decade has dented the region’s exportable surplus of crude. In Saudi Arabia, oil demand has doubled over the past 15 years, transforming the country into one of the world’s top 10 consumers. If the trend continues – which senior Saudi officials believe would be the case without drastic reforms – Riyadh and the Middle East at large will have less and less oil for export every year.

FEAR AT THE PROSPECT OF BEING SHUT OUT
 International oil companies are watching the events in the Middle East and north Africa with trepidation. The region is home to the bulk of the world’s oil reserves, so executives fret both about their current multi-billion dollar investments and future ones.


In the worst case, international groups could see their assets nationalised if new governments turn against foreign investment or if current regimes survive and move against the western investors – as some executives fear could happen in Libya if Muammer Gaddafi remains in power.

The expected turn towards populism, mixed with nationalism, could also slow overseas investment in hydrocarbons. While some countries – notably Saudi Arabia – remain closed to international companies, others such as Libya, Egypt and Oman had been opening up their markets, providing companies from Eni of Italy to US-based ConocoPhillips and Occidental Petroleum access to oil reserves and production.


The investment and technical expertise of foreign oil groups in the region are crucial for global oil supplies too. The Middle East and north Africa need to spend more than $20bn a year until 2030 to boost production, according to the International Energy Agency, the rich nations’ energy watchdog. If unrest slows foreign investment, state-owned companies could struggle to finance the requirements alone, thus tightening global supplies in the future.
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Copyright The Financial Times Limited 2011