Oil - The Black Gold: Is it Losing its Sheen?
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Issue Net Edition | Date : 03 Oct , 2020


Oil was the ‘Black Gold’ of the 20th century, fuelling vehicles, wars, the world economy and, hence, its geopolitics. Today, the world is in the midst of an energy shock that is accelerating the swing to a new order. As the covid-19pandemic spread earlier this year, the global economy has been struck, like never before, with the demand for oil dropping by more than a fifth and a collapse of prices. Since the ‘stabilisation’ of the spread of the virus, if one can call itso, there has been an uneasy recovery, but a return to the old world is unlikely. Fossil-fuel producers are being forced to confront their vulnerabilities, and petrostates, such as Saudi Arabia, and others in the region, are scrambling to balance their budgets.  With the global price of oil hovering at about $40, the oil producing nations, which need an oil price of at least $70-80 a barrel, are having their worst nightmare come true of imbalanced budgets.There have been oil slumps before, but this one is different!

The down slide in oil prices,a reduction of over 40 percent since mid-2014,is attributed to a weakened demand from Europe and China, as it met an excess supply from Canadian and US crude production. According to International Energy Agency (IEA) data, demand for oil, however, has actually been on the rise, up four percent since the beginning of 2012; roughly 3 million more barrels a day are being produced now than in 2011, even amid tensions in West Asia and Ukraine,which in leaner oil days would have driven prices higher. Even today,in the face of this turmoil due to the pandemic, China’s demand for oil imports, already the largest in the world, continues to grow—providing some welcome stability, atleast to the balance-sheets of the oil producing nations.

Pricing, Supply and Demand of Oil

The global oil benchmark, Brent crude, fell in mid-October of 2014, to about $92 per barrel, the lowest price since mid-2012. It may be premature to forecast sustained international oil prices, but if the figure remains close to where it is now, many oil exporting countries will feel the pain, as is already happeningdue to their budgets being basedon previous price expectations. It is, however, interesting to know how the technical committee of the Organisation of Petroleum Exporting Countries (OPEC) plans the oil supply cuts and manipulates the pricing; plus countries such asRussia, Kazakhastan, Malaysia, and other seven, which arenot members of OPEC, but are included in the list of exporting countries, come in as OPEC+.

Major West Asian producers and sellers, such as the Saudi Aramco and the Iraqi State Organistion for Marketing of Oil (SOMO) offer huge discounts to USA and someEuropean countries to gain market share. The same grade of oil, is then offered at a higher cost to Asian nations, in what is known as a differential pricing system; this is termed as the ‘Asian Premium’. Following Saudi’s lead, other nations of the region: Kuwait, UAE and Iraq, follow the same pricing. The costs for the month are declared around the fifth of every month, thus affecting about 12 million barrels/day (mb/d) that are bound for the Asian markets. The Asian refiners have been protesting against such a differential pricing system for long, but to no avail. As per Indian records, the Asian premium against the prices for US ports, for example, in December 2019, and the first three months of this year, was $5.1, $6.29, $3.71, and $7.3, respectively (ToI, 12 September 2020). The gross margins of Asian refineries thus suffer, and the buyer-companies are forced to look around for cheaper sources, or the producers undercut and unleash a price war. The premiums fell sharplybetween April and July this year when the global demand shrank by as much as 14 mb/d; Russia and Saudi Aramco unleashed a price war!

With the shale boom, USA has become the largest crude oil producer, overtaking even Saudi Arabia and Russia, leading to a flood of US oil in the Asian markets; USA produces about 19.61 mb/d with is about 19.48 per cent of the world’s total, and is at the top of the list amongst the consumers too. However, the shale boom has problems on the horrizon as political, financial, technological and geological pressures are closing in. The US-India bi-lateral hydro-carbon trade touched $9.2 billion in 2019-20, a 93 per cent increase over the previous year, making it the fourth-largest oil importer of US crude. Notwithstanding the strained relations between China and USA, the demand for US crude surged 492.5 per cent between June and July this year, while slumping by a record 27.9 per cent from Saudi Arabia in July(ToI, 12 September 2020).

OPEC in its latest monthly report has assessed that the world oil demand would drop by 9.06 mb/d instead of the earlier assessment made a month ago, of 8.95 mb/d, which in turn would lead to an over supply and a further drop in prices.The repercussions of the massive drop in prices has hit many an economy. Iran, already reeling under the effects of years of sanctions, is looking for ways to fill the widening hole in its budget; there are reports that the Iranian Government is offering young men the option of buying their way out of a mandatory two years of military service!Venezuela, which has the world’s largest estimated oil reserves and has used them to position itself as a counter to American imperialism’, received 95 percent of its export earnings from petroleum before prices fell. Russia too, has been impacted, where more than half the revenue in the budget comes from oil sales, even as it continues with its support of separatists in Eastern Ukraine and the occupation of Crimea. The combination of  reduced oil revenues and the Western sanctions, where applied, have begun to take effect.Barring UAE, Kuwait and Saudi Arabia, none of the other OPEC members have the economic flexibility to reduce production; Libya, Algeria, Iraq, Iran, Nigeria and Venezuela, all need maximum oil output and high prices to finance their budgets and social spending programmes.

The 21st Century Energy System

As the public, governments, and investors wake up to climate change, the clean-energy industry is gaining momentum. Research carried out by scientists at Stanford University, USA, has predicted that the world could be on renewable energy alone in another 20-40 years. Many countries are already way ahead in their quest for clean energy through renewable sources. Geography plays an important part in a nation’s ability to generate renewable energy, making other countries to put in that much extra effort. Iceland, due to its landscape, is the world’s leader in production of renewable energywith 55,000 kWh per person; in comparison, the EU average is 6,000 kWh; Kenya currently produces 70 per cent of its energy from renewable sources and was expected to reach the 100 per cent figure, had it not been for the pandemic; on the other hand USA produces only 18 per cent from renewable sources, and this figure is likely to reduce with a budget allocation of only $700 million as against $2.3 billion in the preceding years (!

With so much emphasis on clean, renewable energy, the stock markets are shifting their focus from oil stocks to clean-power stocks, which are up by 45% this year, despite the covid pandemic. With interest rates near zero, politicians are backing green-infrastructure plans. America’s Democratic presidential contender, Joe Biden, wants to spend $2trn decarbonising America’s economy. The EU has earmarked 30 per cent of its $880bn covid-19 recovery plan for climate measures; the President of the EU, Ursula von der Leyen, used her state-of-the-union address earlier in September, to confirm that she wants to cut greenhouse-gas emissions by 55per cent over 1990 levels in the next decade (The e-Economist, 17 Sep 2020). This is because most countries are acknowledging that, for the sake of the climate, reliance on fossil fuels needs to come to an end. Fossil fuels provide heat that is mostly used to provide the energy to move things, be they vehicles or electric generators. Solar panels and wind turbines provide energy as electricity straight off. Maximising their emissions-free benefits means processes and devices that now rely on combustion would, in future, use currents and batteries instead. A picture of a new energy system, that ofelectrification through clean power, is emerging, just as in geo-politics a picture of a new world order seems to be evolving.

With bold action, renewable electricity such as solar and wind power could rise from 5 per cent of supply today to 25per cent in 2035, and nearly 50 per cent by 2050 (The e-Economist, 17 Sep 2020). Oil and coal use will automaticallydrop, although cleaner natural gas would continue to remain central to energy use. This architecture will, presumably, bring huge benefits. Most important, decarbonising energy will avoid the chaos of unchecked climate change, including devastating droughts, famine, floods all leading to mass dislocation. Once developed and settled, it should be more politically stable too, because supply will be diversified, geographically and technologically.

Oil-rich nations,which account for 8 per cent of world GDP and nearly 900m citizens,will have to reform their governance pattern;their governments would have to depend on taxing their own citizens, and reducing subsidies, for sustenance. While some could become more representative, resources to satisfy their own citizens will perforce dwindle. Large consuming countries, which once sought energy security by meddling in the politics of the oil producers, will instead look to sensible regulation of their own power industry, making the 21st-century system less economicallyand geo-politically volatile.

The forthcoming energy system will have its pitfalls though. Even as variations evolve, the threat of how the variations are managed will hover during the process of fruition. Autocratic China could temporarily gain clout over the global power system because of its dominance in making key components and developing new technologies in renewables. Today, Chinese companies produce 72 per cent of the world’s solar modules, 69 per cent of its lithium-ion batteries and 45 per cent of its wind turbines. They also control much of the refining of cobalt and lithium,minerals critical to clean energy. Chinese companies have invested in mines, some of it as a part of its Belt and Road Initiative(BRI), from the Democratic Republic of Congo (DRC) to Chile and Australia, securing access to the minerals needed for solar panels, electric vehicles and the like. Unable to be a petrostate, Communist China may become an “electrostate”.China, the world’s biggest fossil-fuel importer, as well as a leading exponent of renewable energy at gigawatt scales, will have the windin its sails.In this new emerging energy world,Mr Trump’s superpower looks like an also-ran!

China’s Different Strength

Big oilfinds off the coasts of Brazil and Guyana and the development of Australia’s liquefied natural gas (LNG) capacity, along with America’s shale boom, add to China’s opportunities; a buyers’ market is a good place to be the biggest buyer! China’s position as a buyer also allows it to undercut America’s attempts to squeeze oil exporters. Chinese buyers have long continued to import Iranian and Venezuelan crude and maintained their energy alliance with Russia all through American sanctions.

Nevertheless, this buying power cannot mask the geopolitical downside of relying on imports. Being a large importer may give you more power than being a smaller one,but it also leaves you exposed to third-party action. China is acutely aware that much of its oil comes through the straits of Hormuz and Malacca, which could be closed by third-party conflicts or, in an extreme case, the US Navy. In recent months, as relations with America have seen a downturn,China’s concerns about its energy security have risen; China has been buying lots of LNG from America, as well as crude for its stockpiles. Documents of the Communist Party for China’s new five-year plan, highlight the need for a more flexible and reliable energy system.

Although China has invested heavily in the renewable energy sector, while it continues to produce huge volumes of energy from renewable sources supporting its domestic coal production and being the second largest consumer of oil with its insatiable demand being the main issue (India is the third largest consumer). Nevertheless, China also has the standing of being amongst the most prominent investors in renewable energy, with about 25 per cent of their total requirements coming from clean sources.

Renewables may be fossil-fuel free, yet, these technologies also require raw materials. Wind and solar power need a lot more of some non-ferrous metals, notably copper, than systems which burn fossil fuels; batteries require niche materials in ways that fuel tanks do not. Generally, the world has plenty of these necessary commodities, but lacks thecapacity to get them to market. As Andy Leyland of Benchmark Minerals Intelligence, a research firm, states, “There’s no geological shortage. It’s a financing shortage.” Mines which frequently have time and cost over-runs, and are located in countries prone to political or economic instability, do not attract investments from most Western companies.

Chinese companies fill in the void, some of which is through domestic investment. China produces 60 per cent of the world’s “rare earths”, which have properties thatmake them useful in electric motors, among other things. They are not, generally, rare in a geological sense, but they can be in short supply for often they are mined in ways that damage the local environment. For other metals, the now-famous Chinese ‘long-term planning’ comes into play. Congo’s copper and cobalt have attracted Chinese investors for more than a decade; Tianqi, a Chinese private company, has a minority stake in SQM, Chile’s biggest mining company of lithium. China refines more than twice as much lithium and eight times as much cobalt as any other country, according to Bloomberg NEF, a research outfit (see chart).

This has, obviously led to geopolitical concerns.Politicians in America, Europe and Australia have expressed concern at the growing Chinese control of minerals that arecritical to not just energy, but also defence. A company backed by Bill Gates and other billionaires plans to search for cobalt in Quebec; America’s Development Finance Corporation is, for the first time, taking buying equity stakes in mining companies. One such beneficiary is TechMet, which is of the opinion that some investors will prefer mines independent of Chinese control. “It’s a very significant strategic issue for the United States and the West,” says Admiral Mike Mullen, a former Chairman of America’s Joint Chiefs of Staff and now the head of TechMet’s advisory board, “I almost liken it to Huawei. We wake up and they’re in control of the world.”

Closing Thoughts

Today, oil and coal primarily, are the ultimate source of 85 per cent of energy. But the ‘cleanliness’ of this source is under a big cloud; energyaccounts for two-thirds of greenhouse-gas emissions; the pollution from burning fossil fuels kills over 4m people a year, mostly in the emerging world’s mega-cities. Oil has also created political instabilitywithin countries. For decades petrostates such as Venezuela and Saudi Arabia, with little incentive to develop their economies, have been snared in the politics of handouts and cronyism. In an effort to ensure secure supplies, the world’s big powers have vied to influence suchcountries, not least in West Asia.Fossil fuels cause economic volatility, too. Oil markets are buffeted by an erratic cartel:OPEC and OPEC+. Concentration of the world’s oil reserves in a limited geographical area makes supply vulnerable to geopolitical shocks. Little wonder that the price has swung by over 30 per cent in a sixth-month period, 62 times since 1970!

The Paris Accord of 2016 to strengthen the global response to climate change, today has 197 members, notwithstanding President Donald Trump’s announcement of “We’re out”. Members have to pledge to reduce their fossil fuel consumption to reduce the carbon dioxide emissions; the world’s largest fossil fuel companies have to rationalise their existence in a future where carbon emissions must be reduced by 80 per cent before 2050. Yet, Exxon Mobil’s studies show that demand for oil will only increase over the next few decades, till atleast 2040!  The Paris Accord attempts to wean the world away from fossil fuels in the second half of this century; the demand for oil to power passenger cars may drop, but other sectors – road freight, aviation, petrochemicals – may offset this drop.

Yet even as a better energy system emerges, the threat of a poorly managed transition looms. Faced with these dangers, the temptation will be to ease the adjustment, by making the transition a slow process. However, that would bring about a different, even more destabilising set of climate-related consequences. And if the shift towards fossil-fuel-free renewable energy accelerates, as it must, it will cause even more geopolitical turbulence. The move to a new energy order is vital, but it will be messy in a new world order that is also evolving. 

The black gold – oil – may not yet lose its sheen!

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The views expressed are of the author and do not necessarily represent the opinions or policies of the Indian Defence Review.

About the Author

Air Marshal Dhiraj Kukreja

former Air Officer Commanding in Chief of Training Command.

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