Third Annual Conference on the Geopolitics of Energy Florence, 8-9 July 2004

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Third Annual Conference on the Geopolitics of Energy
Florence, 8-9 July 2004

Background Paper


Giacomo Luciani


Mediterranean Programme,
Robert Schuman Centre for Advanced Studies (RSCAS)

European University Institute (EUI)

in cooperation with

Aspen Institute Italia

The fallout of Iraq

Speaking at our second Geopolitics of Energy conference one year ago, Claude Mandil commented on “The Geopolitics of Oil after the Iraq War”. At that time, the vision of those that expected the war to mark a turning point in global oil affairs – allowing for the privatisation of Iraqi oil, the return en masse of international Oil Companies (IOCs) to the Iraqi upstream, a quick build up of Iraqi production and exports, a period of low prices and possibly even the marginalisation of Saudi Arabia – had already lost much of their credibility. Mandil sounded a cautious note:

“The recovery of Iraqi production remains one of the greatest uncertainties currently affecting the oil market. Iraq’s reserves are the third largest in the world after Saudi Arabia and Russia. Production potential is enormous. Iraq has proven reserves of 78 billion barrels and an estimated 108 billion barrels of probable reserves. Of 73 discovered fields, only 15 have been developed.

Despite this vast endowment of resources, Iraq’s performance peaked in 1979 when production reached 3.5 million barrels per day. Production levels fell, affected by the political instability resulting from the Iran-Iraq War and the Gulf War. Lack of investment and poor maintenance in the intervening years further strained the country’s oil infrastructure; bad management and lack of spare parts may have damaged reservoirs. In 2002, output averaged 2.1 million barrels per day under the UN Oil-For-Food program. Iraq’s sustained prewar production capacity was estimated at 2.8 million barrels per day.

Yet production was halted during the recent war and is returning slowly. (…) It will take time before Iraq will surpass 2mbd. Although a limited number of wells were set on fire, looting has resulted in damage to surface installations and loss of data; and it continues. The results of poor management and maintenance during the 1990s combined with insufficient security at oil facilities and questions regarding the state oil company’s (SOMO) legal status may prolong the recovery beyond the end of this year.”

But notwithstanding this caution, Mandil’s expectation one year ago – in line with that of most other commentators – was still that Iraq would exert downward pressure on prices, to the point that possibly OPEC’s target band would turn out to be indefensible:

“In the long term, the world will need Iraqi oil – and Iraq will need oil export revenues to fund its development. (…) As older fields in the North Sea and elsewhere are retired, Iraq’s plentiful, relatively low-cost reserves will become increasingly important. (…)

In the shorter term -- barring any unforeseen events -- consumers should be assured that oil supplies are ample, even if Iraqi production recovers more slowly than initially anticipated. Assuming that Russian production will increase over the near term, a resurgence of Iraqi exports will likely pose some challenging decisions for Dr. Silva Calderon and his colleagues at OPEC. Because oil prices have been held at an artificially high price by the OPEC price band, higher cost producers and nonconventional oil have gained a stronger position in the market. The re-entry of Iraqi oil could create downward pressure on prices, forcing OPEC to act in order to maintain their price band – but such action comes at a cost. OPEC will lose additional market share or revenues, or both, or must accept a price below the OPEC band at a level compatible with a stable market.”

OPEC’s dilemmas

OPEC’s understanding of the market was not altogether different. The fear of excess supplies and soft prices continued for the rest of 2003, although very little softness was in fact apparent in the markets. OPEC reacted to the perceived danger by deciding to cut supplies in September 2003 and then again in February 2004. After the February meeting, Saudi oil minister Ali Naimi, interviewed by Walid Khadduri on MEES, explained:

“In September, we decided to reduce the ceiling from 25.4mn b/d to 24.5mn b/d – a 900,000 b/d reduction. The market, though, behaved otherwise which means that the data in front of us was either inaccurate or it did not include all the future events. And so instead of reducing the 900,000 b/d, we actually increased production beyond the 900,000 b/d to keep the market from overheating. This was done in an informal manner, but by agreement of course. We looked at it in December and we thought it’s OK, let’s leave the ceiling and the leakage continued. Now at this meeting, OPEC data says there will be a reduction in demand or surplus of 3mn b/d in 2Q. The IEA data also indicated a 3-4mn b/d reduction in demand or surplus of that amount; so the quandary was: what do you do, do you wait until you have a huge build-up in inventory and have a precipitous price fall or do you take a preemptive, proactive course of action?”

he February decision, although in fact never fully implemented (see Table below for MEES’s estimate of OPEC production levels in recent months), sent prices skyrocketing. In June OPEC had to formally reverse its decision of four months earlier, and indeed Saudi Arabia started producing at a level not seen since 1990.

hese events are indeed extraordinary in many ways and demonstrate how poor is our understanding of global oil demand and supply even in the very short run. Weather forecasts have now become more reliable than oil demand/supply/market predictions.

Paul Horsnell, in the paper which he presented to the International Energy Forum ministerial meeting in Amsterdam, has presented two very interesting charts showing how expectations concerning demand and supply for a given period (the fourth quarter of 2003) evolved over time. Demand estimates were progressively increased, from mid 2002 to early 2004, gaining fully 3 million b/d, or about 4 per cent. Non-OPEC supply estimates were progressively reduced, losing about 1 million b/d. The difference, needless to say, is quite substantial and much larger than any swing in OPEC quotas.

This points to several important questions.

  • Firstly, should we conclude that we have a systematic tendency to underestimate demand growth and overestimate non-OPEC supply potential?

  • Secondly, is it conceivable that OPEC may ever succeed in defending its stated target band by proactive quota management in the face of such blindness about the even close future?

  • Thirdly, have we entered a new phase in the evolution of the global oil market, characterized by a higher price equilibrium (i.e. the band must be shifted upwards)?

The difficulty experienced in anticipating demand growth is very surprising, because demand estimates use econometric parameters established on the basis of a very large number of observations. These parameters have a high degree of statistical reliability, and point to relations that are stable over time. Of course, there is the China factor: the Chinese economy is one that experiences very rapid structural change, and is therefore difficult to capture with econometric techniques. We are constantly surprised by China in many ways, and with respect to Chinese oil import requirements the matter is complicated by the fact that they are incremental, and grow much faster than demand. There is little that can meaningfully be added at this stage, except to note that the impact of Chinese demand on the global oil market over the next five to ten years (not to speak of further into the future) remains very controversial and clouded in uncertainty.

Prospects for non-OPEC oil

The supply side is more interesting. Here we have two diametrically opposite readings of the situation.

One would insist on the random and unsystematic concentration of “bad news” that characterized the last 12 months, and which is unlikely to be extended over time or repeated in the future. The first piece of bad news was of course Iraq: the political unrest, the looting and sabotage, the increasing realization that massive investment will be required to restore or increase Iraqi oil production capacity and political conditions for that will not be realized for another two years at least (i.e. when a new constitution is approved and a democratically elected government with full legitimacy is in place – if we believe the current, and very optimistic, official calendar of things to come). But there have been more bad news, from Venezuela (where the US and others are hoping that Chavez might eventually be democratically unseated) to Nigeria and other smaller producers. These have all one thing in common: they can be categorized as political interference in industry affairs, i.e. manifestations of irrationality that will eventually be put right.

In contrast, the second approach points to other, more genuinely oil-related ominous developments. The one development that caught the eye of the majority of non-expert observers is the re-categorization of Shell’s reserves, leading to a 20% downward adjustment. However strictly speaking this shift is not so terribly important, because those reserves are not lost – simply not considered proved any longer; and we all know that the concept of proved reserves is quite subjective to say the least. Yet there was more: reports of declines in mature fields much steeper than expected in numerous areas – ranging from Oman to the North Sea and the US lower 48. In other areas – e.g. the Caspian, delays were announced in the bringing on stream of key new fields – notably Kashagan.

In the Barclays Weekly Oil Data Review of 5 May, Paul Horsnell wrote:

“We have been using very downbeat forecasts for non-OPEC growth this year, with no net growth forecast outside Russia for the second straight year and for the third year out of the past four. Our belief is that decline rates in mature areas are higher than has been anticipated, and that the drag from the mature areas is negating the net growth elsewhere. However, now that the flow of data for 2004 for mature areas has started, the picture that is emerging is dramatically weaker than even our prior expectations. Over the past week, new oil production data has been released by the UK and US, and both sets were far worse than expected. In February, the combined year-to-year decline in production in the UK and US alone amounted to an extraordinary 757,000 b/d. The UK reported a February output level that was 411,000 b/d lower than a year ago, following a 240,000 b/d year-to-year decline in January. The US numbers show a 236,000 b/d year-to-year decline in March following a 346,000 b/d decline in February.”

And on the 9th of June he added:

“We expect that the oil market will again move above $40/B. The only question is whether this happens due to some turbulent geopolitics and short-run gasoline market dislocations at a time of painfully limited spare capacity, or whether it happens further down the line due to the grinding of some very ferocious fundamentals. The further down the line you look, the more difficult it is to see how enough production capacity can be brought on in time.”

So, there was a revival of talk about Hubbert’s curve and the “peak”. At the November ’03 meeting of the Oxford Energy Policy Club a majority of the opinions expressed seemed to be quite pessimistic about the prospect of continuing growth in non-OPEC supplies. On the opposite side, Daniel Yergin, writing on the New Your Times on April 4, predicted that it would be another 50 years before any problem of oil scarcity arises. And in the paper he presented at the Amsterdam ministerial of the International Energy Forum, Olivier Appert has written:

“Among the more pessimistic experts, some believe that world production of conventional oil has already peaked, others that this will happen before 2010. The optimists - especially those basing their forecasts on data from the U.S. Geological Survey – say that production should peak in 2020 or later. These divergent opinions rely on different estimates of the ultimate recoverable reserves of conventional oil. But future oil resources will not be limited to conventional oil. By mobilizing other resources (exploiting nonconventional oil resources, improving the recovery of oil in place to add resources, etc.), the production peak can be postponed.”

The debate on Saudi reserves and production prospects

It is in this context that the controversy over Saudi oil reserves erupted. For years, the EIA has published estimates of “required” future Saudi production capacity that seemed quite unrealistic: the latest International Energy Outlook projects Saudi capacity at 14 million b/d in 2015, 18 mb/d in 2020, and 22 mb/d in 2025 (reference case). (See also EIA’s Saudi Arabia Country Analysis Brief published in June 2004). And that is in a context in which non-OPEC production capacity is assumed to continue growing until 2025 – no peak in sight. Does Saudi Arabia have the required resources? Do they intend to increase their production to such an extent?

The controversy about Saudi oil reserves and prospects of future production increases was sparked by Matthew R. Simmons. At a debate organized by the Center for Strategic and International Studies (CSIS) in Washington on February 24, 2004, he argued that Saudi Arabian oil production might soon be peaking, because of expected growing problems with the country’s key long-producing oilfields. In one of his concluding slides, he argues:

  • The entire world assumes Saudi Arabia can carry everyone’s energy needs on its back cheaply.

  • If this turns out to not work, there is no “Plan B”.

  • Global spare oil capacity is now “all Saudi Arabia”.

Representing Saudi Aramco, Mahmoud M. Abdul Baqi and Nansen G. Saleri argued that Saudi production policy has been very conservative, and the Kingdom could increase its production easily. The argument was reiterated on April 27 at the same venue by the Saudi Minister of Petroleum, Ali Naimi, and the CEO of Saudi Aramco, Abdallah S. Jumah. Jumah had the following to say (and I quote from the speaker’s notes published on the CSIS web site, which include some interesting detail which is not in the transcript):
“Saudi Aramco’s current production capacity is 10 million barrels per day, including some 2 million barrels of surplus production capability. This capacity has been tested and put into effect as required. Depending on global market demand, we can produce and sustain the 10 million barrels a day level for more than 50 years, by relying primarily on our already proven reserves. Further reserve expansion efforts will certainly push the plateau beyond 50 years.

(Ad Lib: Only minimum use of the probable and possible reserves will be required to sustain the 50-year plateau.)

[Note: Minimum means only 15% or 15 billion barrels use of probable and possible reserves.]

[Note: These figures place the probable and possible reserves at about 103 billion barrels. Considering the 80 billion barrel figure referenced earlier, the 103 billion barrels include additional recoveries from the existing fields, which are not a part of the 80 billion barrels number, enhanced recovery processes and other reserve expansions referenced below].

We have developed a range of long-term crude development scenarios that call for raising production to 12 or 15 million barrels per day, depending on demand growth. We are confident that we can develop and sustain production at these levels for at least the next half century by utilizing a higher proportion of Saudi Aramco’s probable and possible reserves.

(Note: For 12 MMBD and 50 year plateau, 34% or 35 billion barrels use of probable and possible reserves is required. For 15 MMBD and 50 year plateau, 68% or 70 billion barrels transfer of probable and possible reserves to proved is required).
Potential also exists for extending the 50 year horizon for these higher production levels by further expanding reserves. Such expansion will come from a combination of oil-focused exploration that leverages Saudi Arabia’s rich hydrocarbon potential; the prudent use of technology; well-conceived reservoir management practices; and incremental oil recoveries through the application of enhanced recovery processes.”

(Slide from the presentation by Baqi and Saleri)

The point is therefore that sustaining production at 15mb/d over 50 years would require very substantial draw down of reserves. Higher production levels, as hypothesized by the EIA, would not be sustainable for such an extended period of time. But would it be wise and prudent for Saudi Arabia to greatly intensify the rate of exploitation of its reserves, considering that oil remains the most important asset for the long-term future of the Kingdom?

Furthermore, the Saudi rebuttal of Simmons’s argument proves that Saudi Arabia can indeed increase production, but does not negate his last point quoted above, i.e. that Saudi Arabia possesses almost all available spare capacity in the world, and any talk of increasing OPEC production means in fact increasing Saudi production. When the decision was made to increase OPEC quotas in June 04, Saudi Arabia was the only country with any effective unused capacity left: everybody else was already producing at capacity.

In this context, the centrality of Saudi Arabia, and of US-Saudi relations, can hardly be underestimated. Following September 11, US-Saudi relations have entered an extraordinarily difficult period, which combines a tendency to prejudiced Saudi-bashing to well-intentioned advice and the perception that Saudi stability can only be guaranteed in the long run if taboos are overcome and painful reforms are undertaken.

Russian production prospects and political uncertainties

Asserting the centrality of Saudi Arabia does not necessarily mean negating the increasingly important role that Russia is playing. Indeed, Russian production has continued to increase steadily, and might have grown even more, had it not been constrained by logistical bottlenecks. But Russia’s increase simply compensates for declines elsewhere (in the UK and USA), meaning that incremental demand still needs to be met by OPEC, i.e. Saudi Arabia.

Furthermore, how far can we expect Russian production to grow? Some observers have exceedingly optimistic expectations about Russia. Julian Lee of the CGES, for one, presented the two slides reproduced below at a conference organized by CERI in March 2004. One cannot fail to note that the extrapolation represented by the “second curve” (the red curve) is quite a bold one.

Although the Russian resource base is undoubtedly quite substantial, one cannot but note the numerous unresolved problems that are bound to plague the Russian oil industry for quite a while. The legal and corporate setting of the industry remains uncertain: Putin’s Russia appears to be inclined to recover some of the control on the industry that was lost in the chaotic and corrupt period of the Yeltsin administration. The jailing of Michail Khodorkovski, and pushing Yukos into technical bankruptcy through an assessment of tax arrears for US $3.4 bn, recently upheld in court, shows that life in the Russian oil patch is not for the faint hearted.

Why is the Russian government apparently so determined to bring one of its star companies to its knees? Some specific positions taken by Yukos under Khodorkovski have annoyed Putin: the flirting with, and supporting of, some of Putin’s political opponents; the difference of opinion on whether eastern Siberian oil should be pumped to China or the Pacific Coast; the possibility of a merger with EXXON, which would have effectively put Yukos beyond the reach of the Russian government. These are important points of difference, which certainly played a role in precipitating an outcome that Khodorkovski himself did not fully anticipate (he would have fled earlier, one supposes…). But they show a broader and possibly more important point, which is that the Russian state wants to maintain control.

This conclusion is however seemingly denied by the BP-TNK joint venture, which opened the door to much increased involvement of BP in Russia. It is not altogether clear why BP was allowed to acquire such a strong foothold, in a deal that is apparently destined to remain an exception. It is of course possible that the Russian government may tolerate one major IOC to become strongly established in Russia, but not that all Russian oil companies turn into joint venture partners of IOCs – much as the Sakhalin PSAs were confirmed, but no additional ones were concluded.

So the jury is out, and the future of the BP-TNK joint venture – the extent to which it will be allowed to be successful – may become the best gauge of Russian oil nationalism. To what extent will Russia behave very much differently from the Mexicos and Saudi Arabias of this world? Nationalism remains strong in the country, raising doubts about its ability and readiness to increase production at a rapid pace, even at the cost of loss of control.

As noted, the insufficient capacity of Russian export pipelines has been the limiting factor in increased Russian exports. Expansion of export capacity requires availability of finance, but it also requires a convergence of views on desirable market outlets. The persistent difference of opinion – closely related to geopolitical priorities and arguments – has slowed down or entirely stalled the progress of many projects.

Until recently, controversy had focused on how to get oil out of the Caspian: however, with the CPC in operation and the Baku-Tbilisi-Ceyhan pipeline under construction, the uncertainty about routes out of the Caspian is now greatly reduced. (On Caspian pipelines see e.g. Van Agt). The emphasis has moved to the question of the Black Sea and the congestion of the Turkish straits, to the West; and the question of the export pipeline to China (Daqing) or the Pacific Ocean (Nakhodka) to the East.

In both instances, the strategic issue under discussion is whether Russia, being a continental producer, should be content with serving its markets by pipeline, and play an essentially regional role (i.e. exporting almost exclusively to Europe to the West, and China to the East); or, on the contrary, should aim at establishing a capacity to export long-haul (that is: to the United States) by taking its oil to a deep water port capable of loading VLCCs. This appears to be the reason for preferring Nakhodka, and is also the reason for supporting the oil pipeline project to connect Burgas (in Bulgaria) to Vlore (in Albania) rather than the much shorter route to Alexandroupolis (in Greece); and for insisting in viewing Omisalj (in Croatia) as a main loading harbor for shipping crude to the US (two competing projects there: one favored by Yukos and based on reversing the Adria pipeline, the other based on a partially new line connecting Constanta in Romania to Omisalj, and probably also Trieste), when Trieste – just around the corner of the Istrian peninsula – is a major entry point for the European market, through the TAL pipeline. As frequently is the case, geopolitical considerations seem to favor solutions that are more expensive and make less sense commercially, but governments have no tools or are not willing to provide the required additional finance. The outcome is that progress of the commercially more viable solutions is blocked, while alternatives remain stalled.

Towards regionalisation of international oil trade?

These controversies are interesting not just because they indicate that further developing Russian exports may not be a straightforward affair; but also because they might be interpreted as pointing to growing regionalisation of the international oil market. While sufficient arbitrage will always exist to guarantee that petroleum prices are equalized globally, net of transport costs, most of the oil is in fact likely to move on short haul, establishing closer ties of interdependence between pairs of regions. Thus, if we consider the likely evolution of oil exports from North Africa, the Caspian and Russia, we come to the conclusion that Europe’s reliance on oil from the Gulf is bound to decline. The US will become ever more of a dominant factor in the Atlantic basin, while Gulf oil will increasingly be directed to East and South Asia. The exception in the Gulf is likely to be Saudi Arabia, which might continue to ship significant volumes of oil to the United States, more out of political than commercial motivations. As mentioned, Russia would very much like to do the same, but finds the goal considerably more difficult to reach.

If we accept the inevitability of the tendency towards regionalisation – which might be strengthened by rising transport costs and the preference recently expressed by the European Union for transporting oil by pipeline rather than ship whenever possible, for environmental reasons – we should conclude that the EU has good reasons for concentrating its attention on developing a cooperative relationship with Russia, the Caspian and North Africa, while devoting much less attention to the GCC. But is this a sensible approach, in the light of the noted centrality of Saudi Arabia to global supplies?

In the case of the United States, the tendency to regionalisation is manifested especially in calls to intensify relations with West Africa, primarily in order to reduce dependency on the Gulf. Because this is not enough, proponents of reducing dependency on the Gulf point to the need for having access to Russian and Central Asian oil, notwithstanding the negative logistical implications. So we have the paradox, that while the European Union speaks of possibly eliminating petroleum carrier traffic from the Mediterranean (see “Preliminary Discussion on Options Aiming at Diminishing Risks in the Maritime Transport of Oil and Oil Products”, chapter 5 of Technical Annex 1, “Initiatives on the Development of Infrastructure Projects of Common Interest”, in Annexes to the Euro-Mediterranean Ministerial Conference of Rome, December 03), the US presses for Russian and Caspian oil to be available at deep water ports, for loading on VLCCs bound for the opposite side of the Atlantic: the potential for conflict there should be underestimated.

Finally, regionalisation also means rapidly growing ties within Asia. Especially if Russia deliberately plays down its ties with China, and takes east Siberian oil to the Pacific, the result will be that Gulf producers will focus on exporting to the major Asian markets even more than they already do. In the eyes of Gulf producers, the Asian markets offer the additional advantage that their transformation capacity is much less developed, meaning that there is scope for exporting refined and/or petrochemical products, to satisfy a demand that will systematically outpace domestic supplies. The emergence of an “Asian block”, whose political priorities and values are very much different from those of either Europe or the United States, may significantly alter the interplay of political and economic factors in the international oil industry.

Major developments in international gas trading

As the oil market is moving towards regionalisation, the opposite is happening in the gas market. Historically, the market for gas has been regional rather than global, with three main trading regions being North America, Europe, and the Far East. There has been little arbitration between regions (indeed, also within regions, except for North America), because of the absence of transportation capacity. This has led to widespread price segmentation and persisting differentials between regions.

However this situation is now rapidly changing, due to the emergence, on the one hand, of the United States as a major importing country, “pulling” gas from all directions, not just from within North America; and, on the other hand, of Qatar as the new global source, based on massive investment in new LNG projects aiming at the US and European markets, in addition to Far Eastern ones. Thus, although the ability to redirect gas from one region to another will remain limited some arbitraging will take place through adjustments in the origin of marginal US imports and the direction of marginal Qatari exports.
According to BP (a major producer of gas in the US) “US gas production has recently plateaued despite ample, available domestic gas resources, because they are becoming increasingly costly to recover”. The decline in domestic production, coupled with limited import capacity has led to a shift in the average level of prices. Although the spike of 200/1 remained an exception, Henry Hub prices over the last year never fell below $4.50 per MMBTU, a level that makes LNG import projects quite attractive.

onsequently, it is now expected that US LNG imports will increase very rapidly (see the table from EIA’s Annual Energy Outlook), leading to concerns about security of supply. Dan Yergin, for example, had this to say (at the same CSIS gathering on April 27 primarily devoted to Saudi Arabia):

“U.S. really is on the threshold of a new era in natural gas, and this has major implications. In a sense the U.S. is today in natural gas where it was 30 years ago in oil, about to go from being a minor importer to being a major importer, and a decade from now the United States could literally overtake Japan as the world's number one importer of LNG. That will add to the dimensions of energy security that we talk about, a host of new energy relations, and give a larger dimension to the conversations.”

The importance which is attributed to ensuring abundant LNG supplies to meet the growing US requirements was manifested by the December 2003 LNG Ministerial Summit convened by the US DOE. The Summit’s objectives included:

  • “Reveal innovative approaches to meeting the challenges facing the growth of US LNG”

  • Provide “a perspective of expected LNG market growth over the next two decades”;

  • Identify “significant US market and investment opportunities”;

  • Explore “concerns and issues that producing nations need to discuss to ensure a successful and fast-growing US LNG market”.

In this same context, we can also point to the Geopolitics of Natural Gas Study, jointly launched by the Program on Energy and Sustainable Development at Stanford University and the James A. Baker III Institute for Public Policy of Rice University. The Study generated a set of papers on several major historical pipeline case studies, plus a paper by Peter Hartley and Kenneth B. Medlock III entitled “A Global Market for Natural Gas? Prospects to 2035”. The latter strongly argues in favour of the globalisation of the natural gas market – dominated by Russia on the supply side and the United States on the demand side:

“According to the Rice World Gas Trade Model, in a global natural gas market events in one region of the world will influence all other regions. (…)

The model also suggests that Russia will play a pivotal role in price formation in a more flexible and integrated global natural gas market. Eastern Siberian gas begins flowing into Northern China in the middle of next decade. Toward the end of the model time horizon, specifically 2025-2030, Chinese growth pulls gas from both Western Siberia, via pipeline through Eastern Siberia to Northern China, and from Kazakhastan through Western China. Sakhalin production serves LNG markets as well as Japan via pipeline around 2010. Some Sakhalin gas also moves toward South Korea via pipeline through Nakhodka. Throughout the model period, Russia is a very large supplier to Europe via pipeline, exceeding 50% of total European demand post 2020. Strategically positioned to move large amounts of gas both east and west, the presence of low cost Russian pipeline gas in both Asia and Europe will serve to link Asian and European gas prices. The model also suggests that Russia will eventually enter the LNG trade (via Barents Sea), providing an additional link between gas prices in North America, Europe and Asia. Russia benefits not only from its location and size of resources but also because it was one of the first major gas exporters and has access to a sophisticated network of infrastructure already in place.

Other resource-rich players like Iran and Saudi Arabia must bear the fixed costs of market entry due to the lack of existing infrastructure. Early entry would drive down prices and lead to inadequate returns on investment. Therefore, entry must be delayed until world demand --in excess of alternative sources of supply-- is large enough to accommodate those incremental supplies. Consequently, Iranian and Saudi Arabian LNG supplies do not enter the world market until after 2020. Another factor limiting exports from both countries is domestic demand growth in part to facilitate oil production.

From the point of view of consuming regions, preliminary modeling results suggest that the United States market will be a premium region pulling in gas supplies from around the world.”

In the immediate, however, it is Qatar, rather than Russia, which is emerging as the leading global supplier. After a gestation that has lasted some three decades, Qatar’s North Field is poised to finally become a major factor in the international gas industry (see table from Gas Matters of February 2004, summarising Qatar’s progress).

The globalisation of international gas trade will therefore be made possible by the expansion of LNG trade. However, we should keep in mind what has been noted by van der Linde & Stern (in the paper they presented at the IEF Amsterdam ministerial meeting), i.e. that in any case LNG growth cannot possibly be sufficient to meet the expected growth in global demand, meaning that pipeline gas will need to continue growing - but little progress has been achieved in establishing new pipelines, as political problems continue to prevent the implementation of various projects.

“In the period to 2020, LNG trade is expected to grow manifold, with the most optimistic projections assuming a quadruplicating of LNG trade to around 600 bcm/a. This will fall considerably short of the projected growth in demand of 1700 bcm (IEA). The difference, consequently, will have to be met by cross-border piped gas. Nevertheless, the current development of international gas pipelines yields a less dynamic perspective with regard to the actual commitment to new investments. Many conceptual opportunities are being discussed and explored. And indeed, these will be very much needed to achieve the growth projected. But it takes at least 5 and usually up to 10 years for projects to get off the ground. There are discussions and plans around the development of pipelines from Russia to Europe via the Baltic Sea, from the Caspian region and Iran to Europe, and from Russia to China and beyond. So far, none of these have reached the stage of a commitment to invest. Political issues, regulatory design, as well as the harmonisation of investments and supply risk, prove to be very difficult to align.”

The difficulty in establishing new pipeline projects therefore remains central in the debate on security of gas supplies. As I have noted elsewhere (CEPS Policy Brief 51), it is only through the deliberate creation of redundancy in import facilities – pipelines and LNG terminals – that we can achieve at the same time a more competitive and secure European gas market. However, the market is unlikely to bring about redundancy, tending rather to eliminate bottlenecks only once they become critical. Ensuring competitiveness and security of supply through diversification is likely to require continuing public attention, but how this can be done without distorting market conditions is a question that remains open.


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Memoranda of Understanding and Declarations of Intent

Ministerial Declaration by the Euro-Mediterranean Energy Forum

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Fisk, David, Transport Energy Security: The Unseen Risk? Insuring against Disruptions of Energy Supply (INDES) - CEPS Policy Brief No. 50, Brussels, February 2004.

Hartley, Peter & Medlock III, Kenneth B., A Global Market for Natural Gas? Prospects to 2035, Working Paper no. 33, Geopolitics of Gas Working Paper Series, Program on Energy and Sustainable Development, James A. Baker III Institute, May 2004.

Hayes, Mark H. & Victor, David G., Program on Energy and Sustainable Development Stanford University, Geopolitics of Natural Gas - A joint study from Stanford PESD and the James A. Baker III Institute for Public Policy of Rice University, GSB Energy Club, 10 May 2004.

Hayes, Mark H., Algerian Gas to Europe: The Transmed Pipeline and Early Spanish Gas Import Projects, Working Paper no. 27, Geopolitics of Gas Working Paper Series, Program on Energy and Sustainable Development, James A. Baker III Institute, May 2004.

Hohnen, Paul, Transparency: the Path to ‘Clearly Better' Sustainability and Performance, 9th International Energy Forum, Amsterdam, 22-24 May 2004.

Horsnell, Paul, Energy Investments and Impediments, 9th International Energy Forum, Amsterdam, 22-24 May 2004.

International Energy Agency, World Oil and Gas Investment Outlook, IEA Background Paper, 9th International Energy Forum, Amsterdam, 22-24 May 2004.

Jum‛ah, Abdallah S., Saudi Aramco's Unique Role in Providing Future Oil Supplies, speech of 27 April 2004 at the conference in Washington DC of the Center for Strategic and International Studies (CSIS).

Khristenko, Victor (Russian Vice-Prime Minister) & Lamoureux, François (European Commission Director-General) EU-Russia Energy Dialogue – 4th Progress Report, Moscow/ Brussels, November 2003.

Lee, Julian, Future Russian oil production – the CGES view, CERI 2004 Oil Conference “Insecurity of Supply? 28th - 30th March 2004, UK.

Luciani, Giacomo, Security of Supply for Natural Gas Markets: What is it and What is it Not?, Insuring against Disruptions of Energy Supply (INDES), CEPS Policy Brief No. 51, Brussels, February 2004.

Mandil, Claude, The Geopolitics of Oil after the Iraq War (text) (slides), Aspen Institute Italia Conference “The Geopolitics of Energy: the Asian Shift”, Florence, 8-9 July 2003.

Mastepanov, Alexey M., Energy Strategy of the Russian Federation to the year 2020, presentation

OPEC Secretariat, Oil Outlook to 2025 - OPEC Secretariat Paper, 9th International Energy Forum, Amsterdam, 22-24 May 2004.

Royal Dutch / Shell Group of Companies, Exploration & Production: Reserves & Growth Update, 5 February 2004.

Saghir, Jamal, Energy and Poverty, 9th International Energy Forum, Amsterdam, 22-24 May 2004.

Shepherd, Rob & Ball, James, Liquefied Natural Gas from Trinidad and Tobago: The Atlantic LNG Project, Working Paper no. 30, Geopolitics of Gas Working Paper Series, Program on Energy and Sustainable Development, James A. Baker III Institute, May 2004.

Simmons, Matthew R., The Saudi Arabian Oil Miracle, The Center for Strategic & International Studies, 24 February 2004, CSIS, Washington D.C.

United States Energy Association LNG (Liquefied Natural Gas) Ministerial Summit – Agenda and presentations, Mayflower Hotel, Washington, DC, 16-18 December 2003.

Van Agt, Christof, Caspian Oil and Gas export routes and markets cooperation or competition with Russia? Challenges to be addressed and possible solutions, CIS Oil & Gas Summit 2004 “Exports of Caspian, Caucasus and Central Asian Oil & Gas to international markets” London, 30 March-1 April 2004.

van der Linde, Coby & Stern, Jonathan, The Future of Gas: Will Reality Meet Expectation?, 9th International Energy Forum, Amsterdam, 22-24 May 2004.

Victor, David G. and Makarova, Nadejda, The Belarus Connection: Exporting Russian Gas to Germany and Poland, Working Paper no. 26, Geopolitics of Gas Working Paper Series, Program on Energy and Sustainable Development, James A. Baker III Institute, May 2004;

Zanoyan, Vahan, Institutional Cooperation in Oil and Gas: Governments, Companies and the Investment Climate, 9th International Energy Forum, Amsterdam, 22-24 May 2004.

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