By Philippe de Pontet and Clare Allenson 

Although today's African Union (AU)-U.N. deadline for reconciliation between Sudan and South Sudan has come and gone without a resolution, the Security Council is unlikely to follow through on its threatened targeted sanctions for now (China and Russia are unlikely to endorse them).  While an oil deal in the next few weeks remains unlikely, the economic and patronage imperatives in both capitals finally point toward an interim oil deal before the end of the year or in early 2013 -- despite plenty of spoilers on both sides who see compromise as capitulation. Each side has made an initial offer on transit fees, and while more movement is needed, resumption of most of Sudan's 350,000 barrels per day (BPD) will likely occur by the end of the year or, at the latest, in early 2013.

Ever since South Sudan shut down its northern-bound oil production in January, the two nations have been engaged in a battle of economic attrition, punctuated with actual and proxy battles near their disputed border. South Sudan, which depends on oil for more than 95 percent of its revenue base, injected a ray of hope in recent weeks into the long-languishing talks, with an offer of over $8 billion in debt relief and compensation for Khartoum, and pipeline fees of about $8 per barrel of oil. The government of Omar al-Bashir in Khartoum wasted no time in rejecting the offer, insisting that border security is the top priority -- but its revised (albeit still low) offer of roughly $32 per barrel a few days later indicates that the two countries are slowly moving toward a deal. Sweeteners from China and the Gulf states will probably be necessary to get Khartoum to raise its offer further. Despite the initial rejection, the new terms should provide the basis for a reasonable oil deal that could get Sudanese crude flowing again. Though full production will take several months, the largely unexpected addition of more than 200,000 BPD of Sudanese crude would be a small, but not insignificant, supply bump for highly volatile oil markets.

The embattled Bashir administration cannot afford to appear weak, and declined a meeting with South Sudan President Salva Kiir ahead of the U.N. deadline this week. But it literally cannot afford the drastic austerity that looms on account of lost oil revenues, which explains Khartoum's acceptance to attend an AU summit with Kiir in the near future. The envisioned Sudanese cutbacks make Greek austerity look like a walk in the park -- not to mention the additional pain of high inflation, a sharp depreciation of the Sudanese pound, and an incipient anti-regime protest movement. The Kiir administration faces an equally negative outlook, with inflation well above 70 percent and a 56 percent-unfunded budget despite a nearly 40 percent cut in spending. Dwindling donor patience will serve to push Juba's hand toward a deal. Even more significant is Juba's belated realization that a southern-based pipeline, if it emerges at all, is years away and therefore not a panacea for its pressing needs.

A binding deal on oil revenue sharing will not be possible or sustainable if the Sudans remain in a shooting war on both sides of the border. Both of the military-dominated governments would plough a huge percentage of oil revenues into security, risking an even greater escalation, making both sides understandably wary of an oil deal without security guarantees-particularly Khartoum, which faces multiple insurgencies just a year after its painful loss of the south.

Talks have broken down several times over the location of a demilitarized zone, which would represent the first step to ending hostilities. During her visit to Juba this week, Secretary of State Hillary Clinton will pressure the Kiir administration to follow through on security guarantees in order to move negotiations forward. Juba's implicit bargain now appears to be to demobilize its affiliated militias in Southern Kordofan and elsewhere, in exchange for an independence referendum in Abyei, which would likely see the district join South Sudan. Khartoum will no doubt exact a higher price, through higher transit fees. Hammering out such a deal will be tough, but the reality of a mutually destructive stalemate, together with both Juba and Khartoum's revised oil offers, should offer scope for a deal-albeit a shaky one-sooner than most would expect.

Philippe de Pontet is the director of Eurasia Group's Africa practice. Clare Allenson is an associate in the firm's Africa practice.

By Willis Sparks

Western officials (and more than a few Western celebrities) have criticized China in recent years for its protection of Sudan's government. They've charged Omar al-Bashir's regime in Khartoum with support for ethnically motivated militia attacks on civilians in the country's Darfur region -- and China's government with complicity. Bashir, the world's only fugitive head of state, was indicted by the International Criminal Court in 2008 for Darfur-related crimes against humanity. Beijing uses its veto power to block international efforts to supply UN peacekeepers for Darfur, critics say, to protect its oil interests in the country.

It's ironic then that China's energy needs are now helping forestall a broader (and perhaps bloodier) confrontation in Sudan.

Last July, Sudan became two countries. The mostly Muslim North and mainly Christian South finalized a relatively amicable break-up as South Sudan became an internationally recognized independent state. But like most divorces, this one did not produce a clean break, because the two countries share custody of the country's oil wealth.

Before the separation, Sudan produced about 500,000 barrels of crude oil per day. South Sudan now sits atop 75 percent of that total, but the pipelines that transport the oil and the ports that move it to market lie in the North. Since July, the northern government in Khartoum has faced a series of political and economic crises, and its foreign reserves have dwindled to dangerously low levels. Bashir's government needs some way to draw more cash from the oil it has lost.

Not surprisingly, North and South have yet to agree on how to share oil revenue, and each side has used its leverage to pressure the other. An opening of negotiations offered little promise of progress: Khartoum demanded a transit fee of $36 per barrel. The southern government in Juba offered less than a dollar.

On Nov. 8, President Salva Kiir of South Sudan dramatically upped the stakes in the dispute by ordering the expulsion from the south of Sudapet, the North's national oil company and a financial lifeline for its government. Khartoum countered with an announcement that oil exports from South Sudan would be suspended.

China quickly jumped in.

This oil is especially important to the China National Petroleum Corporation (CNPC), which has equity production in Sudan of about 200,000 bpd, 15 percent of its total overseas output. Despite its growing involvement in oil exploration and production abroad, CNPC is still a newcomer to this game, with fewer options than its international peers.

And CNPC is important for China's government, because the company is a guarantor of China's energy security. Most of the crude that CNPC draws from Sudan is not shipped home to China but is sold on international markets. Yet Beijing has emphasized the importance of holding oil assets overseas, providing fuel that can be directed to China if events threaten a sharp drop in supply.

The country's thirst for energy -- and management of the political vulnerabilities it creates -- remain a top priority for Beijing. Sudan represents less than 5 percent of China's crude oil imports, but add an extended export shutdown in Sudan to the current range of worries and headaches across oil-producing North Africa and the Middle East, and you could have significant upward pressure on global oil prices at a time when the Chinese leadership is already worried over price inflation and the risk of unexpected foreign economic shocks.

This is an especially anxious time for Beijing's economic policymakers. Volatility in Europe and the slow recovery in the United States -- China's largest trading partners -- fuel fears of a sharper-than-expected slowdown inside China. It's also a delicate moment for the country's politics as a leadership transition begins in earnest in 2012.  That's why China moved quickly to pressure the North to renounce its threatened blockade.

To save face, Khartoum announced it would allow the oil to pass but would seize about a quarter of the profits as compensation. Low-level violence will continue, and we can expect to see more of the increasingly common attacks on oil fields along the two countries' poorly demarcated border. There will be more turmoil in restive oil-producing regions in the North. But thanks to aggressive Chinese mediation, the oil continues to flow, and Chinese diplomats are now trying to broker a long-term deal on transit fees.

Don't expect China to dive more deeply into conflict resolution in other countries. On foreign policy, China's leadership is risk-averse even in the most confident of times, and the looming transition to a new president, premier, and party elite over the next two years will make officials even more cautious. Only when political and commercial interests clearly coincide, as they do in Sudan, will Beijing move quickly to intervene in the politics of other countries.

In this case, however, Chinese intervention helped avoid a dangerous foreign conflict -- at least so far -- even if Western critics are cynical about its motives.

Willis Sparks in an analyst in Eurasia Group's Global Macro practice. 

By Risa Grais-Targow

By all rational measures, Cuba is effectively irrelevant to the United States. The island is small, its economy is about the size of New Hampshire's, and since the collapse of the USSR it poses no strategic threat. Yet the Castros have a habit of popping up in the headlines. In part, that is because of the inevitable fascination with a small country that has been a foreign policy irritant for the United States since 1959 and, more recently, its outsized role in Florida politics. But change is coming to Cuba, slowly but surely, and with change comes the possibility of unexpected volatility.

Cuba is gearing up for the first Cuban Communist Party (CCP) congress in 14 years, to be held April 16-19. Much of the event will be focused on formalizing Raul Castro's small steps toward economic liberalization (e.g., trimming the state's workforce and allowing more room for entrepreneurs) outlined in a November 2010 wish-list of 300 reforms. Another, perhaps more important, development will be the identification of the next generation of leaders, including the appointment of a new second-in-command for the CCP (the second most powerful position in Cuba). The long delay since the previous CCP congress suggests that there has been much internal wrangling over that issue.

The Castros are clearly on the way out (Fidel is 84 and Raul is 79), and the CCP has promised that the congress will usher in a new generation of leaders. Just how new and young they will be remains to be seen. On March 25, Raul Castro announced that the 50-year-old Economy and Planning Minister Marino Murillo, who has been the architect of much of the economic reform agenda, would now oversee its implementation as a sort of economic czar, signaling Raul's devotion to the reform process. The CCP may, however, simply shuffle senior party members into new positions rather than appoint younger reformers.

Such developments could also be important for the U.S. and perhaps trade with Cuba. Unless Congress decides to revisit the issue, the Helms-Burton Act of 1996 stipulates that the Cuban embargo cannot be lifted while the Castro regime is still in power. A shift in the leadership could also open the way to dealing with other potential concerns. For example, Cuba is actively exploring for oil in the Gulf of Mexico, raising U.S. concerns about how it would handle disasters similar to the 2010 Macondo well blowout.

But the CCP faces deeper challenges than this round of leadership refreshment. Most young Cubans are disenchanted with the regime. They have spent most of their lives in post-Soviet Cuba dealing with grinding economic hardship. Finding true believers among that generation is likely a difficult task and the regime's ability to implement meaningful reforms will affect the stability of Cuban politics further down the line.

Risa Grais-Targow is an analyst in Eurasia Group's Latin America practice.

By Erasto Almeida and Willis Sparks

As a constant gush of crude oil into the Gulf of Mexico illustrates the dangers of deepwater production, policymakers around the world must make tough choices on how and when to open other deepwater projects. You'd expect that America's ongoing nightmare might generate serious debate in Brazil, where policymakers and petroleum engineers are moving forward with plans to develop one of the world's largest oil discoveries in a generation. Political factors ensure that that's not so.

Brazil's plans are plenty ambitious. British Petroleum's Deepwater Horizon project drilled at ocean depths of 4,920 feet. Brazil's reserves, discovered in 2006, are located beneath a layer of salt more than 7,200 feet down. Petrobras, Brazil's national oil company, will assume ultimate responsibility for bringing the oil safely to the surface if current legislation makes its way through the country's congress.

The technical challenges are considerable. Petrobras will have to reinforce pipes to withstand enormous deep-water pressure. Special alloys must be used to limit the corrosive effects of high levels of carbon dioxide. The unstable ocean floor above the salt will make rigs difficult to anchor. No oil company in the world has ever faced such complex challenges. Yet, Brazil is advancing full speed ahead, and its plans have broad public and political support. Why?

First, there's an element of national pride involved. Brazilian officials remind doubters that Petrobras is the world's leading producer of deep-sea oil reserves. The state-owned company produces more than two million barrels per day, more than three quarters of which is drawn from deepwater wells. Nearly one fifth of the total comes from depths equal to BP's Deepwater Horizon rig. Officials add that, as with the financial crisis, America's current problem flows from a catastrophic failure to regulate. Brazil will adopt tougher safety standards. The country's National Petroleum Agency, responsible for oversight of rig and well safety, is already preparing a detailed study of the state of equipment -- and of contingency plans should disaster strike. Whether the subject is big banks or big oil, Brazilian officials insist there is little risk in their country of American-style regulatory complacency. That said, they're also likely to limit the cost of new regulatory burdens to ensure that plans move forward without unnecessary delays.

Second, Brazil's legislative debate over oil reform has centered in recent months on how the huge expected deepwater profits will be divided among federal, state, and local governments. That gives political powerbrokers at every level a substantial share of the spoils -- and a reason to support the project. 

In addition, the current government sees state-owned Petrobras as a useful tool of economic policy. During the slowdown in Brazil that followed the U.S. financial crisis, Petrobras helped protect local jobs by expanding local investment and buying larger percentages of its equipment from Brazilian suppliers. Petrobras can be even more useful if it meets its public target of doubling production over ten years, and most of the added output will come from the deepwater pre-salt reserves. President Luiz Inacio Lula da Silva has called the deepwater discovery a "second independence for Brazil." In part, that's because it can reduce the country's dependence for growth on economic conditions elsewhere. That's a powerful political incentive for a fast-developing country.

Ironically, the spill in the Gulf could actually accelerate Brazil's plans. If oil-stained U.S. beaches lead to a longer-than-expected U.S. deepwater drilling moratorium, additional supplies of capital and equipment could become available. Some of those supplies will likely make their way south.

Only a major spill that finds its way onto Brazil's beaches could slow the momentum toward developing the pre-salt reserves. That's not impossible. The most promising deposits are located offshore between Rio de Janeiro and Sao Paulo, Brazil's most densely populated cities by far.

But even a large spill might not make a difference. The largest wells are 150 to 250 miles offshore. More to the point, Brazilian officials say that ocean currents would carry leaking oil further out to sea -- not onto Brazil's beaches.

Are they right? We won't know for sure unless and until it happens. But we do know that, for better or for worse, Brazil is about to drill deeper than ever before.

Erasto Almeida is a Latin America analyst at Eurasia Group. Willis Sparks is an analyst in the firm's Global Macro practice. 

By Greg Priddy

It might seem premature to address how the world oil market and other regional powers will accommodate rising Iraq oil production capacity -- considering that the outcome of Iraq's recent election remains unresolved, and the process of putting together a governing coalition has barely begun. But some of the broad dilemmas that more Iraqi oil will create are structural in nature, and not terribly dependent on the new government's makeup. One thing's for sure: Both Saudi Arabia and Iran will face major challenges to their interests if this scenario plays out.

The Saudi-Iraq axis is simpler than the Iran-Iraq one. If Iraq's production capacity rises to even half of the clearly unrealistic 12 million bpd by 2020, which was a goal cited by Oil Minister Hussein al Shahristani, it will likely serve to maintain some of the current overhang of spare capacity for longer than would have otherwise been the case. This would prevent a retightening of the world oil market that may have put upward pressure on prices. Saudi policy will have to confront how to deal with this situation -- both in terms of whether to delay investment in their own capacity, and how to accommodate what has the potential to be a much stronger second-place producer within OPEC. At some point, Saudi Arabia may approach the new Iraqi government for a discussion about how to renegotiate the system of OPEC quotas in order to accommodate Iraq's increasing oil production with both countries' interests in mind. But depending on how the bilateral relationship evolves, achieving this sort of cooperation may be problematic. Iraq has already added written provisions into its service contracts with foreign oil companies dealing with government-mandated output cuts. This demonstrates that the Iraqi side is beginning to grapple with the idea that it may at some point be adding capacity to an oversupplied market and need to exercise restraint.

The implications of increasing Iraqi oil are even more complicated when it comes to Iran. US secondary sanctions under the Iran Sanctions Act (ISA) have been reasonably successful at hindering development of additional Iranian oil and gas production capacity. While they haven't stopped activity altogether, they've kept it at a level where the volume of oil available for export is likely to continue its gradual slide over the next decade as production declines and domestic demand continues to grow. In this scenario, an eventual retightening of the world oil market with attendant higher prices would clearly be in Iran's national interest, helping it to maintain revenues even while volumes fall a bit during the next several years. The increase in Iraqi capacity, however, could prevent this from happening -- taking a toll on Iran's government finances, and potentially creating tension between the two Gulf neighbors. Given the substantial amount of Iranian influence within Iraq, and the still-latent disputes about the border and control over the Shatt al Arab waterway, this market-driven tension could potentially spill over into the geopolitical realm.

All of this, of course, is dependent on whether Iraq's internal stability permits large-scale oil development to move at a rapid pace, which remains a big "if" at this point. Still, it's not just a matter for the oil market. This situation has the potential to substantially redraw the map of state finances and national power in the Gulf.

Greg Priddy is an analyst in the Global Energy and Natural Resources practice at Eurasia Group.

By Ian Bremmer and David Gordon

After years of being wildly bullish on Brazil, we're in for a bump. The country stands to gain from a strong rebound in growth over the course of 2010, but Brazil's newfound economic abundance will lead to a drop in the quality of economic policymaking -- both on macroeconomic policy and, to a much greater extent, through leaning more heavily on state-owned enterprises. As a result, 2010 will be marked by growing investor concern on both macro and sectoral policy as the October presidential election draws near.

Brazil's challenge of abundance looms greatest in the oil sector. The government wants more control over resources, and has very little desire to allow the international community to profit unduly (or, in some cases, even duly) from the exploitation of the country's vast new oil frontier. With Lula's political capital running high, he should be able to approve legislation creating a new exploration and production framework which relies heavily on state-owned Petrobras. What's happening in the oil sector, while more extreme, should be seen as part of broader trend whereby state enterprises grow in relevance and industrial policy becomes more inward focused. That's a negative for Brazilian markets. A rosy economic outlook is also likely to impact the discipline of macroeconomic policymaking. The Lula administration isn't about to abandon a macroeconomic framework which has proved wildly successful, but lowered fiscal vulnerabilities will tempt the administration to keep fiscal policy expansive for longer than markets would like. That will put additional pressure on the central bank precisely when the membership of its board may be in flux...as Central Bank President Henrique Meirelles considers a run for elected office.

Markets will thus become jittery as the elections draw near, particularly given that some of the concerns will be overblown when investors awaken to these risks more explicitly. Lula's hand-picked candidate Dilma Rousseff enters 2010 favored to win the election, and she will undoubtedly deepen the government's turn toward a bigger state. Sectoral policy won't be evenly problematic -- in the telecom sector, these drivers exist, but are weaker; while in transport infrastructure, the political push actually goes the other way (more foreign investment needed given the scope of projects needing completion before the World Cup in 2014 and the Olympics in 2016). If opposition candidate Jose Serra wins, the sectoral up-side will be larger given the lack of a bias toward state-owned enterprises, and fiscal policy will be tighter. But markets will surely be concerned over his long standing criticisms of both exchange and monetary policy.

The situation is a little like post-Mandela South Africa (though from a more attractive economic trajectory), where people and markets expected continuity until Thabo Mbeki disappointed. Leaders like Mandela and Lula are impossible acts to follow. Post-Lula, Brazil will not have the capable policymaking of the past several years and Brazil will be in for a bumpier transition as a new administration seeks to put its stamp on managing the country's newfound economic wealth. Still, the long-term outlook for the country remains strong. By 2011, Brazil should be set for a bounce.

Next up: India-Pakistan

Ian Bremmer is president of Eurasia Group, and David Gordon is the firm's head of research.

By Greg Priddy

Saudi Arabia faces a complex set of challenges in its role as leading member of OPEC amid ongoing economic and financial market volatility. After achieving an unprecedented level of compliance with OPEC production cuts from other members earlier this year, the kingdom now confronts a problem: compliance is beginning to fray, even as a weakening of the U.S. dollar and a surge in global equities markets push the oil market surging ahead.

If the breakout above $75 per barrel for West Texas Intermediate (WTI) crude oil is sustained and the momentum continues, it's entirely possible that Saudi Arabia will intervene to try to tamp down prices. If that happens, it wouldn't be as part of any understanding with the United States -- a relationship now under serious strain -- but from pure self-interest. With the global economic recovery still fragile, a rapid momentum-driven escalation in oil prices could weigh on consumer confidence and economic growth. That could produce a drop in oil prices. Saudi Oil Minister Ali al Naimi has spoken in recent months of a "goldilocks" range for crude oil at around $75 per barrel, and hinted at action to blunt any sustained push past $80 per barrel.

The Saudis also need to manage price increases to maintain pressure on Iran. Iran's nuclear progress has Gulf Arab governments on edge -- and the Saudis, in particular, would like to avoid taking any action that provides Iran's government with extra revenue. The Saudi government can balance its budget with WTI crude oil in the vicinity of the high $50s. That means they are now replenishing reserves at a rapid pace after running a deficit for the first half of this year. Despite spending cuts, Iran is still under financial pressure, and the Saudis would like to keep it that way.

Managing output levels and prices will be difficult, given that global inventories of crude oil and petroleum products remain well above their normal ranges. Any move by the Saudis to tamp down a surge in prices would likely involve a modest amount of increased exports -- say 500,000 bpd -- and could be pulled back once it has its intended effect of breaking the market's momentum. To bring inventories down, however, the leading Gulf Arab members of OPEC (Saudi Arabia, Abu Dhabi, Qatar, and Kuwait) will need to keep their own output well below pre-September 2008 levels through at least the end of 2010. Right now, compliance outside the Gulf Arab members has receded, particularly in Iran and Angola. Nigeria remains at its target, but that's a result of the continuing violence in the Niger Delta, not a policy decision to keep its promises.  

Greg Priddy is a Global Energy & Natural Resources analyst at Eurasia Group.

JOE KLAMAR/AFP/Getty Images

By Eurasia Group analyst Willis Sparks

The Iraqi government draws 95 percent of its revenue from oil production. Every plan its political leaders can imagine will depend on reliable access to oil profits, and every political faction knows that the country can't achieve lasting political stability until a durable agreement is reached on who owns the estimated 115 billion barrels of reserves and who holds the right to sell them. As tens of thousands of US troops withdraw from the country over the first eight months of 2010, competition for control of that oil will intensify.
 
After years of haggling, Iraq's political leaders have yet to reach agreement on a hydrocarbon law that determines how oil profits will be divided among the country's competing factions -- a plan that is necessary to revive an energy sector that has suffered from years of under-investment -- and a steep drop in oil prices from $147 per barrel last July to less than $65 today.
 
Plans to attract badly needed investment and technical expertise from international oil companies face serious political obstacles. Many Iraqis continue to believe that the United States invaded Iraq to grab control of its oil. As Iraq fell under foreign military occupation, its would-be political leaders discovered that pledges to protect Iraqi oil for Iraqis boosted their personal popularity. Support for opening the country's oil sector to Western companies won't win many votes in upcoming parliamentary elections, now scheduled for January.
 
Political competition for control of the country's oil will sharply intensify next year. The post-Saddam constitution stipulates that Iraq's natural resources belong to the Iraqi people. But different political factions read this idea in different ways. The document also provides that "the federal government, with the producing governorates and regional governments, shall undertake the management of oil and gas extracted from present fields." Some interpret this clause to mean that the central government in Baghdad has the right to manage Iraq's oil. Provincial leaders argue that this stipulation gives local governments the right to exploit resources located on their territory, especially in newly discovered fields.
 
This is the dispute that generates constant tensions between Baghdad and the Kurdistan Regional Government (KRG). Kurdish leaders, ever ready to assert the KRG's political and economic autonomy and much less resistant to doing business with Western companies, claim the right to formulate their own energy strategy and to award contracts to international oil firms. Baghdad insists these contracts are invalid and has "blacklisted" companies that invest in the Kurdish region. This multilevel game of chicken stokes political instability and fuels mutual suspicion.
 
And though the two sides managed to agree on an improvised revenue-sharing scheme that gives the KRG 17 percent of the profits from the oil exploited on its territory, the lack of an established energy law limits the inflows of investment that Iraq's rusting energy sector badly needs if it's going to maintain current levels of production -- let alone expand output.        
 
The Iraqi government has now received its wake-up call. On June 30, Baghdad launched an international bid round to offer service contracts for field development. Iraqi officials calculated that access to some of the country's vast reserves would persuade reluctant firms to ignore the considerable political and security risks and jump into Iraq's oil sector. They gambled that the bid round would make for good television, broadcasting it across the country. They were wrong. Oil Minister Hussein al Shahristani now faces an uncertain political future.
 
As Iraq moves toward the next parliamentary elections scheduled for January 2010, oil will remain at the heart of every political debate. And as US troops begin to leave the country in large numbers, the Iraqi government will need steady flows of oil revenue to finance reconstruction of the country, further development of Iraq's army and police forces, and the social spending needed to provide Iraqis with basic services. Until Iraq's various political factions forge the political compromises necessary for equitable sharing of oil profits, and until large-scale outside investment in oil infrastructure expands production and export capacity, there will be plenty to fight over and no guarantee that Iraq can be rebuilt.  

MARWAN IBRAHIM/AFP/Getty Images