Oil

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 Philippe de Pontet

Major new oil finds in Uganda, Ghana, and Sierra Leone could bolster government revenue, finance social spending, and lift entire communities out of poverty -- or not. The resource curse is about to be put to the test again in Africa, as each of these recent discoveries have the potential to produce upwards of a billion barrels of crude. If the past is any indication of things to come, these countries may live to rue the discovery of black gold. But if they study the cases of other oil-cursed African nations -- Nigeria, first and foremost -- they may learn how not to manage the windfall.

It has been 40 years since oil was found in the Niger Delta. Four decades, $80 billion, and 134 billion barrels later, living standards have actually fallen, amid environmental decay, rampant corruption, and a succession of rebel groups that seem to get more violent with each new incarnation. Many Nigerians are now convinced that true economic and political development will only come after the last drop of oil has been pumped, not an imminent prospect for a country with more than 30 billion barrels in reserves.

In the meantime, instability, the threat of sabotage, and oil bunkering have taken offline half of the country's production capacity -- which totals nearly 3 billion barrels per day -- and multinationals such as Shell are seriously considering leaving. Angola, which currently chairs OPEC, has dethroned Nigeria as sub-Saharan Africa's top oil producer and China's most dependable supplier. Nigeria's downward trend is likely to continue over the next 18 months as the election campaign heats up, unleashing a new cycle of rent-seeking unrest in the Delta. If oil prices continue to rise and global inventories tighten, Nigerian supply risk could again become a driver of price spikes and volatility as in 2007.

Of course, Nigeria is not the only resource-cursed nation on the African continent -- it's just exhibit A. On a smaller scale, the governments of Chad, Equatorial Guinea, Sudan, and Gabon have all squandered billions of dollars in oil revenues, with more money ploughed into Swiss bank accounts and Mediterranean villas than into their own economies. Gabon's recently deceased leader Omar Bongo amassed about a dozen palaces in France during his 40 years in power -- properties that will be inherited by Gabon's new President Ali Bongo if they aren't confiscated by French courts.

In Chad's case, a World Bank-mandated escrow account and strict 80 percent earmark for social spending are not enough to prevent President Idriss Deby from turning the revenues into his own bank account and financing vehicle for war. Less perfidious, perhaps, but just as destabilizing in its own way, is the case of southern Sudan, where oil provides more than 95 percent of government revenues and less than 2 percent of jobs. Oil literally sucks the oxygen out of the economy and undermines other sectors, such as agriculture, where most people actually work, while turning the government into a rent-seeking enterprise.

Turning back to the newest members of the oil club, Uganda, Ghana, and to a lesser extent Sierra Leone are for now relatively well-governed and reform-oriented nations at peace with themselves and their neighbors. Ghana and Uganda are among Africa's perennial donor darlings -- if any countries have a shot to break the curse, these are good candidates. Sierra Leone has come a long way since the 1990s when the country was practically synonymous with the phrase "blood diamonds." Sierra Leonians voted the opposition into power last year in free, fair, and peaceful elections (much like Ghana).

What will oil wealth do for (or to) these countries? It's hard to say, but maybe Ghana, Uganda, and Sierra Leone can break the resource curse--at least they have clear models not to follow across the continent. 

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

By Eurasia Group analysts Robert Johnston and Willis Sparks

Until the middle of last year, a sharp rise in oil prices figured among the most important developing stories in global politics. Many analysts expected high economic growth to continue for the foreseeable future -- particularly in leading emerging markets such as China, India, Russia, and Brazil -- enriching and empowering the governments of countries with oil to sell, and generating anxiety among consumers about longer-term access to supply. In July 2008, oil sold at $147 per barrel.

Fast-forward six months. On Jan. 7, oil closed at $42.63. The steep price drop flows in no small part, of course, from the global financial turmoil now dominating the headlines -- a meltdown that weighs on economic growth and sharply reduces demand for oil and other key commodities. Oil market players are now more worried about the resilience of demand than security of supply.

In the new industrial and geopolitical environment, speculation has intensified over which countries and energy players are best positioned to weather the downturn -- and which ones are more likely to suffer. In other words, who will be the winners and losers? Here are a few answers you might not expect.

Winner: Saudi Arabia

How can Saudi Arabia, a leading oil producer, possibly be considered a winner from a sharp drop in oil prices? The Saudis enjoy windfall profits as much as others do, but it's important to remember when assessing winners and losers that these are relative terms. When a trend hurts one player less than it hurts his competitors, he can credibly call himself a winner. Saudi leaders have budgeted much more conservatively than regional rival Iran, which is burdened with aging oil infrastructure and the need for high oil revenue to finance diesel imports. Lower prices harm Iran's economy much more than Saudi Arabia's, creating turmoil in Iran ahead of presidential elections in June.

Winner: India

We all know that fast-emerging China has worked up an unquenchable thirst for crude oil. But India actually imports a larger percentage of its oil than China does. To protect its political popularity, the Congress Party-led Indian government subsidizes expensive petroleum products to keep costs low for consumers. That's even more important for 2009, an election year in India. When prices are high, the Indian government must compromise India's fiscal health to safeguard its own political capital. Earlier this year, the Congress Party found itself forced to risk a political fight with powerful diesel end-user groups (farmers and bus drivers, in particular) by raising regulated retail diesel prices by 10 percent following a rise in global spot prices. Lower oil prices have now relieved some of that pressure.

India's national oil companies also benefit from lower prices. They now face less risk of getting priced out of competitive international upstream acquisitions (as they did in Kazakhstan and Angola) as lower oil prices force many of their rivals to become more selective in where, how, and how much they invest.

Winner: International Oil Companies (IOCs)

Like the Saudis, the IOCs (supermajors) are unlikely winners from low oil prices. Certainly, they're likely to take significant losses in their downstream businesses as demand for refined products falls sharply. But for the most part, IOCs can sustain these losses thanks to a disciplined approach to capital spending. Investments like the high-cost Canadian oil sands projects provide an exception, but IOCs have few upstream projects now underway that require oil prices of more than $40 per barrel to generate reasonable returns.

IOCs will also likely benefit from greater access to reserves as lower prices force many governments that now need a lot more foreign investment to back away from policies that favor domestic firms or seek greater rents from IOCs.

Finally, the big oil companies will likely face less scrutiny in Washington as retail gasoline prices and corporate profits fall. President-elect Barack Obama's advisors have already signaled that they have no plans to follow through on campaign pledges to tax windfall profits. Lower prices will also slow momentum toward greater spending on efforts to advance alternative fuels. Climate change policies that would impose new burdens on consumers of oil will falter, at least for the near term.

Loser: Russia

Russia remains the largest global oil producer, but its oil sector prospects have deteriorated dramatically as prices have fallen. Policy misjudgments and geological challenges have exacerbated Moscow's problems. After increasing production capacity from 6 million to more than 9 million barrels per day between 1999 and 2004, Russia's capacity growth has since slowed sharply and its production outlook is now bleak. According to most forecasts, production will contract in 2009. Output at older fields in western Siberia is declining rapidly, and resource nationalism has undermined investment in newer fields. In greenfield areas like eastern Siberia and the Arctic shelf, the need for substantial infrastructure investment will add to the cost of development. All these problems undermine Russia's ability to compete for the shrinking supply of global investment capital.

Loser: Frontier Markets

Frontier markets, smaller developing states with emerging economies, have not traditionally been the target of oil industry development efforts. Many of them are geographically remote and lack stable political and regulatory structures for foreign investment. In the atmosphere of "pre-peak oil" worries, reserves in places such as Uganda, the Republic of the Congo, Mozambique, Suriname, Papua New Guinea, and Kirgizstan attracted commercial interest that was driven by so-called junior (or minnow) exploration companies that specialize in identifying attractive geological plays that they hope eventually to pass on to larger companies. But lower oil prices have sharply limited the capital available to these smaller companies as markets cut allocations to the prospects that look most risky. This is a risk not only for these small-cap companies, but also for the economic development of countries that might benefit from their investments.

Loser: New Energy Technologies

Projects to develop new energy technologies are struggling as markets recalibrate expectations for oil prices and, by extension, consumer and government demand for alternative technologies and fuels. This is true for biofuels, coal-to-liquids, oil shale, and many types of oil sands technologies. Development of these fuels has already been dogged by environmental controversy, but with oil prices easing, the energy-security-based arguments for government support of these fuels will look much less politically compelling. Markets for venture-capital-driven clean fuels based on fuel cells and hydrogen are also contracting. Governments will continue to subsidize clean fuels, but with less urgency as retail gasoline prices fall, significantly diminishing public demand for new energy technology.