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Energy, Investment and Geopolitics

Sait Halim Pasa Yalısı, Istanbul, Turkey

12 December 2013

The launch meeting of the Bosphorus Energy Clubhas identified key global and regional game-changers that are likely to shape and inform critical investment decisions, policy choices as well as energy diplomacy in the region.  It has also provided thought for food regarding the Club’s future orientation.

Global game-changers

1 – Energy is no longer a simple commodity – it is an instrument of national security, economic prosperity and competitiveness, and should be treated in a multi-disciplinary fashion.

2 – What makes the world energy somehow unstable are mostly the “above-the-ground factors”, such as technological breakthroughs, revival of nuclear power, new renewable initiatives, price volatility, emergence of a new Atlantic energy market, massive need for investment, shifting trade flows, resource nationalism, and novel forms of IOC vs. OC

3 – Two key megatrends will shape our world out to 2030: demographic patterns, especially increasing young population in developing world, aging population in the OECD world; and growing resource demands which, in the cases of food, energy and water, might lead to scarcities.

4 – In the period ahead, we will likely face further vulnerabilities such as the geopolitical, security and social ones that occur in the Straits of Hormuz, the Malacca Straits, the East China Sea, the Caspian Sea, the KRG vs. Baghdad, and the Eastern Mediterranean as well as the domestic instabilities triggered by the Arab Spring, the Nigerian labour strikes, the attacks in Algeria and the ongoing unrest in Iraq.

5 – The energy demand growth will continue to grow, albeit at a different pace. China will continue to be the strongest demand growth country if it deals with its debt problem and boosts productivity. The US is expected to experience its fastest growth in a decade, driven by a reduction in fiscal austerity, a resurgent housing market, and the favourable condition of American corporate, bank, and household balance sheets. Europe has stabilised sovereign debt markets and systemic risk is for now substantially reduced, but energy demand growth will be slow.

6 – New suppliers are emerging on the world energy map beyond conventional producers in the Gulf, Latin America and Eurasia. The US could surpass Saudi Arabia as the world’s biggest oil producer in 2017, and it could eclipse Russia as the world’s largest natural-gas producer by 2015. Australia is currently the third largest LNG producer in the world, behind Qatar and Malaysia, and could become the largest in a few years.The Arctic region is widely believed to hold the Earth’s sole remaining significant deposit of untapped hydrocarbon reserves and competition over the region is becoming fiercer.

7 – Resource nationalism is on the increase as resource countries insist on equitable sharing of the risks and upsides. There is need for a new  form of partnership between IOCs and NOCs. Seven major state controlled energy corporations (i.e. Saudi Aramco, Gazprom, PDVSA, China’s CNPC, Iran’s NIOC, Petrobras of Brazil and Petronas of Malaysia) presently control over 30 percent of the global oil and gas production and over 30 percent of reserves, while. ExxonMobil, BP, Chevron and Shell now control just 10 percent of production and 3 percent of reserves.

 8 – While resource countries become tough (particularly in high-price environment) and also expand their investment to other resource regions, industrialised energy importing countries are resorting to what is called “economic patriotism” to protect their strategic sectors. Regionalism, characterised by the Transatlantic Trade and Investment Partnership, ASEAN, APEC, GCC, NAFTA, Shanghai Co-operation Organisation, African Union and like, is gaining added impetus and substance, thus further eroding the pillars of globalisation.

9 – In this dynamic global context, the real game-changer is the rising gas production in North America from shale basins, which is transforming the global gas market. The shale gas “revolution” has redrawn the US energy landscape and kick-started a re-industrialisation of its economy, providing a competitive edge to US companies. It will also have geopolitical implications. Energy intensive industries now potentially have a bigger energy cost advantage when located in the US than the labour cost advantage China holds. The North American success is difficult to replicate in other shale gas-rich parts of the world.

10 – “Energy democracy” is gaining ground. The public worldwide has taken a strong interest in how their energy future will be shaped, as they are likely to be affected seriously from climate change, local pollution, high-energy prices, energy poverty, and geopolitical conflicts. Today, the leaders in Beijing feel the need to take into account local protests on heavily polluting fuels, nuclear power plants, fuel price hikes, and low carbon/cleaner energy. One discussant emphasized the importance of focusing our efforts on “energy for peace and future generations”.

11 – The “golden age” for natural gas has been repeatedly mentioned. From electricity to transportation to LNG, natural gas is revolutionising the world markets. By 2035, natural gas demand will outpace that of any other individual fuel, resulting in nearly 50 percent higher than in 2011. Power generation continues to be the largest source of gas demand, accounting for around 40 percent of global demand. It has both commercial as well as geopolitical consequences. If the US shale gas finds its way to world markets in increased volumes, the implications will be profound.

12 – The “nuclear renaissance” has not dithered away; it has simply shifted to the east. Today there are some 435 nuclear power reactors operating in 31 countries plus Chinese Taipei, with a combined capacity of over 370 GWe. In 2011 these provided about 13.5 percent of the world’s electricity.Nuclear power capacity worldwide is increasing steadily, with over 60 reactors under construction in 13 countries. Nuclear generation will increase by two-thirds, reaching 4,300 TWh in 2035, led by China (around half the global increase), South Korea, India, and Russia. Significant further capacity is being created by plant upgrading.

13 – Renewables have suffered in recent years. Rising US natural-gas output and relatively lower natural gas and coal prices have put severe downward price pressure on wind and solar power. However, it is likely that nearly half of the increase in global power generation will be from renewables by 2035. That will put it ahead of natural gas and just behind coal as the leading fuel.

14 – Renewables are seen as the logical choice for fast-growing, energy-hungry economies because they are quick to assemble, highly predictable, easy to integrate and have no adverse impact on the environment. China’s total renewable output by 2035 will likely be more than in the EU, the US, and Japan combined. Germany offers a different story in renewables. Energiewende (energy transition) has put Germany on a radical footing
 – as it looks to de-carbonise its economy and lead the race 
for green growth.

15 – Throughout the discussions, “where to source money for energy finance” was frequently asked.To meet the rising energy demand, huge amounts of investment (to the tune of $37 trillion between now and 2035) are needed. The answer: There is no shortage of funds if the right projects with right commercial fundamentals and right partners could be developed.

16 – The conventional financial sources are not adequate. Sovereign Wealth Funds, private investors, Islamic Finance and Public-Private Partnerships are the way to go. Islamic financial instruments are set to play a growing role in energy finance – in the Muslim world and beyond. Norway’s Sovereign Wealth Fund, the world’s largest, will inject significant capital to the renewable energy sector. China continues its shopping of energy assets around the world.

Regional game-changers

17 – Russia’s energy influence has declined recently. Seemingly, it is losing its edge against the changing gas market. Both abroad and inside Russia, the key impact has been that Gazprom, Russia’s main “energy arm”, has lost some market share and faced price renegotiations.The independent gas producers as “unbounded” companies are seen as more “compatible” with the EU Internal Energy Market. Moscow’s top concern is its vulnerability to fluctuations in the price of energy and regain the lost ground in the markets.

18 – Russia requires its oil and gas income both to project its influence abroad and keep domestic stability and prosperity, not least via such projects as the Nordstream and the South Stream. A reduction in government income, and thus in government expenditures, would be likely to have enormous political consequences domestically.

19 – With half of the Russian budget coming from energy revenues (80 percent is from oil and 20 percent from natural gas), the government could be in a difficult position. This situation could be changed if innovation and liberalisation could be introduced into Russia’s oil and gas sector, especially LNG and relevant infrastructure.

20 – Today, China is the most obvious power on the rise, likely to challenge the US more energetically as the world’s economic superpower over the next two decades if things progress as widely predicted. China is the most populous country on earth with 1.3 billion citizens. It already consumes more oil than any other country save the US. And it’s set to soon surpass the US as the world’s largest oil importer. China is on international oil and gas shopping spree. So far in 2013, over 20 percent of oil and gas deals globally involved a Chinese firm. Beijing is not alone: India and other dynamic Asian economies now boast growth rates that could outstrip those of major Western countries for decades to come.

21 – The Middle East and the Gulf will remain fundamental energy players. US preferences for providing energy security abroad can diminish, but this is unlikely to result in a strategic retreat from this region.For major net exporters such as Qatar, Libya, Bahrain, Saudi Arabia and Kuwait, the contribution of fuel to GDP exceeded 50 percent of GDP in 2013. Conversely, the economic impact of the energy system on net importers like Morocco, Lebanon, Jordan and Tunisia is severe.

22 – The lowest performer, Jordan, for example, spends nearly 20 percent of GDP to import 96 percent of its energy needs. 8.5 percent of regional GDP was spent by these countries on subsidies. Net importers such as Morocco and Tunisia are rolling out renewable energy capacity in a bid to reduce the economic impact of imports and mitigate against fluctuating fossil fuel pricing.

23 – As the US demand for this region’s natural gas and oil exports wanes due to the “shale revolution”, the importance of Asian markets will grow. Some projections indicate that up to 90 percent of Gulf oil exports could be destined for India and China. Further evidence of the Gulf’s orientation eastwards is evident in Saudi Arabia and Kuwait’s funneling of investments into refineries located in China, Indonesia, Vietnam and India, where consumption of Gulf hydrocarbons and petrochemicals is expected to continue rising.

24 – The critical investment decisions regarding TANAP and TAP, it was stressed, did not represent a “silver bullet” for European energy diversification yet because we are only talking about 10 bcm against the current demand of 500 bcm.

25 – With only one supplier, depressed European demand and other alternatives available, it is difficult to speak yet of a genuine Southern “Corridor”. Azerbaijan is the best option to deliver gas to the South European markets because it is not a direct rival of Russia. To fulfill the potential of the Southern Corridor, gas from new sources such as Turkmenistan, Iran, Iraq and Eastern Mediterranean should be mobilised.

26 – With regard to Iran’s re-emergence in the world energy markets as a full player, the consensus view was that it is too early to speculate but the potential for Iran to return to oil markets could particularly shake up OPEC and the global outlook.The sanctions are not lifted in any real way yet, which will come when the next stage of agreements is reached. In order to reverse the decline in Iranian oil output and to speed up the relatively slow pace of gas production, it is not enough simply for Tehran to secure a resolution of the nuclear issue and an end to sanctions.

27 – At the same time, the Rouhani administration has to implement a major overhaul of Iran’s domestic oil and gas production policies. It will have to secure major foreign investment in a way that balances its own deep- seated rejection of production sharing agreements with the desire of international companies to secure agreements based on balancing risk and reward.

28 – The nuclear deal would open the way for Iran to be recognised as a legitimate regional power alongside Turkey, Egypt, Iraq, Saudi Arabia, Israel and Pakistan, and address boiling domestic social and economic discontent. If all goes well, it will take some time for the international energy groups to feel safe enough to go back or expand production and purchases in Iran.

29 – Discussants concurred that despite risks, the plan tobuild one gas and two oil pipelines directly from Kurdish-controlled northern Iraq to Turkey with or without the approval of Baghdad will likely go ahead, thus for the first time providing the Kurds direct access to world markets. The KRG would offer Turkey a high quality low cost energy alternative to Iran and Russia while Turkey might serve as a conduit for KRG energy exports to Europe.

30 – The oil pipeline deal will allow the Kurds to export up to one million barrels per day, but it might also make reconciliation between Erbil and Baghdad harder to achieve or indeed easier to agree to a genuine deal. Turkey is not keen on losing investment in southern Iraq, which holds the country’s largest explored oil and gas reserves, and endangering its regional balance of power interests.

31 – The commercial case for selling Eastern Mediterranean gas to Turkey is overwhelming, both in terms of cash returns and of regional contributions towards development of the Southern Corridor. The Eastern Mediterranean countries only have a very narrow window of opportunitybefore they would face increasingly competitive new supplies to Europe set to come online over the next several years.

32 – A settlement could help promote several major objectives: energy cooperation in the Eastern Mediterranean; the enhanced energy security of Europe though further development of the Southern Gas Corridor, and resolution of the Cyprus question. And that, in turn, would vastly transform the atmosphere for any resumption of negotiations for Turkish entry into the EU.

33 –What Turkey possesses to compensate for its energy supply deficiency is the best geographical position between the world’s second-largest natural gas market, continental Europe, and the substantial gas reserves of Russia, the Caspian and Black Sea basins, the Middle East/Gulf and the Eastern Mediterranean. Turks are not content only to be a simple “bridge” over which energy flows; they aspire to becoming a regional “hub”. Yet, being a regional energy hub is not just about having pipelines crisscrossing your territory.

34 – Turkey must be able to import enough gas to satisfy both domestic demand and any re-export commitments. It should also liberalise the markets, develop an integrated multi-disciplinary energy system management, pursue “soft-power diplomacy” avoiding sharp confrontations, invest in human capital and technology innovation, build “energy champions” operating like successful international peers, and put in place right governance structures and sound physical infrastructure.