Q&A with energy watcher James Coyle

Published in the Orange County Register on April 4, 2013. To access the original article, click here.

Q: What factors are causing high gas prices worldwide?

A: First, there's the ever-increasing need for fuel in China and, to a lesser extent, India. These countries push up demand. In China, they're putting 70,000 new cars on the road every day. Those aren't replacement cars; that's a net increase of vehicles every day. And when you combine that with declines in production from Libya, Syria and Iraq and sanctions on petroleum exports from Iran, you have a recipe for high prices.

Q: So when will we get relief at the pump?

A: I hate to be pessimistic, but as long as demand for oil continues to grow worldwide, we can anticipate high prices. While prices in March moved down slightly because of seasonal fluctuations, the long-term trends predict prices remaining around $4 per gallon.

Q: What needs to happen for gas to become more affordable?

A: The usual answer is drill, baby, drill – but the domestic amount of traditionally-recoverable oil that is suitable for production as gasoline offers just a short-term solution. We're talking about unrecovered deposits in the Arctic National Wildlife Refuge in Alaska, off the coast of California and some other places. They could provide relief for 10 years, maybe 20. Recent advances in the recovery of oil from shale extend the timeline out to 50 years, but at a high environmental cost.

In the short term, any increase in supply, regardless of where we drill, will drop the prices. There really is no such thing as a domestic or world market. That's a fallacy; it's all one market. So we can increase tar sands production in Canada, and all that will do is produce enough oil so that China can add another 70,000 cars to the road.

Q: Taking a longer view, are there opportunities for improvement?

A: There are a couple of possibilities that provide some hope. One is biofuels. Researchers are really starting to experiment with the growth of algae and other things that could be burned for energy – not to put gas in your tank but to generate electricity so oil can be freed up to use for gasoline.

Also, we are witnessing a revolution in the production of petroleum and natural gas from shale oil. Ten years ago, the question was "How long before we run out?" It was a scary possibility. Then, in 2002, a new technique was established to unleash energy from shale through fracking. Now, for the first time since the 1960s, the U.S. is exporting energy. This is the most viable source of hope, because other technologies are just too immature. It is, however, a two-edged sword: the sudden availability of cheaper oil and gas from fracking is kicking the bottom out of alternative energy technologies.

Q: Won't conservation help?

A: Yes, it becomes clear that a big part of the answer is conservation, which doesn't have to mean people riding everywhere on bicycles. It can mean things as simple as checking your tires. If everyone in the U.S. kept their tires properly inflated, we would see a 5 percent reduction in the use of gasoline. That might not sound like a lot, but we consume 20 million barrels of oil a day. Five percent would equate to an extra million barrels of oil daily.

China--The New Balancer

In 1991, Zbigniew Brzezinski described Central Asia and the Caucasus as "The Grand Chessboard."  He concentrated on the competition between Russia and the West for control of Mackinder's World Island.  Brzezinski wrote in the belief the United States was the world's sole superpower.

Since then, America has been bloodied in the wars of Iraq and Afghanistan.  A country that Brzezinski considered to be on the periphery, China, is assuming a larger role on the world stage.  The chess match continues, but the Russian Federation has a new opponent:  the People's Republic of China.  "China is likely to overtake the United States (as an oil importer), and Russia has to stake its claim in China," said Raiffeisenbank analyst Andrey Polishchuck.  The head of Russian studies at the China Institute of Contemporary International Relations, Feng Yujun, concurred:  "It has become very important for Russia to expedite entering the Asia-Pacific, especially the Chinese market.  It risks losing more opportunities if it keeps dragging its feet."

The record is pretty clear that it is China, and not Russia, that is in the driver's seat on energy deals.  Rosneft is scrambling to fulfill crude oil contracts with China, while reducing forecasts for production from the Vankor field in East Siberia.  As a result, Russia might have to reduce it's delivery of crude to Europe. The company emailed Reuters that "Rosneft's production plans will without doubt ensure that oil supply commitments are met...In the event of possible deviations, existing agreements and the most profitable supply routes will be prioritized."

Rosneft is also granting the China National Petroleum Corporation (CNPC) an equity stake over one of its oil fields.  Rosneft would maintain control of the project (51% ownership) but China will receive 49% in return for its willingness to help develop the field.  The deposit, the Srednebotuobinsk field, is close to the Eastern Siberia-Pacific Ocean (ESPO) pipeline which delivers crude oil to Daqing, China.  Rosneft has a similar deal with the Chinese company Sinopec, to produce oil in the Republic of Udmurtia.

At the same time, Russia has been trying to negotiate for two years a contract to sell natural gas to China, and deliver it via pipeline.  These efforts have been in vain, despite numerous statements from the highest authorities that a deal was imminent.  Despite the Chinese need for energy to fuel its economic machine, it refuses to accept the Russian price for the gas.  According to the Brookings Institute's Erica Downs, "The Russians probably need this more desperately than the Chinese." Fyodor Lukyanov, head of the Moscow think tank, the Council on Foreign and Defense Policy, believes that a gas deal would be a "major breakthrough" for Russia, but the economics of the proposal would scuttle it.  "China...won't agree to major concessions just to improve its strategic partnership with Russia."

This follows on the heals of Chinese president's Xi Jinping's recent visit to Central Asia. Xi signed an agreement in Turkmenistan to double gas exports to China, cut the ribbon on the Galkynysh gas field (the world's second largest), and pledged $8 billion to build a pipeline from the field to China.  In Kazakhstan, Xi signed $30 billion in deals that included the CNPC purchase of 8% of the Kashagan oil fields, agreed to double the size of the pipeline from Kazakhstan to China, and agreed to build a new refinery.  In Uzbekistan he signed $15 billion in purchases of oil, gas and gold; and in Kyrgyzstan he agreed to a $3 billion deal to construct another pipeline.  In Tajikistan, he signed another $3 billion pipeline deal, which resulted in Gazprom cancelling its own pipeline project to that country.

Alexander Rahr, the research director of the German-Russian Forum, believes that Russian President Vladimir Putin is allowing China to increase its Central Asian presence, so that Russia can concentrate on its Western flank.  ""I think this was a firm choice, a difficult choice, but it was made.  He cannot afford to have geopolitical battles with NATO and the West on the one hand and, parallel to that, battles with China for influence in Central Asia."  Rahr believes Russia is using energy to keep Belarus, Ukraine and Modova aligned with Moscow instead of Brussels.

As China moves deeper into Central Asia, it is forcing Russia out--as the Tajikistan pipeline incident demonstrates.  It is locking up energy supplies that Russia was previously selling to Europe, is obtaining equity interest in Russian energy fields, and forcing Russia to divert supplies from European buyers.  China is telling Russia what to do, and not the other way around.

China's Growing Energy Appetite and Strategy

Analysts who follow the energy "Great Game" being played between Russia and the Rest are turning their attention away from the European front, toward the growth of China. Asia Times' correspondent Pepe Escobar explains the dynamics of Chinese energy growth in the magazine The Nation. China is the world's fifth largest oil producer, at 3.7 million barrels per day, just below Iran and slightly above Mexico. China consumes 10% of the world's production, second only to the United States' 27% share and triple its consumption of 30 years ago. The International Energy Agency estimates that Chinese oil consumption will reach 11.3 million barrels a day by 2015.

China's top three oil suppliers are Saudi Arabia, Iran and Angola. China has invested $120 billion in Iran's energy sector over the past five years (so much for UN sanctions!), and purchases 14% of its imported oil from the Islamic Republic. The Chinese energy company Sinopec has agreed to invest an additional $6.5 billion to build oil refineries there. China is also the principle supplier of machinery and parts used in Iran's oil production.

Escobar reports that Saudi Arabia has tried to wean China away from its reliance on Iran, offering to supply the Chinese with the same amount of oil it buys from Iran--but at a discount. China's interest in a strategic relationship with Iran has trumped profit, however, and Beijing rejected the Saudi offer. Christina Lin, who follows Chinese military developments, reports that China views Iran as a means of counterbalancing U.S.-supported Arab monarchical states. This does not mean the Saudis are frozen out of the market, however; over half of Saudi oil exports are now to Asia, as opposed to 14% to the United States. Saudi Aramco owns refineries in both Qingdao and Fujian provinces, and is China's principal trading partner in the Middle East.

Most of this oil comes to China through two naval choke points: the Strait of Hormuz and the Strait of Malaccca. 20% of China's oil imports transits Hormuz, and a full 80% of its imports has to go through Malacca. To overcome this maritime vulnerability, the Chinese are trying to develop overland supply routes from Central Asia. As an example, the Kazakh oil fields lie close to the Chinese border and the Chinese company financed a pipeline to deliver its oil to the Middle Kingdom. The Chinese have become so close to the Kazakhs that there have been four heads-of-state summits in the past four years. President Hu Jintao has declared that the relations between the two countries are a "strategic partnership of long-term stability, good-neighborly friendship and win-win cooperation," according to Robert Cutler in the Asia Times.

Another source of petroleum was the strife-torn country of Libya. According to a report published in asahi.com, China has invested large sums of money in Libya. There had been 36,000 Chinese in the country before hostilities began, working on 75 joint venture projects with an additional 50 projects in the pipeline. Each year, China was importing 7.4 million tons of petroleum from Libya.

China has also begun receiving Russian oil via the Eastern Siberia-Pacific Ocean (ESPO) pipeline. China lent the Russian-state run company Rosneft $25 billion to build the line, and the plans are that it will bring 15 million tons of petroleum annually for the next 20 years. This is equivalent to 6% of China's 2010 petroleum consumption, according to asahi.com.

China's growing energy appetite, however, cannot be satiated by Russian and/or Central Asian pipelines. As much as they might fear the vulnerability, they will continue to be reliant on a maritime delivery route. To protect themselves, they are developing a "string of pearls," a series of Chinese naval bases stretching from the straits of Hormuz to the energy-hungry cities of China's east coast. According to Christina Lin, these pearls include upgraded military facilities on Hainan Island, an upgraded airstrip and oil drilling platforms in the contested islets of the South China Sea, a canal in Thailand, and intelligence-gathering facilities near the Strait of Malacca; ports in Burma, Bangladesh, and Sri Lanka; a naval base in Gwadar, Pakistan; and facilites in Port Sudan. The string of pearls gives the Chinese military an overseas presence for the first time in modern Chinese history.

Other Central Asian countries are jumping into the game: following the Kazakh example of getting the Chinese to finance oil projects, Turkmenistan has turned to China to finance natural gas projects. the Turkmen have the world's fourth largest gas reserves, and they sell their gas to China, Russia and Iran. Bloomberg Businessweek reports that Turkmenistan is doubling the amount of natural gas it had originally planned to sell China, and will be shipping 60 billion cubic meters per year by 2015. China is a welcome new market for Turkmenistan, who lost its previous main customer (Russia) after a pipeline explosion disrupted deliveries to that state.

Overall, China's natural gas consumption is expected to grow by 22.6% in 2011, according to a report released by the research arm of China National Petroleum Corporation (CNPC), as reported by the China Daily. Consumption will grow from 106 bcm in 2010, to 130 bcm in 2011,and to 230 bcm in 2015. Domestic output of the fuel will rise 58% in the same time period, reaching 150 bcm in 2015. The CNPC report verified that China imported 4.4 bcm from Central Asia in 2010, and has opened negotiations with Russia for an additional 70 bcm per year by 2015.

With such astronomical projections of increases in petroleum and natural gas consumption, China will be first in line for any production increases from anywhere throughout the world. The current relaxation in oil and gas prices will not be able to be sustained in the mid to long term in the face of Chinese energy demands.

Ukraine Moving to New Energy Sources

The Ukraine is moving to find new energy sources. The October 27 visit of Russian Prime Minister Vladimir Putin to the nation's capital, Kyiv, failed to result in any new agreements (except a protocol of intention). The warming in relations from the election of pro-Moscow Ukrainian president Viktor Yanukovych has not extended to the energy field.

In October, Ukrainian Deputy Prime Minister Andrey Klyuyev reported he was negotiating with Azerbaijan to increase supplies of Azeri crude to be delivered to their Kremechuk refinery. (www.oilandgaseurasia.com/news/p/0/news/9049. Ukraine is interested not only in Azeri oil, but natural gas, as well. Ukrainian First Deputy Minister of Fuel and Energy Sergiy Chekh announced the cabinet had approved a memorandum that will authorize Azerbaijan to send 5 bcm per year of natural gas. This will be an important source of feedstock after Ukraine's planned SPG Terminal begins operations. The ultimate capacity of this terminal will be 10 bcm per year, so Azerbaijan can provide 50% of capacity. (www.today.az/print/news/business/77519.html)

We reported earlier that Ukraine is trying to maximize use of the Odessa-Brody oil transit line by reversing flow and accepting Venezuelan oil for delivery to Belarus. The Russian oil company "Transneft" plans to send observers to monitor the pumping (www.oilandgaseurasia.com/news/p/0/news/9542). This is the same company being investigated by the Russian Audit Chamber, after a minority stock holder said it had stolen up to $4 billion in another project. ("Transneft Accused of Stealing $4 billion", The St. Petersburg Times, November 19, 2010)

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.

Future of Caspian Energy

The International Energy Agency (IEA) is preparing to publish a report touting the Caspian region as ready for a sizeable increase in production and export of energy, according to the Financial Times (November 2, 2010). The FT has seen an advance copy of the annual World Energy Outlook, which forecasts oil production will peak at about 5.4 million barrels per day between 2025 and 2030, almost double current production. The main driver will be Kazakhstan's Kashagan and Tengiz fields. As for natural gas, the IEA says that Turkmenistan will become one of the 10 largest gas producers in the world.

The IEA warns there are a number of barriers to the countries' achieving these lofty goals. For example, getting the oil to market needs a pipeline network that will require massive investments. As for gas, the IEA warns that Russia could stifle development of Caspian exports, because such a flow to international markets would be direct competition to their own natural gas industry.

The International Monetary Fund, in their April 2010 World Economic Outlook, also discuss economic growth in the CIS region. They say that the current economic recovery is underpinned by higher commodity prices in oil, gas and metals. The IMF predicts that higher volume of investments and gas exports will mean a projected 12% growth rate this year. The IMF warns, however, that Kazakhstan faces problems in its banking sector that calls for an independent assessment of its largest banks' balance sheets.

In the meantime, Azerbaijan continues to expand its energy export business. The US Army War College's top analyst on CIS countries, Stephen Blank, writes that in the past three months alone, Azerbaijan has agreed to ship a small amount of Turkmen oil via the Baku to Ceyhan pipeline; is increasing its exports of natural gas to Russia, and is estblishing AGRI (Azerbaijan-Georgia-Romania Interconnector) as a route in addition to Nabucco to get its gas to market. (www.eurasianet.org/node/62288)

Free and unfettered access to Caspian oil supplies is clearly in the interest of the United States and the entire Western World. As the IEA will point out in its study, the area has the ability to "meet almost all the projected import requirements of North America in 2035."

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.

Pessimism in Russian Energy Industry

Sixty one percent of participants in a session of the St. Petersburg International Economic Forum predicted Russian economic stagnation in the next 2-5 years. In another session, 55% predicted stagnation in the next ten years. ("Russia's Resource Curse," Oil & Gas Eurasia, No. 7, July-August 2010.) The Russian economy is highly dependent on the sale of oil and natural gas, and recent events in the energy sector would appear to support this pessimism.

According to oilru.com, production of natural gas in the first half of 2010 was 19% higher than the first half of 2009, but most of the production was consumed domestically. While exports increased 27% over the previous year, most of the exports went to countries of the former Soviet Union instead of to the hard currency markets of the European Union. The increase in sales to the EU was only about 4%, not an ambitious feat since sales in 2009 had dropped 11.5% from the year before. The 2010 increases may also be transient, as oil.ru reports that sales to the EU in June dropped over 40% (Oil and Gas Eurasia, 27 August 2010).

Gas volumes only tell half the story: the natural gas being sold is being discounted. European gas purchasers demanded price reductions in 2009, and Gazprom gave at least five clients discounts amounting to $2 billion annually. Now, one of Gazprom's biggest customers, the German company E.On, is demanding further reductions. This Spring, E-On convinced Gazprom to allow it to buy at least some of its contracted gas purchases at the lower spot price until 2012. E-On has asked for a further price reduction, claiming it will be in the red by October unless suppliers reduce their price (The St. Petersburg Times, 24 August 2010).

Problems are not limited to natural gas. According to LUKOIL Vice President Leonid Fedu, Russian crude production will begin to fall in 2015-2016. (Oil & Gas Eurasia, 8September 2009).

It is difficult to interpret what a long-term reduction in energy revenues would mean to the Russian state. On the one hand, a reduction in economic rents could force the government to become more dependent on the good will of the people. Under this theory, reduced rents leads to increased responsiveness to the people, and eventually to democracy. On the other hand, a reduction in economic rents could lead to a reduction in services to the people, creating social unrest, and a strengthening of totalitarian tendencies.

Dr. James J. Coyle is available to speak to your organization or at your event. Please contact him at jimcoyle@verizon.net.