the geopolitics of energy

The Geopolitics of Energy

Presentation by

Fareed Mohamedi

Chief Economist, PFC Energy

to

Energy and Nanotechnology Conference

Houston, Texas

May 3, 2003

Strategic Advisors in Global Energy

|

The Geopolitics of Energy

Introduction Focus on oil and gas The OPEC system, supply management

and prices Implications of the US invasion of Iraq Longer term issues related to the

development of adequate oil supplies Meeting US gas demand

|

Unprecedented OPEC cohesion

OPEC forged a deal in 1999 that has withstood a number of challenges

Turkey

Saudi Arabia

Iran

Egypt

Israel

Iraq

Syria

The deal was underpinned by the following developments: The election of Chavez The problems of the Iraq Oil for Food program The creation of the Riyadh Entente in the mid-1990s

It provided a means for S. Arabia and Iran to work together It helped coordinate regional policies vis-à-vis Iraq It helped coordinate OPEC price and market share strategies Saudi ruling family used it to show its own public plus the rest

of the ME that its foreign policy was rooted in the region

|

C.P Abdallah’s Survival Strategy Key For Riyadh Entente

Domestic Politics

•Restore social balance

•Curb subsidies

•Rule by committee

Economic Policy

•Entrepreneurial economy

•State balances books

•FDI for industry

Foreign Affairs

•American ally

•Strong regional bonds

•Coordination w. Iran

Low Priority

High Priority

|

$20.00

$22.50

$25.00

$27.50

$30.00

$32.50

$35.00

$37.50

J F M A M J J A S O N D

$20.59

$14.44

$19.25

$30.29

$25.95 $26.12 $26.62

$10

$15

$20

$25

$30

$35

1997 1998 1999 2000 2001 2002 2003

2003 Prices Strong, But Fall As Year Progresses

Annual WTI Prices

2003 WTI Prices

$/b

$/b

Prices will be relatively high for 2003 thanks to high 1Q prices in the run-up to war in Iraq.

The average 2003 price will be about equal to those seen in the past two years.

Despite the loss of the war premium, fundamentals remain tight enough to keep current prices in the upper-$20s.

However, as inventories rise, prices will be pressured downwards.

|

Last 6 Months: Three Supply Shocks

-2,500

-2,000

-1,500

-1,000

-500

0

D-02 J-03 F-03 M-03 A-03

Iraq

Venezuela

Nigeria

Recent Lost Production Due To Supply Shocks

kb/d

The market was hit by a triple whammy of supply shocks in the past few months:

First from the unexpected Venezuela strike Then the predictable but still very significant outbreak of war in Iraq And finally by losses due to civil strife in Nigeria just as refinery demand for

the country’s gasoline-rich grades was stepping up

|

Last 6 Months: OPEC Managed The Challenges

OPEC has managed by increasing production from its other members

Production outside Venezuela and Iraq increased 1.7 million b/d between November and March, Saudi Arabia accounting for 1.0 million b/d

Despite much tighter fundamentals than during the last Gulf War, daily WTI prices this time peaked at only $37.83, compared to $40.42 in 1990

Saudis also communicated effectively: markets were reassured additional supplies were on the way, OECD members did not release strategic inventories

21

22

23

24

25

26

27

28

O-02 N-02 D-02 J-03 F-03 M-03 A-03

VenezuelaIraqOPEC-9

mmb/d

OPEC Crude Production Saudi Crude Production

7,750

8,000

8,250

8,500

8,750

9,000

O-02 N-02 D-02 J-03 F-03 M-03 A-03kb/d

|

0

250

500

750

1,000

1,250

4Q02 1Q03 2Q03 3Q03 4Q03

46.0

46.5

47.0

47.5

48.0

CanadaKazakhstanRussiaBrazilNon-OPEC Liquids Supply (rt axis)

Non-OPEC Supply Keeps Growing…

Absolute and Year-on-Year changes in Non-OPEC Crude Supply

kb/d mmb/d

Every quarter of 2003 except 2Q will see rising Non-OPEC Liquids supply, with strongest growth in 4Q

On a year-on-year basis, Russia will continue to lead the growth at 500,000 b/d

2003 Non-OPEC Liquids supply to rise 1.6 million b/d, filling much of the 2.7 million b/d rise in global crude demand

|

OPEC-10 Avoids Crisis in 2003…

23

24

25

26

Jan Mar May Jul Sep Nov

-2

-1

0

1

2OPEC-10 Crude SupplyProjected Inventory Changes

OPEC-10 Crude Supply and Projected Inventory Change

mmb/d

Need for inventory replenishment will allow OPEC-10 to produce 800,000 b/d more crude than 2002, but this is weighted to the first half of 2003

Increasing Non-OPEC supply and slower demand growth point to reduced demand for OPEC crude from now on

Only low inventories and Iraq outage give OPEC-10 a temporary reprieve

202122232425262728


OPEC-9 VenezuelaIraq Quota

2003 OPEC production and Quotas

|

The oil companies are not behind this warWho are the oil companies?What have they become?

The US oil companies would rather have sanctions removed from all major producer countries

The non-US oil companies used the constraints on US companies to make inroads into the Middle East

The current Administration has not fulfilled the few promises it made to the oil patch

Drilling offshore FloridaRemoving the subsidies for ethanolRevoking ILSAAlaska is not seen as a real oil play

Was The Invasion of Iraq An Oil War?

|

ECONOMICSPHERE

DIPLOMATICSPHERE

MILITARY SPHERE

Counter Proliferation

First Strike

Anti-terrorism

AmericanInternationalism

Lead, Others Will Follow

End Treaties, Non Binding

Fix It yourself

IMF: SystemicWB: Poverty

Energy SecurityDiversity

George W. Bush’s New World Order

United States: Sole Superpower

Military Superiority – Space and Technology

High Importance Low Importance

|

Oil Key to New Iraq

The administration of the Iraqi oil industry will be a challenge, particularly in the first year or two, and the prospects of a short-term jump in production are effectively nil.

The challenges will be:

1. To minimize short-term production losses while maintaining a reasonably safe operating environment

2. Create an environment (political, administrative, legal) that will allow a very rapid conclusion of negotiations for investment in new capacity

Only then is substantial growth in production is possible. In the best case, real growth (from 2001-2002 peak capacity) will not happen before 2005.

|

0

500

1,000

1,500

2,000

2,500

3,000

F-03

M-03

A-03

M-03

J-03

J-03

A-03

S-03

PFC Energy Projected Iraqi Production Return

kb/d

0

1,000

2,000

3,000

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03kb/d

Iraqi Production On A Declining Trend

Technical issues:– Relatively little damage to fields and infrastructure– Halliburton statement about getting up to “regional standards” (which are

quite high) is an uncertainty– Fields are on a declining trend even when they do come back

Political issues:– Need to get revenue flowing means that the US will want quick resumption– But lack of government recognized by UN and existing sanctions/OFF regime

mean US has to win battle at UN before exports can resume

How and When Exports Will Resume?

|

UN recognizedgovernment

Resumedoil

exports

Oilnegotiations

Oildeals

IMF program

Paris club

London club

Donorsmeeting

Reparationsmeeting

US-UN Relations

Despite Washington’s reluctance to deal with the UN, the international organization’s role is crucial for the economic rehabilitation of Iraq

|

Battle Over UN Role

A battle is taking place in the UN Security Council over who has authority in post-war Iraq

This battle will delay UN recognition of the new occupation government in Iraq, and will be crucial for oil sector and financial sector decisions moving forward

USauthority

US/unauthority

UN/usauthority

US occupation

Preferred US route —marginal UN role

Preferred French route — limited UN role

Resumed Oil-for-Food

program

Complete UNweapons

inspections

New resolutionlifting

sanctions

Preferred Russian route —central UN role

Suspended Sanctions

Resumed Oil-for-Food

program

Gradual OFF phase-out

New resolutionlifting

sanctions

|

Crude Production Growth Potential In Iraq Assuming Rapid Negotiation of Investment Terms and Internal Stability

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

200

1

200

2

200

3

200

4

200

5

2006

200

7

200

8

200

9

2010

Oil

Fie

ld P

rod

uct

ion

Cap

aci

ty (

mb

op

d)

P90 Upsteam Capacity

Mean (P50) Upstream CapacityP10 Upstream Capacity

P90 Upstream Capacity (status quo)Mean Upstream Capacity (status quo)

P10 Upstream Capacity (status quo)

Best Case Scenarios

This model assumes that there will be no commercial or logistical constraints on companies. In other words, within 12 to 18 months contracts would be signed and companies would find the necessary equipment to ramp up operations in an aggressive manner

|

Back To Market: In 2004 Moment of Truth

202122232425262728


OPEC-9 VenezuelaIraq Quota

2003 OPEC production and Quotas

mmb/d

1. Declining market share for the group—Non-OPEC plus Iraq will outpace demand growth

2. Seasonal demand decline in half of 2004 will force OPEC to implement a very large production cut from already low levels

3. Uneven increase in capacity among OPEC-10 has initiated a debate about quota redistribution that will heat up when more cuts need to be made

4. Saudi Arabia’s unique position as swing producer will leave it with the difficult choice of enduring an untenable price and low production, or crashing the price.

|

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

02 03 04 05 06 07 08 09 10

Limited Margin of Maneuver for OPEC

In an $18+ price environment, Non-OPEC and Iraqi supply will capture all of the incremental demand, at least until 2006. This leaves very little margin for OPEC-10 to increase production in the next four years.

Non-OPEC Supply and Demand Growth:New OPEC-10 Supply Not Needed

million b/d

Non-OPEC Supply Growth

Iraq Supply Growth

Global Demand Growth

|

18.0

20.0

22.0

24.0

26.0

28.0

30.0

32.0

34.0

36.0

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

OPEC Quota and OPEC Capacity

The opening up of the upstream sector in a number of OPEC countries has started a trend of rising capacity. Some of these increases might not go through (Kuwait, Saudi Arabia, Iran), but others are already underway. This rising excess capacity, with the potential return of Iraq, will destabilize OPEC from the inside.

OPEC-10 Quota Potential and Capacity Expansion at Odds

million b/d

OPEC-10 quota

OPEC-10 Production

OPEC-10 Capacity

|

0

2,500

5,000

7,500

10,000

12,500

Sa

ud

iA

rab

ia

Ira

n

Ve

ne

zue

la

UA

E

Nig

eri

a

Ku

wa

it

Lib

ya

Ind

on

es

ia

Alg

eri

a

Qa

tar

Ira

q

0%

10%

20%

30%

40%

50%Current Quota

2004 Capacity

Percent of 2004 Capacity Idledif Current Quota Kept (rt axis)

Quota Reallocations Out of the Closet

As long as demand for OPEC-10 crude has stayed high, rising production capacity in Algeria, Nigeria and Libya has not been an issue. However, as OPEC is forced to cut production, increasingly large and untenable percentages of member countries’ capacity would have to be shut in to maintain quotas. By 1H 2004, there will be no way to avoid the quota allocation issue any longer.

Current OPEC Quotas and 2004 Estimated Capacity

kb/d

|

$20.00

$22.50

$25.00

$27.50

$30.00

$32.50

$35.00

$37.50


$20.59

$14.44

$19.25

$30.29

$25.95 $26.12 $26.62

$10

$15

$20

$25

$30

$35

1997 1998 1999 2000 2001 2002 2003

2003 Prices Strong, But Fall As Year Progresses

Annual WTI Prices

2003 WTI Prices

$/b

$/b

Prices will be relatively high for 2003 thanks to high 1Q prices in the run-up to war in Iraq.

The average 2003 price will be about equal to those seen in the past two years.

Despite the loss of the war premium, fundamentals remain tight enough to keep current prices in the upper-$20s.

However, as inventories rise, prices will be pressured downwards.

|

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

35

86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5

Debt Flows

Asset Flows

Billion US$

Current Account Balance

Can Saudi Arabia Take Lower Prices?

The Capital Account of the Balance of Payments

|

0

50

100

150

200

250

86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5

ExternalAssets

External and Domestic Liabilities

Billion US$

Saudi Arabia: Assets and Liabilities

Can Saudi Arabia Take Lower Prices?

|

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

Current Account Balance

Debt Flows

Asset FlowsBillion US$

Iran: Capital Account

Can Iran Take Lower Prices?

|

0

5

10

15

20

25

30

35ExternalAssetsExternal

Liabilities

Billion US$Iran: External Assets and Liabilities

Can Iran Take Lower Prices?

|

The Other Wild Card: The Neo-Con Agenda

Has the neo-con agenda peaked, or will new phases unfold over the next few years?

Create a Pax Americana in the Middle East Win the peace in Iraq

Succeed in creating a viable democracy

Convince the Middle East to abandon Palestinian state

Answering the North Korean challenge in Asia Containment or regime change?

Induce China to cooperate and accept US agenda in the region

Downgrading the UN and Bretton Woods institutions Contain the French and Russian challenge

Institutionalize American Internationalism

|

The Neo-Con Agenda in The Middle East

The Neo-Conservative agenda sees regime change in Iraq as the first step towards fundamentally altering regional dynamics: Consolidate US and Israeli interests in the region Create appropriate conditions in the Levant for quick solution to Israeli-

Palestinian conflict on Sharon’s terms Force change in neighboring states and the Gulf

Israel

Iraq

Turkey

PNA

Pax Americana Short Term

Secular reformist take over in Iran

Isolated, politically neutralized and forced

to reform

Authoritarian leader/popular

revolution in Syria; peace deal

Leadership reform and peace deal

Political isolation and threats

IraqPNA

Syria

Lebanon Weakening Syrian power PNA

Saudi Arabia

Iran

Egypt

Medium term

|

How Will Saudi Arabia Respond?

It will largely depend on the US success in Iraq:

Successful US, with pro-US regime in Baghdad

US unsuccessful, with Shi’a regime emerging

US unsuccessful, with Shi’a-

Sunni Nationalist regime

Washington may use it to dislodge the Al-Sauds

The Saudi public could see the New Iraq as a model

Iran could emerge as a major influence over Iraq weakening the rationale for its alliance with Saudi Arabia

The US would be opposed to an Iranian backed Iraqi govt. and use the Saudis to offset this growing power

For Iran an insular, domestically preoccupied Iraq could pose less of a threat and a model

The Al-Sauds could see this as an opportunity to have some influence

Riyadh Entente will remain useful for the Saudis

The OPEC strategy will be maintained = higher prices

Saudis will use the oil price as a weapon against a strong Iran/Iraq bloc in OPEC and the region

Riyadh Entente will be reinforced to oppose US

Could the OPEC strategy be maintained?

|

Note 1: 2002 reserves and production for all companies are PFC estimates. 2002 production is based on 1H2002 data. Reserve Estimates are primarily based on a 110% reserve replacement rate. Data for BHP, CNOOC, PDVSA, Pemex, Yukos, and MOL represents 2001 data. * Data for Petronas and Lukoil pertains to 2000. Data for TNK

pertains to 1999. Rosneft’s reserves estimates are for 2000 and are obtained from IEA’s Russia report. Note 2: PDVSA (1,340; 102,499), Rosneft (152; 27,915) and Pemex (1,574; 51,655) excluded for scaling reasons.

Changing CompetitionReserves vs. Production: 2002

Global Competitors

Regional Majors

Focus Players

What is Happening in the Oil Industry?

0

5000

10000

15000

20000

25000

0 600 1200 1800

Production (mmboe)

Res

erve

s (m

mbo

e)

ConocoPhillips

Oxy

Shell

ChevronTexaco

BP

TFE

ENI

ExxonMobil

Repsol YPF

BG Marathon

Statoil

Petronas*

Lukoil*

Petrobras

Yukos

CNOOC

PDVSA (1,340; 102,499)Pemex (1,574; 51,655)Rosneft (152; 27,915)

Anadarko

EnCana

BHP

Hydro

MOL

TNK

|

Replacing Core Areas

Many core areas in maturity phase

– Business going to Non-OECD basins

– Strategy depends on region (e.g., Petrobras, Repsol YPF, and PDVSA in Latin America and Petronas in Asia-Pacific)

Selected “oil cores” transiting to gas

With the exception of deepwater plays, major companies are not creating new core areas through exploration, but through production deals

Production deals create new challenges -- new risks

Core “transitions” from oil risk to gas risk -- e.g. technical to commercial

|

Global Competitors Must Replace Maturing Legacy Assets

Replacement of earnings from historical assets

Growing earnings in areas where Regional Majors & Governments control

0%

20%

40%

60%

80%

$0 $2,000 $4,000 $6,000 $8,000

ExxonMobilBP

Shell

ChevronTexaco

TotalFinaElf

2000-2002 Average Upstream Net Income From North America & Europe

% N

ort

h A

me

ric

a &

Eu

rop

e o

f W

orl

dw

ide

To

tal

% of Upstream Net Income from N. America and Europe

Reported and PFC estimates.

|

Reserves held by Russian companies

Full IOC accessreserves

Access to Oil & Gas Reserves Constrained

NOC Reserves (no equity access)

NOC reserves(equity access)

Source: PFC Upstream Competition Service & BP; reserve figures are conventional billion boe, 2001

140 / 7%113 / 6%

324 / 17%

1,354 / 70%

|

Industry Shift

Divestiture in mature areas

Majors withdrawing from non-strategic areas

Independents moving in and aggregating positions

New independents likely to be created to capture opportunities unattractive to large independents

|

National Oil Companies

NOCs growing importance in the industry

– Generally more commercial and some privatizing

But NOCs can be threat to state especially if political leadership is from different background from NOC managers

Distrust of IOCs falling – even among populist or leftist governments

– States looking for production deals to attract capital and technology

What States want is evolving so IOC access issue is a very dynamic and at times confusing one for IOCs

|

EntrepreneurialCapitalist

SocialDemocraticCapitalist

AuthoritarianGlobalizer

PopulistDevelopment

RentierState

EntrepreneurialBureaucracy

StatistBureaucracy

PublicEntrepreneurs

Privatized &Competitive

Façade/NoInstitution

Excluded

TraditionalMonopoly

Oligopoly

LimitedOpening

OpenCompetition

Government NOC IOC Role

DrivingForces

Incr

ease

d O

pp

ort

un

itie

s

State Types and Implications For NOCs/IOCs

|

The Global Portfolio & Risk

Source: PFC’s Petroleum Risk Manager

Based on 26 Risk Factors at end-2002DA B C

Size = Reserves

|

US Nat. Gas Supply: A Pressing Issue

Energy security also means natural gas supply security

– Defined as reliable supply at a reasonable cost

Demand encouraged, but supply shrinking

– Washington encouraged the growing consumption of gas but has actively discouraged production

– In 2002, gas supply has declined by 5.6% in continental US, forcing the suppression of industrial demand

– In the next few months, up to 4 bcf of industrial demand need to be suppressed to allow storage to refill for next winter

– Industries and jobs lost in the US

|

US Nat. Gas Supply: A Political Question?

Continental supply is extremely difficult to grow quickly -- no matter how high the price:

– Basin exhaustion a fact of life in a mature asset base

– Accelerating decline rates creating treadmill effect

– Regulatory hurdles for areas now open to exploration

– Access to federal land practically closed

– Offshore Florida, California and East Coast closed

– LNG: siting issues, so little help in the foreseeable future

– Alaskan/MacKenzie Delta pipelines: Right Answer, wrong decade

|

US Has No Surplus Gas Supply

Excess Pipeline Gas Supply Capability in the US(I.e., as a Share of US Gas Consumption, annualized)

Sources: *PFC estimates. Includes Canadian imports, **EIA.

-5%

0%

5%

10%

15%

20%

25%

30%

35%

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

|

Canadian Pipeline Imports Nearly Tapped; New LNG Supply of Increasing Importance

LNG Imports

0

1

2

3

4

5

6

7

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

bc

fd

Additional Spot or New LNGPotential

LNG Imports from Atlantic BasinProjects

Capacity of Existing Terminals(Including Expansions)

Canadian Imports

4

5

6

7

8

9

10

11

12

13

14

Oct

-93

Oct

-95

Oct

-97

Oct

-99

Oct

-01

Oct

-03

Oct

-05

Oct

-07

Oct

-09

bc

fd

Imports from Canada

Current Pipeline Capacity

|

Abnormally Large Gas Storage Draws Lead to Increased Price Volatility

Working Gas in Storage

500

1,000

1,500

2,000

2,500

3,000

3,500

Apr-02

May-02

Jun-02

Jul-02

Aug-02

Sep-02

Oct-02

Nov-02

Dec-02

Jan-03

Feb-03

Mar-03

BC

F

5-Yr Max/Min Current Year Historical Avg.

|

U.S. Gas Prices(Henry Hub)

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

$5.00

$5.50

$6.00

Oct

-93

Jun

-94

Fe

b-9

5

Oct

-95

Jun

-96

Fe

b-9

7

Oct

-97

Jun

-98

Fe

b-9

9

Oct

-99

Jun

-00

Fe

b-0

1

Oct

-01

Jun

-02

Fe

b-0

3

$/m

mb

tu

$9.13

Market Tightness is Driving up U.S. Gas Prices -- Floor Price is Rising

$8.72

Strategic Advisors in Global Energy

Corporate Offices

1300 Connecticut Avenue, N.W. Suite 800Washington, DC 20036 USATel: 1-202-872-1199 Fax: 1-202-872-1219

3, Cité Paradis75010 Paris, FranceTel : (33.1) 4770-2900 Fax : (33.1) 4770-2737

Houston, TexasTel : 1-281-599-7099 Fax: 1-281-599-9891

[email protected] www.pfcenergy.com

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