Simmering geopolitical hot spots pose risk to energy stability

28th March 2014 By: Jeremy Wakeford

The tensions between the West and Russia, sparked by the political turmoil in Ukraine, carry echoes of Cold War geopolitics. But, in today’s world, energy often lies at the heart of geopolitical manoeuvrings. Conflicts over energy resources – particularly oil and gas – often given rise to regional political ructions. And the integration of global energy markets means that these local conflicts pose risks to the world economy.

The issues playing out in Ukraine are clearly multifaceted, but Ukraine’s strategic position as a transit point for Russian gas exports to Europe is an important aspect. Europe relies on Russia for around 25% of its gas supply, while Russia needs its European customers to ensure revenue flows.

The world has many other conflict hot spots with an energy dimension. In particular, geopolitical strife is endemic in the hydrocarbon-rich Middle East and North Africa region. A quick survey of problem areas demonstrates the tenuousness of the recent stability in world oil prices.

Iran was for several years near the top of the geopolitical risk tables as tensions over its nuclear enrichment programme festered. But, since the election of a more moderate President in 2013, relations with the West have eased notably. Nonetheless, Iran’s oil production has been constrained by US and European Union sanctions, such that output fell from around 4.3-million barrels per day (mbpd) in early 2011 to 3.4 mbpd late last year. Given the slow pace of negotiations, it could be some time before production levels recover.

Although no longer on newspaper front pages, the ongoing civil war in Syria still poses significant threats to regional stability. Syria itself has never been a major oil producer, with production prior to the insurrection in 2011 running at around 400 000 bb/d, of which more than half was exports. As the war has dragged on, oil output has fallen steadily, exports have dried up, and much of the infrastructure that has not been destroyed has come under the control of rebel forces and Al Qaeda groups. The main threat to oil markets is the destabilising effect on neighbouring countries, as militiamen, weapons and hundreds of thousands of refugees flow across Syria’s porous borders.

As an immediate neighbour with its own problems, Iraq is especially at risk. The country is beset by deep-seated ethnic and religious fault lines, with escalating tensions between the Shiite, Sunni and Kurdish elements. Suicide bombings kill hundreds of civilians each month, while militants frequently blow up sections of a major pipeline carrying crude oil to Turkey.

Fortunately for oil exports, the bulk of Iraq’s oil is produced in the Shiite-dominated southern region, which thus far has been relatively stable. Oil production has recovered impressively in the last few years to over 3.5 mbpd as big international oil firms have invested heavily to take advantage of some of the industry’s lowest production costs. But the possibility of Iraq raising production levels to 8 mbpd or 10 mbpd – as the International Energy Agency and the Iraqi government hope – seems remote. Some see the country sliding inexorably toward civil war or at least partition.

Libya is seemingly further down the road to disintegration, with the central government having little power and the country increasingly falling into the hands of local militias. Libya’s oil output – running at 1.6 mbpd before the civil war broke out in 2011 – has fallen considerably and become highly erratic. The government has lost control of the main oil export terminal to local rebels.

Neighbouring Egypt is a poster child for the phenomenon of declining net oil exports, having shifted to net importer status in 2007 as production declined, while consumption rose. The political turmoil poses a potential risk to oil transit through the Suez Canal.

Venezuela, another key oil exporter, is also becoming increasingly unstable in the post-Hugo Chavez era. The government of President Maduro is resorting to increasingly authoritarian tactics in the face of street protests. Meanwhile, the oil industry has suffered from a perennial lack of investment and production is far below potential.

With all these disruptions and threats to oil flows, why have oil prices not risen since 2011? The main reason is crude oil production in the US has surged impressively from around 5.4 mbpd in early 2011 to about 7.8 mbpd at present. This is largely the result of hydraulic facturing, which has liberated previously inaccessible ‘tight oil’ deposits in states like North Dakota and Texas. Saudi Arabia has also ramped up its crude production to near its all-time high of around 10 mbpd.

Despite the recent balance in global oil supplies, as long as the world economy is critically dependent on finite fossil fuels, there is sure to be conflict over these concentrated stocks of power. The number of localised conflicts is a reminder that geopolitics presents a constant risk to oil and gas supplies and prices.