*LEGAL NOTICE Neither the European Commission, nor any person acting on behalf of the Commission, is responsible for the use which might be made of the information contained in this publication. The views expressed in this publication have not been adopted or in any way approved by the Commission and should not be relied upon as a statement of the Commission's views. EUROGULF:An EU-GCC Dialogue for Energy Stability and Sustainability Project Ref.: 4.1041/D/02-008-S07 21089 With the support ofthe European Commission, Directorate-General for Energy and Transport* Mediterranean Programme,Robert Schuman Centrefor Advanced Studies (RSCAS), European University Institute (EUI) Energy policy Unit - National Technical University of Athens (EPU-NTUA)EconergyOxford Institute for Energy Studies (OIES)Final Research Report (as presented at the Concluding Conference in Kuwait, 2-3 April 2005) For more info and programme, follow hereEUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Eurogulf Tasks of the ProjectPage 2 of 3 Executive Summary and Policy Paper Task 1: Economic and Political Conditions for Energy Security Subtask 1.1: Prospects for Oil & Gas Exports from the GCC Member Countries Paper author: Naji Abi-Aad (ECONERGY - Economics & Energy Consultants)Subtask 1.1b: Prospects for Oil and Gas Exports from the GCC Member CountriesPaper authors:Robert Skinner and Robert Arnott (Oxford Institute for Energy Studies - OIES) Subtask 1.2: Supply Responses to Price Changes in the Medium Term and the Definition of an Optimal Price Band for Guaranteeing Energy Security in the Long Term Paper authors:Robert Skinner and Robert Arnott (Oxford Institute for Energy Studies - OIES) Subtask 1.3:DiscussionoftheDesirableRateofExploitationofGCCHydrocarbon Resources in the light of the Objectives of Maximising Revenue and Achieving Economic Development in the Long Run Paper authors:Robert Skinner and Robert Arnott (Oxford Institute for Energy Studies - OIES) Subtask 1.4: Promoting Economic Diversification as a Tool to Encourage Countries holding Major Hydrocarbon Reserves to Increase Production in line with Growing Global Demand at Stable PricesPaper authors:Giacomo Luciani (EUI, RSCAS, Mediterranean Programme) and Naji Abi-Aad (ECONERGY - Economics & Energy Consultants) Task 2: Enhancing the Efficiency and Transparency of the International Oil Markets Subtask 2.1:The Reference Pricing System: Origins, Rationale, Assessment Paper author:Robert Mabro (Oxford Institute for Energy Studies - OIES) Subtask 2.2: Reforming Reference Pricing and Seeking for Alternative Pricing Systems Paper author:Giacomo Luciani (EUI, RSCAS, Mediterranean Programme) with the assistance of Ouarda Merrouche (EUI, RSCAS) Subtask 2.3: Strategic Stockpiles vs. Market Intervention for Price Stabilisation Paper author:Giacomo Luciani (EUI, RSCAS, Mediterranean Programme) Task 3: Promoting Greater GCC Reliance on Gas through the Development of anInterconnected GCC Gas Network and Competitive Gas Market; as well as Increased Exports to the EU through Major New Pipelines and LNG Projects Paper author:Naji Abi Aad (ECONERGY - Economics & Energy Consultants) Subtask 3.1:Potential for Greater Gas Utilisation in the GCC Countries Subtask 3.2:Creating an Integrated GCC Gas Grid and Promoting a Competitive and Transparent GCC-wide Gas Market Subtask 3.3:Promoting Gas Pipeline Exports from the GCC to the Near East and Europe Subtask 3.4:Potential for Increased LNG Exports from the GCC Countries to Europe EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Eurogulf Tasks of the ProjectPage 3 of 3 Task 4: Development of Renewable Energies, Promotion of the Rational Use of Energy and Reduction of CO2 Emissions in the GCC Region Paper author: EPU-NTUA, Athens Subtask 4.1:Analysis of the Constraints for the Market Development of RES in the GCC Member Countries and Needs for Financial Support Subtask 4.2:Potential Role of the CDM to Support the Development of RES Subtask 4.3:Potential Role of a CO2 Emission-Trading Scheme in the GCC Member Countries to enable the Development of RES Projects Subtask 4.4:Establishing an Initial List of RES Projects for Priority Consideration in the Context of EU-GCC Co-operation Task 5: Institutional Aspects of EU-GCC Co-operation in the Field of Energy Subtask 5.1:Discussion of the Respective Role and Co-operation between the several International Institutions having Competence in the Field of Energy Paper author: EPU NTUA, AthensSubtask 5.2:The Relevance of the Energy Charter Treaty for EU-GCC Co-operation Paper author:Sanam Salem Haghighi (EUI, Law Department and RSCAS, Mediterranean Programme; OPEC, Vienna) %UROPEAN5NIVERSITY) NS T I T UT E 2005 - All rlghts reserved.No part of thls paper may be dlstrlbuted, quoted or reproduced by any means wlthout permlsslon of the authors. |f publlshed onllne, slngle download and prlnt for personal non commerclal use ls permltted. |n authorlzed quotatlons, please acknowledge the source.Por querles and lnformatlon, please contact author(s), or - Mediterranean ProgrammeRobert Schuman Centre for Advanced Studiesuropean University Institute, ItaIy- Oxford Institute for nergy Studies (OIS), Uk- nergy PoIicy Unit NationaI 7echnicaI University of Athens(PU-N7UA), Greece- conergy, Lebanon(JBDPNP-VDJBOJ&YFDVUJWF4VNNBSZBOE1PMJDZ1BQFS&630(6-'An U-GCC DiaIoguefor nergy StabiIity and SustainabiIity%UROPEAN#OMMISSION3YNERGY0ROGRAMMEEUROGULF:An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy Paper Giacomo Luciani 2005 All rights reserved. No part of this paper may be distributed, quoted or reproduced in any form without permission by the author(s). EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 3 of 26 Table of Contents Introduction......................................................................................4 1.Prospects for Oil and Gas Exports from the GCC Member Countries..................................................................................5 2.Defining a long-term equilibrium price band.............................6 3.Reforming reference pricing.....................................................9 4.A cooperative approach to Strategic Stocks ..........................12 Private stocks and demand flexibility .....................................12 Cooperative management of supply emergencies.................13 5.Economic Diversification........................................................16 Downstream integration of the oil producing countries ..........16 Petrochemical exports and the question of double pricing ..18 6.Gas dialogue..........................................................................20 7.Development of renewable energies, promotion of the rational use of energy and reduction of CO2 emissions in the GCC region .....................................................................................22 8.The GCC member countries and the Energy Charter Treaty.23 9.Concluding remarks ...............................................................24 Robert Schuman Centre for Advanced Studies andthe Mediterranean Programme ..............................................25 EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 4 of 26 Introduction TheEUROGULFprojectwaslaunchedin2002byaconsortiumledbythe RobertSchumanCentreforAdvancedStudiesattheEuropeanUniversity Institute,andcomprisingtheOxfordInstituteofEnergyStudies,theEnergy PolicyUnitoftheNationalTechnicalUniversityofAthensandECONERGY SalofBeirut.FundingisprovidedbytheEuropeanCommissionthrougha grant from the SYNERGY programme. The objective of the project is to analyse EU-GCC relations with respect to oil and gas issues and propose new policy initiatives and approaches to enhance cooperation between the two regional groupings. The project has originated a collectionofpaperswhoseprovisionaldraftshavebeendiscussedintwo workshops:inRiyadhinApril2004,andinFlorenceinNovember2004.The finalversionsofallpaperswillbecirculatedattheconcludingconferencein Kuwait, on April 2 & 3, 2005.ThisExecutiveSummaryfocusesonthemainthemesoftheproject,and especiallyhighlightsthemajorpolicyrecommendationthattheproject originated.Responsibilityforanalysisandpolicyrecommendationrestswith the author of each paper and is not necessarily shared by all members of the consortium. The responsibility for this Summary rests with the Project director, prof. Giacomo Luciani. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 5 of 26 1.Prospects for Oil and Gas Exports from the GCC Member Countries Ourresearchsubstantiatesthecommonlyheldviewthatoilproductionfrom the GCC is set to increase in importance over the next 20 years. However, the rateatwhichGCCproductionincreaseswillbeaffectedbyincreases(or declines)innon-Gulfandunconventionaloilproduction,whichinturnwillbe affected by a number of factors, including price.Prospects of GCC oil exports towards the EU are a potentially important area ofoildialoguebetweentheEUandtheGCC,consideringthattheshareof theGCCcountriesinEuropeanoilsuppliesislimitedwhencomparedtothe importanceoftheirreserves.EU-GCCoilexchangesareinfluencedbythree main factors: xOil reserves in the GCC are exploited less intensively than elsewhere in the world: their share of global production is less than half of their share of global reserves (21 per cent as against 42 per cent); xTheEUisdiversifyingitsprimarysourcesofenergy,relyingrelatively less on oil, and relatively more on natural gas and coal;xThe EU is the preferred destination for oil from Russia, the Caspian and NorthAfrica,primarilyforlogisticalconsiderations,whileGulfoilis mostly directed to the East or in some case - to the US. ThesefactorshavelimitedthedirectdependenceoftheEUonGCCoil exports,butthemarketforoilisglobal,andtheimportanceofsuchdirect dependence is therefore relative. The EU is dependent on GCC oil production andexportsbecausethelatterareessentialtotheorderlyfunctioningofthe global oil market, and the GCC members countries are the marginal suppliers of world oil. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 6 of 26 2.Defining a Long-term Equilibrium Price Band One of the objectives of the EUROGULF project was to investigate whether it is possible to determine an optimal price band, i.e. a rationally-defined level ofpriceswhichwillguaranteefuturesuppliesandthefullutilisationofglobal energy resources. In approaching this task, the project has started with the definition of a much broaderpriceband,whichisboundatitsupperlimitbyapricelevelwhere incrementaldemandisnegativelyaffectedandalowerlimitwheresupply would be shut in.Thedefinitionoftheupperboundarycanbeestimatedfromstudiesofthe price elasticity of demand for crude oil.Oil is less of a factor in the OECD economies than in was in 1973.More of it is in transport, where for reasons including taxation, hedonic values attached topersonalmobility,andstructuralandotherbarrierstointermodalshiftsin transportation,demandelasticityislower.Butthepriceofoilaffectsother commodity prices, not the least of which is natural gas - and more and more gasisbecomingthefuelofchoiceinpowergeneration,andelectricityis essentialtoamoderneconomy.So,higher,sustainedoilpriceswould eventually take their toll on economic growth.Thisistheconclusionofrecentreportsbyintergovernmentalagenciessuch as the IMF and the OECD/IEA (See Analysis of the Impact of High Oil Prices on the Global Economy, IEA, May, 2004; available on the IEA website). Their analysesinMay2004,atthebeginningofthecurrentrun-upinprices concluded the following: xAsinthepast,theneteffectontheglobaleconomyofhigherprices wouldbenegative.Producergainswouldbemorethanoffsetby consumer losses. xDependingonwhatproducersdowiththeextrarevenues(import goods and services or pay down debt and rebuild reserves), the effects would be less or more severe respectively. xImpactsontradedeficitsandbudgetscouldputpressureoninterest rates and therefore prompt tighter monetary policy responses. xExchange rates would be affected, leading for example to a rise in the USdollar,impairingcertaindevelopingcountriescapacitytoservice dollardenominateddebtandaddingtocurrentaccountimbalances, particularly in countries where prices of oil products do not reflect their costs.At the time of writing, some of these effects are beginning to appear.EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 7 of 26 Analyses of price effects on inflation and therefore policy responses and their knock-on macroeconomic effects confirm that this subject is a moving feast.Oil does make up a smaller share of the consumer basket in OECD countries.Someresearchindicatesthattherewasashiftintheimpactaround1980; pre-1980oilpriceincreasesfeddirectlythroughtothecoreCPI,whereas sincethentheirdirectimpactasbeennegligible.Someresearchsuggests that the impact on the economy of price increases during the seventies were compoundedbymonetarypolicyresponses,butthishasbeenlessthecase since 1980. From todays price level of around $50 per barrel, it would seem that extreme pricelevelsinotherwords,atruepriceshockwouldberequiredbefore worldeconomicgrowthwouldfallabruptly.Suchextremelevelswouldseem to be above the current levels, but this tempting conclusion must be cautioned bythequalificationthatitistooearlytotell.Thiscautionisevenmore warranted, as indicated above, given the recent devaluation of the dollar. Thedefinitionofthelowerboundarycanbeestimatedbylookingatthe operating cost of existing global production. Such analysis highlights the price level, at which existing production would be shut-in as uneconomic. It is clear from such analysis that over 87 per cent of crude production today would still beeconomicatoilpricesdowntoaround$8perbarrel.However,more importantisthepricelevelatwhichnewcapacitywillgeneratesufficient economic return to justify investment.Ouranalysisfor2020,whichwecarriedoutinlate2003,hasshownthat nearly 80 per cent of conventional oil production, up to 104 million barrels per day,couldbedevelopedandoperatedatacostoflessthan$8perbarrel, withOPECremainingthelowestcostproducer.Morerecentdatasuggests that, given the rise in steel prices and other inputs associated with the finding, developmentandproductionofoil,thismarginalcostwouldhaverisen, perhaps to $12 - $14/bbl.Thereforethepricebandhaslimitssomewhereabove$50/bblandnot much below $14/bbl and certainly not below $8/bbl. In a free market, where there is no constraint on production capacity, it would be natural for prices to fall to the marginal cost of production, which in the low demand case would be around $8 per barrel. However, the fact that the actual oil price has traded within a band of $18 - $26 per barrel for over 80 per cent of the past decade demonstrates the market power of OPEC. Our research suggests that the oil price required by the private oil companies andnationalgovernmentsisonaveragesome$10-$12perbarrelhigher thanactualdevelopmentcostsrequiredforprojectstobreakeven.More interesting is the fact that the price required by private oil companies is lower thanthepricerequiredbynationalgovernmentseventhoughtheymightbe involved in more expensive and technically more difficult developments.EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 8 of 26 Todateouranalysissuggeststhataminimumoilpriceof$25is sufficienttosecureinvestmentinnewsupplies,butevenatthislevel pressure would be put on the budgets of national governments.Our conclusion is that there is no prescriptive or optimal oil price band that will guarantee long term security of supply of energy. We have identified that the broad range of prices where projects are economic but which do not adversely affect demand is between $8 and $50 per barrel. We have also shown that an oilpriceinexcessof$20perbarrelisrequiredforcompaniesand governmentstojustifyinvestmentstoshareholdersandtobalancebudgets respectively. However, prices required by companies and governments are a moving target, compounded by shifts in the exchange rate of the U.S. dollar.Wedonotsubscribetotheviewifonlybecauseitescapesprecisionthat oilpricesneedtobesufficientlyhighandimplicitlythatsomeinternational mechanismshouldbecontrivedtoensuretheyare,forGCCmembersto bear the burden of the massive investment required to satisfy global demand.It is clear that in the case of the GCC, an oil price of just $8 per barrel would besufficientintheorytojustifyinvestmentandraisefinance,butformost countries it would fall well short of meeting their budgetary requirements.Finallyitmustbeacceptedthatfindinganddefiningapricebandisnotonly elusive, it could be dynamic. As soon as the oil price nudges into the upper or lowerzones,thedynamicrelationshipsofsupplyanddemandwouldadjust, and the price would be affected. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 9 of 26 3.Reforming Reference Pricing Thecurrentpriceregimeforoilininternationaltradewasintroducedinthe second half of the 1980s and is known as reference pricing. The concept of a market-related system which involves a formula linking the price of a given exportcrudetoareferenceprice(orasetofreferenceprices)arisingina particular market was pioneered by PEMEX in 1986. The pricing formula has the following form: Export price of crude X = Marker price (or prices) R plus or minus adjustment factor F. Initially the marker prices were spot WTI, dated Brent, or spot ANS, all prices forphysical(wet)oilbarrels.Thelogicisthatamarkerpricemustbe generatedinaphysicalmarketwherethetransactionsaresalesand purchasesofbarrelsofoil.However,thesespotmarketsofmarkercrudes haveproblems:theyareverythin;thenumberofpricequotationsforactual transactions is very small; they can be more easily squeezed than very liquid futuresmarkets.Mostexportingcountrieshavethereforereplaceddatedby futures Brent, and spot WTI by the NYMEX price of the contract for light sweet crudes.SoBrent,WTI,Dubai/Omanetc.remainthemarkercrudesbutthe relevant prices of the first two are taken from what is in essence a market of financial instruments.Theeconomicpriceofacommodity,agoodoraserviceisthepricethat arisesfromtheinteractionofthesupplyofandthedemandforthis commodity, good or service in a market where sellers and (buyers) offer and (purchase) them.In contrast, for oil the price of a physical barrel in international trade is linked very closely to that of a futures contract. This price results, of course, from the interaction of supply and demand; but of the supply and demand for this item, which is a futures contract, not a physical barrel of oil. Thedeterminantsofatransactioninthefuturesmarketincludeexpectations about developments in the supply of and demand for oil. In that sense there is a relationship with the physical oil world, but not to actual conditions at given pointsintime.Thepointisthatinaphysicalmarketthebuyerpurchasesa commodity, good or service because it has a place in his/her consumption or investmentplans-butpurchasesaresometimesalsomadeordeferredin response to expectations about changes in prices or other supply conditions. Inafuturesmarketthetraderwillbuyorsellnotbecausehehasaphysicalneedfortheitembutentirelyonthebasisofexpectationsaboutsubsequent price movements. There are other determinants for transactions on futures markets that are not related to the oil situation. This is because the futures oil contract is a financial instrument,heldbymanyeconomicagents(particularlyhedgefunds,banks, otherfinancialinstitutions)inaportfolioofvariousfinancialinstruments.The aim is to optimise the composition of the portfolio. Funds move in or out of a EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 10 of 26 financialmarket,beitoil,bonds,foreignexchangeetc.etc.,dependingon relative expectations.Hence a decoupling between price movements in the futures market and theeconomicfundamentalsofthesupplyof,anddemandfor,the physical barrel may occur from time to time. Thecurrentoilpricedeterminationsystemcanbedescribedsuccinctlyas follows:(a) The marker prices are determined in two futures exchanges NYMEX in New York and IPE in London.(b) OPECattemptstoinfluencepriceformationonthefuturesexchanges intwoways.Themostimportantisbysignallingitspricepreferences by altering the level of its policy-determined production ceiling (and the associatedproductionquotas).Anothersignallingdevicewasthe adoption a few years ago of a price band. (c) Those that buy or sell futures contracts may or may not respond to the signals.ApositivemarketresponsetoanOPEC(production)signal dependsonwhetherOPECappearstobeunitedinthemakingofthe policy decision; on how credible (that is how realistic) the OPEC policy decision appears to be; and on whether the market is taken by surprise by the policy decision or whether it had widely expected it and therefore fully discounted it in the price.(d) BothOPECandthemarketcontinuallyassessthelikelyfuture movementsinsupplyanddemand,thefactorsthatmaycauseeither curvetoshiftinonedirectionortheother,andnumeroussourcesof uncertainties-themostimportantbeingthosewhichaffecttheworld economic outlook and the geopolitical situation (for example, in Iraq).Isitpossibletoimproveonthecurrent,flawedfunctioningoftheoilmarket andbringaboutgreateradherencetomarketfundamentals?Boththeoil producingcountriesandthemajoroilimportingcountrieshaveaninterestin oilpricestability,butalsoinpricesthatareresponsivetomarketconditions, andthereforesustainableinthelongrun.Thereisanobvioustradeoff between these two objectives. Provided a market design could be arrived at, which simultaneously guarantees greater price stability and responsiveness to market conditions, both sides would probably see its merits. Acombinationofgreaterpricestabilitywithincreasedrelianceonmarket mechanisms may be brought about by the development of active new physical oilmarkets:candidatesareintheMediterranean,intheGulfitself,and probably in the Far East (Southeast Asia). The project examines in particular theprospectthataliquidphysicalspotmarketmightdevelopintheEastern Mediterranean,andassertsthatthisshouldbeanimportantpriorityforthe EU. An Eastern Mediterranean spot market does not require the participation of the GCC oil producing countries, but would benefit from it. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 11 of 26 Theactualbenefitofdevelopingnewphysicaloilmarketswilldepend fromtheirdesign.TheEuropeanCommissionshouldtakestepsto ensurethattheyaretransparent,basedonstandardisedcontracts tradedinanexchange,andwithnumerousplayers.Whileintheendthe successandshapeofnewmarketsdependsontheactionofsellers,buyers and intermediaries, rather than on government intervention, governments and theCommissioncanencourage/facilitatethecreationofmarketsand influence their design. However,inordertoensurethatfundamentalsplayamoreimportantrolein priceformation,theactiveparticipationofoilproducingcountrieswillbe necessary. Theprojectarguesinfavourofeitheroneorbothofthe following developments:x Allowingsecondarytradingandthedevelopmentofasecondary market in major crude oil;x And/orprimarytradingbasedonrecurrentauctionswith uncertainty in the sellers supply.If only secondary trading is allowed, a lot of information will be gained for price discovery,andtheoilexportingcountrieswillgainamuchmoredirect influenceonpricesthroughvariationsinvolumesexported,relativetowhat theyhavenow.Ifauction-basedprimarytradingisoptedfor,theprice determined in such auctions will become the guide to the market, and volatility maybeveryfundamentallyreduced.Nevertheless,themarketwouldstillbe veryactive,indeedmoreactivethanunderthecurrentreferencepricing system; producers would receive its signals and be able to respond to them. Ideally,theEUshouldproposeanexchange-basedtradingsystemwith frequentprimaryauctionsforthemajorcrudeoilsorganisedinan appropriate weekly or monthly calendar coupled with continuous secondary trading of standard parcels.EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 12 of 26 4.A Cooperative Approach to Strategic Stocks The project has analysed the policy of accumulating strategic stocks as it has beenpracticedintheUS,EuropeandundertheIEAEmergencyResponse system,aswellastherecentdebatewithintheUnionconcerningthe possibility of increasing the level of mandatory stocks from 90 to 120 days of consumption.Thisanalysispointstoseveralproblemsinthedefinitionofan effective policy for the accumulation and utilisation of strategic stocks, notably: xThe difficulty of defining the appropriate level of strategic stocks xTheimpossibilityofdistinguishingtheuseofstocksinstrategic emergencies from their use as market intervention tools xTheverylimitedandseeminglyineffectiveuseofthestocksinactual experience.Such doubts have also been voiced in the context of the proposals to increase EuropesstrategicstocksputforwardbytheCommissionin2002and withdrawn in 2004. Private stocks and demand flexibilityAgainstthisbackdrop,theprojectproposesthatacleardistinctionbemade betweenthewisdomofmaintaininglargepublicstocksandthatof encouraginglarge(r)privatestocks.Theproblemsconcerningpublicstocks are very much related to their public nature that is to the need to have clear activationcriteria,cost-benefitanalysis,anddifferentiationbetween emergencycontingenciesandmarketintervention.Noneofthesearguments applies to privately held stocks, and the wisdom of encouraging private actors in the industry to hold larger stocks would appear to be out of discussion. The drive towards cost cutting and maximisation of return on invested capital hasmeantthatallcompanieshavestrivedtominimisetheirworkingcapital, andonewaytodosoistoreducestocksandprogressivelyeliminateall redundanciesinoneslogisticssystem.Theconsequenceismuchgreater vulnerability to supply disruptions. Thedebateaboutinsufficientinvestmentunderconditionsofmarket liberalisationisongoing,andmaybeexpectedtoeventuallyconvergeon solutions that will re-establish some stability and resilience to the system. This debate,however,mainlyconcentratesonnetworkenergy,andappearsto have overlooked the problems of the oil industry. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 13 of 26 We may think in terms of adopting regulations at various stages in the industry mandatingacertainlevelofstocksandredundanciesinseveralcrucial facilities,whichmaycontributetotheoverallreliabilityofthesystem.Ina sense,thisiswhatisdonewhenoilcompaniesaremandatedtomaintain stocks equal to at least x days of consumption except that these stocks are thencalledstrategicandarenotfreelycontrolledbythecompanies themselves. Itisproposedtointroducerulestomandatecompaniesto maintainstocksofcrudeandproductsaswellasacertainredundancy incapacityincruciallogisticsorrefiningcapacity,butallowthe companiestomoreflexiblyusesuchstocksandexcesscapacitywhen they feel a need to do so.Majorusersofoilproductsandgasshouldalsobeencouragedtoinvestin flexibility. Depending on the circumstances, this may mean maintaining a dual firingcapability,ormaintainingsufficientstocks.Consumersshouldbe educatedaboutthevolatilityofenergypricesandencouragedtoprotect themselvesagainstit.Presently,contractualinstrumentsthatmayallowthis arenotonoffer,buttheymightbeencouragedorevenmandatedonoil product suppliers. E.g. requesting oil products suppliers to offer contracts thatwillguaranteepricesorlimitpriceincreasestothefinalconsumer overagivenperiodoftimemaycreatesufficientincentiveinthe industrytoholdlargerstocksandinvestinredundancy.Suchcontracts arecertainlyfeasibleonthebasisofdirectorindirecttradingonfutures markets but are out of reach for the individual or small consumer.Similarly, limitingbyregulationtheextenttowhichrefiners,distributors andmajorindustrialconsumerscantransferoilpriceincreasesonto thefinalconsumerwouldencouragefuturestradingandholdingof stocks.The discussion on oil stocks cannot be separated from the discussion on the volatility of crude oil prices, and that strategic stocks should be understood in averynarrowsense,andresortedtoonlytodealwithactualandclearly identifiableexceptionalcircumstances;otherwisetheemphasisshouldbeon creatingamoreresilientandstableinternationaloiltradingenvironment, which will dampen the shocks to which the final consumer is exposed. Cooperative management of supply emergenciesThehypothesisofsomekindofcooperativemanagementofsupply emergencies has been greatly enhanced by the informal agreement between the Executive Director of the International Energy Agency, Claude Mandil, and the Minister of Petroleum of Saudi Arabia, Ali Naimi, in the run-up to the 2003 warinIraq.TheagreementenvisagedthatSaudiArabiawoulduseits unutilisedcapacitytomakeupforanyshortfallinglobalcrudeoilsupplies, andtheIEAwouldabstainfromusingitsstrategicstocks.Thisagreement constitutesapowerfulandextremelysignificantprecedent,becauseit EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 14 of 26 implicitlyassertsthatexistingunutilisedcapacityinSaudiArabiaisthefirst lineofdefenceagainstunexpectedandundesirableinterruptionsor disturbances in the regular patter of crude oil supplies.Although the Mandil/Naimi understanding is a purely informal pact, it has been publicly described by its two parties, and not objected to therefore implicitly ratifiedbytheirrespectiveconstituencies.Wemaythereforespeakofan informal agreement to cooperatively manage unutilised capacity and strategic stockstocompensateforunexpectedandunintendedshortfallsincrudeoil availability. In this context, several interesting questions become of relevance. Firstly, themajorindustrialcountriescannotbeindifferenttothe existenceofunutilisedproductioncapacity.Indeed,theinterestofthe importingcountriesinhavingasufficientcushionofunutilisedcapacity available for situations of stress is clear. Nevertheless, the importing countries do nothing to share the investment burden, which is required to maintain such unusedcapacity.Indeed,theimportingcountriesconstantlyclaimthatthe producingcountriesshouldallowmoreofaninvolvementoftheinternational oil companies in investing upstream however the international oil companies arecertainlynotinterestedininvestinginunusedcapacity.Itisprobably impossibletoenvisagethatgovernmentsoftheimportingcountrieswould contributetothefinancingofinvestmentinunusedcapacity;however,inthe contextofacooperativeapproachtodealingwithsupplyemergencies,theinvestmentbyproducingcountriesinunusedcapacityshouldbe creditedtothemastheircontributiontotheoverallstabilityofthe system.Secondly, the issue of location of stocks: should stocks necessarily be held in theEUormaytheybeheldoutsideoftheUnion?TheCommissionhas explicitlyindicated:stockscouldbeheldintheEUMemberStatesand candidate countries or equally in producer or transit countries. This opens the door to some very interesting possibilities that deserve in depth discussion:x The EU might decide to invest in the creation of storage facilities offeringtheiruseforfreetoproducerswishingtodeposittheir crudeinthem.Producerswouldretainownershipandcontrolofthe crudeundernormalcircumstances,buttheEUwouldbeallowed accessunderemergencyconditions.Producersmightreceivea certificateforthecrudetheydepositinthestorage,whichtheymight useascollateraltoborrowfromthefinancialsystem.TheEuropean Investment Bank might specifically be mandated to issue loans against thesecertificates,e.g.tofinanceinvestmentincreatingunutilised capacityinthesameproducingcountries.Theavailabilityofsuchan oildepositwindowwouldencourageproducingcountriestoabandon the attempt to modify their production levels in anticipation of changes inmarketbalance:experiencehastoldusthatsuchanticipationscan prove unfounded, leading to even worse market imbalances. The ability todivertoiltoadepositwindowincaseofweakdemand,orto withdrawfromitincaseofunexpectedlystrongdemand,would enhance the ability of major producers to maintain prices at levels close to their targets.EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 15 of 26 x Storagefacilitiesmightbecreatedinconnectionwithmajor pipelines.Theymight,inthiscontext,befunctionaltothestabilityof theMediterraneancrudeoilmarket,whosecreationisanticipatedand encouragementproposed.ForcrudeoiloriginatingintheGCC countries,whichwouldentertheMediterraneanprimarilythroughthe Suez Canal and/or the SUMED pipeline, creation of storage facilities in Egypt might be considered. x Strategicstocksshouldincludenotonlycrudeoilandoil products that have been sold by the original owner to a titleholder ofadifferentnationality.Nationaloilcompaniesoftheproducing countriesshouldbeencouragedtointegratedownstreamintorefining andmarketingintheEU,andthusbecomesubjecttostockholding obligations and own stocks within the EU. National oil companies of the producingcountriesshouldalsobeencouragedtoestablishstocksof crude oil possibly for trading purposes within the territory of the EU. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 16 of 26 5.Economic DiversificationAll oil-producing countries pursue the goal of economic diversification. As long as they remain pure exporters of crude, the GCC countries have all incentive tomaximiseoilrevenue,eventothedetrimentofglobalprosperity.Butthe moretheybecomeintegratedintotheglobaleconomy,themoretheir perspective will change.Economicdiversificationmustbebasedontheareasofstrengthand comparativeadvantage.Inthiscontext,diversificationintodownstreamoil production,petrochemicals,andotherenergy-intensiveindustriesisof paramount importance. Although there may be other areas in which the GCC countriesmayenjoyoracquirecompetitiveadvantage,itisdifficultto conceiveofasatisfactoryscenarioofeconomicdiversificationthatdoesnot make the best of their resource endowment. Inthelongrun,theGCCmembercountriesmustbecomefully industrialised,andassimilatedtotheindustrialcountriesthatare members of the OECD. Several OECD member countries are also major oil exporters,Norwayfirstandforemost,andtheytooofcoursecareabout maximisingtheiroilandgasexportrevenue,howeverthequalityofrelations withthemiswidelyperceivedtobemorecooperativethanwiththeGCC member countries. The difference clearly lies in the level of industrialisation. Downstream integration of the oil producing countriesDownstreamintegration,includinginrefiningandmarketinginthemajor importingcountries,createsgreatermarketstabilitybyfacilitatingthe feedbackfromthefinalconsumermarkettotheupstreamproducer.Greater awarenessofconsumerdemands,bettercontrolofmarketshare,greater attentiontoproductquality,areall-importanttopreserveconsumer acceptance in the long run.Environmental issues also come into play. Transporting lighter products poses less of a hazard to the natural environment in the event of an accident, while the worst hazard is created by the transport of heavy fuel oil. The EUs stated intention of pursuing a reduction in the maritime transport of crude oil across theMediterraneanwouldbestbeservedbypromotingrefiningclosetothe sourceandtransportationoflighter,morevolatileproducts,accompaniedby severe restrictions on the transportation of heavy fuel oil. Strategicstorageofoilproductscandelivermuchgreatersecuritythanthe strategicstorageofcrude.Notalloilproductsmaybesaidtobeequally essential, and the storing of products may allow guaranteeing consumption of the essential needs for a longer period, coeteris paribus. It is noteworthy that EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 17 of 26 theEUstrategicstoragepolicyhasbeenessentiallyaimedatguaranteeing the storage of products.Intheindustrialcountries,refinerieshavelongbeentheleastbeloved segmentoftheintegratedoilcompanies,andfrequentattemptshavebeen madetorestructurethesectorandreducecapacity.Thishasgenerally pitchedcompaniesagainstgovernments,becauserestructuringisfacilitated bycooperationbetweenalloilcompanies,i.e.byrestrictionofcompetition. National governments and the EU commission have opposed this, preventing oil companies from implementing cooperative agreements aiming at reducing refiningcapacity.Inotherwords,thecompetitionauthoritiesintheindustrial countries may have slowed down a process of industry restructuring, which is widely recognised to be necessary and in the best interest of the consumer in the longer run.Inaddition,environmentalrequirements(especiallytherequirementforsite restoration)havegreatlyincreasedthecostofpermanentlyshuttingdowna refinery,encouraginglessdrasticapproaches.Theresultingexcesscapacity has depressed refinery returns, thus also hindering the upgrading of refineries and the improvement of the quality of products.In short, it is not clear that the alleged advantage of locating refineries close to markets rather than close to the source of crude oil reflects truly objective and technicalfactors,ratherthanartificialobstaclesbroughtaboutbylegaland regulatory specificities.TheGCCcountriesmayprogressivelychangetheirprofileandbecome suppliersofmoreproductsandlesscrudeoiltotheMediterraneanmarket whileatthesametimeextendingtheirmarketingpresenceintheEuropean markets, so as to better control their market outlets and share. From the point ofviewoftheEuropeanUnion,thepotentialadvantagesanddisadvantages ofthispossibleevolutionshouldbeweightedcarefully.Itislikelythatthis evolutionmightberesistedorencouragedthroughappropriateregulatory decisions, on a wide range of aspects going from environmental requirements forthetransportofcrudeoilandoilproducts,torequirementsforholdingof strategic stocks, or relevant rules pertaining to the closing of refining capacity. Theconsiderationofadvantagesanddisadvantagesshouldbeconductedin thelightofthepreviouslyexposedargumentsinfavourofsupportingthe economicdiversificationoftheGCCmembercountries.Ifweacceptthe hypothesis that supporting GCC economic diversification will contribute tothesecurityandstabilityofsupplies,thensurelyfacilitating downstream integration of the oil producers into refining is a step in the right direction. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 18 of 26 Petrochemical exports and the question of double pricingTherapidgrowthofproductionofcommoditypetrochemicalsintheoil producingcountrieshasbeenviewedasathreatbytheindustryinEurope. TheEuropeanchemicalindustryhasformanyyearsclaimedthat petrochemicalsproductionintheGCCcountrieswasundulysubsidised,and successfully bid for protection. This has been a serious bone of contention in EU-GCC relations ever since the signing of the 1988 cooperation agreement. In the context of EU-GCC relations it is extremely important to reach an agreementopeningthedoortogreateropennessoftheEuropean petrochemical products market.AllGCCmembercountrieshaveambitiousprogramstodeveloptheir petrochemicalexports.WiththeexceptionofSaudiArabia,allGCCmember countriesaremembersoftheWTO,andnoactionhasbeeninitiatedunder the WTO to argue that the production of petrochemicals is subsidised. Indeed, thefactthatpetrochemicalproductionisexpandingalsoincountrieswhere theindustrydependsonimportedfeedstock,suchasBahrainorDubai, provesthatsubsidiescannotbethereasonfortheindustryssuccessand competitiveness.Inviewofovercomingtheremainingdifficultieswithrespecttothepricingof NGL to the petrochemical industry in Saudi Arabia the following action plan is proposed:1.The Saudi Government should pass a resolution abolishing all previous decisions concerning pricing of LPG and affirming the full autonomy of Saudi Aramco in establishing a pricing structure in line with the companys own long termstrategicobjectives.Thenewresolutionshouldpreferablynotethat Saudi Aramco occupies a dominant position on the domestic market for LPG andshouldnotabuseit.Thismaybeachievedife.g.contractualconditions forthesupplyofLPGtodomesticcustomersareagreeduponthrougha processofcollectivenegotiationsbetweenSaudiAramcoanditsindustrial customers,andthesameconditionsareofferedtoalldomesticcustomers, existing as well as new. The resolution should also assert that Saudi Aramco isrequiredtoextendtoallinternationalcustomersthatareinthesame conditions as domestic customers equivalent contractual conditions. Possibly, theresolutionshouldalsoestablishaspecialarbitrationboardtosettle disputes or mediate between the parties in the absence of an agreement. 2.AnassociationofallindustrialusersofLPGshouldbeformed, including SABIC, all of SABICs joint venture partners, and other private Saudi petrochemical.Thisassociationshouldpreferablybesetupentirely independentlyofGovernmentinitiative,althoughtheGovernmentmay acknowledge its existence and affirm its right to negotiate with Saudi Aramco on behalf of all industrial users of LPG. The association should be open to all captive customers of Saudi Aramco. A captive customer is one which has no supply alternative and necessarily depends on Saudi Aramco for its supply ofLPG.Operationallyspeaking,captivecustomersshallbedefinedas EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 19 of 26 customersservedbypipeline,independentlyofthefactthattheymaybe located within the borders of the Kingdom or outside of them. 3.Thecurrentgovernment-sanctionedpricingstructureshouldbe replaced by a freely negotiated contractual agreement between Saudi Aramco andtheAssociation.Theagreementmaybevalidforafixedperiodoftime (e.g.fiveyears)andberenegotiatedthereafter.Intheabsenceofanew agreement whenever one is due, compulsory arbitration shall be envisaged.InjudgingoftheprospectsofGCCexportsofcommoditypetrochemicalsit shouldbekeptinmindthatallmajorEuropeanoilandchemicalcompanies aredivestingtheircommoditypetrochemicalsbusinesses,becauseitisnot viewed as promising enough. In one case (Netherlandss DSM) the business was sold to SABIC of Saudi Arabia. Previously, ENI had been negotiating the saletoSABICof50%ofitsENICHEMsubsidiary,asasteptoreduceits involvement in petrochemicals. Two other major European companies, Basell andLanxess,arecurrentlyintheprocessofbeingeithersoldorfloatedin dependently by their respective parent companies (Shell, BASF and Bayer). Inthelightoftheserealities,theEUandtheGCCshouldengageina dialoguetoachieveamoreadvancedmodelofdivisionoflabourbasedon transferring the production of commodity petrochemicals to the Gulf. This may involveissuesrelatedtotheprivatisationofGCCpetrochemicalcompanies and the preservation of competition between them, avoiding the creation of a dominant company enjoying excessive market power. In other words, the EU haslegitimateintereststhatshouldbepreserved,butthesedonotcoincide withtheall-outdefenceofEuropeancommoditypetrochemicalproducers, whose best strategic option may well be to be acquired by Gulf producers and become part of the latters global drive. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 20 of 26 6.Gas dialogue The projects research has highlighted the obstacles that continue to hinder an agreementtoimplementtheGCCGasGrid,whichhasbeenonthedrawing boardsincetheearly1980s.Instead,Qatar,themainpromoterofgas interconnectionintheGulf,hasbeentryinghard,withoutbigsuccessuntil now,tolinkwithitsGCCneighbours,suchasBahrain,theUAE,Omanand Kuwait, through single and segmented projects One of the reasons for that failure could be the little experience of the GCC in building and operating gas transportation networks or grids. Here, we believe thataEU-GCCdialoguemaybeextremelyhelpful,withtheEuropeans bringing to mind their experience in the gas industry and its transport sector. In addition, the EU could effectively promote, on the basis of the experience of its member countries, the benefits to be derived from establishing a GCC-wide gasnetwork,allowingindividualproducerstoselltoanycustomeralongthe network, and breaking the pattern of segmented projects geared to export, or closed,verticallyintegratedprojectsforthedomestictransformationofgas. TheGCCcouldalsolearnfromtheEUexperienceregardingpowerandgas deregulation and liberalisation, as well as the links between domestic prices of petroleum products and those of natural gas. AsawaytoencourageandpromoteaGCCGasGrid,theEUcouldwell encourageEuropeancompaniestoestablishnaturalgasconsumingand export-orientedvalue-addeddownstreamventuresandrelatedindustriesin theGCCregion.Thisisespeciallytrueifthefuturegasdevelopmentinthe region would be reoriented more and more towards domestic markets due to export constraints and market saturation.EstablishingaGCC-widegasgridisanimportantprerequisitewhich wouldfacilitatetheseriousthinkingofbuildingapipelinebetweenthe GCCtotheNearEastandEurope.Infact,inorderfortheQatarigas reservestobesuppliedbypipelinetothenearestpointconnectingwiththe Europeangasnetwork,theymustbechannelledthroughoneormoreGCC countries.BringingnaturalgasfromtheGCC,andmorespecificallyQatar,toEurope, requiressolvingacomplexpuzzleofseveralpieces,allofwhichmustfallin place.Nevertheless,ifanexportpipelineisputinplacelinkingQatarto TurkeyacrossSaudiArabia,JordanandSyriaandcapableofserving Lebanon as well, several very important objectives would be served. It should be pursued as a priority in the context of a EU-GCC Partnership. That would go hand by hand with the EU support of the Arab Gas Pipeline project, which istolinkEgyptwithJordan,Syria,Lebanon,andultimatelyCyprusand Turkey.Tosomeextent,diversificationofgassuppliestotheEUcancomefrom increasingimportsofLNGwhichbeingtransportedbyship,enjoysgreater EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 21 of 26 flexibility,atleastintheory.Letusherefocuson.Since2001,Qatarhas concludedmanylandmarkdealsaimedtosupplyitsLNGintoEuropean markets.WhileGCC-EUgastrademustdevelopinacompetitiveenvironmentwith operationalresponsibilitiesrestingfirmlywiththegasindustry,theGCCand European Union can play an important role in coordinating and supporting this trade. The establishment of an advisory body to facilitate the development of commongasstrategiesandtheexchangeofinformationbetweentheGCC and EU gas industry and buyers could make an important contribution to gas trade.Suchabodyisparticularlyimportantinthecurrentperiodoftransition toacompetitivegasmarketasuncertaintycanimpedethedevelopmentof investment and trade.AdialoguebetweentheGCCandEUgasindustriesandtransitcountriesis alsoimportantinthecontextoffacilitatingandsafeguardingnewinvestment andcommercialopportunities.Newopportunitiesforforeignparticipationin theGCCgasanddownstreamindustriesareemergingandthisshould stimulate the development of trade. Theemergenceofriskmitigationstrategiesandfinancialinstrumentsisan important development that is not yet fully exploited in the gas industry.TheEUisalreadymakingadirectpoliticalandfinancialcontributiontothe development of gas infrastructure through its Trans European Network (TEN) programme.AcloserdialoguewiththeGCCcouldhaveanimpactin identifying and prioritising new projects that could facilitate the development of gas trade with the GCC. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 22 of 26 7.Development of Renewable Energies, Promotion of the Rational Use of Energy and Reduction of CO2 Emissions in the GCC Region Theprojecthasconductedathoroughanalysisofopportunitiesforthe developmentofrenewableenergysources(RES),thepromotionofthe rational use of energy (RUE) and the reduction of CO2 emissions in the GCC region. The project also points to a preliminary list of projects, which could be undertaken in the context of EU-GCC cooperation. Inthelongerrun,themostpromisingopportunitiesforcooperationinthe reductionofCO2emissionsmaybefoundinthesearchformoreadvanced, cleanerfuels,andinthecaptureofCO2.ArecentstudyoftheInternational Energy Agency has highlighted that the oil producing countries of the Gulf are the ideal candidates to develop carbon sequestration.It should be noted that concentration of refining, petrochemical and other energyintensiveactivitiesclosetothemainhydrocarbonfieldsis environmentallysound,becauseitfacilitatescarbonsequestrationand thereductionofemissions.Totheextentthattheglobaleconomywill move, as some predict, from using petroleum products to using hydrogen and fuelcellsintransportationandstationaryuses,theGCCmembercountries willbeabletocompeteasproducersofhydrogen.Thelatterisinfactnot foundinnature,butmustbeproduced,andoneoftheeasiestmethodsof doingsoisthesteamreformingofhydrocarbonsmethaneorsomeofthe productsofrefiningcrudeoil.Steamreformingofhydrocarbonsisaprocess generatingsignificantcarbonemissions,whichtheGCCmembercountries wouldbeinapositiontosequestratecheaplyandefficiently.Inshort,the strategyofintegratingdownstreamandexportingqualitypetroleumand petrochemical products rather than crude is fully in line with the Kyoto protocol and is not vulnerable to changes in the technology and fuel preferences of the major energy markets. TheEUandtheGCCshouldengageindialoguetopromoteRESandRUE andexperimentwithcarbonsequestrationandcleanerfuels,inviewof developingtechnologiestoprotecttheenvironmentwhileatthesametime making the best possible use of scarce energy resources. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 23 of 26 8.The GCC Member Countries and the Energy Charter Treaty AlthoughmembersoftheGCCwerenotaskedtoparticipateintheEnergy Charter Treaty negotiations, no provision impedes their eventual membership. WhilethemainobjectiveoftheTreatywastobuildanenergycommunity betweentwosidesofthecollapsedironcurtain,itsscopehasexpandedby grantingobserverstatustootherimportantenergyproducingcountries,from Algeria and Nigeria to Iran and all members of the GCC.TheECTprovisionsnotonlyguaranteethesafeandsecureinvestmentin, andtradewithGCCcountries,butalsocontributetotheirindustrial development,andprotecttheiroutwardinvestmentandtrade.InJanuary 2003,theSecretaryGeneraloftheECTSecretariathighlightedthe 'tremendousadvantages'thataccessiontotheTreatywouldbringtooiland gas exporting countries'.The ECT seeks to overcome existing legal problems oftoday'senergyenvironmentandguaranteestablepoliticalandeconomic cooperation. For that purpose, membership of the ECT would make the voice of some of the most important energy-rich countries heard in the progressive definition of an energy regime at the international level. The ECT has created apreferentialinvestment,tradeandtransitareathattheGCCcountries should be interested in being a part of.EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 24 of 26 9.Concluding remarks TheEUROGULFprojecthasgeneratedanimportantbodyofanalysisand several innovative proposals, some of which can be undertaken directly by the EUandtheGCC,othermaybepromotedbythesetwogroupingsinother institutionalcontexts,notablytheIEAandOPEC.TheInternationalEnergy Forum also offers an institutional framework for the promotion of new forms of cooperation.MostoftheproposalsputforwardintheprojecttoenhanceEU-GCC cooperationcouldalsobetakenupinotherregionalcontexts.Thus,for example, the adoption of new price determination rules on the part of the GCC majoroilproducerswouldhaveglobalsignificancenotjustfortheEUand theGCC;thedevelopmentofaspotmarketintheEasternMediterraneanis primarily,butnotexclusively,ofregionalinterest;itcouldbemirroredbythe parallel development of new spot markets in the Far East or elsewhere.Innovative approaches to strategic stocks would have global significance and impact,althoughspecificmechanisms,e.g.thecreationoftheproposedoil depositwindowshouldbeestablishedonaregionalbasis(butcouldbe imitated in other regions). Economicdiversificationissuesalsohaveaglobalfacet,whichisbestdealt withinthecontextoftheWTO,andaregionaldimension,totheextentthat trade in petrochemicals has been an area of conflict between the EU and the GCC.ThedevelopmentofgasnetworksconnectingtheGCCcountriesisprimarily ofinteresttothecountriesthemselves,andindirectlyofglobalinterest;the establishmentofpipelineconnectionsbetweentheGCCandEuropeisof regionalinterests,butparalleldevelopmentshavebeendiscussedinthe direction of Eastern markets. Measures to encourage reduction of CO2 emissions are of global significance, althoughtheEUhasmaintainedakeenerinterestthanotherinternational actors.Finally the question of GCC membership in the ECT is primarily for the Energy Charter Secretariat to deal with, although the Union has a major voice. EU-GCC energy cooperation is therefore per force institutionally complex and cannot be conceived of in isolation from dialogue and cooperation in a broad arrayofinternationalinstitutionsandforums.Itshouldnotbeviewedas aimingattheestablishmentofpreferentialtieswhichwouldbeunrealistic andfinallyunnecessarybutatimprovingglobalconditionsinthe international exchange of oil and gas, to the benefit of all. 17/03/2005 EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 25 of 26 Robert Schuman Centre for Advanced Studies and the Mediterranean Programme TheRobertSchumanCentreforAdvancedStudiescarriesoutdisciplinaryand interdisciplinary research in the areas of European integration and public policy in Europe. It hosts the annual European Forum. Details of this and the other research of the centre can be found on: http://www.iue.it/RSCAS/Research/.ResearchpublicationstaketheformofWorkingPapers,PolicyPapers,Distinguished Lectures and books. Most of these are also available on the RSCAS website: http://www.iue.it/RSCAS/Publications/.The EUI and the RSCAS are not responsible for the opinion expressed by the author(s). TheMediterraneanProgrammewassetupattheRobertSchumanCentreforAdvanced Studies of the European University Institute in 1998. It focuses on the Mediterranean region. TheMediterraneanProgrammeengagesinresearchwiththetwinaimsof:a)generating intellectually excellent scholarly work; and b) contributing to the general policy debate relating to the flows of persons, goods and ideas between and within the Northern, Eastern, Southern and Western Mediterranean areas in its four core fields of interest: EUMediterranean/Middle East Relations, Political Regimes, State, Economy and Society in the Middle East and North African, International Migration, Energy Relations in the Mediterranean region. TheMediterraneanProgrammeanditsactivitieshavebeenfinancedby:Capitalia, CompagniadiSanPaolo,Enispa,EnteCassadiRisparmiodiFirenze,European Commission,EuropeanInvestmentBank,FondazioneMontedeiPaschidiSiena,and Regione Toscana. The AnnualMediterraneanSocialandPoliticalResearchMeetingbringstogether scholars from across the region. http://www.iue.it/RSCAS/Research/Mediterranean/Meetings.shtmlEnergy relations with the Mediterranean, Gulf and Central Asian countriesis a key area of expertise within the Mediterranean Programme. Current work covers: regulation of energy markets;issuesintheefficiencyandstabilityofglobalenergymarkets;anddevelopmentof gas exports and regional transportation networks. EUROGULF Project EUROGULF-AnEU-GCCDialogueforEnergyStabilityandSustainabilityisaproject supportedbytheEuropeanCommission,DGTREN,undertheSynergyProgramme.This projectisledbytheMediterraneanProgramme,inco-operationwiththeOxfordInstituteof EnergyStudies,theNationalTechnicalUniversityofAthensandECONERGYSalofBeirut. The project runs from May 2003 to April 2005. The first workshop took place in Riyadh on 5 and 6 April, 2004. The second workshop in Florence, in November 2004. The final conference willbeorganisedinKuwait1-2April2005.Anoutlineofthisprojectispostedonthe Programmes web site. EUROGULF-HCT Project EU-GCCCo-operationthroughthePromotionofHydrocarbonTechnologyTransfer ImprovingtheEUSecurityofSupplyisaprojectsponsoredbytheEuropeanCommission, DG TREN, under the programme Energy, Environment and Sustainable Development. It is ledbytheNationalTechnicalUniversityofAthensinco-operationwiththeMediterranean Programme and others. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Executive Summary and Policy PaperPage 26 of 26 MEDSUPPLY Project MEDSUPPLYDevelopmentbysouthernandeasternMediterraneancountriesofenergy sources for Europe was a project supported by the European Commission, DG TREN, under theSynergyProgramme,andoperatedbyaconsortiumconsistingoftheObservatoire MditerranendelEnergie(OME)ofNice,theMediterraneanProgrammeandSonatrach corporationofAlgeria.TheprojectwasconcludedinMay2003andallprojectreportsare availableonCDRomuponrequest.ApresentationtoDGTRENwasheldinBrusselson9 October 2003.Caspian Oil and Gas Scenarios TheProgrammejointlyorganisedwiththeInternationalEnergyAgency(IEA,Paris)a Conference on Caspian Oil & Gas Scenarios: After a decade of rising expectations, what will a factual analysis decide for the decade to come? which was held in Florence on 1415 April 2003.TheconferencepapersareavailableonthewebpagesoftheMediterranean Programme and the IEA. Insuring Against Disruptions of Energy Supply (INDES) Insuring against Disruptions of Energy Supply (INDES) was a project organised by CEPS in co-operationwiththeMediterraneanProgrammeandotherpartnerswithfundingfromthe Fifth Framework Programme. Materials from this project are available from the projects web site http://www.energymarkets.info/indes/index.html . Conferences on the Geopolitics of EnergyInconjunctionwiththeOxfordInstituteforEnergyStudies,theProgrammeorganiseda conferenceon Energy:InterdependenceorConflictAcrosstheMediterranean,whichtook placeonApril26and27,2001.ThekeynotespeechwasgivenbyMs.LoyoladePalacio (VicePresidentoftheEuropeanCommissionandCommissionerinchargeofEnergyand Transport). Since2002,theProgrammehasorganisedinFlorenceanAnnualConferenceonthe Geopolitics of Energy in association with the Aspen Institute Italia. xThe first conference (Emerging Challenges in the Field of Energy Policy for Europe, the USA and Russia) took place on July 9 & 10, 2002. Some of the materials were published in Aspenia as well as in Medenergie. xThe second conference (The Geopolitics of Energy: The Asian Shift) tool place on 89 July 2003; the complete materials were published in OGEL.xThe third conference took place on 8&9 July 2004; the complete materials are posted on the RSCAS website. Allconferenceswerecharacterisedbyhigh-levelparticipationfromacademia,international organisations(EuropeanCommission,InternationalEnergyAgency,OPEC)andenergy companies.For further information: Mediterranean Programme Robert Schuman Centre for Advanced Studies European University Institute Via delle Fontanelle, 19 50016 San Domenico di Fiesole (FI), Italy Fax: + 39 055 4685 770 E-mail: lotta.svantesson@iue.it http://www.iue.it/RSCAS/Research/Mediterranean/Index.shtml EUROGULF:An EU-GCC Dialogue for Energy Stability and Sustainability Subtask1.1:Prospects for Oil & Gas Exports from the GCC Member CountriesAuthor: Naji Abi-Aad (Econergy) Project Title:EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability Project Ref.:4.1041/D/02-008-S07 21089Client: The Commission of the European CommunitiesDocument Title:Economic and Political Conditions for Energy SecurityTask Ref.:1Version 02.03.2005 Final Conference in Kuwait, 2-3 April 2005 Most projections about oil and gas supplies over the next two decades concur that the role of OPEC,andspecificallyoftheGulfsuppliers,isboundtoincrease.However,considerable disparitiesarefoundinthedetails,concerningthespeedandextentatwhichincreasing suppliesfromtheregionwillbeneededorobserved.Thedifferencesdependinparton assumptionsaboutpricesandtheresponseofoilandgassuppliesfromotherregions, including notably supplies from Central Asia or West Africa; and/or about the development of nontraditionalsourcesofcrudeoil,suchastheOrinocoheavyoilsorCanadastarsands; and in part on differences of opinion concerning the potential for growing supplies from other importantproducers,suchasMexico,theRussianFederationorVenezuela(thelatterof course being an OPEC member). Our objective is to evaluate specifically the future role of the GCCcountries,whichrequiresinadditionadiscussionoftheprospectsofnon-GCCGulf countries, including Iran and Iraq. 2005 All rights reserved. No part of this paper may be distributed, quoted or reproduced in any form without permission by the author(s). EUROGULF:EUROGULF: An EU An EU- -GCC Dialogue for Energy Stability and Sustainability GCC Dialogue for Energy Stability and Sustainability EUROGULF:EUROGULF: An EU An EU- -GCC Dialogue for Energy Stability and Sustainability GCC Dialogue for Energy Stability and SustainabilityEUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 2 of 36Table of Contents1.The GCC on the World Oil Map3 2.Demand Outlook6 3.Supply Outlook8 3.1Russia9 3.2The Caspian12 3.3Africa13 3.4Non-GCC OPEC Countries14 3.4.1 Venezuela14 3.4.2 Iraq14 3.4.3 Iran16 3.4.4 Libya17 3.4.5 Algeria18 4.Different Forecasts Proposed for GCC Oil18 4.1The EIAs International Energy Outlook 2004 (IEO 2004)18 4.2The IEAs World Energy Outlook 200422 4.3The IEPE Scenarios (official forecasts adopted by the EC)24 5.The GCC Meeting the Call on its Oil: An Assessment27 6.Last Word: EU-GCC Oil Interlinks36 EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 3 of 361.The GCC on the World Oil Map Intheory,manykeyfactorsshouldbeaffectingtheprospectsofoilandgassupplyand exports from the member countries of the Gulf Cooperation Council (GCC), including proved reservesandundiscoveredresources,costsofsupply,oilprices,investment,government policy and industrial development.However, it is widely known that the supply policy of the other main oil producers, both within the Organization of Petroleum Exporting Countries (OPEC) or non-OPEC producers, and the strategies of the consuming countries are decisively impacting the role played by the GCC on the international oil market. ThehugereservebaseexistingintheGulfisawell-knownfeatureoftheglobalpetroleum industry. According to the latest issue of BP Statistical Review of World Energy, the six GCC countries(Bahrain,Kuwait,Oman,Qatar,SaudiArabia,andtheUnitedArabEmirates UAE)containhugequantitiesofprovedreservesofcrudeoilandnaturalgas,estimatedin early 2004 at around 478 billion barrels of crude oil and 41,920 billion cubic metres of natural gas, representing about 42 per cent and 24 per cent of the worlds total respectively. Oil & Gas Reserves & Resources in the GCC Country Crude Oil Proved Reserves, early 2004 (billionbarrels,(1)Crude Oil Undiscovered Resources, 2000 (mean*, billion barrels,(2)Natural Gas Proved Reserves, early 2004 (trillioncu m, (1)Natural Gas Undiscovered Resources, 2000 (mean*, trillion cu m, (2)Bahrain0.11.60.903.40 Kuwait96.54.01.560.17 Oman5.65.20.950.96 Qatar15.25.425.771.16 Saudi Arabia262.7136.06.6819.29 UAE97.810.16.061.26 Total 477.9162.341.9223.31 % of World41.617.323.815.9

*TheUSGSfiguresarerecordedaslow,mostlikely,andhighestimateswhichareintendedtoreflecta90-per cent range of probability (95 to 5 per cent) that the occurrence of petroleum will lie between the two stated values. The most likely occurrence is referred to as mode. If the consistency between the USGS assessors and average valuesproducesaconsensus,theestimatesarethenfittoalog-normaldistributiontocalculatethemeanand other fractiles.EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 4 of 36Sources: (1) BP Statistical Review of World Energy, June 2004 (2) USGS, World Petroleum Assessment, 2000 Whenlookingattheundiscoveredpetroleumresourcesintheregion,theUSGeological Survey(USGS)arguedin2000thattheGCChasanundiscoveredcrudepotentialofsome 162billionbarrels(mean1,around17percentoftheworldstotal).Theundiscovered resourcesofnaturalgasintheregionwereestimatedataround23.3trillioncubicmetres (mean), or about 16 per cent of the worlds total. Experience has shown that oil development and production in the GCC is a relatively cheap undertaking. But supply costs have fallen considerably almost everywhere else in the last two decades.Newsourcesofconventionaloilsupplyfromnon-OPECcountriesand unconventionaloilsuchasbitumenandsyntheticcrudehavebecomeincreasingly competitivewithOPECsuppliesonacostbasis.Furthermore,technologicalprogressis expected to reduce the cost of the gas-to-liquids (GTL) conversion technology, improving the economics of supplying liquid hydrocarbon fuels from gas. That could lead to the appearance ofanewspecialoilproducerintheGCC,namelyQatar,which isplanningtobetheGTL Capital of the World. ThelowestoilsupplycostsarethoseforconventionaloilproductioninSaudiArabia,being roughlyaquarterofthatinmanyotherareasoftheworld.Productioncostsinothermajor Gulf countries are similar to those in the Kingdom. Russian oil production costs are believe to bestillfarfromreachingthoseoftheGulf,althoughtheyhavedeclinedinrecentyears followingcostreductionsduetotheapplicationoftechnologyandmoreefficientworking practices, as well as the effect of the depreciation of the Russian Rouble. AlthoughtheinvestmentrequiredtoraiseoilproductioncapacityintheGCCismuchless thaninmanyother parts oftheworld, thedevelopmentofoilreservesinthe regionto meet growingglobaldemandwillneverthelessrequireconsiderableamountsofcapital.Official statementsindicatethatbetween$4,000and$5,000ofnewinvestmentisrequiredforeach daily barrel of new oil production capacity in the area.Inadditiontolowsupplycosts(withanaverageproductioncostoflessthan$2perbarrel), everyGCCmembercountryenjoysafreeaccesstothesea,withanextremelywell

1TheUSGSfiguresarerecordedaslow,mostlikely,andhighestimateswhichareintendedtoreflecta90-per cent range of probability (95 to 5 per cent) that the occurrence of petroleum will lie between the two stated values. The most likely occurrence is referred to as mode. If the consistency between the USGS assessors and average valuesproducesaconsensus,theestimatesarethenfittoalog-normaldistributiontocalculatethemeanand other fractiles.EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 5 of 36elaborated export pipeline infrastructure linking petroleum fields with marine export terminals and loading platforms.Incontrastwithallthosepositiveelements,theGCCshareofglobaloilproductionismuch lower (around 21 per cent in 2003) than their share in world total reserves. Oil reserves in the Gulfhavebeenunder-exploitedfordecades,whileoilreservesinNorthAmerica,Europe andRussiaarebeingover-exploited.Thisstateofaffairsshowsnosignofchanging, althoughthereislittledoubtthattheexistingreservebaseintheGulfwouldallowformuch higher production levels. However, basing an extrapolation of future Gulf production and exports onreserves, geology andproductionpotentialisfundamentallywrong.Basingthesameonproductiontrendsin recentyearsisequallybasicallyincorrect.Thatwasrecentlyshown,intheoccasionofthe recentwarinIraq,whenSaudiArabiaaloneincreaseditsproductionbycloseto2.5million b/dequaltothetotalproductionlevelthattheCaspianmightreachinthecomingyears, after 15 years of negotiations and billions of dollars of investment! Therefore,webelievethecommonandpracticalproceduretoderivefutureoilproductionin theGCCistocalculatethedifferencebetweenprojectedglobaldemandandprojected supplies from the rest of the world.EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 6 of 362.Demand Outlook AburningquestionconcernsthelotthatmaybefallonGCCoiliftheconsumptiontrends continue,leavingvastamountsofGulfresourcesstrugglingformarkets.Again,muchwill depend on future growth of world demand. According to OPEC and the International Energy Agencys(IEA)forecasts,basedonbusiness-as-usualannualgrowthrateof1.6percent, incrementalglobaloildemandbetween2003and2010willreacharound10millionb/d,an increase that would present no problem in comfortably absorbing Gulf oil.However,thesepredictedratesoffutureworlddemandgrowtharecontested.RoyalDutch-ShellandtheCentreforGlobalEnergyStudies(CGES)predictaslowerannualaverage growthof1.1percentinglobaldemandfromnowand2010,whichimpliesincremental demand of only 5.5 million b/d during that period. If the latter projections prove to be accurate, the future market for Gulf oil will be very small. Anyway, and according to almost all forecasts, the only region on which the Gulf can count is non-OECD Asia, such as China, India and South Korea. Oil demand from this region, prior to the1997-98Asianfinancialcrisis,wasgrowingatveryhighrates,reflectingthespeedy growth of these Asian Tigers economies. In some cases, for example China, the growth rate ofoilconsumptionhasexceeded10percentperyear,andin2002reached12.5percent. ThisexplainswhyoilimportsfromtheGulfintoSouthEastAsia(includingChina)were exponentially increasing, from 2 million b/d in 1973 to over 7 million b/d in 2002. However, the very high growth rates in Asian demand could prove to be unsustainable. Gulf oil-producing countries have held out high hopes for Asian markets for the future. This is especiallythecasevis--visChina,thereasonbeingtheveryhigheconomicgrowthrates achievedintheChineseeconomyforthepast10years,whichhavechangedthecountry from a net exporter of oil to a net importer. China's energy dependence on Gulf oil increased from zero in 1993 to about 4 per cent in 2002, although the volume of Chinese imports from the Gulf was less than 0.8 million b/d. The Gulf's high hopes for China are fuelled by the IEA's energy projections. In its 2004 World EnergyOutlook,theAgencyprojectedthatoildemandinChinawouldgrowatanaverage annual growth rate of 3.4 per cent from 5.2 million b/d in 2002 to 7.9 million b/d in 2010, and to13.3millionb/din2030.ConsequentlyChineseoilimportsshouldriseto6millionb/din 2010 and to over 11 million b/d in 2030. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 7 of 36However,futuredemandprojectionsareinvariablyerroneousbecausetheycannotpredict several developments that can change assumptions on the basis of which the forecasts have been made. Moreimportantly,theseforecastsarebasedontheassumptionthatthehighgrowthinthe Chineseeconomywitnessedinthepast10yearswillbesustained.Thisisfarfromcertain. ThereisanargumentsayingthatcertainseriousproblemsintheChineseeconomycould negatively affect growth. Economic growth in China suffers from many imbalances that could lead to serious problems, if not to an economic crash. Furthermore, the horrendous future cost (according to the above-mentioned IEA forecasts) of China'sfutureoilimportsbillwouldactasaconstraintonitseconomicgrowth,andwould conceivably impel the state to intervene to prevent oil imports rising to such high levels. It is usefultorememberherebythatChinadoesnotyethaveafullymarket-orientedeconomy. The state still holds the key to its economic growth. TheeconomicfutureoftheotherAsian"Tigers"remainsuncertain,thatofSouthKorea, Taiwanetc,dependstoalargeextentonexportstotheindustrializednations:themore prosperous the latter, the higher the demand for Asian exports - the engine of growth in Asia's economy. But in the event of economic recession in the industrialized countries, the growth of these economies may be arrested. AlthoughthebulkoftheincreaseindemandwillcomefromAsia(bothforoilandgas),a recent IEA report "flags as an issue the increasing dependence of the IEA member countries on the Middle East states": from 50 per cent in 1985, it is currently just under 60 per cent, and would reach 70 per cent (a return to the situation of 1970) during the decade 2010-2020, and 75percentby2020.Itmaybegintodecreaseafter2020,withtheexpectedriseinthe importance of oil from non-conventional sources. In the same context, and according to the EU Green Paper, by 2020, OPEC (and specially its Gulf members) will cover some 50 per cent of the Union's needs with a global production of the order of 55 million b/d (from around 32 million b/d in 2000). EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 8 of 363.Supply Outlook Itisnotonlyoildemandthatshapesthefutureof(abundantormeagre)oilsupplyfromthe GCC, but also - and perhaps more significantly - the future of oil supplies from sources other than the GCC such as Russia, the Caspian Sea and West Africa, and other non-GCC OPEC countries such as Iraq, Iran, Libya and Algeria. Thereisaconsensusintheoilindustrythat,overthenextfewyears,non-OPECoil production will continue to grow, while it is also clear that oil production in the USA, North Sea and several individual oil producing countries is stagnant or declining. As commonly seen in the past decades, growing oil output in non-OPEC countries would be eating from the market share of OPEC exporters, while increasing crude production from non-GCC OPEC producers would have similar impacts on the GCC countries. Overandabovethehugeinvestmentsandadditionalincrementalsuppliescomingfromthe main producing zones, one can add a further 1.5 million b/d of synthetic oil produced from tar sands in Alberta, Canada, as well as 0.7 million b/d of extra heavy oil from Venezuela. InfocusinginthepresentstudyontheEU,itisbelievedthattheGCCoilproducersface strongcompetitionontheEuropeanmarketsfromRussia,theCaspiansuppliersandIraq, and especially from Mediterranean riparian producers, notably Libya and Algeria. In fact, the rapiddevelopmentofNorthAfricanoil(andgas)resourcesfollowingtherecentpolitical dtente may alleviate the competitive weakness of Europe in securing adequate imported oil (and gas) supplies. Another problem facing Gulf oil is OPEC's pricing mechanism, set up to defend the oil price, whereby OPEC is the swing producer, or last-resort supplier. This effectively means that the higher the incremental oil supplies from Russia, or the Caspian Sea or West Africa, the lower theproductioninOPEC,correspondingly.Furthermore,thereareincreasesinproduction capacitiesinnon-GulfOPECmembers,suchasAlgeria,LibyaandNigeria,whichmake abiding by this quota most difficult, and the pressure falls on the Gulf, notably Saudi Arabia. One shouldalso notforgetthe USenergys strategy ofshiftingits oilimportsawayfromthe Gulf to other areas. A recent report by Vice-President Dick Cheney was clear in that direction, whileitisbelievedthattheUS-RussiancooperationplaysamajorroleinachievingthisUS (and Western) strategy of dispensing with Gulf Oil. It is now becoming clear that high oil price actually aids this American strategy, as well as directly contributes to the continual increase in EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 9 of 36non-Gulf oil supplies, but what seem vague are the impacts of the US control of Iraq on that strategy.However, there are inescapable facts: the largest oil reserves block by far is found in the GCC region,andthegeographicregionsthatthemajoroilcompanieswillbeabletoturntofor futureexplorationanddevelopmentarelimited.AfterdeepwaterareasintheGulfofMexico andWestAfricahavebeenfullydevelopedandmajorcompanieshaveinvestedheavilyin Canadian and Venezuelan heavy oil, the next horizon is the former Soviet Union (FSU) and, again, the Middle East and the Gulf.3.1Russia OneofthebigquestionmarksforthenextdecadesconcernstheFSU,particularlyRussia. Analysts have radically changed their views from the time when Soviet production and, later, Russianoutputwasdeclining.Theperceptionatthattimewasthattheregionwouldnever returntothepeakreachedinthemid-1980s.Todaytheperceptionisofamajorgrowthin both Russian and Caspian oil production for at least the next ten years, especially with many majorinternationaloilcompaniesracingtospendbillionsandbillionsindevelopingthe petroleum industries there. High prices created enormous windfall profits for the oil companies that could be invested in expansioninproductionandexportcapacitiesinthesehigh-costareas.Itisnocoincidence that the great jump in Russian oil exports since 2000 happened when high prices of oil started to appear on the market. Then,renewedhigherprices,exceedingtheOPEC$22-28/barrelband,hasencouraged radical growth in Russia's oil production, the higher prices serving to convince oil companies to invest part of their profits in high-cost oil and in increasingly higher capacity.Russian oil production consequently surged by 30 per cent over the period 2000-03, growing by2millionb/d,thehighestincreaseofanycountry overthatperiod.By2003,Russiahad overtakentheUS,tobecomethelargestnon-OPECoilproducerandthesecond-largest crude producer in the world. In the near future, Russia could well become the worlds largest producer. There have been incentives to expand production over this period, in particular due to the investment climate, together with a fiscal regime that applies a flat corporate tax rate.TheobservedincreasesinRussianoilproductioncontinuetocomeprimarilyfromWestern Siberia,withtheapplicationofnewtechnologieshavingimprovedoperatingefficiencies. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 10 of 36Further increases in production from this region are still expected, despite the over-production in Soviet times that has affected well-productivity.TherecentexceptionalgrowthinoilproductioninRussiamayalsobeunsustainable.In particular,plannedhighertaxationratesmaycurbgrowth,whileuncertaintyoverthe developments of international crude oil prices could have an important impact upon the likely scale of increase in output. There is also the possibility that investment activity will be affected bytheimpactuponthebusinessclimateofthetensionsbetweentheRussianoilcompany, Yukos, and the government. ManyanalystsareregardingtheYukoscrisisasaclassiccaseofRussianbrinksmanship, withboth sidesthreateningtheworstbutwithneitherreallyinterestedinpushingproduction offthecliff.Still,operationaldifficultiesrelatedtofrozenbankaccounts,tradefinancingand thelikearesettoretardgrowth,perhapseventoremovesignificantchunksofproduction. Output could also be curbed by Moscows efforts to increase its control over the oil industry. The Kremlins battle with Yukos could hit the companys production plans if it is taken over by a less efficient state-controlled firm. Furthermore,somearguethatproductiongainsoverthelastseveralyearshavebeen primarilytheresultofone-timeeffectsfromrestoringshut-inwellsandapplyingsimple enhancedrecoverymethods,ratherthanofnewfielddevelopmentsandsuccessful exploration.BP,forone,appearsconfidentthatitcansustaingrowththrough"brownfield" projects, augmented by some new developments. Inthemedium-to-longerterm,attentioncontinuestobefocusedupontheavailableexport infrastructure and how production levels might be affected by the need to replace projects in largefieldswiththoseinsmallerones.Inaddition,theshoringupofcapacityintheoil heartland of Western Siberia is less obvious. When looking at future Russian oil output potential, the reserves picture tells us that there is enough oil to enable a swift and sustained growth in production. But, how much do we really knowaboutprovedoilreserves,undiscoveredresourcesandfutureproductivecapacityin Russia and in the FSU in general? In fact, the industry does not know how much of the recent increased production comes from well repairs, because more than 10,000 wells were shut-in in the early days of the political and economic transformation. Many related questions remain withoutclearanswers:howmuchoftheincreasedoutputisprovidedbyproducingfields beyond their reasonable limits? How much of it is coming from infield drilling, new pockets in existing fields, or new provinces? Analysts making projections of the ever-rising production in RussiaandtheFSUfindthemselves,insomeways,in"never-neverland",becausetheir existing database is not adequate to make accurate projections. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 11 of 36Currentreservesareestimatedat60billionbarrelsandundiscoveredoilisalsolikelytobe substantial.Theresourcebasedoesnot,therefore,representausefulindicatorofhowoil output will grow. Longer-term problems in mature fields, where the water cut is as high as 80 per cent, is expected to read to substantial rates of decline that will need to be offset by new capacity.Long-termsustainableproductionwill,therefore,beaffectedbythebalance betweenavailableinvestmentandtheseratesofdecline,sothatanindefiniteincreasein production,althoughsupportablebytheresourcebase,isnotconsideredpossible.Itisthe speed at which this oil is developed and exported that is the central concern. TheRussiangovernment'sforecastofproductiongrowth,ascontainedinthe"Energy Strategyto2020"approvedinSeptember2003,isratherpessimistic,rangingbetween8.4 and 8.9 million b/d in 2005 and 8.9 and 9.8 million b/d by 2010. This contrasts with the more buoyantmoodreflectedbytheprojectionsofoilcompaniesthemselves,withaggregate expectationssuggestinganincreasetoover11millionb/dby2010,anoutputlevel considered by many as plateau for Russia. Of course, both these groups have their reasons foralternativeportrayalsoffuturepotential:privateoilcompanieshaveanincentivetopush upbothcurrentproduction,aswellastheoutlookforoutputlevels,withtheintentionof increasingthevaluationoftheirassetsforfuturepossibletakeovers.Governmentforecasts emphasisethelikelihoodofinsufficientinfrastructureconstrainingexports,whilealsotaking into account the potential bias in oil companies' declarations. It has even been suggested that the government may control longer-term production levels, in order to protect reservoirs from beingdamagedbyover-exploitation.Furthermore,theextenttowhichtheRussian government can and will be willing to exert control over private companies will have extremely importantimplicationsforlonger-termoilmarketfundamentals;possiblepolicyinstruments include licensing and the fiscal and legal upstream framework. Theexportinfrastructureisthenseenasakeypotentialconstrainttoexportexpansion,a similarsituationseenintheCaspian.Therecentsurgeinexportshasbeenmainlymade possiblebyanincreaseduseofrailtransportation,largelytoportsorrefineries.Theexport capacityprojectsthatareunderconsideration,intermsofboththeirproposedvolumeand likelytiming,suggestthatmedium-termexportinfrastructureexpansionisconsistentwitha rapid expansion of production, although not at such high rates as observed in the recent past.The CGES estimates that Russia's total oil production could reach 12 million b/d by 2010, i.e. anincrementof3millionb/dfrom2004,andindicatethatby2006,thecontinuousrisein Russianoilexports(bothcrudeandproducts)mayexceed7millionb/d.Ifhighprices continue, Russia's oil capacity by could reach 13.3 million b/d by 2015. Russia by this stage wouldbecometheworld'slargestoilexporter,(exceedingevenSaudiArabia'sexport volume). EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 12 of 363.2The Caspian Petroleum production growth in the Caspian continues to be strong, but not as expected with rivalries between the US and Russia overshadow efforts by the Caucasus States to develop exportcapacityfortheiroilandgasgrowingsupplies.Politicalmeddlingandattemptsfrom outside to control the economies of the region explain the numerous development delays. However, political changes usher in a new era. The accessions in 2004 as president of Ilham AlievinAzerbaijanandMikhailSaakashviliinGeorgiahavemarkedthebeginningofanew round of leadership in the region. Thus far both Saakashvili and Aliev have carefully cultivated theirrelationshipswithRussia,whilecontinuingtheirsupportforUS-supportedoilandgas pipeline projects in the Caucasus. Future available infrastructure remains the key constraint to the expansion of exports from the Caspian.TheCaspianPipelineConsortium(CPC)projectrepresentsthemostrecentmajor development for increasing exports from the region. Plans to expand the capacity of the CPC pipelineexist,whichcouldseeexportsfromKazakhstanthroughthisrouterisetoover1.3 millionb/dby2015.Otherambitiousplansexisttodevelopnewinfrastructure,suchasa Trans-CaspianpipelineandapipelinetoWesternChina.Legalhurdlescouldcontinueto hinderprogresswithanylinealonethebedoftheCaspian,duetotheunresolvedstatusof ownership, while the profitability of the China project is questionable.Other large projects are also under consideration in countries of the region, such as exports through to the Gulf and Mediterranean coasts. The Baku-Tbilisi-Ceyhan (BTC) pipeline is the key current project for expanding exports from Azerbaijan to international markets. By 2010, Azerbaijan expects to send over 1 million b/d to the Mediterranean via this pipeline. TheBTCpipelinereceivedaboostinearly2004withthesigningofa$2.6-billionloan package. But, in July 2004, the US efforts to secure export routes for Caspian oil suffered a doubleblow.TheGeorgiangovernmentorderedatemporaryhaltintheconstructionofthe BTC pipeline, and the Ukrainian government decided to open the Odessa-Brody pipeline for shipments of Russian oil, instead of pumping European-bound oil from the Caspian. NewexportroutesaresignificantforCentralAsianplayersaswell,particularlyKazakhstan. With agreement on the Kashagan project recently reached in March 2004, the way is cleared foraconsiderableproductionincreasefromtheNorthCaspian.TotalKazakhoilproduction could exceed 1.8 million b/d by 2010 and 2.2 million b/d in 2020, more than doubling the 2003 EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 13 of 36productionofjustover1millionb/d.Toaccommodateincreasedexports,Kazakhstanhas indicated serious interest in participation in the BTC pipeline. The plans for the 20-million ton/year (400,000 b/d) Kazakhstan-to-China oil pipeline are also moving ahead, and Kazakhstan's Prime Minister Daniyal Akhmetov announced in early March 2004thatconstructiononthesecondphaseofthe2,500-kmpipelineistobeginduringthat year.CooperationbetweenChinaandKazakhstanoiltransportationhasacceleratedsince Russia's interest in an oil pipeline to China was put on the back burner in early 2004. Iranisalsopositioningitselfasa key export routefortheincreasedvolumes ofCaspian oil. Currentlyapproximately20,000b/dofKazakhcrudeisbeingexportedviaIran,and30,000 b/d of Turkmen crude is being exported through Iranian swaps at the port of Neka. Plans for eventualconstructionofapipelinefromKazakhstanthroughIrantotheGulfarestillonthe drawing board, and as Kashagan production picks up, these plans are likely to be revisited. Turkmenistan's oil production increased to 9 million tons in 2003, a 9-per cent increase over 2002production.Butthislevelwasstillbelowthegovernment's2003targetof13.5million tons, which called for a 50-per cent increase over 2002 levels. For 2004, Turkmenistan again had plans anambitiousincrease:thetargetwasto produce15 milliontons, upmore50 per centfromtheresultachievedin2003.Amorelikelyresultis10.5milliontonsin2004and 10.8 million tons in 2005. In Uzbekistan the government is now worried about the current declining trend (oil output has declined since 1999 when it peaked at 8.1 million tons), after experiencing a sizable increase inoutputduringthe1990sthatenabledthecountrytobecomeself-sufficient.Oilproduction (includingcondensate)declinedslightlyin2003toapproximately7milliontons,heightening this concern.With all that in mind, production from the Caspian region is expected to increase by more than 1 million b/d in the period 2002-10 and by another 1 million b/d in the next decade, rising to 4.5 million b/d by 2025. 3.3Africa WestAfrica,andespeciallyitsoffshoreareas,whicharebelievedtobeveryprospective petroleumregions,hasbecomeamajoroil-producingprovince,wheremostofthe international oil companies are being actively working in development and production projects. EUROGULF: An EU-GCC Dialogue for Energy Stability and Sustainability 1.1 Prospects for Oil & Gas Exports from the GCC Member CountriesPage 14 of 36Increases in output from this region will be coming primarily from Angola, which is expected to be the key country in Africa from which increases in oil production can be predicted over the medium term, followed by Chad, Congo and Equatorial Guinea. Angola'sstate-ownedoilcompany,Sonangol,announcedinMay2003thatoiloutputcould increase to 1.6 million b/d by 2005, up from around 0.9 million b/d, due largely to the expected expansionofdeepwaterproduction.Deepwaterprojectsthatwererecentlytobetendered couldpush outputupevenfurtherinthemediumterm,with someanalysts believingthatas muchas2.5millionb/dcouldbeproducedby2010.Onshorefieldsalsoofferexcellent opportunities for expansion.Inotherdevelopments,thecompletionin2003oftheChad-Cameroonpipelinewillleadto land-lockedChadbecomingthelatestoilexporterintheregion.Asustainableproduction peak of over 0.2 million b/d is expected to be achieved in the ne