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The Geopolitics of Energy
Presentation by
Fareed Mohamedi
Chief Economist, PFC Energy
to
Energy and Nanotechnology Conference
Houston, Texas
May 3, 2003
Strategic Advisors in Global Energy
| Page 2
The Geopolitics of Energy
Introduction Focus on oil and gas The OPEC system, supply management
and prices Implications of the US invasion of Iraq Longer term issues related to the
development of adequate oil supplies Meeting US gas demand
| Page 3
Unprecedented OPEC cohesion
OPEC forged a deal in 1999 that has withstood a number of challenges
Turkey
Saudi Arabia
Iran
Egypt
Israel
Iraq
Syria
The deal was underpinned by the following developments: The election of Chavez The problems of the Iraq Oil for Food program The creation of the Riyadh Entente in the mid-1990s
It provided a means for S. Arabia and Iran to work together It helped coordinate regional policies vis-à-vis Iraq It helped coordinate OPEC price and market share strategies Saudi ruling family used it to show its own public plus the rest
of the ME that its foreign policy was rooted in the region
| Page 4
C.P Abdallah’s Survival Strategy Key For Riyadh Entente
Domestic Politics
•Restore social balance
•Curb subsidies
•Rule by committee
Economic Policy
•Entrepreneurial economy
•State balances books
•FDI for industry
Foreign Affairs
•American ally
•Strong regional bonds
•Coordination w. Iran
Low Priority
High Priority
| Page 5
$20.00
$22.50
$25.00
$27.50
$30.00
$32.50
$35.00
$37.50
J F M A M J J A S O N D
$20.59
$14.44
$19.25
$30.29
$25.95 $26.12 $26.62
$10
$15
$20
$25
$30
$35
1997 1998 1999 2000 2001 2002 2003
2003 Prices Strong, But Fall As Year Progresses
Annual WTI Prices
2003 WTI Prices
$/b
$/b
Prices will be relatively high for 2003 thanks to high 1Q prices in the run-up to war in Iraq.
The average 2003 price will be about equal to those seen in the past two years.
Despite the loss of the war premium, fundamentals remain tight enough to keep current prices in the upper-$20s.
However, as inventories rise, prices will be pressured downwards.
| Page 6
Last 6 Months: Three Supply Shocks
-2,500
-2,000
-1,500
-1,000
-500
0
D-02 J-03 F-03 M-03 A-03
Iraq
Venezuela
Nigeria
Recent Lost Production Due To Supply Shocks
kb/d
The market was hit by a triple whammy of supply shocks in the past few months:
First from the unexpected Venezuela strike Then the predictable but still very significant outbreak of war in Iraq And finally by losses due to civil strife in Nigeria just as refinery demand for
the country’s gasoline-rich grades was stepping up
| Page 7
Last 6 Months: OPEC Managed The Challenges
OPEC has managed by increasing production from its other members
Production outside Venezuela and Iraq increased 1.7 million b/d between November and March, Saudi Arabia accounting for 1.0 million b/d
Despite much tighter fundamentals than during the last Gulf War, daily WTI prices this time peaked at only $37.83, compared to $40.42 in 1990
Saudis also communicated effectively: markets were reassured additional supplies were on the way, OECD members did not release strategic inventories
21
22
23
24
25
26
27
28
O-02 N-02 D-02 J-03 F-03 M-03 A-03
VenezuelaIraqOPEC-9
mmb/d
OPEC Crude Production Saudi Crude Production
7,750
8,000
8,250
8,500
8,750
9,000
O-02 N-02 D-02 J-03 F-03 M-03 A-03kb/d
| Page 8
0
250
500
750
1,000
1,250
4Q02 1Q03 2Q03 3Q03 4Q03
46.0
46.5
47.0
47.5
48.0
CanadaKazakhstanRussiaBrazilNon-OPEC Liquids Supply (rt axis)
Non-OPEC Supply Keeps Growing…
Absolute and Year-on-Year changes in Non-OPEC Crude Supply
kb/d mmb/d
Every quarter of 2003 except 2Q will see rising Non-OPEC Liquids supply, with strongest growth in 4Q
On a year-on-year basis, Russia will continue to lead the growth at 500,000 b/d
2003 Non-OPEC Liquids supply to rise 1.6 million b/d, filling much of the 2.7 million b/d rise in global crude demand
| Page 9
OPEC-10 Avoids Crisis in 2003…
23
24
25
26
Jan Mar May Jul Sep Nov
-2
-1
0
1
2OPEC-10 Crude SupplyProjected Inventory Changes
OPEC-10 Crude Supply and Projected Inventory Change
mmb/d
Need for inventory replenishment will allow OPEC-10 to produce 800,000 b/d more crude than 2002, but this is weighted to the first half of 2003
Increasing Non-OPEC supply and slower demand growth point to reduced demand for OPEC crude from now on
Only low inventories and Iraq outage give OPEC-10 a temporary reprieve
202122232425262728
J F M A M J J A S O N D
OPEC-9 VenezuelaIraq Quota
2003 OPEC production and Quotas
| Page 10
The oil companies are not behind this warWho are the oil companies?What have they become?
The US oil companies would rather have sanctions removed from all major producer countries
The non-US oil companies used the constraints on US companies to make inroads into the Middle East
The current Administration has not fulfilled the few promises it made to the oil patch
Drilling offshore FloridaRemoving the subsidies for ethanolRevoking ILSAAlaska is not seen as a real oil play
Was The Invasion of Iraq An Oil War?
| Page 11
ECONOMICSPHERE
DIPLOMATICSPHERE
MILITARY SPHERE
Counter Proliferation
First Strike
Anti-terrorism
AmericanInternationalism
Lead, Others Will Follow
End Treaties, Non Binding
Fix It yourself
IMF: SystemicWB: Poverty
Energy SecurityDiversity
George W. Bush’s New World Order
United States: Sole Superpower
Military Superiority – Space and Technology
High Importance Low Importance
| Page 12
Oil Key to New Iraq
The administration of the Iraqi oil industry will be a challenge, particularly in the first year or two, and the prospects of a short-term jump in production are effectively nil.
The challenges will be:
1. To minimize short-term production losses while maintaining a reasonably safe operating environment
2. Create an environment (political, administrative, legal) that will allow a very rapid conclusion of negotiations for investment in new capacity
Only then is substantial growth in production is possible. In the best case, real growth (from 2001-2002 peak capacity) will not happen before 2005.
| Page 13
0
500
1,000
1,500
2,000
2,500
3,000
F-03
M-03
A-03
M-03
J-03
J-03
A-03
S-03
PFC Energy Projected Iraqi Production Return
kb/d
0
1,000
2,000
3,000
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03kb/d
Iraqi Production On A Declining Trend
Technical issues:– Relatively little damage to fields and infrastructure– Halliburton statement about getting up to “regional standards” (which are
quite high) is an uncertainty– Fields are on a declining trend even when they do come back
Political issues:– Need to get revenue flowing means that the US will want quick resumption– But lack of government recognized by UN and existing sanctions/OFF regime
mean US has to win battle at UN before exports can resume
How and When Exports Will Resume?
| Page 14
UN recognizedgovernment
Resumedoil
exports
Oilnegotiations
Oildeals
IMF program
Paris club
London club
Donorsmeeting
Reparationsmeeting
US-UN Relations
Despite Washington’s reluctance to deal with the UN, the international organization’s role is crucial for the economic rehabilitation of Iraq
| Page 15
Battle Over UN Role
A battle is taking place in the UN Security Council over who has authority in post-war Iraq
This battle will delay UN recognition of the new occupation government in Iraq, and will be crucial for oil sector and financial sector decisions moving forward
USauthority
US/unauthority
UN/usauthority
US occupation
Preferred US route —marginal UN role
Preferred French route — limited UN role
Resumed Oil-for-Food
program
Complete UNweapons
inspections
New resolutionlifting
sanctions
Preferred Russian route —central UN role
Suspended Sanctions
Resumed Oil-for-Food
program
Gradual OFF phase-out
New resolutionlifting
sanctions
| Page 16
Crude Production Growth Potential In Iraq Assuming Rapid Negotiation of Investment Terms and Internal Stability
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
200
1
200
2
200
3
200
4
200
5
2006
200
7
200
8
200
9
2010
Oil
Fie
ld P
rod
uct
ion
Cap
aci
ty (
mb
op
d)
P90 Upsteam Capacity
Mean (P50) Upstream CapacityP10 Upstream Capacity
P90 Upstream Capacity (status quo)Mean Upstream Capacity (status quo)
P10 Upstream Capacity (status quo)
Best Case Scenarios
This model assumes that there will be no commercial or logistical constraints on companies. In other words, within 12 to 18 months contracts would be signed and companies would find the necessary equipment to ramp up operations in an aggressive manner
| Page 17
Back To Market: In 2004 Moment of Truth
202122232425262728
J F M A M J J A S O N D
OPEC-9 VenezuelaIraq Quota
2003 OPEC production and Quotas
mmb/d
1. Declining market share for the group—Non-OPEC plus Iraq will outpace demand growth
2. Seasonal demand decline in half of 2004 will force OPEC to implement a very large production cut from already low levels
3. Uneven increase in capacity among OPEC-10 has initiated a debate about quota redistribution that will heat up when more cuts need to be made
4. Saudi Arabia’s unique position as swing producer will leave it with the difficult choice of enduring an untenable price and low production, or crashing the price.
| Page 18
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
02 03 04 05 06 07 08 09 10
Limited Margin of Maneuver for OPEC
In an $18+ price environment, Non-OPEC and Iraqi supply will capture all of the incremental demand, at least until 2006. This leaves very little margin for OPEC-10 to increase production in the next four years.
Non-OPEC Supply and Demand Growth:New OPEC-10 Supply Not Needed
million b/d
Non-OPEC Supply Growth
Iraq Supply Growth
Global Demand Growth
| Page 19
18.0
20.0
22.0
24.0
26.0
28.0
30.0
32.0
34.0
36.0
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
OPEC Quota and OPEC Capacity
The opening up of the upstream sector in a number of OPEC countries has started a trend of rising capacity. Some of these increases might not go through (Kuwait, Saudi Arabia, Iran), but others are already underway. This rising excess capacity, with the potential return of Iraq, will destabilize OPEC from the inside.
OPEC-10 Quota Potential and Capacity Expansion at Odds
million b/d
OPEC-10 quota
OPEC-10 Production
OPEC-10 Capacity
| Page 20
0
2,500
5,000
7,500
10,000
12,500
Sa
ud
iA
rab
ia
Ira
n
Ve
ne
zue
la
UA
E
Nig
eri
a
Ku
wa
it
Lib
ya
Ind
on
es
ia
Alg
eri
a
Qa
tar
Ira
q
0%
10%
20%
30%
40%
50%Current Quota
2004 Capacity
Percent of 2004 Capacity Idledif Current Quota Kept (rt axis)
Quota Reallocations Out of the Closet
As long as demand for OPEC-10 crude has stayed high, rising production capacity in Algeria, Nigeria and Libya has not been an issue. However, as OPEC is forced to cut production, increasingly large and untenable percentages of member countries’ capacity would have to be shut in to maintain quotas. By 1H 2004, there will be no way to avoid the quota allocation issue any longer.
Current OPEC Quotas and 2004 Estimated Capacity
kb/d
| Page 21
$20.00
$22.50
$25.00
$27.50
$30.00
$32.50
$35.00
$37.50
J F M A M J J A S O N D
$20.59
$14.44
$19.25
$30.29
$25.95 $26.12 $26.62
$10
$15
$20
$25
$30
$35
1997 1998 1999 2000 2001 2002 2003
2003 Prices Strong, But Fall As Year Progresses
Annual WTI Prices
2003 WTI Prices
$/b
$/b
Prices will be relatively high for 2003 thanks to high 1Q prices in the run-up to war in Iraq.
The average 2003 price will be about equal to those seen in the past two years.
Despite the loss of the war premium, fundamentals remain tight enough to keep current prices in the upper-$20s.
However, as inventories rise, prices will be pressured downwards.
| Page 22
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
35
86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5
Debt Flows
Asset Flows
Billion US$
Current Account Balance
Can Saudi Arabia Take Lower Prices?
The Capital Account of the Balance of Payments
| Page 23
0
50
100
150
200
250
86 87 88 89 90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5
ExternalAssets
External and Domestic Liabilities
Billion US$
Saudi Arabia: Assets and Liabilities
Can Saudi Arabia Take Lower Prices?
| Page 24
-12
-10
-8
-6
-4
-2
0
2
4
6
8
10
12
14
Current Account Balance
Debt Flows
Asset FlowsBillion US$
Iran: Capital Account
Can Iran Take Lower Prices?
| Page 25
0
5
10
15
20
25
30
35ExternalAssetsExternal
Liabilities
Billion US$Iran: External Assets and Liabilities
Can Iran Take Lower Prices?
| Page 26
The Other Wild Card: The Neo-Con Agenda
Has the neo-con agenda peaked, or will new phases unfold over the next few years?
Create a Pax Americana in the Middle East Win the peace in Iraq
Succeed in creating a viable democracy
Convince the Middle East to abandon Palestinian state
Answering the North Korean challenge in Asia Containment or regime change?
Induce China to cooperate and accept US agenda in the region
Downgrading the UN and Bretton Woods institutions Contain the French and Russian challenge
Institutionalize American Internationalism
| Page 27
The Neo-Con Agenda in The Middle East
The Neo-Conservative agenda sees regime change in Iraq as the first step towards fundamentally altering regional dynamics: Consolidate US and Israeli interests in the region Create appropriate conditions in the Levant for quick solution to Israeli-
Palestinian conflict on Sharon’s terms Force change in neighboring states and the Gulf
Israel
Iraq
Turkey
PNA
Pax Americana Short Term
Secular reformist take over in Iran
Isolated, politically neutralized and forced
to reform
Authoritarian leader/popular
revolution in Syria; peace deal
Leadership reform and peace deal
Political isolation and threats
IraqPNA
Syria
Lebanon Weakening Syrian power PNA
Saudi Arabia
Iran
Egypt
Medium term
| Page 28
How Will Saudi Arabia Respond?
It will largely depend on the US success in Iraq:
Successful US, with pro-US regime in Baghdad
US unsuccessful, with Shi’a regime emerging
US unsuccessful, with Shi’a-
Sunni Nationalist regime
Washington may use it to dislodge the Al-Sauds
The Saudi public could see the New Iraq as a model
Iran could emerge as a major influence over Iraq weakening the rationale for its alliance with Saudi Arabia
The US would be opposed to an Iranian backed Iraqi govt. and use the Saudis to offset this growing power
For Iran an insular, domestically preoccupied Iraq could pose less of a threat and a model
The Al-Sauds could see this as an opportunity to have some influence
Riyadh Entente will remain useful for the Saudis
The OPEC strategy will be maintained = higher prices
Saudis will use the oil price as a weapon against a strong Iran/Iraq bloc in OPEC and the region
Riyadh Entente will be reinforced to oppose US
Could the OPEC strategy be maintained?
| Page 29
Note 1: 2002 reserves and production for all companies are PFC estimates. 2002 production is based on 1H2002 data. Reserve Estimates are primarily based on a 110% reserve replacement rate. Data for BHP, CNOOC, PDVSA, Pemex, Yukos, and MOL represents 2001 data. * Data for Petronas and Lukoil pertains to 2000. Data for TNK
pertains to 1999. Rosneft’s reserves estimates are for 2000 and are obtained from IEA’s Russia report. Note 2: PDVSA (1,340; 102,499), Rosneft (152; 27,915) and Pemex (1,574; 51,655) excluded for scaling reasons.
Changing CompetitionReserves vs. Production: 2002
Global Competitors
Regional Majors
Focus Players
What is Happening in the Oil Industry?
0
5000
10000
15000
20000
25000
0 600 1200 1800
Production (mmboe)
Res
erve
s (m
mbo
e)
ConocoPhillips
Oxy
Shell
ChevronTexaco
BP
TFE
ENI
ExxonMobil
Repsol YPF
BG Marathon
Statoil
Petronas*
Lukoil*
Petrobras
Yukos
CNOOC
PDVSA (1,340; 102,499)Pemex (1,574; 51,655)Rosneft (152; 27,915)
Anadarko
EnCana
BHP
Hydro
MOL
TNK
| Page 30
Replacing Core Areas
Many core areas in maturity phase
– Business going to Non-OECD basins
– Strategy depends on region (e.g., Petrobras, Repsol YPF, and PDVSA in Latin America and Petronas in Asia-Pacific)
Selected “oil cores” transiting to gas
With the exception of deepwater plays, major companies are not creating new core areas through exploration, but through production deals
Production deals create new challenges -- new risks
Core “transitions” from oil risk to gas risk -- e.g. technical to commercial
| Page 31
Global Competitors Must Replace Maturing Legacy Assets
Replacement of earnings from historical assets
Growing earnings in areas where Regional Majors & Governments control
0%
20%
40%
60%
80%
$0 $2,000 $4,000 $6,000 $8,000
ExxonMobilBP
Shell
ChevronTexaco
TotalFinaElf
2000-2002 Average Upstream Net Income From North America & Europe
% N
ort
h A
me
ric
a &
Eu
rop
e o
f W
orl
dw
ide
To
tal
% of Upstream Net Income from N. America and Europe
Reported and PFC estimates.
| Page 32
Reserves held by Russian companies
Full IOC accessreserves
Access to Oil & Gas Reserves Constrained
NOC Reserves (no equity access)
NOC reserves(equity access)
Source: PFC Upstream Competition Service & BP; reserve figures are conventional billion boe, 2001
140 / 7%113 / 6%
324 / 17%
1,354 / 70%
| Page 33
Industry Shift
Divestiture in mature areas
Majors withdrawing from non-strategic areas
Independents moving in and aggregating positions
New independents likely to be created to capture opportunities unattractive to large independents
| Page 34
National Oil Companies
NOCs growing importance in the industry
– Generally more commercial and some privatizing
But NOCs can be threat to state especially if political leadership is from different background from NOC managers
Distrust of IOCs falling – even among populist or leftist governments
– States looking for production deals to attract capital and technology
What States want is evolving so IOC access issue is a very dynamic and at times confusing one for IOCs
| Page 35
EntrepreneurialCapitalist
SocialDemocraticCapitalist
AuthoritarianGlobalizer
PopulistDevelopment
RentierState
EntrepreneurialBureaucracy
StatistBureaucracy
PublicEntrepreneurs
Privatized &Competitive
Façade/NoInstitution
Excluded
TraditionalMonopoly
Oligopoly
LimitedOpening
OpenCompetition
Government NOC IOC Role
DrivingForces
Incr
ease
d O
pp
ort
un
itie
s
State Types and Implications For NOCs/IOCs
| Page 36
The Global Portfolio & Risk
Source: PFC’s Petroleum Risk Manager
Based on 26 Risk Factors at end-2002DA B C
Size = Reserves
| Page 37
US Nat. Gas Supply: A Pressing Issue
Energy security also means natural gas supply security
– Defined as reliable supply at a reasonable cost
Demand encouraged, but supply shrinking
– Washington encouraged the growing consumption of gas but has actively discouraged production
– In 2002, gas supply has declined by 5.6% in continental US, forcing the suppression of industrial demand
– In the next few months, up to 4 bcf of industrial demand need to be suppressed to allow storage to refill for next winter
– Industries and jobs lost in the US
| Page 38
US Nat. Gas Supply: A Political Question?
Continental supply is extremely difficult to grow quickly -- no matter how high the price:
– Basin exhaustion a fact of life in a mature asset base
– Accelerating decline rates creating treadmill effect
– Regulatory hurdles for areas now open to exploration
– Access to federal land practically closed
– Offshore Florida, California and East Coast closed
– LNG: siting issues, so little help in the foreseeable future
– Alaskan/MacKenzie Delta pipelines: Right Answer, wrong decade
| Page 39
US Has No Surplus Gas Supply
Excess Pipeline Gas Supply Capability in the US(I.e., as a Share of US Gas Consumption, annualized)
Sources: *PFC estimates. Includes Canadian imports, **EIA.
-5%
0%
5%
10%
15%
20%
25%
30%
35%
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
| Page 40
Canadian Pipeline Imports Nearly Tapped; New LNG Supply of Increasing Importance
LNG Imports
0
1
2
3
4
5
6
7
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
20
10
bc
fd
Additional Spot or New LNGPotential
LNG Imports from Atlantic BasinProjects
Capacity of Existing Terminals(Including Expansions)
Canadian Imports
4
5
6
7
8
9
10
11
12
13
14
Oct
-93
Oct
-95
Oct
-97
Oct
-99
Oct
-01
Oct
-03
Oct
-05
Oct
-07
Oct
-09
bc
fd
Imports from Canada
Current Pipeline Capacity
| Page 41
Abnormally Large Gas Storage Draws Lead to Increased Price Volatility
Working Gas in Storage
500
1,000
1,500
2,000
2,500
3,000
3,500
Apr-02
May-02
Jun-02
Jul-02
Aug-02
Sep-02
Oct-02
Nov-02
Dec-02
Jan-03
Feb-03
Mar-03
BC
F
5-Yr Max/Min Current Year Historical Avg.
| Page 42
U.S. Gas Prices(Henry Hub)
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
Oct
-93
Jun
-94
Fe
b-9
5
Oct
-95
Jun
-96
Fe
b-9
7
Oct
-97
Jun
-98
Fe
b-9
9
Oct
-99
Jun
-00
Fe
b-0
1
Oct
-01
Jun
-02
Fe
b-0
3
$/m
mb
tu
$9.13
Market Tightness is Driving up U.S. Gas Prices -- Floor Price is Rising
$8.72
Strategic Advisors in Global Energy
Corporate Offices
1300 Connecticut Avenue, N.W. Suite 800Washington, DC 20036 USATel: 1-202-872-1199 Fax: 1-202-872-1219
3, Cité Paradis75010 Paris, FranceTel : (33.1) 4770-2900 Fax : (33.1) 4770-2737
Houston, TexasTel : 1-281-599-7099 Fax: 1-281-599-9891
[email protected] www.pfcenergy.com