Home > Energy Market Articles, Geopolitics in energy prices > Energy Security – at a price

Energy Security – at a price

Introduction:

Among the major factors that affect energy use are depleting resources, technological innovation, weather and geopolitical risk. Unlike technology and energy reserves which are long term factors, geopolitical risk adds to the immediate volatility of energy prices. Weather as a factor of nature cannot be controlled. On the other hand, geopolitical risks can impact both market supply and demand on a short and long term basis and directly impact energy security.

Geopolitical Risks:

How it started:

Energy security is normally perceived as geopolitical risks that disrupt supply including attacks on oil and gas infrastructure like oil and gas wells, pipelines, shipping routes and refineries. A defining moment in energy security stems from the oil embargo in 1973, when Arab countries retaliated against the USA which had supported Israel in the Yom Kippur War.  The embargo lasted till Mar 1974, after which the USA enacted the strategic petroleum reserve. The SPR stores crude and products reserves which are to be used only in times of emergency.  To this date, the SPR stores more than 700 million bbls of oil or about 34 days of use.  See link.

Since then, various geopolitical events have occurred that disrupted energy supplies. Some major events include the Iranian revolution in 1979, Iraq-Kuwait war in 1991 and Sep 11. Energy security is a particular concern as the major oil producing countries are in the Middle East, a politically unstable place.

Today’s issues:

Today, the Iranian nuclear standoff has potentially the greatest disruption on oil supplies. Iran borders the Straits of Hormuz, a narrow strait between it and the UAE. Between 15 to 16.5 million barrels of oil pass through the Straits daily, which is about 20% of the world’s consumption. Other choking points that are major channels for the transportation of crude oil are the Suez channel, the Straits of Malacca and others. See the world choke points.

Supply disruptions come not only from sovereign wars but also terrorism and militant attacks. During the period 2006-2008, militant attacks in Nigerian oil producing delta kept offline the production of almost 1.3 million barrels of oil. This happens at a time when the world surplus crude capacity was thin at about 1.5 million barrels.

Gas affected too:

Aside from crude oil, natural gas is also affected by geopolitical concerns. In 2007 and 2008, Russia twice cut off the gas supplies to Ukraine on price disputes. Ukraine is a transit point for the gas pipelines to the major consuming nations of Western Europe. Western Europe suffered from shortages for almost a week, during which alternative fuel oil was used in power stations.

However, geopolitical risks have less of an impact on natural gas than crude oil. A major reason is that the major producers of natural gas are Qatar, Russia, Algeria and Indonesia, and the natural gas trade is not as globalised as crude oil due to higher transportation costs. The countries mentioned also have relatively lower geopolitical risks.

Demand impact:

Geopolitical risks can also affect demand, and a consequent decrease in prices. This was evident in the September 11 incident. The initial reaction was a spike in oil prices as it was suspected that the act was linked to the main Saudi oil supplier. When that turned out to be untrue, demand fell in the later months on lower economic activity and reduced air travel. Air travel worldwide used an estimated 4-5 million barrels a day.

Offsetting Security Measures:

The SPR reserves by the USA was a response to enhance energy security. Since then, the OECD countries in Europe, Japan and South Korea have started their own reserves. In 2003, China also launched its own storage reserve programme with an initial capacity of 210 million barrels, with eventual capacity reaching up to 90 days of forward demand or 270 million barrels. These purchases put a floor on crude oil prices in early 2009, as China and others buy up crude oil to fill up the storage tanks when prices fall too low.

New transportation routes:

New pipelines for oil and gas have also been planned and constructed to diversify and complement energy transportation routes. These pipelines have surfaced especially in Central Asia across the Caspian and the Black Sea, bring natural gas and crude oil from Kazakstan and Azerbaijan to the Turkish ports, and bypassing the transit pipelines normally used for Russian gas and oilfields. China too has constructed pipelines to divert crude and gas from the Western Siberian fields to its main consuming coastal regions.

Alternative sources of fuel:

Alternative sources of fuel are another solution for energy security. These can include the oil sands, coal, renewable energies like solar, wind and tidal, nuclear fuel and bio-fuels. These alternative fuels all have their own limitations. For example, the oil shale deposits in the USA and Canadian Rockies potentially hold about 1.5-2,5 trillion barrels, even larger than 250 billions of oil in Saudi Arabia. However the cost of extraction is enormous – about $70 to $100 per barrel, and oil prices have to be sustained above this level for economic feasibility.

The global trends of renewable energies use are expected to increase from 6% in 2006 to 10% in 2030 of primary energy use (World Energy Outlook 2008). This is the result of improved technological efficiency, accommodative energy policies and assumed higher fuel prices. Whilst the share of renewable energies will grow, total energy use is also expected to increase and fossil fuels are expected to still account for 80% of the world’s energy use.  An additional 20 barrels of crude oil is expected from the present daily ~85 million barrels presently. Most of the increase in crude oil production is expected from Middle East and Africa. As a result, the continued reliance on imported crude oil is expected to continue.

Coal and Climate change:

Another source of energy, coal is found in abundance in China and USA, and other major consuming countries. In fact, coal accounts for about 25% of the present energy mix. However, coal is a major contributor to greenhouse gases. It is estimated that the emissions from all the coal powered plants in USA together account for about 40% of the total gas emissions in the country. This can be solved by implementing carbon sequestration technologies in plants. Such implementations are more economical in new plants (and there are not many new constructions) but cost more to retrofits in existing plants. It is estimated that subsidies either in the form of a carbon tax of $40-60/ tonne or direct subsidies are needed to sustain its use. With technological improvements though, the prices may decrease over the years.

Energy Security – at a price

Thus said, energy security comes at a price. The world is not expected to wean of its dependence of oil or imported oil for that matter over the next two decades. This is in spite of increased use of alternative sources of energies. Economics can be the solution but this means the average consumer paying more for energy in an era when the competition and demand for energy resources are already increasing.

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  1. August 26, 2012 at 3:50 am

    Good article.
    Current market scenario forces me to consider regulatory risk also which plays an important role (ref: Dodd Frank Act) …

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