GEOPOLITICS IN OIL AND GAS MARKET

Stephen Adjei

(14MT000605)

OUTLINE

• INTRODUCTION

• OIL AND GAS PRICING

• GEOPOLITICS

• ANALYSING GEOPOLITICAL COMPONENTS

• VARIOUS GEOPOLITICAL FACTORS

• IMPACT OF GEOPOLITICS

INTRODUCTION The Oil and Gas industry

forms the engine of the world’s economy

Oil and gas are used as fuels in vehicles or home for heating. And in industrial processes and products for the operation of machine technology.

Gas plays a fundamental role in economic growth and development, with a greater contribution to the generation of electricity.

Main source of energy for the military hence a key role in national security

CONTINUATION

• Huge petroleum revenue generated are used for developmental projects such as the construction of schools, hospitals and roads.

• Because of the diverse uses of oil and gas and their direct links to economic and social wellbeing, the demand for these commodities continues to grow as incomes rise and populations expand in most developing countries.

• It has been observed that whenever the oil prices increase the price of various products also increases.

OIL AND GAS PRICING

• There are numerous factors that determine the price of oil and gas. These factors include

oil benchmarks

supply and demand

the role of The Organization of Petroleum Exporting Countries (OPEC)

financial markets

legislation

Weather

Geopolitics

• Gas pricing is often affected by demand and supply and price of oil.

CRUDE BENCHMARKS

• Benchmarks are reference price for buyers and sellers. The three mainly used are

• Western Texas Intermediate (WTI) which has an API gravity of about 39.6, hencce light and with a sulfurcontent around 0.24%, making it very sweet. It is used primarily in the United States of America.

• Another type, the Brent, essentially draws its oil from more than a dozen oil fields located in the North Sea. It's also still considered a sweet crude, despite having a higher sulfur content than WTI.

continuation

• Thirdly, the Oman Blend comes from the Middle East region and is a medium-sour crude grade considered less sweet as compared to WTI and Brent

The geographical location of these oil markers which affects the

transportation cost to refinery plus their different properties

affect their pricing.

OPEC (The Organization of Petroleum Exporting Countries

• OPEC, a consortium of 13 countries: Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. OPEC is responsible for 40% of the world’s oil production, and sets policies among member countries to meet global consumption.

• OPEC can affect the price of crude oil, by increasing or reducing production among member countries.

SUPPLY AND DEMAND

• As population tend to increase as the years goes by, the demand for oil and gas increase and hence price increases.

• In some seasons, demand decreases and this brings about a reduction in prices.

WEATHER Seasonal changes in

weather affects the demand for oil.

Extreme weather conditions (hurricanes, tornadoes, thunderstorms) can physically affect production facilities and infrastructure disrupting the supply of oil and induce pricing spikes.

In 2005 Hurricane Katrina halted oil production along the Southern Gulf Coast of the United States

POLITICAL INSTABILITY

Political instability in the Middle East has caused great concern about access to oil given that this region accounts for a large amount of the world’s oil supply. In July of 2008 oil prices reached over $136 a barrel due to global concerns about the wars in both Iraq and Afghanistan. One of the main reasons that oil prices rose so precipitously during this time period was due to the fact risk of delivering oil was high hence high cost.

When oil prices rise to these levels the consumer then cuts back on consumption rate in order to save money. This in turn decreases demand, which begins to drive the price of oil down.

RESTRICTIVE LEGISLATION

• Majority of the world’s oil reserves and production are controlled by government-run companies

• Energy policies and taxes in oil-rich countries also affect the price of oil.

• If a government bans oil exploration in a place with proven reserves, such as the Gulf of Mexico, then commodity markets mark this as a “loss” in crude oil supply and gas prices go up as a result

FINANCIAL MARKETS

• It has been noticed that the oil markets are increasingly interconnected with other financial markets such as the exchange rate market, stock market and futures market. Meanwhile, much of the oil trade has been done through financial markets where many traders participate in oil deals not for use, but for profit-making by utilizing price fluctuations. These activities in turn exacerbate the market's volatility

GEOPOLITICS

• Geopolitics refers to the study of the effect of geography; physical features of the earth and its atmosphere such as climate, topography, demography, natural resources and of human activity on international politics and international relationship.

• That is, how human activities in a certain geographical location affects the world at large and in this presentation how it affects the Oil and Gas Market in particular.

ANALYSING GEOPOLITICAL COMPONENTS

GEOGRAPHY

ECONOMICS

TECHNOLOGY

Geography

• Geography limits what is possible in the natural world and helps toreinforce sovereign borders. For example, the Himalayas provide anatural barrier between India and China while absence of sea hasmade countries landlocked.

• The level of air and ground pollution in a country will have an effecton legislation, which will affect companies’ decisions to invest.

• Climate has always been associated with Geography. The variousprevailing winds and tides affect the routes ships take to navigate theworld’s oceans, which can affect the economic viability of a project.

Economics

• Economic constraints include the market forces that determine theprice of oil, which has a direct impact on the tax revenues androyalties received by national governments and individuals, which inturn limits the options available to decision makers.

• Interest rates, inflation levels and trade barriers all affect the appetiteof organizations for doing business in any given country hence effecton decision making

Technology

• Technology will affect demand and supply. For example, when the USdeployed advanced drilling and recovery techniques to tapunconventional sources of oil and gas global demand droppedmassively which affected oil prices globally.

• High Technology in the area of security during transport of producedfluids is vital in investment. In times of war, security concerns are highand for the safe transport of crude, one needs high level oftechnology which affects the price at the long run.

GEOPOLITICAL FACTORS

• CONFLICTS IN THE PERSIAN GULF

( Verrastro et al, 2010) concluded in their report

that fossil fuels will continue to provide the main

source of global energy needs for many years to

comes with the Persian gulf being the marginal

supplier of oil to the world.

Unfortunately this is a region with unresolved

interstate conflicts, weapons proliferation, and

worsening domestic political conditions

key geopolitical events and factors that have affected the oil and gas markets are as follows

TYPES OF THREATS IN THE PERSIAN GULF

• According to (Kemp, 2000) “” There are three general categories of threats that disrupts Persian Gulf oil supplies and hence affect global oil prices:

• Military threats and spread of weapons

• domestic instability and terrorism within the Gulf states themselves

• Conflict over the Caspian Basin’s promising energy reserves; The Caspian Basin could contain as much as 200 billion barrels of oil and 279 trillion cubic feet of natural gas

CONTINUATION

• The Persian Gulf countries contain a significant percentage of the world's oil reserves and production capacity: it is body of water bordering Iran, Iraq, Kuwait, Saudi Arabia, Bahrain, Qatar, United Arab Emirates, and Oman

• Proven oil reserves of 728 billion barrels, representing 55 percent of the world's oil reserves at the end of 2006. Oil production capacity of 25.4 million barrels per day (33 percent of the world total) at the end of 2006 Total oil production of 23.6 million barrels per day in 2006. About 2.4 - 2.9 million barrels per day of excess oil production capacity, as of March 2007, of which 1.9 to 2.4 million barrel per day is located in Saudi Arabia.

PERSIAN GULF AND GLOBAL ENERGY

STRAITZ OF HORMUS

• Over 90 percent of oil exports from the Persian Gulf pass through

the Strait of Hormuz, a vital sea passage only 30 miles wide at its

narrowest point. It is commonly believed that a tanker accident, a

terrorist attack, or a military effort to close the Strait would send

energy prices skyrocketing, threatening the global economy

The GULF WARDuring the Gulf War that began in 1990, WTI(West Texas Intermediate) and Brent crude oilprices doubled in the beginning of 1990 anddropped ~30% by the end of that year. TheUnited States invaded Iraq in 2003. During thiswar, Brent crude oil rose by 7% and thendeclined by 12% by the end of the war.These geopolitical tensions led to supplydisruptions, which increased global crude oilprices. In the Gulf War, supply dropped by ~7%,and in the Iraq War, supply dropped by ~3%.The 2013 Middle East tensions didn’t havemuch impact on oil prices due to increasedproduction in the United States.

GEOPGRAPHICAL LOCATION AND GAS TRANSPORT

• In the case of gas, (Yegorov and Wirl 1056-1057) discussed that the market structure is not dependent on pure economic aspects. Gas market differs from other markets due to high share of transport and infrastructure costs. Gas is transported from the field to the consumer mostly through pipelines. Geography and politics therefore play critical role in this situation

• Land locked countries have very few choices of transport routes, and geopolitics more than economics governs the choice of pipelines including projects

THE CASE OF TURKMENISTAN

Land locked countries Like Turkmenistan have very few choices of transport routes, and geopolitics

governs the choice of pipelines including projects.

It contains several of the world's largest gas fields.

Russia monopoly power over its gas transmission

Turkmen natural gas became a competitor with Gazprom, the Russian state monopoly. Since all of the pipelines connecting the region to world markets were owned by Gazprom and routed through Russia, Turkmen natural gas was squeezed out of the market. As a result, Turkmenistan's incentives for increasing its production of natural gas disappeared.

This reduces the amount of global gas produced hence affecting the world at large.

SAUDI ARABIA AND THE 2014-2015 DROP IN OIL PRICES

Energy prices started to move downward in late-2014, when Saudi oil began to flood energy markets.

One school of thought suggests Saudi Arabia is trying to push US shale production out from the

market by making extraction unprofitable and ultimately expanding its share of the market at the

expense of US producers. This will be effective as the cost of production from US shale-based

hydrocarbons—tight oil and shale gas through hydraulic fracturing or fracking is very high.

Another school of thought suggests this is in the quest to see economic collapse of its allies as those

countries relied massively on revenue from oil and gas. If Saudi Arabia decides not to reduce

production, oil production will just continue flowing and there is not much that the other countries

can do about it.

OPEC can cut down its production to balance the total production but from the past experience of

losing its buyers it has hesitated.

IMPACT OF GEOPOLITICS

• Geopolitics has the capacity to exert sudden and disruptive pressureon the operations and security of energy assets across the world,meaning that no country or company is truly exempt from the effectof geopolitical change.

• Oil and gas companies frequently engage with national and localgovernments, local populations, subnational groups and nationalorganizations, and consequently they are deeply affected by politicalchange.

• Geopolitics has contributed price fall in many instances and this has brought about the Laying off of workers in the Oil and Gas industry.

• Controls the economy of oil producing countries either positively or negatively; more revenue when prices are high and less revenue when prices fall

continuation

In early 2012, relations deteriorated between then Repsol YPF and the Argentine Government, which decided

to expropriate Repsol’s 51% stake in YPF. In the months following the expropriation, Repsol saw a loss of almost

half of its market capitalization.

In Nigeria, political instability and regional and religious sectarianism have contributed to the ongoing theft of

up to 350,000 barrels of crude oil per day, which costs the oil and gas industry approximately US$1b per month

in lost revenues.

Strikes by oil workers enraged at perceived government corruption reduced Libyan oil production by 88% in

2013.

(EY Global limited, Navigating Geopolitics in Oil and Gas)

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