25 April 2006

Energy Partnership: Pacific Asia and the Middle East

The last line of the last paragraph is informative...

Middle East Economic Survey
No 33
Energy Partnership: Pacific Asia and the Middle East
By Gawdat Bahgat

The following article by Dr Bahgat was written for MEES. Dr Bahgat is Director of the Center for Middle Eastern Studies, Department of Political Science, Indiana University of Pennsylvania, USA.

In January 2005 an unprecedented meeting between major Gulf oil producers and Asian oil consumers was held in the Indian capital, New Delhi. Energy ministers from Iran, Kuwait, Oman, Qatar, Saudi Arabia, the UAE, China, India, Japan, and South Korea discussed different proposals to consolidate oil and gas cooperation between the two sides. These include the development of an Asian petroleum market, mutual investments in upstream and downstream sectors, and building strategic petroleum storages. This gathering underscores a fundamental characteristic of the global oil market – the Gulf states are the major center of gravity on the supply side while Pacific Asian nations have become the major center of gravity on the demand side of the equation. The implications of this growing partnership on global energy markets and strategic ramifications are the main focus of this essay. The framework of the analysis can be summarized as follows:
For the next decade global oil markets will continue to reflect competition between four major producing regions – Russia, the Caspian Sea, West Africa, and the Middle East. On the consuming side the competition is mainly between the Pacific Asia, the US, and Western Europe.

Each of the consuming regions has forged an energy partnership with one or more of the producing areas. Europe receives substantial proportion of its oil and gas supplies from Russia. Since the early 2000s the US has sought to reduce its dependence on oil supplies from the Middle East and sought to increase imports from Canada, Mexico, Venezuela, and West Africa. Finally, Pacific Asia’s skyrocketing demand is met, mainly, by supplies from the Gulf.

In the foreseeable future the Middle East, particularly the Gulf producers, will continue to be the driving force to ensure global energy security. The world will grow more dependent on oil supplies from the Middle East. The region has the hydrocarbon resources to meet growing global demand.

World oil market is well-integrated. The competition between various producers and consumers should not be seen in zero-sum terms. The source of oil matters less than the availability of supplies. In other words, in today’s oil market who buys and who sells one barrel of oil has little impact on energy security. Instead, the availability of adequate supplies significantly insures security and stability. Within this context, the developing energy partnership between Asian Pacific nations and Gulf producers should be seen as a positive step. It would enhance energy security for both sides and contribute to global economic stability and prosperity.
The following section examines the concept and implications of “energy security.” This will be followed by a brief analysis of the main characteristics of the energy sector in the Gulf producers and Pacific Asian consumers. Finally, the strategic environment and the geopolitical ramifications of the Asian/Gulf energy partnership will be examined.

Energy Security
Modern society has grown more dependent on energy in almost all human activities. Different forms of energy are essential in residential, industrial, and transportation sectors. Energy is also crucial in carrying out military operations. Indeed, the attempt to control oil resources was a major reason for the Second World War. In short, our increasing reliance on energy has heightened the importance of energy security. The first oil-shock in the aftermath of the 1973 Arab-Israeli war put energy security, and more specifically security of supply, at the heart of the energy policy agenda of most industrialized nations.1 Since then policy-makers and analysts have sought to define the concept “energy security” and its implications.

The European Commission defines energy security as “the ability to ensure that future essential energy needs can be met, both by means of adequate domestic resources worked under economically acceptable conditions or maintained as strategic reserves, and by calling upon accessible and stable external sources supplemented where appropriate by strategic stokcs.”2 Barton, Redgwell, Ronne and Zillman define it as “a condition in which a nation and all, or most, of its citizens and businesses have access to sufficient energy resources at reasonable prices for the foreseeable future free from serious risk of major disruption of service.”3 In short, energy security refers to sustainable and reliable supplies at reasonable prices. In this essay the concept energy security includes the following parameters:
The different threats to energy security include geopolitical, economic, technical, psychological, and environmental ones.

The definition of “security” embodies the element of “price” or achieving a state where the risk of rapid and intense fluctuation of prices is reduced or eliminated. Oil prices vary from country to country depending on several factors including the quality of crude, destination, taxes, exchange rates, and refining capacity, among others. For long time OPEC has played the role of swing producer. This means that when others, such as Russia, the Caspian, or West Africa, increase their production, OPEC reduces its share in order to prevent prices from falling. In addition, since the early 2000s, and until recently, OPEC observed a “price band”, which reflected the organization’s preferred price range.

Prices have a strong impact on the availability of funds to invest in exploration and development of oil resources. Energy security depends on sufficient levels of investment in resource development, generation capacity, and infrastructure to meet demand as it grows. Traditionally, high oil prices have led to accumulation of funds at the hands of national and international oil companies and more investments. Eventually, new investments add more supplies to the market and contribute to lower prices. Systematic under-investment characterized the oil industry in the 1990s due to stable oil prices, at low level since the mid-1980s. This under-investment contributed to shortage of supplies and higher prices since the early 2000s.

Spare capacity has traditionally played a significant role in temporary severe interruptions of oil supplies. Few OPEC producers, particularly Saudi Arabia, have purposefully maintained spare capacity to ensure stability in global markets. Global economic growth, particularly in Pacific Asia, has subjected the oil market to an unexpected demand shock that has practically eliminated spare capacity. Accordingly, the international oil industry has entered a period of fundamental change. In the mid-2000s spare capacity is at one of its lowest recorded levels.

Security of supplies can be enhanced by an overall diversification of supply. Put differently, the more producing regions the more stability in international oil markets. Thus, increasing supplies from Russia, the Caspian Sea, West Africa, and other regions would reduce the vulnerability of over-dependence on one single region. Wars, military operations, and political tension in the Middle East have prompted calls to reduce dependence on supplies from that region. Although the political situation in the Middle East provides many grounds for concern there has not been any major disruption of supplies from the region since the 1973-74 oil shock. Middle Eastern producers realized that imposing an oil embargo for political purposes was unproductive. In the following decades major producers have increased their production to compensate for any shortage resulting from political upheavals around the world.

From the perspective of producers, demand security also merits attention. Major resource holders have voiced their concern regarding long-term security of demand for their oil.4 This concern is based on two grounds. (a) The cyclical growth patterns and policies that dampen the demand for oil and favor other sources of energy. (b) OPEC producers have failed to diversify their economies and continued to be heavily dependent on oil revenues. Thus they are concerned about securing markets for their major source of income. Within this context, the growth of Asia’s oil demand is seen as a welcome development by OPEC producers.
To sum up, the globalization of oil markets suggests that rhetoric regarding the goal of self-sufficiency in energy is obsolete. Energy security is an international issue that requires growing interdependence between major producers and consumers. The skyrocketing demand for oil in Pacific Asia is a case-in-point.

Pacific Asia
A recent report issued by the US National Intelligence Council (NIC) predicts that the 21st century is likely to be the “Asian Century”. It argues that the emergence of China, India, and other Asian powers, is similar to the advent of a united Germany in the 19th century and a powerful US in the early 20th century.5 This rapid rise of Asia is driven by the incredible high and sustained economic growth the region has witnessed since the early 1990s, led by its fastest growing economies – China and India. Together the two nations have more than 2.2bn people, more than one-third of total world population. Finally, both China and India are nuclear powers and their military capabilities, both conventional and non-conventional, are on the rise. In short, Asia has the necessary “ingredient” to become a global power and is on its way to become a prominent player on the international scene.

Several characteristics can be identified in Asia’s energy outlook. First, Asia Pacific nations have very limited oil and natural gas reserves. Indeed, the region holds the lowest oil reserves and the third-lowest natural gas reserves in the world. Second, Pacific Asia has a huge and growing gap between its low oil and gas production and its consumption. Pacific Asia as a region produces only 10.2% of world oil and consumes 28.8%. The figures for natural gas are 11.9% and 13.3% respectively. These gaps are filled by imports from overseas, particularly from the Gulf. Third, like in Europe and the US, a substantial proportion of oil in Pacific Asia is used to meet the region’s rising transportation sector, particularly in China and India. The sustained high economic growth has led to soaring vehicle ownership. The number of vehicles in China in 1980 was less than 2mn. By 2002 it increased tenfold to almost 18mn. In India, vehicles totaled 10.7mn in 2000, an increase of 245 % since 1984.6

To sum up, despite some variation between Asian economies they all share a dominant characteristic – domestic oil and gas reserves are extremely limited and inadequate to meet their current and anticipated economic growth. They compete with each other and with other major consumers over hydrocarbon resources.

The Gulf
Currently energy interdependence between OPEC producers, particularly the Gulf states, and Pacific Asia is strong and is projected to grow further in the next few decades. Pacific Asia’s consumption of oil and natural gas is projected to grow faster than any other region in the world. On the other side of the energy equation, the Gulf region holds the largest oil and natural gas reserves, cheapest cost-production, direct access to global markets, overall well-developed energy infrastructure, and spare capacity. Indeed, the Gulf’s share in global oil production is much lower than its share in world’s oil reserve. In other words, the Gulf region is under-exploited while most other regions, particularly Russia, the North Sea, and the US, are over-exploited. Thus, it is widely projected that oil production from the Gulf will rise and the world will become more dependent on oil supplies from the region. Pacific Asia consumers already import most of their oil needs from the Gulf region.

Given these geological characteristics, Pacific Asia consumers have sought to further consolidate their energy partnership with the Gulf producers. In 1999 the Chinese President Jiang Zemin visited Saudi Arabia and announced the creation of a “strategic oil partnership” between the two nations. In 2004 China’s Sinopec, along with other international oil companies, signed an agreement to explore for natural gas in Saudi Arabia. In the same year Sinopec signed a memorandum of understanding to buy 250mn tons of liquefied natural gas (LNG) from Iran over 30 years. Iran will also export 150,000 b/d of crude oil to China after Sinopec develops the Yadavaran field. Since 1994 Iran, India, and Pakistan have negotiated the construction of a pipeline to export natural gas from Iran to the two large Asian consumers. Japan also is involved in several oil schemes in the Gulf, particularly in Iran and Kuwait.

Energy Security: Lessons and Prospects
Several conclusions can be drawn from the foregoing discussion of energy outlooks in consuming and producing regions. First, the notion that energy security can be improved by reducing dependence on one particular region is unrealistic and misguided. The market for oil (and to a less extent for natural gas) is global and well-integrated. Second, given its geological characteristics, the Gulf region will continue to be the driving force in global oil markets and in ensuring energy security. Third, Pacific Asia’s growing energy needs suggests that its close energy ties with and dependence on the Gulf will further grow in the foreseeable future. Fourth, this growing energy interdependence between the two regions is likely to have political and strategic ramifications. Historically, nations with great energy demand have sought to secure their energy resources by forging close political and military ties with their oil and gas suppliers. Strategically, Asian powers such as China and India share similar stand with Gulf states on issues such as the legitimacy of using nuclear energy for civilian purposes, opposition to economic sanctions, and peaceful resolution of the Arab-Israeli conflict that would guarantee Palestinian rights. Fifth, there has been growing speculation that China’s growing dependence on energy supplies from the Gulf might prompt Beijing to expand its naval power and a rivalry between the US (the largest oil importer) and China (the second largest oil importer) over the Gulf (the largest oil exporter) might start.

This essay argues against the last conclusion. The thrust of this study is that energy security should not be seen in zero-sum terms. Rather, continued dialogue and mutual understanding of common interests between consumers and producers will offer the appropriate conditions to establish and consolidate energy security. Within this context international organizations such as International Energy Forum (IEF) can play an important role in facilitating this cooperation.7

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