Political Economics Prof

Tag: natural gas

A Note on the Geopolitics of Oil
Saudi Oil Minister

BACKGROUND INFORMATION

Oil is measured in barrels.

A barrel is 42 gallons.

Total global daily production is around 96-97 million barrels/day.

Saudi Arabia, Russia and the United States all produce around 10
million barrels a day. With their
allies, these three countries account for close to 40% of global production.

Because of the improved technology of shale oil
production, U.S. output has gone up almost 5 million barrels/day since 2008.

Currently, total global production is greater than total demand by
somewhere between one and three million barrels/day.

There are record amounts of oil in storage.

A small percentage increase of supply over demand has led to a
large decrease in price.

In the fall of 2014, a barrel of oil cost about $100/barrel. Last month the price fell to around
$30/barrel. Since then, it has rallied
to around $40/barrel.

THE ECONOMICS AND GEOPOLITICS OF OIL

The economies of seventeen countries critically depend on oil
production and the price of exported oil. Many others, like Brazil and Mexico, partly depends on oil exports.

It has been a year and a half since the price of oil began to
fall. Many countries are now in
recession. Government revenues, mostly
dependent on oil sales, have fallen drastically and budgets are showing large
deficits. In some countries, including Venezuela and Nigeria, the situation is serious enough to threaten the stability of the
country.

Given global inelastic demand, a small percent decrease in global
supply, around 3%, would lead to a large increase in price, probably around
60-100%. All countries, including Saudi
Arabia, would be economically better off.
Many other oil producers, but not Iran, have called for lower
production. So why hasn’t it happened?

Saudi Arabia and its Persian Gulf allies have had a number of objectives
in pumping out a record level of oil and watching the drastic fall in price:
- Punish Iran, a Shia rival for power in the Persian Gulf and
  throughout the Arab world. Saudi Arabia
  is Sunni.
- Punish Russia for supporting Iran and then Syria.
- Stop the growth of shale oil production in the United States.
- Drastically reduce the level of global capital investment in oil.
- Reduce production of high cost oil by making it unprofitable
  to continue production.
Two geopolitical changes in the last 18 months have hardened Saudi
Arabia’s determination to produce record amounts of oil:

Lifting of economic sanctions
against Iran

Saudi anger at the U.S. in
supporting the end of sanctions.

  Russian military intervention
supporting the Shia regime in Syria

Both events strengthened Saudi Arabia’s intentions of punishing
Russia, the United States, and Iran by keeping production at record levels and prices
low. If Saudi Arabia and their Gulf
allies agreed to reduce production and prices rose, the U.S., Iran, and Russia
would benefit.

THE SAUDIS MISCALCULATE

The Saudis have not succeeded in meeting their goals as much or as
quickly as they expected. The overall
strategy was to force other countries to cut back production of unprofitable
oil and the Saudis and their allies would benefit from their high output and
higher prices.

They miscalculated. Like
Saudi Arabia, most of the oil is pumped by government-owned or government-controlled
companies. They don’t care about
profits, only revenue. Government oil
companies are a source of power, employment, patronage and corruption. Except in the extreme where less revenue
threatens the regime, these countries have no incentive to reduce output. A substantial reduction will lead to higher
market prices; other countries or companies will maintain or increase
output. Without widespread cooperation,
the end result will be the same total output and the same low prices, except
the countries that reduced output will lose market share and end up with even
less revenue.

The only hope is that major producers, both OPEC and non-OPEC, can
get together and agree to a collective reduction in production. A meeting is scheduled in Qatar on April 17. Saudi Arabia and Russia say they will attend
the meeting; U.S. oil companies probably won’t.

Iran won’t attend and says it will increase production regardless
of what other producers do. They have
softened their position by recently saying that if they are allowed to increase
production to some unspecified level, they will stop any further increase in
production.

What changed? Why is Saudi
Arabia signaling it might reduce output?

Internal pressures. Fragile society with suppressed
tensions. Kept together by a huge social
welfare system financed by oil revenue. The
Saudi government is running a large budget deficit which is rapidly reducing its sovereign wealth fund that finances the lost revenue.

Saudi would be the “last man standing” but it
might be a Pyrrhic victory. The price
might be too high.

The Russian economy is really hurting. A continuation of low prices for oil and
natural gas could eventually threaten Putin’s power.

Clear signal to Saudis that they want, or need,
an end to low prices. Given the
continuing economic pain at home, Putin appears willing to cooperate with Saudi Arabia – the geopolitical rival of its client states in the Middle East – in exchange for a stable domestic economy and increased government
revenues at home.

A third miscalculation. U.S.
shale production hasn’t gone down anywhere near as much or as fast as the
Saudis expected. Two reasons:

Private companies look to marginal costs and
shutdown expenses, not average cost, in deciding whether to continue
production. Reacting to low prices, they
have lowered their costs and reduced their losses. American drillers adapted to lower prices by shutting down low-producing wells, using new technology to increase output per well, reducing drilling costs by drilling deeper and faster with fewer workers, and forcing suppliers to reduce their prices to producers.

Until first quarter of 2016, many oil producers
had locked in higher selling prices through futures contracts.

American oil executives are saying that in the better shale oil
areas, new wells can be profitable at $30/barrel. Oil experts believe that at $45-$50/barrel, total
U.S. shale production will stop falling.
Above $50/barrel, U.S. shale oil production will increase again.

Some countries may not cut production as promised. U.S. shale producers can offset a reduction
in total supply. In that sense, the
U.S., not Saudi Arabia, has become the swing producer.

Both U.S. and global inventory are at record levels. Even if production falls three million
barrels a day, inventory drawdowns can make up most or all of the
decrease. Total supply would
remain at current high levels and prices would fall again.

THE RECENT PRICE INCREASE

The futures market and speculators have driven the price of oil
from around $30/barrel to $40/barrel.
Little has changed from the underlying supply/demand balance that drove
the price from $100/barrel to $30/barrel.
Why the increase?

Speculators look ahead. Like
gamblers at a roulette wheel, they pick a number and “puts down their money and
takes their chances.”   They are betting
that the major oil producers have reached the panic point and will agree to
reduce production on April 17. They are also covering short positions These actions increased the world price of oil. But, as the
above comments indicate, only temporarily.

THE UNITED STATES: NAFTA IS THE NEW OPEC

The United States is poised to become the world’s largest producer of oil and possibly the world’s largest exporter of refined oil products. Combined with a fall in domestic demand for refined oil products because of electric and hybrid vehicles, the United States could become a net exporter. All of America’s remaining import needs could be filled by Canada and Mexico. Already, the United States does not need any Middle East oil. One reason for past American involvement in the Middle East no longer exists. The main economic reason for an alliance with Saudi Arabia no longer exists.

The United States controls the technology of shale production. This technology is vital to opening new fields and recovering residual oil in old fields. It is also a geopolitical weapon. Currently, U.S. sanctions against Russia includes withholding oil drilling technology.

Related, the United States is already self-sufficient in natural gas, exporting to Mexico, and building liquid natural gas (LNG) plants for export. To reduce dependence on Russia, Poland and Lithuania are building LNG receiving plants. Poland is considering a pipeline from its LNG plant to Ukraine. The United States, plus new natural gas finds in the Mediterranean and shale fields in Poland and Ukraine, could replace much of the Russian exports to Europe.

CONCLUSION

The geopolitics of oil complicates the economics of oil. Inelastic demand for oil implies that a small percentage decrease in output will lead to a large percentage increase in price and revenue. But geopolitical rivalries make cooperation difficult and probably temporary.  Some of these rivalries have an overlay of intense religious or historical animosity. Virtually every OPEC member has a history of cheating on production quotas. And now any reduction agreement can be countered by increased output in the United States, Canada, and Mexico.

Oil prices are the result of a complicated interaction of political and economic factors.  Oil buys power and influence.  Saudi Arabia is betting that they can use their oil policy to reassert some control over the tangled conflicts in the Middle East.  Russia hopes that oil and natural gas exports will fuel domestic political stability and geopolitical ambitions. Oil and natural gas exports to Europe are Russia’s most effective foreign policy weapons. Ironically, both countries’ ambitions are at the mercy of increased output and technological improvements in American shale oil production.

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For further reading, see

https://politicaleconomicsprof.com/2015/11/saudi-arabia-oil-and-geopolitics.html

https://politicaleconomicsprof.com/2015/09/energy-and-geopolitics-ii-world-ex.html

https://politicaleconomicsprof.com/2015/09/energy-and-geopolitics-i-united-states.html

https://politicaleconomicsprof.com/2015/04/the-russian-economy-and-geopolitics-of.html

https://politicaleconomicsprof.com/2015/04/the-death-of-opec-sheikh-rattle-and-roil.html

https://politicaleconomicsprof.com/2015/01/changing-oil-prices-different.html

https://politicaleconomicsprof.com/2014/12/cheaper-oil-winners-and-losers.html

For excellent ongoing analysis of the geopolitics and economics of
the global and national oil markets, see http://oilprice.com.

The classic book on the history of the global oil industry and the
rise of OPEC is Daniel Yergin, The Prize.
March 22, 2016
Energy and Geopolitics II: The World ex-United States

Middle East Oil Wells

OVERVIEW

Outside of the United States and Canada, most of the world’s
oil and natural gas is owned and produced by governments or
government-dominated companies with minority shareholders. Two examples of the
latter, public companies with stockholders, are Petrobras in Brazil and Gazprom
in Russia. But government officials,
especially the president, control management and make the important decisions.

Production and investment decisions are not made based on
financial criteria alone. Often,
internal political or foreign geopolitical factors are more important. Many countries’ economies and government budgets depend critically on oil and natual gas revenue from exports. Maintaining internal peace and welfare programs are more important than rational economic considerations.

What this means is that production and distribution
decisions in these countries are made using different criteria than by private
companies in the United States and Canada. Producing and exporting oil and natural gas are mostly political
decisions. Petrostates like Russia, Brazil, Venezuela, Nigeria,
Algeria and other countries in the Middle East and Africa have not used their
oil and gas revenue to industrialize or diversify their economies. Generating revenue for government, not profits for investment, is the main
concern of these countries.

For many countries, exporting oil or natural gas (and other
commodities) is the major source of hard currency revenue and government
income. Domestic spending, importing
consumer goods, government social welfare and subsidy programs, foreign policy
and even internal stability and corruption depend on commodity export
earnings. As does servicing foreign
borrowing, which has grown rapidly in the last six years.

With much greater potential supply of oil and natural gas
because of new discoveries and innovative production technology, and growing
substitutes, no one country or small group of countries will be able to control global
supply or price.

Among the fossil fuels, the long run outlook (20 years) of
natural gas appears to be the best. Even
without the fall in natural gas prices, the global trend away from coal to gas to generate power will likely
continue and increase demand for gas. In Asia, however, both coal and natural gas production are increasing because of the huge increase in the demand for electricity.

Massive increases in profitable
reserves and technological changes in production and distribution will
permanently bring down prices of natural gas in high-cost areas like Asia and
Europe. LNG, more tankers and interconnect pipelines will make the global
gas market more integrated, more like the global oil market.

Three new potential major producers of natural gas are
Argentina, Bangladesh and Egypt. Qatar
and Australia have completed and can expand large new LNG complexes. Some of Qatar’s new gas revenue is supporting Sunni fundamentalist
groups in Syria and Iraq.

Substitutes for oil and gas should be cost competitive in
the near future. Solar, especially
decentralized solar on buildings, will continue to grow rapidly as the
technology improves and the costs keep coming down. Adoption of solar
will accelerate if battery storage costs come down and countries don’t have to
build or expand electricity plants and grids.
Solar panel costs are falling rapidly and Elon Musk says his new lithium
battery plant in Nevada will reduce storage costs by 30%. Wind turbine currently depends on subsidies
but there is some new technology that may eliminate the gigantic windmills
(375 feet high) and lower costs.

Many countries are looking at nuclear
again because of major advancements in technology and safety. There are currently 437 nuclear power reactors operating worldwide. 60 more are under construction, another 165 are planned, and 331 more are proposed. The number of nuclear power plants in the world could easily double in the next two decades. China alone plans to build 46 new ones by 2020. Japan, which paid $270 billion to import fossil fuels (mostly natural gas) in 2013, currently plans to start up 15 shut-down nuclear power plants. On the other hand, Germany is shutting down the last of its 17 nuclear power plants, substituting solar and wind (interruptible) backed by gas.

Other sources of energy beyond the use of fossil fuels are
being researched and developed in laboratories.

The key is how long oil and gas prices stay at current
levels and what the new equilibrium prices will be. This is not just
an economic question. Domestic policies,
like China’s and America’s policies to reduce carbon emissions from coal, and
geopolitics will play key roles. Also,
there will be major shifts in where oil and gas are produced, who exports, new
technology and the expanding importance of substitutes.

THE EASTERN MEDITERRANEAN

Huge new natural gas fields have been discovered in the
eastern Mediterranean. The largest so
far are in the coastal waters of Israel, Gaza, Egypt and Cyprus. The fields may extend north to Greece, Lebanon
and Syria. Israel, now self-sufficient
in natural gas, could supply Palestine and Jordan. Pipelines could be built
from Israel, Gaza and Egypt to Cyprus and then another set to Greece, which
would connect into the proposed integrated pipeline systems of central Europe
and, through Austria, to the rest of Europe. Or a pipeline could be built to connect with the large pipeline running through Turkey to Europe. South-Central European countries could eliminate their almost complete
dependence on Russian natural gas and threaten “reverse flow” to Ukraine. Egypt already has an LNG plant and other
producers could construct them, expanding their geographical market for their
gas.

If this occurred, it would be a tremendous economic boon to
all the countries involved. So what’s
the problem? Geopolitics. There are countries involved that don’t like
each other. To say the least. Besides Israel and Gaza, Cyprus is divided
into Turkish and Greek areas. Would the
economic benefits be great enough to overcome political rivalries, many based
on long-standing hatred and conflict?

RUSSIA AND EUROPE

Russia is Europe’s largest external source of oil and
natural gas. Europe is Russia’s largest
customer for both. But the conflict in
Ukraine has changed the geopolitics. Russia
may pay a very high economic price for its intervention in Ukraine.

It is also one reason that I don’t think Russia will invade
and conquer the whole country, as Putin has threaten to do. Or even increase destabilization pressure. Europe would expand sanctions, look to new
sources of energy and accelerate programs to import less Russian oil and
gas.

While these policies will probably have little short-run
effect on the volume of Russian exports of oil and gas to Europe, a longer-run
combination of lower prices and less volume would have serious economic
consequences for the Russian economy.
Since Putin’s and his successors’ political popularity in Russia partly
depends on continuing the high rates of economic growth and standards of living
made possible by increased revenue from energy and commodity exports, pursuing
an aggressive or confrontational policy against Ukraine and Europe could have
serious domestic consequences for the current and future Russian governments.

Under U.S. pressure, Europe has imposed some economic
sanctions on Russia, the most effective being that Russian companies cannot
access European financial markets. As
loans come due, the companies, many of which are government owned or
controlled, have to borrow hard currency from the Russian government. Russia’s foreign reserves of hard currency
are shrinking. Over half are committed
to future retirement costs, although the fund can be raided.

New internal capital to modernize old fields and develop new
fields is not available. Global bond
markets are closed. Russia’s response
has been to relax rules limiting foreign investment in Russian oil and gas.

In addition, Europe is beginning to institute actions that
will reduce its dependence on Russian oil and natural gas, which means lower
export earnings for Russia regardless of the change in energy prices.

Europe has large natural gas reserves but will not develop
them quickly because of political opposition, lack of infrastructure and more
difficult drilling geology than the U.S.

RUSSIA AND CHINA

China imports more oil than does the United States. Before the tariff batlle, China was importing more U.S. crude oil.  China is about to become a major importer of natural gas as it substitutes gas for domestic coal production.  So China has joined the United States as a large market on the demand side.

Russia is now China’s largest supplier of oil.

Russia’s president Vladimir Putin has his own “pivot towards
Asia.” Russia’s main market for oil and
natural gas is Europe. With the
expectation that sales will be lower in the future and that older fields are
declining in production, Putin has turned to China for capital investment and
as a major export market. China plans on
substituting natural gas (and other energy sources) for its dependence on coal
(cough, cough). Russia has a huge new
field in eastern Siberia it wants to develop.
The cost is somewhere between $55 billion and $100 billion. Russia doesn’t have the capital and can’t
raise it in western financial markets because of the economic sanctions. So, apparently, the deal is that China
supplies part of the capital and agrees to take the production for the next 30
years. Although secret, apparently at a
low price. Russia originally announced
that sales to China would bring in $400 billion over the 30 years but that was
before the large drop in the price of natural gas, especially in Asia, and the
reality that there will be a lot more natural gas available from other sources.

Russia is now encouraging China and other Asian countries to
invest in Siberian oil and gas. Knowing
that Russia has used oil and gas exports as a geopolitical weapon against
Ukraine, Europe, Georgia, Serbia and Armenia, potential investors in China,
Japan and South Korea have to be worried about the political consequences of
becoming too dependent on Russian oil and gas.
And having their investments expropriated by future Russian government.

There is another complication. China is rapidly extending its influence into
the old Soviet republics in central Asia.
China has offered economic aid, including railroads and natural gas
pipelines connecting China and central Asian republics. One of the world’s largest natural gas fields
is in Turkmenistan; this is where Russia gets some of the natural gas it sells
to Europe. There are other possible gas fields. All of this creates the potential for
geopolitical rivalry between Russia and China in the area.

China also borders Kazakhstan, another former Soviet
republic. Kazakhstan is a large oil
producer and has the potential to produce more.
Russia sees Kazakhstan as in its sphere of influence. The president of Kazakhstan was the Communist
boss of the republic when it broke away in 1991. The Chinese, however, have made a number of
proposals that would divert some of Kazakhstan’s oil to China. Russia is not happy about this prospect.

In the long run, this policy could create
serious geopolitical problems for Russia. Supplying China with cheap
oil and gas while China expands its influence in Central Asia and renews its
claims (legitimate) on eastern Siberia is a dangerous policy. But that
will someone else’s problems, not Putin.

OPEC

OPEC has been ineffectual as an oil cartel, probably since 1985 when Saudi Arabia cut production with disastrous results. Iraq has invaded both Iran and Kuwait to grab large oil fields. Saudi Arabia and Iran are deadly enemies and compete to dominate the Persian Gulf region (and Islam). Many of the oil exporting states have seen civil wars and declining production. OPEC’s exports and net exports have been declining while global production is rising.

OPEC’s control has also been eroded by the growth and development of oil production in non-OPEC countries, even before shale. What shale does is greatly increase potential global oil production in non-OPEC countries if prices rise. Maybe even more important, shale oil greatly increases oil reserves outside of OPEC countries. Before shale, a high percent of the proven reserves in the world were in OPEC countries, mostly in the Middle East. This implied that OPEC’s market power would last a long time. No longer.

NAFTA

NAFTA (The U.S., Canada and Mexico) is the new OPEC. Almost all of the net increase in global oil
production since 2007 has come from NAFTA countries. Future increases in oil production will come
mostly from American and Canadian fracking, and deep-water rigs in the Gulf of
Mexico.

NAFTA is the new OPEC also in the sense that the American
and Canada companies, using fracking technology, can react quicker to changes
in global supply and demand, and subsequent price changes. New technology, better management and organization, and large cost reductions because of low prices have reduced the break-even cost of shale oil and gas.

The best oil fields in the United States have marginal costs
of pumping out and distributing oil about equal to all but the lowest cost fields in the Middle
East. Because of fracking technology, fixed
cost/barrel to modernize and expand existing fields is probably higher in most of the
Middle East and the rest of the world than expanding or opening new fields in the United States.

The geopolitical implication of all this is the United
States could cut off all oil imports from the Middle East and quickly substitute
NAFTA oil, mostly American. There are
major geopolitical implications if the United States has oil security, doesn’t
need Middle East oil and becomes a major exporter of petroleum and natural gas. Maybe the Iranian agreement, over strenuous
Israeli and Saudi objections, is an indication of the changing, more flexible
geopolitical policies of the U.S. in the Middle East.

SUMMARY

Global demand for energy will continue to increase in the foreseeable future. Global production of all sources of energy, including coal production in Asia, will increase. New technology on both the demand side (electric vehicles and autonomous driving) and supply side (fracking, LNG) will change the economics of energy. This will have geopolitical consequences. Middle East oil will become relatively less important. U.S. exports of oil and natual gas might have geopolitical effects. Development and sales of new technology such as solar and wind, may, in the long run, become more important than fossil fuel extraction.

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This is a summary of prior posts plus new information and conclusions. The latest related post was on Russia and the Geopolitics of Energy.

For an excellent history of the rise of OPEC, see Daniel Yergin, The Prize.

For an excellent, detailed article on Gazprom, see http://oilprice.com/Energy/Energy-General/How-Russias-Energy-Giant-Imploded.html. Gazprom has a virtual monopoly on Russian natural gas production and exports. Its management has very close ties with the Russian government. Putin has used Gazprom to implement both internal and foreign policy objectives. Gazprom owns a TV network and a major bank. Some of its profits were diverted to pay for the incredibly expensive Olympic Winter Games, with billions of dollars ending up in the pockets of oligarchs and government officials. Overseas, Gazprom has cut off or threatened to cut off gas supplies to Europe, Ukraine, Georgia, Armenia, the Baltic States, Slovakia and Serbia on orders from the Kremlin. In each case, Gazprom was used as a blunt geopolitical weapon to change another country’s democratic or anti-Russian politics.

September 12, 2015
Ukraine and Russia

Russian T-72 Tank Seen in Ukraine

HISTORICAL BACKGROUND

Most of what is now Ukraine
came under Russian control in the 1700s, due to the expansionist policies of
Catherine the Great. Part of western
Ukraine (Galicia) was a province of the Austro-Hungarian Empire.

With the collapse of the
Romanov regime in 1917 and Austria-Hungary in 1918, Ukrainians attempted to
establish an independent republic.
During the Russian Civil War, Ukrainian nationalist groups fought on the
side of the Communist Red Army because they knew that if the monarchy were
reestablished, Ukraine would be forced back into the Russian Empire. Their hopes for independence were crushed as
the triumphant Communist regime absorbed Ukraine into the Soviet Union.

Ukrainians suffered under the
Stalinist regime. Because the Ukraine
was the “bread basket” of the Soviet Union, grain and other crops were
systematically confiscated by the Communist government to feed industrial
workers at subsidized cost and exported to earn foreign currency. Bad weather plus confiscations in 1932-33 led
to millions of Ukrainians starving to death.

During World War II, some
Ukrainians fought with the Nazis, hoping to be free of Russian rule. After the war, Ukraine was treated harshly as
punishment. All Tatars in the Crimea were
deported to the interior of Russia; over half died.

RECENT CONFLICT BETWEEN UKRAINE AND RUSSIA

From 1991 until 2004, Ukraine
was ruled by former Communist bosses and their protégés. Little changed politically or economically. Some state assets were privatized, creating a
small group of oligarchs with ties to government officials. Corruption was rampant. Old industries were not modernized. Production and exports were still mostly
oriented to supplying Russia with food, industrial materials like pipe and
weapons. There was little economic growth or development.

Fed up with the lack of
progress, corruption, and economic stagnation, Ukrainians took to the streets in
2004 to protest the regime of President Viktor Yanukovych. The “Orange Revolution” was one of a number
of popular protest movements against authoritarian regimes on the Russian
periphery. President Yanukovych was
replaced by a democratic government.
Unfortunately, the President and the Prime Minister became bitter
enemies. The pro-Russian party of former
President Yanukovych had a strong position in parliament. The government appeared paralyzed and didn’t
institute the reforms demanded by the “Orange Revolution” protesters. Aided by Putin’s campaign managers and Russian money, Viktor Yanukovych was elected President again
in 2010.

Unlike the peaceful “Orange
Revolution” of 2004, the 2013-2014 demonstrations protesting the pro-Russian
policies of President Yanukovych led to the use of violence against the
demonstrators. This time the removal of
Yanukovych led to an armed rebellion against the new government by Russian separatists in the eastern
provinces (Yanuokovych’s political base), a Russian takeover of the Crimea and
a shooting war with Russia over control of Ukraine’s eastern provinces.

NATURAL GAS AS A GEOPOLITICAL WEAPON: UKRAINIAN DEMAND FOR RUSSIAN NATURAL GAS

Before the conflicts began,
Ukraine depended on Russia for about two-thirds of its natural gas, about 30
billion cubic meters a year. The cost
was around $10 billion minus transit fees, a major cost for a small economy of around $200-$250 billion. Demand has
decreased because of the loss of territory and a severe recession, down to probably
around 20-25 billion cubic meters. But
Russia has increased the price and threatened to continue the current shut-off
of gas through the winter. Ukraine agreed to pay arrears for past purchases and pay COD for future purchases. Russia agreed to supply gas for six
months.

The money for these purchases
and other debts will come from a $17 billion loan from the IMF. In addition to paying for Russian gas and
oil, a $3 billion Russian loan will come due in 2015.

Ukraine is trying a number of
strategies to reduce its dependence on Russian natural gas. One is conservation. Ukraine, despite being poor, has one of the
highest natural gas per capita usage rate in the world. A major reason is that the cost to consumers
and industry is heavily subsidized; the retail cost is about 25% of the
wholesale cost Ukraine pays to Russia.
Raising the internal price under current conditions will be politically
unpopular and maybe impossible.

Ukraine has tried to receive
natural gas from neighboring countries by “reverse flow” of Russian gas
delivered through Ukrainian pipelines.
Russia has successfully pressured at least two of the four countries
(Slovakia and Hungary) not to do this.

In the future, Ukraine may be
able to develop large shale gas fields which may be an extension of shale gas fields in adjoining eastern Poland.
Ukraine also intends to build a short pipeline to Poland. Gas will come from an LNG plant Poland is
building and other non-Russian sources through interconnect pipelines.

RUSSIAN GAS PIPELINES THROUGH UKRAINE

Worried that Ukraine could
shut off deliveries to Europe, Russia’s strategy has been to bypass the Ukraine
pipeline network. The Nord Stream
pipeline in the North Sea reduced the percent of Russian natural gas exported
to Europe through Ukraine from 80 percent to 50 percent. It brings gas directly to Germany, its
largest EU customer.

The proposed South Stream
pipeline through the Black Sea to Bulgaria would have enough capacity to
eliminate Ukraine as a transit point for Russian gas. As a political reaction to Russia’s military
actions, the European Union pressured Bulgaria to suspend participation in
building the pipeline and terminal. The
South Stream pipeline currently is on hold.
The interim Bulgarian government before the recent elections signed an
agreement to be part of a competing pipeline consortium that brings Azerbaijan
natural gas overland through Turkey and Greece to Bulgaria. A European Union committee is discussing building interconnect pipelines through Central Europe (heavily dependent on Russian gas coming through Ukraine) to Austria.

UKRAINE’S ECONOMY

Even before the conflict with
Russia, the Ukrainian economy had not progressed. In 1991, the economies of Poland and Ukraine
were about the same size. Since then,
Poland’s economy has tripled in size while Ukraine’s economy before the current
conflict was about the same size as in 1991.
The differences may be somewhat smaller since much of the Ukraine
economy, maybe as much as 40%, is underground.

The continuing war in the
east and the loss of the Crimea has devastated Ukraine’s already weak
economy. The eastern provinces contain
the bulk of the Ukraine’s manufacturing capacity and coal mines. Russian has imposed sanctions on some
Ukrainian exports. Ukraine’s economy is
expected to shrink by 8% this year and again next year. If fighting continues, this is probably too low an estimated.

Ukraine’s foreign-exchange
reserves are falling rapidly. International
loans from the IMF and aid from the European Union have only bought time for
Ukraine. It seems impossible that
Ukraine can meet its debt obligations without new loans and aid. Two months ago, the IMF said that Ukraine
will need an additional $19 billion if the fighting continues. Even with new loans, it is likely that
Ukraine will have to default or renegotiate its external debt. Part of its external debt is owned by Russia.

POLITICAL CONSEQUENCES TO UKRAINE AND RUSSIA

Ukraine
is the most important application of the Russian foreign policy doctrine of
recovering lost territories and forming the old Soviet Union (actually, the old
Russian Empire since Communism is no longer the official ideology). Putin’s power and domestic support crucially depends
on this strategy succeeding. After a massive and emotional propaganda campaign, there is no
way the current Russian government of Vladimir Putin can allow Ukraine to
retake its lost eastern territory or the Crimea. When it appeared that the Ukrainian army
might defeat the separatist rebels, Russia sent in Russian special forces and
heavy weapons.

What has
Russia gained and lost by seizing Crimea, supporting the eastern rebels and
sending Russian military forces and weapons into Ukraine? Russia has
gained direct Influence or control over 15-20% of Ukraine’s population, which
was Russian or pro-Russian before the invasions. There is little economic advantage; the
eastern provinces the separatists control are a depressed area with old
industries and uncompetitive coal mines. Many of the companies have shut down because of the fighting or management fleeing the area.

Both Ukrainian and Russian
refugees will continue to leave the area controlled by the separatists. As of the end of October, the United Nations estimates that about one million people have left, out of a pre-war population of 4.5 million. Other estimates are higher. About half have gone to Russia and half to other parts of Ukraine. Refugees tend to be the young and better educated. Russia will need to heavily
subsidize the region just to restore devastation and basic services. Already eight large convoys from Russia have carried food (and probably military goods) to the separatist-controlled areas of Ukraine.

This will
leave a Ukraine of about 35 million people that just voted 92% to be
anti-Russian and pro-Europe. Russia has given Ukraine nationalists a
permanent issue. It also eliminates part of the economic and political
power base of the pro-Russian oligarchs.
Most of the oligarchs, including the President, are now firmly
pro-Europe.

In the
long run, Russian intervention may eliminate a 300 mile buffer zone from NATO
forces and puts a large anti-Russian country right on its borders. But without internal reforms and with Russian
troops on its eastern and southern (Black Sea) territory, Ukraine will continue
to be weak economically and militarily.

In retaliation to economic sanctions, Russia has banned about $9 billion of imports, mostly food. Foreign food products are disappearing from Russian stores. Russian substitutes either don’t exist or are of poorer quality. This is the first sign that the Russian people, at least the urban middle class, are beginning to pay a price for Russia’s intervention in Ukraine. Greater economic pain will follow.

====================================================================

For background, see an earlier blog:

https://politicaleconomicsprof.com/2014/06/ukraine-background-to-current-crisis.html

For earlier analysis, see:

https://politicaleconomicsprof.com/2014/03/the-crimea-russia-and-us-options.html

November 15, 2014
Ukraine – Background Outline, Scenarios, and Comments

Petro Poroshenko

“You don’t
understand, George, that Ukraine is not even a state.”

Vladimir Putin to
George W. Bush, April 2008

FACT SHEET

Size of country – largest totally in Europe (size of Texas)

            Borders
seven countries (see map), mostly Russia and Belarus

            Russia or
pro-Russian countries and regions (Moldova) on three sides

Ethnic – 77%
Ukrainian

            17% Russian
speaking (about 9-10 million people)

                        Mostly
in eastern provinces, Odessa and Crimea.

            6% Other,
including Crimean Tatars

                        Also
religious divisions reflecting regional and political divisions.

Population – about 44-46 million. (minus 2.5 million in
Crimea)

            Very low
birth rate and very high death rate.

            Declining
population and labor force.

                        Very
low life expectancy among men.

                        Rapidly
aging population.

                                    Heavy
per capita alcohol consumption.

            Demographics
similar to Russia and Eastern Europe countries.

HISTORY

Ukraine was the original “Russia”

            Scandinavian
name meaning Red.

Kievan “Rus” first Russian kingdom
to convert to Christianity (Orthodox).

Turbulent, bloody history because of location and wide
plains. Tribes going west from Central
Asia, Vikings going south to trade with Constantinople, buffer zone between
Ottomans and Russians, source of slaves and mercenaries. In modern times, often part of another
country’s empire.

            Now between
Russia and European Union.

            Western
influences in the western half, especially among young.

Crimea annexed by Russia in 1783; most of the rest of current Ukraine conquered by Catherine the Great in 1795.

            Seized by
Russia after fall of Yanukovych in Febrauary 2014.

Only second time in the area’s history that Ukraine is a
separate country.

POLITICAL

Poorly governed since independence in 1991.

            Corruption,
organized crime, oligarchs, lack of political reform.

                        Corrupt
police and judicial system.

Orange Revolution in 2004 (non-violent), repeated in 2013-14
(violent).

Both times, demonstrated against
corruption, for closer ties with Europe.

Forced resignation of President
Viktor Yanukovych, pro-Russian president.

Generational split, with older generation more inclined to
be sympathetic to Russia and younger generation more pro-West.

New president Petro Poroshenko (often spelled Porochenko in Western press), signs EU associative status
treaty, first move to closer ties with Europe.

Major players:

            Viktor
Yanukovych (corrupt former president, generally

pro-Russian).

            Yulia Tymoshenko
(leader of Orange Revolution, generally pro-West).

            Petro
Poroshenko (current president, one of eight major oligarchs).

            Vladimir
Putin (ruler of Russian since 2000.
Former KGB officer).

            Oligarchs,
who seem to be supporting pro-West government and

                        opposing
Russian militias.

RULE BY OLIGARCHS

The new president, Petro Poroshenko, is one
of the oligarchs. He appointed three
oligarchs as provincial governors. Two refused,
one accepted. One who refused, Rinat
Akhmetov, is reported to be the richest man in Ukraine, with substantial
holdings in the disputed areas. A former
supporter of Yanukovych, he suggested a fourth oligarch be appointed governor
of Donetsk province. He was forced to
flee by separatist gunmen.

Akhmetov controls a personal militia. He was able to thwart pro-Russian separatists
in a key city south of Donetsk province.
North of Donetsk province, a key industrial city and province is ruled
by another oligarch, Ihor Kolomoisky. He
is strongly anti-Russian. Moving
quickly, he has used his personal wealth and power to equip Ukrainian military
forces and fund a professionally-trained provincial militia. Not surprising, a branch of his bank in
Moscow has been seized by the Russian government.

Wall Street Journal, “Ukraine’s
Secret Weapon Against Putin: A Feisty
Billionaire,” June 28-29, 2014.

ECONOMIC



Economic stagnation since independence in 1991.

At official exchange rates, Ukraine economy about $150 billion/year, about 1/3 the size of the economy of New Jersey.

Economic structure a legacy of Soviet Union.

About 1/4 of total Soviet
industrial production.



Much of industrial output still oriented towards Russia but
total exports to West now greater than to Russia.

Part of industrial area in eastern Ukraine adjacent to
Russia. Coal mines, iron ore, steel
mills, fabricated metal products like large diameter pipes, armaments for
Russia, oil refining, chemicals. Area of
pro-Russian protests.

            Economically
depressed, especially Donetsk region.

Serious pollution problems.

Most of industrial companies owned by eight oligarchs.

Breadbasket of Soviet Union.

            Provided
about 1/4 of food in Soviet Union.

Dependent on Russia for about 2/3 of natural gas supplies
and most of oil.

Russia’s export of gas and oil used
as political weapon. Gas supplies to
Ukraine cut off three times since 2006.

2010 treaty with Russia –
subsidized gas prices in exchange for extending lease for Russian fleet based
in Crimea. Treaty broken by Russia when Crimea
taken over this year. Gas prices raised
to European levels.

Gas use for heating, cooking and
industrial fuel heavily subsidized.

            Extremely
wasteful use of fossil fuels.

Four of six oil refineries owned by
Russian companies.

Ukraine has potentially large shale
gas deposits.

UKRAINIAN NATURAL GAS IMPORTS

In 2012, Ukraine consumed 53.8 billion cubic
meters (bcm) of natural gas. Domestic
production was 19.7 bcm. Total imports
from Russia were 32.4 bcm, or about 63% of total usage. For a relatively poor country, Ukraine’s gas
usage is unusually high. Total usage is
three times that of Poland and larger than France. (Source:
International Energy Agency)

Cost of imported Russian natural gas about $10 billion per year. Ukraine having trouble paying. Needs Western financial assistance.

In 2013, the European Union (EU) countries
imported $166 billion of oil and natural gas from Russia. The EU ran an $86 billion trade deficit with
Russia.

LARGER ISSUES

Integration of former Soviet satellite countries in central
Europe into economic, military and political unions of Western Europe.

            Best
opportunity for peaceful integration in over 1,000 years.

Resurgence of Russian nationalism – sees integrating Europe
as a geopolitical and military threat.

            Supported
by Belarus and some factions in Ukraine.

                        Geographical
buffer zone next to NATO countries.

            Lack of
political and economic reforms in all three countries.

            Major
campaign to modernize Russian military weapons.

Russian use of oil and natural gas as geopolitical weapons.

            May be less
effective in future.

                        Large
deposits of shale gas in Europe and Ukraine.

                        Alternative
European import sources.

Internal threats to European section of Russia.

            Declining
European population.

            Rising
Muslim and Asian population in southern and eastern areas of Russia.

                        Muslims
make up 10-15% of Russia’s population.

Potential threat of China to Eastern Siberia and Vladivostok
(Chinese territory until 1860).

Europe moving to reduce imports of Russian natural gas.

            Opportunity
for U.S. Canada and other countries to export LNG to Europe.

                        Canada
building large LNG facility in eastern Canada to export

                        natural
gas to Europe.



Russian Black Sea pipeline to bypass Ukraine on hold.

SCENARIOS

Ukrainian forces defeat pro-Russian rebels
but guerrilla war continues.

            Continued
centralized control.

                        President
appoints provincial governors.

            Russia
reduces support but continues covert operations.

  Ukraine
rebuilds military forces with outside assistance.

Continued fighting leading to new constitution that gives
substantially more autonomy to eastern provinces.

            Possible if
Russian rebellion contained and truce holds.

Reduces highly centralized
political control of country.

Continued fighting and continued Russian pressure to
destabilize eastern provinces with ultimate aim of absorbing two to five
provinces without invasion of Russian troops.

            Victory for
Russian nationalism without economic sanctions.

Russian interference has probably
strengthened desire of western 2/3 of Ukraine to move closer to EU and
eventually NATO.

Russian invasion of eastern Ukraine.

Russian annexation of two eastern
provinces, adding 5-6 million people to European Russia.

Harsher economic sanctions. Serious impact on Russian economy.

Ukraine signs economic treaty with EU and eventually becomes
a member of EU.

            Receives
substantial financial aid.

            Outside
pressure for political reform.

Scenarios are not mutually exclusive. Some or all may happen at different times in
the future. For example, if eastern
provinces become part of Russia, the rest of Ukraine will probably ask to
become a member of NATO and EU.

COMMENTS ON SCENARIOS

Ukraine’s president has signed an associative member agreement with the EU, as he promised he would. Russian nationals’ rebellion in two eastern provinces and Russian threats eliminated prior policy alternative of trying to balance Ukrainian foreign and economic policies between Russia and the West. One consequence is that Ukraine will probably now receive about $32 billion in economic aid and loans from IMF, EU and US. IMF loans come with strings attached – Ukraine will have to reduce domestic subsidies for natural gas users and begins to reform government. I would also guess that Ukraine will have access to Western military gear and training. In longer run, good chance Ukraine will join EU and NATO.

I think there’s a good chance that current
and threatened economic sanctions will lead Russia to lessen support for pro-Russian
rebels in Ukraine, especially if Donetsk falls to the Ukrainians. Russia
still controls Crimea. There will probably be less overt but continued
covert Russian support. Putin will reduce rhetoric. Russia may continue
to threaten Ukraine with invasion.

Putin cannot appear to totally abandon the pro-Russian rebels. His seizure of
Crimea, military buildup on the border, hawkish rhetoric and military support
for the Russians in eastern Ukraine increased his popularity in Russia. He has to
appear to be continuing his support for the rebels without triggering economic
sanctions that will seriously damage the Russian economy.

Russian oil output is declining.
Russian has huge shale and deepwater oil and gas deposits but needs
Western technology to get at them. This is more important to Putin’s strategic objectives than supporting
Ukrainian rebels. In addition to keeping large European market, increased
production opens up large new markets in Asia, especially China, which intends
to triple LNG imports in the next 8-10 years. Economic and military
resurgence of Russia and Russian nationalism depends on exports of oil and
gas.

Russia will continue
to attempt to destabilize and subvert Ukrainian government but won’t invade, despite
huge military advantage. Combination of economic sanctions (including
access to Western technology needed to develop huge untapped oil and gas
fields), fall in foreign investment and tourism,
and increased capital flight would seriously hurt Russian economy.
Exports, mostly oil and gas, are about 1/4 of Russian economy and pay for
military modernization among other Putin objectives. Europe will
accelerate trend to using less Russian natural gas and oil, but will remain a
major market for Russia.

Huge potential increase in
global supply because of new technology to get at shale natural gas (and oil)
will make up for potential loss of Russian natural gas to Europe.
Eventually.   Other countries must
make massive investment in drilling, pipelines, LNG plans and LNG tankers. Needed new LNG ships will cost about $50
billion (New York Times, August 5).
Total elimination may take five to seven years but alternative sources of
supply already available.

Europe and Ukraine have their
own potentially huge deposits. Political opposition to fracking will slow
up development in France and Germany but probably not in Poland, Romania and
Ukraine, the countries with the largest potential deposits. Ukraine will
invite in Western oil countries to help develop natural gas reserves and
modernize economy. Hopefully, EU ties and foreign investments will lead
to economic growth.

If U.S. built a
pipeline network from North Dakota and Canadian shale natural gas fields to
Texas and/or east coast, and the U.S. government licenses liquified natural gas
(LNG) plants, the U.S. could export very large amounts of natural gas to Europe
at a lower price than Russia is currently charging. One new U.S. LNG
plant has been approved and seven more are pending. Canada has already started design work on an
LNG plant in eastern Canada. This could eliminate future Russian threat of
shutoff and strengthen ties of European economy to U.S. and Canada. Major
geopolitical change.

Speculative, more unlikely scenarios. 1) Ukraine voluntarily lets go of two eastern provinces. Gets rid of most of remaining Russian population and economic ties to Russia. Russian population in Ukraine less than 10%. Future firmly with West. 2) Government and judicial system becomes less corrupt and fights organized crime.

For an earlier discussion after Russia seized the Crimea, see The Crimea, Russian and U.S. Options.

ADDITIONAL INFORMATION

For a quick look at the huge disparity of the Russian and Ukrainian military forces, see

http://www.bbc.com/news/world-europe-26437359

Not in the video — Ukraine’s main battle tank, the Russian T-64, has been taken out of service in Russia because it is obsolete. Russia’s tank force includes about 550 T-90s that are comparable to the West’s best tanks. Next year, Russia says they are starting production on the T-95 which, on paper, may become the best tank in the world. It is also a step towards a fully robotic tank, which makes sense in a country with declining population. Russia’s military superiority may be irrelevant if Russia believes stronger economic sanctions will be imposed if they invade Ukraine.

By the way, U.S. design and production to replace the Abrams tank has been slowed by budget cuts and sequesters. The conservative Republicans are a danger to the national security of the country.

I would emphasize that many of the top leaders in the Ukrainian military, SBU and police started their careers, and were trained, by the Soviet Union. Also, since about 17-20% of Ukraine’s population is Russian, I would assume that a lot of police and military are unreliable. It is probably one reason some Ukrainian police and military units surrendered to Russian militia without a fight and gave the militias equipment. Poroshenko is replacing top military leaders. Then there is corruption.

Economic comparisons are harder because much of both economies are underground. Probably higher in Ukraine – one estimate by two Ukrainian economists in 2012 is that 44% of the economy is underground. Even adjusting for that, the Russian economy is about 10 times larger than Ukraine’s. Roughly, $200 billion vs. $2 trillion.

One of
the problems is that modernizing the Ukrainian economy does not necessarily
mean increasing employment. The world’s largest steel company took over
Ukraine’s largest steel complex. It spent billions modernizing the plants
and increasing capacity but reduced employment from 57,000 to 33,000. One
of the oligarch just built a fully automated steel pipe plant that created few
new jobs.

But Russia is vulnerable to economic sanctions and, in the near future, possibly declining exports of oil and natural gas. The two are related; economic sanctions would deny Russia the Western technology they need to get at huge untapped oil and natural gas deposits.

INFORMATION SOURCES

BBC News, “Ukraine Crisis Timeline”

http://www.bbc.com/news/world-middle-east-26248275

New York Times, “Ukraine Crisis in Maps”

http://www.nytimes.com/interactive/2014/02/27/world/europe/ukraine-divisions-crimea.html?_r=0

CIA World Factbook

Financial Times

Novenite (From Bulgaria, in English)

VICE – Russian Roulette (on YouTube)

  Video interviews in areas controlled by pro-Russian militias.

kvivpost.com (from Ukraine, in English)

June 29, 2014
The $100 A Barrel Solution

The high and sustained price of crude oil is having
unintended consequences.

Global consumption of crude oil rose by 14% between 2000 and
2010, about equal to the increase in population. Almost all of the increase was in Asian
countries, especially China
and India, and,
surprisingly, the Middle East and other oil-exporting
countries. The Middle East
as a whole increased oil consumption by 56%, led by Saudi
Arabia with a 78% increase. Heavily subsidized and inefficiently used,
domestic consumption of oil accounts for about one-fourth of Saudi
Arabia’s huge oil output, about 2.5 million
barrels a day.

In contrast, the U.S.
and Europe decreased oil consumption by a small amount, less
than 1% in the U.S, over the same period.
Some of this is due to the recession, but there are longer-term trends
that might lead to continued decreases in total oil consumption.

It is important to remember that crude oil is an input;
people and companies like airlines consume refined products.

Good for U.S.

The high and sustained price of crude oil has made it profitable
to develop huge deposits of shale oil and shale natural gas. I remember reading a few years ago that
developing shale oil in the U.S.
and Canada
would be profitable if the price of crude oil stayed above $80 a barrel. Since then, improved extraction technology
has lowered the breakeven price.

The U.S.
also has huge reserves of natural gas in shale.
A current estimate is that the U.S.
has the second largest natural gas reserves in the world. Some of it is extracted as a by-product of
shale oil drilling.

The low price of natural gas will continue the trend of
substituting it for oil and coal. One
advantage is fewer carbon emissions into the atmosphere. This has already started in the U.S.
as natural gas accounts for all of the growth in power generation. Low natural gas prices have led to a large
substitution of gas for coal in generating electricity so far this year.

The Obama administration has just announced strict coal
emission standards. About 43% of
electricity is generated by coal. The
percent has been declining but substitution of cleaner natural gas for coal
will probably accelerate if the standards remain. They could be weakened or reversed by a
Republican administration.

There is no net reduction in carbon emissions if electric
and hybrid cars are powered by electricity generated from coal.

The boom in shale natural gas spurred by the high cost of
oil has slowed down; prices have fallen and the number of operating wells has
declined. But even a moderate increase
in the price of natural gas still gives it a huge price advantage over $100 a
barrel oil.

Gasoline consumption has been going down. Besides the recession and the higher cost of
gasoline, other factors are the mandate to use ethanol, and the subsidized
adoption of electric and hybrid cars. In
addition, the Obama administration has announced higher long-run mpg
requirements for cars. Higher mpg
requirements could be reversed by a Republican Congress and president.

Total fossil fuel energy inputs may go down. This is almost certain to happen under
Obama’s comprehensive “cap and trade” plan for all energy. This will further reduce imports of oil and
increase demand for domestically-produced natural gas. Even though originally a Republican idea, it
is opposed by Republicans and some conservative Democrats, especially from
coal-mining states.

A higher percent of U.S.
oil and gas imports will come from Canada. This will make us less dependent on hostile
or unstable suppliers.

But the big change is that the U.S.
has become a major exporter of
refined oil products. Besides crude, the
U.S. has been a
large imported of refined oil products, mostly from Europe.
U.S. exports
have risen very rapidly in the last few years to almost $100 billion a year in
refined oil products. In 2011, the U.S.
exported more gasoline, heating oil and diesel oil than it imported for the
first time since 1949.

Domestic production reached an eight year high in 2011. The number of new wells drilled per year
continues to rise.

This has dramatically changed America’s
net imports of oil products. The
peak in 2005 was over 12 million barrels a day; last year our net imports were
8.4 million barrels a day, which was 11% lower than in 2010. Net imports are expected to fall again in
2012.

The underlying trends – increased domestic production of oil
and natural gas, slowly declining consumption, increased exports – should
continue the trend of reducing net imports.

If the U.S.
expands its oil refining capacity and approves the XL pipeline, there will be long-term
increase in U.S.
exports of refined oil products, making the U.S a dominant exporter of refined
oil products. Higher crude oil prices
can be passed on as higher prices of exported refined oil products. As more imports and domestic production of
crude are exported, this should also help our balance of payments deficit.

Bad for China and Japan (at least in the short run)

In the short run, high crude oil prices are bad news for China
and Japan. Chinese imports of crude and refined oil are
rising rapidly due to a huge increase in car and truck production. This year China
may surpass the U.S.
as the world’s largest net importer of oil products. You might also take some comfort that the
price of gasoline in China
is $5 a gallon.

China
has huge untapped natural gas reserves.
As these are developed, they will be used as a substitute for the massive
amount of coal that is burned to generate electricity. China
is the world’s largest producer and consumer of coal; its coal-burning plants
are inefficient and dirty.

Japan
has virtually no domestic oil production, importing all of its crude oil needs.

Japanese imports of natural gas are also way up as all of
its nuclear power plants have been shut down.
Many, maybe most, will never be restarted. There is a movement in Japan
to permanently close all nuclear plants.

One consequence of all this is that the U.S.
seems to have a widening cost advantage in energy inputs, especially in
manufacturing. Combined with other
trends, the U.S.
may become more price competitive in many areas of manufacturing. A few global companies have already brought some
manufacturing back to the U.S.
from China.

Bad for Iran

This is counterintuitive.
How can high crude oil prices be bad for the world’s third largest crude
oil exporter?

Iran
is also a big importer of refined
oil products like gasoline. Domestic
consumption of refined oil products increased 38% between 2000 and 2010. The domestic price of gasoline, starting at
$1.30 a gallon and rising to about $2 a gallon, is heavily subsidized by the
government,. Iran
is selling crude oil at about $2 a gallon and is buying gasoline at about a
little under $3 a gallon. The regime is using
crude oil revenue to heavily subsidize gasoline and other basic consumption
items, and also giving cash allowances to the poor. The regime is scared that an increase in
gasoline prices might spark protests, as it has in other countries, and will increase
subsidies to the poor to pay for the higher prices.

These policies buy support for the regime but at a cost of
using much of their oil export revenue. The
result is a corrupt and inefficient economy.

The longer-term problem for Iran
is that total crude oil production is going down while domestic consumption and
imports of refined products is going up.
Iran could
increase domestic production of oil and natural gas but the economic embargo
and the use of oil revenue for subsidies and nuclear power (and probably nuclear
weapons development) has meant little increase in domestic refining capacity. Unless there is a change of policies and use
of oil revenues, Iran
may cease to be a net oil exporter.

The U.S.
generates more revenue from exporting refined oil products than Iran
does exporting crude oil.

Iran
is the latest example of the oil curse.

Conclusion

For the foreseeable future, natural gas will be substituted
for both oil and coal. U.S.
imports of crude oil will continue but probably at the same or lower level than
now. More of imported crude will be used
as the input to produce refined manufactured products that are exported. This is the reason for building the XL pipeline. We will still run a trade deficit in energy
but it will be a declining percent of GDP.

It is in the U.S.
national interest for crude oil prices to remain above $80 a barrel for a
sustained length of time so that investment in shale oil and shale natural gas
production and distribution continues.

Public energy policies, or lack of, will be crucial in
determining the speed at which these changes occur.

______________________________________________________________________________

Related Post: The Oil Curse

May 29, 2012