Prognosis by Ken Egli for ISN Security Watch
The tense situation on the world energy market is unlikely to change in 2008. A return to an oil price of US$50 per barrel or below is an unrealistic scenario, as a massive increase in demand over the past few years has put pressure on oil-producing countries to keep up with the production of additional supplies.
According to the US Energy Information Agency (EIA), the largest increase in energy demand in the near future is to be expected in the non-OECD (Organization for Economic Cooperation and Development) countries.
Many developing countries - especially China and India - have rapidly growing national economies, which, like their OECD counterparts, are run on fossil fuels. Most of them are unable to cover their energy demand with their own production capabilities.
China for example, despite having considerable energy reserves, is an increasing net importer of oil and other fossil fuels. At the same time, energy demand in the OECD countries is also likely to remain high.
In contrast, oil production in non-OPEC countries has been stagnating over the past few years, leaving OPEC to pick up the slack. The grouping, however, has been reluctant to massively increase oil production to dampen prices, claiming that speculation is responsible for the high prices, not the actual supply on the market. Whether the OPEC countries are keeping their production growth on a modest level for profits or are hindered by technical difficulties is unclear.
However, many investors seem to expect rising demand to exceed supply. Several political scenarios in the Middle East are further adding to this expectation and are increasing the volatility of energy prices. Such scenarios include the conflict over Iran's nuclear program, or a widening of strife in Iraq and a subsequent regional armed conflict, which could compromise the production and transport of fossil fuels around the Persian Gulf.
The importance of this region for global energy security can also serve as an explanation for the nervous reaction of the market to terrorist activity in the area.
There have been several attempts by militant groups on the Arab Peninsula to interrupt the production or transport of energy resources.
On 24 February 2006, militants driving two vehicles packed with explosives attempted to enter the Abqaiq oil processing facility in Saudi Arabia, which removes hydrogen sulfide from crude oil and reduces the vapor pressure from the liquid, making it safe for transportation in tankers. When guards opened fire, the vehicles exploded, killing two militants and two guards but leaving the facility's operations unimpaired.
Had the attack succeeded, Saudi Arabia's export of and the world's supply of crude oil would have been seriously interrupted. Such terrorist activity against critical energy infrastructure poses a severe danger to the world's energy security.
A comparably cheap militant operation possibly can create billions of dollars in economic damage. It is very likely that such attempts, successful or not, could lead to spikes in energy prices during the next year. At the same time, the price level will also remain high given the fact that a sudden end of political troubles in the Middle East in 2008 is highly unlikely.
Another area of concern that could drive up prices is Russia and Eastern Europe. Russia is the most important supplier of natural gas on the regional European gas market and therefore vital for Europe's energy needs. Gas, unlike oil, can only be transported in large quantities via pipelines running through the former Soviet republics of Eastern Europe. Almost all of those countries are consuming a considerable amount of gas from northern Russia and are therefore subject to political pressure by the Kremlin and Russia's state-owned gas giant, Gazprom.
When a dispute about the price of natural gas between the Ukrainian government and Gazprom escalated in late 2005, supplies to the country were cut on New Year's Eve 2006, driving up gas prices in Europe and leading to supply decreases of up to 27 percent of the EU's total consumption. The scenario of another crisis between the Russian energy giants and the politically weak non-EU countries in Eastern Europe cannot be dismissed in the coming year and could lead to price spikes on the European energy market.
Russia's willingness to use its energy deliveries to exert political pressure has also triggered concerns in Europe about its own energy dependence. Some politicians and interest groups have repeatedly warned that Russia could use its resource power to push its political agenda in Europe.
The most alarmist experts have voiced concern that Russia could directly use the "energy weapon" against Europe. However, this scenario is unlikely in the near future, as Russia's economy is heavily dependent on the European market to sell its natural gas.
Substituting the European market is rather difficult for Russia, as the existing pipeline infrastructure is oriented toward Europe and no connection exists between the resource-rich northwest of the country and the emerging markets in the Far East. In order to reach the wider world market with its natural gas, Russia must either build pipelines into the Far East or develop a considerable capacity to liquefy natural gas, neither of which is likely to happen in the coming years.
A real danger however, is the deteriorating state of Russia and Eastern Europe's pipeline infrastructure. As Stratfor reported early in December, a section of the Europe-bound Urengoi-Pomary-Uzhhorod natural gas pipeline was destroyed by an explosion on 6 December.
According to Stratfor, deferring maintenance is the most likely explanation for problems with the Russian-Ukrainian energy infrastructure.
In July 2006, a similar incident hit the Druzhba oil line. Transneft, the company that operates the pipeline was forced to temporarily close the Druzhba-1 line, which carries one-eighth of Europe's crude oil imports, after a spill on the Russian border with Ukraine and Belarus. Such technical problems combined with Russia's growing domestic energy consumption could in the long run severely compromise Europe's energy security.
In the short run, however, smaller incidents like the explosion in the Ukraine could lead to price spikes on the markets and need to be taken into consideration.
The resource race
The coming year will certainly see a continuation of the open and covert race for energy supplies by the major world powers. It is very likely that the situation between governments could intensify, especially concerning the disputed northern polar region, which, due to climate change, is becoming increasingly accessible by sea.
Russia staked its claim in August 2007 in planting a small flag on the seafloor on the North Pole. Canada soon thereafter announced a plan to modernize its naval fleet in order to protect its interests in the region.
Although an open conflict over such resource-rich areas remains unlikely over the next few years, it could trigger major diplomatic disputes. At the same time, the foreign policy agenda of many western governments will be heavily influenced by their energy interests, which could soften the stance toward autocratic regimes possessing such energy resources.
China will continue to be a major player in the quest for energy assets, actively seeking deals with energy-rich countries in Africa and the Middle East, including Iran. The country's efforts to build a strategic partnership with regimes hostile to the US could negatively influence the relationship between the two powers. China's ever-increasing hunger for foreign fossil fuels will put more pressure on other countries to enter the race.
Enter alternative energy
Increasing energy prices have made alternative or "green," energy sources more attractive over the past few years. The year 2008 will likely see an increase in the use of wind, hydro- and solar energy. Their overall importance however, will remain marginal: In 2006 the share of renewable energies of the EU (25) countries' energy consumption was only 6 percent. In the near future, this share might increase, but only on a small scale.
Ethanol as an alternative source of fuel has been the focus of intense discussions as it may be the West's only feasible way of substituting the use of fossil fuels on a large scale. However, this alternative seems to cause its own economic problems.
In a 6 December article, the UK weekly magazine the Economist reported that the increasing demand for corn from the ethanol industry seemed to be driving up the price of grain, which was leading to higher food prices. Although this line of thinking may be a bit alarmist, the ethanol industry will certainly face tough questions about the repercussions of its fuel production. Nevertheless, the popularity of ethanol as cheap fuel will certainly increase in 2008.
Nuclear power
At the moment, the only serious alternative to carbon-based fuels seems to be nuclear power, which is neither very popular among many western countries nor easily achievable for others.
In 2008, the discussion over who has the right to possess nuclear technology will likely continue. Whether new nuclear power plants should be constructed will also be on the table. The whole overall dialogue will be centered on one question: Which is more important, the reduction of carbon emissions or the safety concerns regarding the use and proliferation of nuclear technology.
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