Geopolitical and Cyber Risks to Oil and Gas

Whether an oil and gas company is working in the United States or is spread throughout the world, it will face geopolitical and cyber risks which could affect global energy security.

Geopolitical Risk

There are numerous geopolitical risks for any oil and gas company. Even if a company just works in the United States, it needs to know what is happening in countries all over the world, especially those countries that are large oil and gas producers. Because oil markets are so tightly connected globally, major political events in oil exporting states could seriously affect the price and even availability of oil. An attack on an oil platform in Nigeria, a terrorist event in Iraq, the closing down of port facilities in Libya and many other examples come to mind. Consider the potential effects of a major attack on the Ab Qaiq facility in Saudi Arabia. If this facility is damaged or destroyed on a large scale by rockets or bombs, the world oil market could be out 6-7 million barrels of oil a day- out of the 90-92 millions of barrels a day the world needs. World spare oil production capacity is about 2.3 million barrels a day. It could take some time to get this online. The spare production can be ramped up, but not immediately. Given that the grand majority of excess capacity in the world is located in Saudi Arabia and that this excess capacity could be significantly cut back with damage to Ab Qaiq, the situation is even riskier.

Another major risk nearby is transits through the Straits of Hormuz. About 16-17 million barrels a day goes out of the Straits. Any attempts to close the Straits (even unsuccessful ones) could have significant effects on the prices of various grades of oil. Even with the seemingly warming in relations between the U.S. and Iran, it is still possible that things could take a turn for the worse in the Gulf region. If the present negotiations with Iran break down, tensions could rise to even higher levels than before negotiations began. This could bring discussions of the military option more public. If there is a major conflict involving Gulf countries, the United States and its allies, then all bets are off on where oil prices may go. There could be many scenarios: from oil prices increasing $100 over the pre-conflict base price to well over $200 over the pre-conflict base price.

In many other parts of the world, geopolitical risks going “kinetic” can affect oil markets. Syria is a potential whirlpool of trouble for the entire Middle East. Egypt and Libya are far from stable. Algeria could be heading into some rough times. The Sudan’s will remain problematic and potentially quite violent for some time to come. The East China Sea and South China Sea disputes are not resolved. The Central Sahara could be a source and locale for troubles for some time to come.

Terrorist events can happen anywhere. Google Earth allows terrorists and others to get very close looks at major oil and gas facilities, transport choke points and more. Also, there are not that many tankers plying the vast seas and oceans of the world. Some of the most important routes are between the Gulf region and East Asia and Europe. Others travel from West Africa to Europe, and less so to the United States than before its shale oil revolution. The Mediterranean has many important tanker shipping routes. The Red Sea is a crucial route for both ships going north and south. Over 50 percent of oil trade happens on maritime routes. Many of these tankers cross through vital chokepoints like the Strait of Malacca, the Strait of Hormuz, The Bab al Mandab, The Suez Canal, The Turkish Straits, The Danish Straits, The Panama Canal, and various harbor and river routes where risks may be higher r at sea. Even whilst at sea, ships are at risk as shown by pirate attacks and hijackings off of East Africa, West Africa and previously off of Indonesia. There are about 1,996 crude oil tankers. However, only 623 of these are of the Ultra Large Crude Carrier (ULCC) or Very Large Crude Carrier (VLCC) variety that are the most important for transporting crude oil economically over long distances from the Gulf region to places like China (the biggest importer of oil), the United States, Japan, South Korea, and Europe. VLCCs can carry about 2 million barrels of oil while ULCCs can carry up to 2.3 or, rarely, 2.5 million barrels of oil. Normally these massive ships carry crude oil, but sometimes carry many different types of crude oil. Smaller petroleum tankers may carry both crude and refined products depending on their trade routes and the state of the markets at any times. There are about 493 Suez Max tankers, which can hold about 1 million barrels of oil and refined products and about 408 Afrimax vessels, which hold about 500,000 to 800,000 barrels of crude or refined products. Additionally, there are 417 Panamax vessels, which can carry 300,000 to 500,000 barrels of oil or refined products.

This may seem like a lot of ships to some. However, especially in tight markets, the pressure is immense to keep these ships at sea and to keep them on time. Moreover, there are lots of logistical complexities in trying to keep the crude moving at the right times and to the right places. If anything disturbs this complex economic and logistical ballet of behemoths, then the economic effects could be considerable. If the oil does not arrive on time then refinery production and deliveries of refined products to markets could be disturbed. Most countries have crude and product reserves to handle short term disruptions that may result from tanker losses. If the tanker losses are large or other disruptions occur in the supply chains of crude via ships, then those reserves could be worn down. It takes well over a year to build one of these tankers.

If the market for tankers is soft and some available tankers are moored in port, (such as when close to 500 hundred ships and dozens of tankers were moored off Singapore a few years ago), then the chances are better of getting the shipping logistics back to normal faster. However, problems could still arise in getting ships needed in Houston or Ras Tanura from Singapore. The travel times of these massive ships add considerable costs and disruptions.

When disruptions occur, some crude cargos can change direction and can be sold and resold, depending on the sorts of contracts that are in effect, along the way. Sometimes the disruptions are from political events, such as revolutions, insurrections, civil instability, and natural events like hurricanes and tsunamis. For example, when the tsunami hit Japan on March 11, 2011, many cargos were delayed or reconfigured. However, these sorts of events are different from terrorists blowing up a series of ships, as the psychology is different.

There is a certain amount of flexibility built into crude tanker transport markets, but a larger question is what would happen if many of them were taken out in various parts of the world. Would such a “black swan event” cause great disruptions? This is most likely. The follow on question would be how the tanker and other connected markets would react to this to help resolve the logistical attacks and how this might affect tanker insurance and lease rates.

Given that the crude and other products feed into other supply chains and markets, there could be cascades of disruptions in many parts of the world from a significant attack on even one large VLCC. Attacks on more ships would become increasingly more complex and costly in their effects.

If even one ship is sunk with a missile, the effects on oil markets and the world economy could far outweigh the mere few hundred millions of dollars in value the tanker and its cargo may represent. Ports, pipelines, refineries, tankers and other parts of the oil, transport and other infrastructures could be affected.

The destruction of an oil facility in a sensitive area that may be worth a few billion dollars could have a negative economic impact globally in the hundreds of billions, if not more. Attacks on the Houston Ship Channel, the Louisiana Offshore Oil Port, Ras Tanura in Saudi Arabia, the Jubail Complex in Saudi Arabia, Kharg or Lavan Island in Saudi Arabia could have considerable impacts economically and even militarily.

The impacts of attacks on these facilities would be stronger when oil and tanker markets are tight, and when the world or salient regional economies are growing quickly. An attack on a major tanker route out of Saudi Arabia heading to China or Japan will have a lot less effect on tanker and oil markets when there are excess tankers at anchor, and when there is excess capacity in oil production to make up in a relatively short time than when both tanker and oil markets are tight and there is little excess capacity. The less elastic the markets, the more effect any attacks will have. If a terrorist group wanted to have the most impact on the world economy it would likely attack in times of high growth in various important economies and when there is little excess oil capacity and no spare tankers. Often these three markets are tied together. When the global economy is growing quickly oil markets are under stress. When oil markets are under stress then tanker markets are stressed.

Looking to the future, some countries could be facing political turmoil such as Russia, Saudi Arabia, Iran, and Venezuela. This turmoil is not deterministic, but it is also not completely out of the bounds of probability. Depending on the type of turmoil, damage, and loss of production and export capacity, these events could have significant effects on world oil markets.

If such turmoil is going to happen, it is better for the world oil markets and the world economy that these happen during times of greater excess production and export capacity than the losses in oil production and export capacity from the turmoil. The worst of all possible combinations would be the loss of production and export capacity during very tight market times in a country where most of the excess capacity is found, which is in Saudi Arabia. If the world economy is growing quickly all around, then the effects of such turmoil will be far greater than if the world economy is in a slow growth period.

There are also regional aspects; during the 2011 Libyan Revolution, Europe’s economy was starting to dig itself out of a deep recession that had affected most European countries. Most of Libya’s oil that was cut off for a while was supposed to go to European countries, especially Italy, Spain, and France. Libyan oil production was about 1.7 million barrels a day until the civil war/ revolution began in February 2011. About 1.5 million barrels a day was exported. After the beginning of the conflict, production dropped to about 200,000 barrels a day, and did not recover until the post-civil war “recovery” that began about 8 months later. In the period between the start of the civil war/ revolution and the start of the ramp up, oil production dropped to 100,000 barrels a day and then on down to about zero barrels a day. Very little was exported during the times of the conflict. The fact that many European economies were growing slowly, or in some cases not growing at all, helped alleviate the potential effects of the cutting off of oil shipped from Libya. About 85 percent of Libya’s oil exports before the conflict went to Europe. The countries that relied considerably on Libyan were Italy, Austria, Ireland, Switzerland, Spain, Austria, and France. However, most of these were in slow-growth phases due to the ongoing recession and growing financial crises in their countries. The tanker markets were also soft and there was significant excess capacity of oil production in Saudi Arabia. The Saudis tried to backfill some orders for Libyan crude, but some of these did not work out well due to the heavier, sourer nature of the available Saudi crude compared to the usually light, sweet crude out of Libya. Switzerland is different from the other European countries as its “consumption” of Libyan oil was mostly for trading the oil in hedge funds and the big commodity firms in Geneva. The rest of these countries needed it for their overall economic needs.

Libyan crude production increased to about 1.4-1.5 million barrels a day until further problems occurred in mid-2013 with strikes at the ports and some energy facilities. Production is now down to 200,000 barrels per day. The effects on prices has been a lot less this time than during the civil war due to new, more flexible trading arrangements and better planning for such contingencies out of Libya, but also because the European economy and tanker markets remain weak.

Many Americans may think that they are relatively immune from geopolitical turmoil in oil disruptions because of the shale oil and gas revolution in the United States and Canada. However, there is potential for the increase in trade of oil with Canada which will result in greater access to oil and gas.  But, this will not buffer the United States from the vagaries of oil prices caused by geopolitical events. This is mainly due to oil being a globally traded commodity.

Unlike the oil industry, the natural gas industry is not fully globally integrated, but it looks to be heading that way. As more countries invest in both conventional and unconventional reserves production, the development of LNG (Liquefied Natural Gas) export and import facilities, and expansions of major international pipeline networks, the world natural gas market will have some great changes. Some of these may include the convergence of prices of natural gas globally. Recent prices of natural gas (FOB – Freight on Board, where the buyer pays for transport costs) in China were about $15 per MMBTU (Million British Thermal Units), a common measurement of natural gas amounts. In Japan they were in the $16-17 ranger per MMTBTU. In many parts of Western Europe LNG (FOB) prices were about $9-11 per MMBTU. Natural gas in the United States recently has sold for about $3 per MMBTU. Qatar could sell at cost for much lower, as it sells to the United States for about $3 MMBTU similar LNG that it sells to China and Japan for much higher prices. With the convergence of prices, the lower cost countries will likely be the survivors. Others may have to drop out if they have to export the LNG at a loss, unless the country subsidizes these exports, which would be problematic under the World Trade Organization (WTO) agreements.

Those countries that develop their LNG export facilities the fastest will capture more of the most important markets (such as Japan, South Korea, and especially the potentially gigantic market in China), than those countries that doddle along in their decisions to export or not. The future of global gas markets is more of a very competitive and very expensive 4D chess game played by very powerful people, rather than just some engineering or economics exercise as some look at it.

As the now regional and segmented natural gas markets develop into global integrated markets, they  will become more efficient and regional prices will start to converge toward a global price, much like oil. As the global natural gas markets develop, there will be more spot markets developed and less need for long term contracts in many instances. For decades, oil and gas prices were linked. As a global natural gas market develops, and especially with the further spread of the shale gas revolution, fewer and fewer natural gas contracts will be linked to oil prices. However, this integration of the natural gas industry globally also brings the risk of terrorist or political driven turmoil at or near LNG ports, LNG ships, and even in the market trading centers in places far removed from the United States. The more globally integrated the natural gas markets are, the more likely reverberations to prices will occur globally, rather than just locally. It is sort of like dropping a large rock in a pond with many barriers compared to dropping a large rock in a pond without many barriers in it. The waves will have more extensive effects without the barriers.

At the moment, the United States has a special domestic market that is fairly immune from outside events, as one would expect that they would happen in Canada, the United States’ major natural gas trading partner. This will change over time as U.S. natural gas markets get more connected with the world. The United States have some buffers during difficult gas shocks globally due to massive shale gas reserves. However, it could take a long time for these reserves to surge into the domestic markets to make up for the price increases.

Large profits can be made in exporting natural gas to places like China, Japan, South Korea, and Western Europe where gas prices are much higher. Over time those price differentials will decline because more LNG and piped gas will be flowing to the more profitable markets, hence putting pressure on prices.  Global gas prices will tend to converge, but not entirely given different extraction, production, liquefaction and gasification prices.

With greater integration there are also new risks to consider. Some of these include potential attacks on major LNG facilities as natural gas becomes a more vital part of the world economy and some countries. There are also increased risks that as the global markets get more integrated in natural gas, events distant from the United States could affect prices in the United States much like what happens now with oil markets.

There are great profits to be made from exporting the potentially massive amounts of natural gas (mostly shale gas), from the United States into these newly developing world markets. (The greatest profits can be made in the first years of the development of these markets prior to the lowering of prices in Asia, Europe and higher priced areas as the markets get integrated.)

However, nothing is ever certain and some planning and emergency regulations may be required to help potential shocks from entering U.S. markets. Complete immunity is not possible when a market is globalized, but with proper consideration risks might be mitigated. A very large natural gas strategic reserve system might be best built and filled when the natural gas is cheap for times when it may be less accessible (likely for the short run given how quickly shale gas pads and production can be set up).

Cyber Risks

According to Europol there have been many cyber-raids in 2012 on logistics and computer networks connected to container ships by criminal gangs to obtain the illegal drugs they had hidden in the holds of the ship. The gang truck drivers were able to find the containers, get the security codes, and were able to get the drugs off the ship without being caught. This could be the start of far more serious cyber-attacks on shipping and maritime logistical networks. The oil and gas industry is information intensive and it is hard to get around that. Computer systems, the internet, and other cyber-based devices and operations are key elements to the operations of the industry. For example, Saudi Aramco and many other oil companies in the Middle East region have been cyber-attacked in recent years.

In addition, cyber-attacks have both financial and real effects, including distortions in the prices of oil and gas. Hacking into the derivatives and futures markets could wreak serious havoc on the industry. Real effects could include attacks on SCADA (Supervisory Control and Data Acquisition) systems that control oil and gas pipelines. SCADA is also used in refinery operations.  If a container ship can be hacked, how far off is it when an LNG or oil tanker is taken over or hacked? Tanker traffic is often controlled and monitored via computer systems and the internet. Clever cyber warriors and others are likely trying to crack these systems (or potentially have even cracked them at times), but the industry would rather not discuss such events. It may be entirely possible to use something like STUXNET on affected SCADA systems to send the wrong signals to those trying to monitor the complex logistics of the shipping. A ship may be seen on the company’s monitor being one place, whereas it might be somewhere else. That is anyone’s guess, but I suggest that is not impossible. The new pirates attacking tankers may be cyber-pirates sending in malicious code, not just the barefoot Somalis and others tossing hook anchors on to the stern of the tanker and climbing up.

Cyber risk can also have considerable effects on the overall supply chains for the oil and gas industry. To get an oil rig, a refinery, a series of pipelines up and running takes a massive administrative supply chain effort that could involve sometimes hundreds if not thousands of subcontractors and suppliers that have to get things done in a specific order and on time. Anyone who has built a house or even had a kitchen remodeled knows how important it is to get the carpenters, electricians, masons, and roofers to be on schedule and in the right order. Now consider the complexity of getting all the right people, equipment and information on schedule and in the right order in the build out of a complex oil rig in 10,000 feet of water 150 miles at sea with millions of dollars (and maybe lives) at risk due to any scheduling mistakes.

A cyber-attack on major refineries and pipeline systems could bring costs that may seem unthinkable at the moment. However, this could just be a matter of time if the industry does not constantly update its protective systems and understanding of the risks. The industry remains constantly vigilant as hackers and cyber-warriors like the SEA (Syrian Electronic Army) are always looking for opportunities to attack. Constant vigilance will not be enough if one of these attackers gets “lucky” and gets through. The sophistication of cyber warriors and hackers is not static, nor should the sophistication of the oil and gas industry to counter these threats be static.

Note: All opinions expressed are those of the author alone. Sources supplied upon request.

Paul Sullivan is the Adjunct Senior Fellow for Future Global Resources Threats at the Federation of American Scientists and a Professor of Economics at the Eisenhower School at the National Defense University. He is also an Adjunct Professor of Security Studies at Georgetown University and a columnist for newspapers in Turkey and Mongolia.

Dr. Sullivan is an expert on resource security issues, with a special focus on the nexus of energy, water, food and land. He is also an expert on issues related to the economics, politics, and militaries in the Middle East and North Africa. 

Energy and World Economic Growth

Introduction

Rapid growth in the developing world has changed the economic center of gravity towards Asia, especially with regard to the world’s energy economy. World-wide demand for energy, especially energy that can propel automobiles, is increasing. High energy growth is producing two problems.  The first, widely recognized, is the increased greenhouse gas concentrations that result from burning fossil fuels. Barring a substantial reduction of fossil fuel use, world-wide temperatures could increase to dangerous levels. While the huge infrastructure of the energy economy rules out quick changes, if action is taken now, the necessary world-wide reduction of greenhouse gas emissions may still be possible. However, the required uptake of clean energy technologies will require strong government policies to offset initial investment costs.1

The second problem is less widely recognized. The share of GDP that must be spent on oil supplies may also limit economic growth. At times, the price of oil is limited only by the strain it places on the world economy. We have seen episodes where high and rising oil prices precede an economic downturn. During the downturn, oil prices can drop to levels that, along with a weak economy, discourage investment in new oil production. When strong growth returns, we can see the cycle repeated.

These events are not surprising because oil has a very low elasticity of demand and supply with respect to price. That means very large price changes are required to increase supply or decrease demand. In addition, oil has a very high elasticity of demand with respect to income. That means economic growth strongly increases oil demand. Lastly, oil expenditures can be a large enough component of GDP to adversely affect economic growth if they grow too large. Added together, these interactions can produce the following cycle:

Oil prices are only one factor affecting the world economy. Nonetheless, world GDP growth and oil prices are periodically engaged in the cycle described above. Oil prices can also stabilize at levels that are not high enough to cause a downturn in GDP growth, while GDP growth is not high enough to push oil prices past the level where the share of GDP spent on oil reverses GDP growth.3

The Clean Energy Challenge

High economic growth encourages more fossil fuel use and increased greenhouse gas concentrations.  High oil prices also provide an opportunity for clean alternatives to be more competitive. However, if high oil prices periodically blunt economic growth, it is more difficult to make clean-energy policies a government priority. Economies that are struggling with low growth and high unemployment are less likely to maintain strong clean-energy policies. Without these policies, we cannot hope to limit the increase of world-wide temperatures to 2oC above pre-industrial levels, the level deemed likely to avoid the more serious consequences of climate change and accepted by the G8 countries as a target to be achieved by international climate policies.4

A recent IEA study5 estimated the increase in clean power-sector technologies that would be needed to prevent a world-wide temperature increase of over 2oC (Figure 1). They estimate that the future annual growth of nuclear power must be between 23 and 31 gigawatts (GW). To put this into perspective, the historic high in building nuclear power plants was 27 gigawatts per year (GW/yr).  Photovoltaic power must, after 2020, reach 50 GW/yr and, after 2030, exceed 100 GW/yr. Onshore wind investments must exceed 60 GW/yr from now through 2050. Offshore wind must exceed 20 GW/yr after 2020. After 2020, coal with carbon capture and storage would need to grow by more than 20 GW/yr.

The challenges to achieving the 2oC scenario in the transport sector are no less daunting, requiring that the world sales of electric vehicles double each year between 2012 and 2020. Advanced biofuel production must grow from ~ zero to 22 billion gallons by 2020. IEA estimates that the incremental energy-sector investment that would be needed to keep world-wide temperatures from increasing over 2oC is $37 trillion (cumulative investment between now and 2050).6 The bulk of this investment would have to be made in the developing world.  It is not likely that these additional investments, over and above what is necessary to provide required energy supplies, will be made without strong government policies, even though they would produce offsetting savings in the long term. Without strong world-wide economic growth, it will be difficult, if not impossible, to implement the policies necessary to achieve the 2oC scenario.

Figure 1

Average Annual Electricity Capacity Additions to 2050

2012 IEA Energy Technology Perspectives 2oC Scenario

Source: IEA, Energy Technology Perspectives 2012

Oil and Economic Growth

World oil prices have, from time to time, reached levels that have impaired world economic growth such as the aftermath of the 1973 oil embargo. This first “energy crisis” accompanied a major change in the way petroleum was controlled and priced. Prior to 1970, world oil prices were managed by a relatively small number of large oil companies. These companies enjoyed liberal access to most countries’ oil resources. They could develop large oil fields in host countries with terms that allowed ample world supply at non-competitive but reasonable prices. These companies pursued a strategy to maintain affordable and stable oil prices that supported economic growth in the industrialized world and encouraged increased demand for oil. These arrangements were undone by reforms in the member-countries of the Organization of Petroleum Exporting Countries (OPEC). The reforms moved the control of the world’s largest oil resources from the international oil companies to OPEC and, given sufficient OPEC cohesion, the ability to control of world oil prices. OPEC’s control of oil prices was short-lived. The rapid price hikes associated with the 1973 embargo and the 1979 Iranian revolution stimulated new supplies, especially from the North Sea and Alaska. High oil prices also stymied demand as consumers turned to more efficient automobiles.

By 1981, oil prices began a steady decline. Saudi Arabia tried to maintain higher prices by cutting production until by 1985, its output had fallen to 3 million barrels per day (mmb/d), 70 percent lower than it had been in 1980.  In 1986, Saudi Arabia adopted netback pricing7 to regain market share. Oil prices collapsed to $10 per barrel (/b)8. By 1988, the OPEC pricing regime was replaced by commodity market pricing, a system that remains in place today and for the foreseeable future. The London InterContinental Exchange (ICE) established a contract for Brent, a mixture of high quality North Sea crudes[ref]The selection of Brent and WTI as marker crudes reflected several factors: 1) the desirability of Brent and WTI to most refiners; 2) the sources of Brent (UK and Norway) and WTI (United States) relative to the world’s financial capitals, London and New York; 3) the supply of Brent and WTI would not be controlled by national governments or OPEC; and 4) Brent and WTI were produced in sufficient volume to be an important component of world oil supply.[/ref].  Additionally, the New York Merchantville Exchange (NYMEX) established a contract for West Texas Intermediate (WTI), high-quality crude similar to Brent.

Only a small percentage of the world’s crude petroleum is WTI, Brent or other traded crudes.  Nonetheless, these marker crudes affect the contract price of other types of crude oil since most crude oil contracts are indexed to one or more marker crudes. Spot oil prices also respond to whether the oil commodity markets are in backwardation or contango9

This new pricing regime did not entirely eliminate OPEC’s price setting role. A few OPEC countries maintain spare production capacity. Saudi Arabia, by far, keeps the largest production capacity in reserve. Saudi Arabia can increase or decrease its oil production in response to world market conditions. If Saudi Arabia believes that prices are too high, they can put spare capacity into production, putting downward pressure on market prices. Likewise, if Saudi Arabia believes that prices are too low, they can reduce production (increasing spare capacity) putting upward pressure on market prices.  Most other oil producing countries and all private oil companies are price takers. They only respond to higher or lower oil prices by increasing or decreasing planned investments in new production capacity. Whether or not these investments are made has little impact on current oil supplies or prices, but has a large impact on future oil supplies and prices.

Figure 2

The new pricing regime produced relatively stable oil prices until 1999 (except for a sharp increase in 1990 due to the Gulf War). In 1999, oil prices began a sharp upward trend culminating in an extremely sharp $40/b rise from January 2007 to June 2008. With record high oil prices, U.S. demand finally slackened and, soon after, failing financial institutions launched a world-wide banking crisis.  Oil prices plummeted reversing in one year the gains made since 2005.

Since 2008 there have been two rapid increases in oil prices. In early 2011, the Libyan civil war removed 1.5 mmb/d of light-sweet crude from the market. Oil prices spiked again in 2012 due to increased supply outages from Iran, Nigeria, Sudan and Yemen. The 2012 run-up was followed by a significant price slide due to a deteriorating economic outlook in the Eurozone and uncertainty whether the EU and the European Central Bank would take the necessary actions to prevent an unraveling of the euro.

Figure 3

Source: IEA, World Energy Outlook 2011

Figure 3 shows oil prices and annual changes in world-GDP. Each spike in oil prices was followed by a sharp drop in world GDP growth. The price rise from the 1973 oil embargo preceded a 4% drop in world GPD growth. Within two years, world growth slid from over 6% to 1%. The oil-supply outage resulting from the 1979 Iranian revolution doubled oil prices. Growth slid from 4% to 2% and, later, to below 1%.

The spike in oil prices resulting from the 1990 Gulf War led to a drop in world GDP growth from over 3% in 1990 to 1% in 1991. GDP growth did not reach 3% until 1994. The price spike from 1999-2000 was followed by a drop in world GDP growth from over 4% in 2000 to 2% in 2001. The world economy appeared to survive the long price rise from 2002 to 2007 until 2008, when the world suffered the worst financial crisis since the 1930s. World GDP growth dropped from over 4% in 2007, declined to less than 2% in 2008 and plummeted to -2% in 2009. While these high oil prices did not cause the world-wide recession, they were a contributing factor. High oil prices directly affected automobile sales and travel-related industries. High oil prices also reduced a household’s disposable income for other goods and services that remained after paying unavoidable fuel expenses.10

While each oil spike has been followed by a sharp drop in world economic growth, since 198711, there has been only one sharp reduction in world economic growth that was not preceded by an oil price spike.12 GDP growth has remained above 3%, apart from the 2nd or 3rd years following an oil price spike.

The world oil market has been subject to unplanned supply outages for quite some time. However, since 2011, supply outages have increased considerably from most prior years. They also reflect causes are likely to be chronic conditions as opposed to one-off events. During 2010, oil supply outages averaged less than 1 mmb/d; since 2011, they have averaged ~ 3 mmb/d and remain high today. Reports of insurgent attacks on oil-producing and distribution infrastructure, ethnic or sectarian conflict and civil war in the oil-producing states of the Middle East and North Africa (MENA) are too common to enumerate. The security situation has caused private industry to withdraw personnel from regions that are not deemed to be safe. In addition to loss of trained personnel, insurgent attacks on infrastructure, political disputes concerning sovereignty, disagreements about the validity of oil-related contracts and other problems are not likely to be passing problems that we can assume will be resolved. While these may be necessary side effects as countries replace autocratic rule with democratic governments, they nonetheless pose a great risk for future oil supplies. The International Energy Agency recently warned that relatively stable oil prices should not conceal “an abundance of risk” as “much of the Middle East and North Africa remains in turmoil.” “The current stalemate between the West and Iran” is “unsustainable” and “sooner or later, something has to give.”  The political situation in the MENA region reflects a “precarious balance” that does not bode well for “clear, stable and predictable oil policies, let alone supplies.”13

OPEC production capacity has been essentially flat for the last 30 years. Over that time, growing oil demand has been met by additions to non-OPEC capacity. A number of disappointing non-OPEC supply developments helped drive the sharp rise in oil prices from 2002 and 2008. During that period, the cost of oil and gas drilling equipment and support activities increased by 260%.14 More recently, the growth of Canadian oil sands and U.S. tight oil production has kept the world oil market in balance. Without increased oil production in the United States and Canada, non-OPEC production would have been in decline in recent years.

Sufficiently high oil prices are needed to sustain the growth on non-OPEC oil. The IEA estimates that the cost of oil sands and tight oil production ranges from $45/b to over $100/b. 15 As production moves from the most productive plays to less promising plays, costs will tend to move to the upper end of the IEA range. For example, Global Energy Securities estimates that the price of oil needed to generate an attractive internal rate of return increases from $67/b in Eagle Ford (Texas) to $84/b in Monterey/Santos (California).16 While current oil prices are higher than they need to be to justify increased investment, they are not that much higher than what’s needed to motivate the large investments needed to grow non-OPEC oil production.17

As long as world oil demand grows, so will the cost of oil. The only long-term pathway to lower oil prices is to reduce and reverse the growth of world oil demand.

World Economic Growth, Unemployment and Poverty

In OECD 18 economies, unemployment is the most serious consequence of limited GDP growth. Okun’s law describes a statistical relationship between an economy’s potential rate of growth, its actual rate of growth and changes in unemployment. According to this rough relationship, a 2% difference between a country’s actual GDP and its potential is associated with 1% more unemployment. Applied over time, unemployment will grow by 1% if economic growth is 2% below an economy’s potential.19 The picture in developing countries is more complicated because of movements of labor between the agricultural and industrialized economies. Growth below a developing country’s economic potential limits or reverses the movement from the agricultural sector to the industrial sector causing underemployment.20

While increasing productivity within the agricultural sector is a development priority, it also leads to underemployment in the agricultural sector.

The relationship between economic growth and the movement of the population out of the agricultural sector is vividly illustrated in the recent history of China. By the late 1970s China possessed an inefficient agricultural economy with a rudimentary industrial sector. China possessed a population exceeding 1 billion people, of which the vast majority lived in poverty. Economic reforms produced a sustained GDP growth that has averaged 10.2 percent per year.21As a result, China has moved 400 million people out of poverty into the modern economy. Currently, ~ 650 million people still live in the agricultural sector, 450 million more people than are needed.

High Chinese economic growth would permit more people to move out of the underemployed agricultural economy to productive labor in the modern economy, as there are 450 million people living in poverty.22 Within one generation, emigration out of the agricultural sector can be the first step to careers in commerce, business, education, medicine, engineering, science and management.

Reducing Petroleum Demand

By 2014, more oil will be consumed outside the OECD than within.23 Increased personal income and increased auto ownership appear to be as inextricably linked in rapidly developing economies as it had been in the OECD after the Second World War. With economic growth, automobiles (especially luxurious automobiles), are likely to be purchased in increasing numbers. Domestic automobile consumption will also help developing economies move from export reliance to supplying domestic markets.

With a rapidly increasing consumption of energy for personal mobility, it is imperative to satisfy this growth with non-petroleum energy. If the world continues to rely on petroleum fuels for personal mobility, high oil prices are likely to cause periodic episodes of low growth causing significant hardships for hundreds of millions of people.

Energy Security Trust

The Energy Security Trust, proposed by President Obama,24 aims to make current electric vehicle technologies cheaper and better with $2 billion for research. In addition to advances in batteries, electric vehicles and ubiquitous electric refueling, it will also fund sustainable biofuels.25 As stated by the White House; “In each of the last four years, domestic production of oil and gas has gone up and our use of foreign oil has gone down. And while America uses less foreign oil now than we’ve used in almost two decades, there’s more work to do. That’s why we need to keep reaching for greater energy security. And that’s why we must keep developing new energy supplies and new technologies that use less oil. The Secure Energy Trust will ensure American scientists and research labs have the support they need to keep our country competitive and create the jobs of the future.” The success of initiatives like the Energy Trust Fund would produce world-wide benefits as the uptake of competitive advanced clean energy technologies would be global. Competitive alternatives to petroleum-fueled personal transportation, combined with strong clean-energy policies, would go a long way to achieving the G8’s 2oC climate goal. They would also remedy an important impediment to world GDP growth.

Carmine Difiglio is the Deputy Assistant Secretary for Policy Analysis, U.S. Department of Energy and may be reached at carmine.difiglio@hq.doe.gov.  His work and publications include the first engineering-economic transportation-energy model, several other modeling projects including the International Energy Agency’s Energy Technology Perspectives project, studies of international oil and natural gas markets, and policies to promote energy security, energy efficiency, motor-vehicle efficiency and alternative transportation fuels.  Difiglio also serves as Co-Chair of the World Federation of Scientists’ Permanent Monitoring Panel on Energy and Vice-Chair of the IEA Standing Group on the Oil Market.  He was Vice-Chair of the IEA Committee on Energy Research and Technology, Chairman of the IEA Energy Efficiency Working Party and Chairman of the Transportation Research Board Committee on Energy and Transportation. Difiglio’s Ph.D. is from the University of Pennsylvania. The data and views expressed in this paper are those of the author and are not endorsed by the U.S. Department of Energy or the United States government.