THE last twelve months have been tumultuous for the global oil industry, with prices reaching as high as $70 a barrel, nearly double of what they were a year earlier – a far cry from the price band of $20 to $28 a barrel that OPEC had hoped to maintain for some time. Various explanations have been given for this rapid price rise, i.e. China’s exploding demand, USA’s high gasoline requirements, the lack of spare production capacity to meet global demand of 82 million barrels per day (mmb/d),¹ the tight refining capacity, the ‘fear premium’ arising from terrorists attacks and political instability in some countries.

In the longer term there are some who view that supply will not be able to keep up with demand and the Hubbert’s peak for global production is not far away. It was a geologist at Shell, M.K. Hubbert, who had predicted in 1956 that America’s domestic production of oil would peak in the early 1970s and then decline. His forecast has turned out to be largely correct.

There are others who argue that the world still has plenty of oil, both in discovered and undiscovered fields, and through the application of superior technology for imaging and drilling, oil supplies can continue to meet demand through at least the next two decades. The optimists include the US Geological Survey, the respected International Energy Agency (IEA), as well as specialist drilling firms like Schlumberger. Nonetheless, the drive to expand domestic oil sources will continue and the scramble to locate equity oil abroad is bound to intensify and become very competitive.

The article takes a look at the current oil profile of USA, China and India and then addresses the issue of global opportunities for obtaining oil. The three countries are respectively, the first, second and fifth largest oil consumers in the world with India likely to take third place in the next four to five years. Second, they are heavily dependent on imports. Third, they offer an interesting contrast between private and national oil companies in the policies followed in the search for oil. Finally, China and India have been identified as the leaders in the rise of oil resource nationalism, which again is impacted by the geopolitics of different regions of the world.

America’s primary energy consumption² consists of oil (40%), coal (24%), gas (25%), nuclear (8%), and hydro (3%) and is therefore a fairly balanced mix of sources. The share of gas and nuclear energy are highest among the three countries. Its current oil consumption is around 20 mmb/d which represents 25% of total global demand. At an annual average growth rate of 1.5%, it is expected to be 27 mmb/d in 2025. Domestic production has been declining and dependency on imports to the extent of 65% currently, will increase. Its sources of crude are also well distributed and the main suppliers are Canada, Mexico, Saudi Arabia, Venezuela, and Nigeria. Contrary to the general impression, the USA depends on the Middle East only to the extent of 19%, compared to China 38%, and India 66%. Nonetheless, the Middle East and Saudi Arabia in particular are key elements in America’s oil security as the region holds 63% of the world’s reserves.

America’s oil industry is entirely privately owned. The oil majors have their crude sources at both home and abroad but only two companies, ExxonMobil and ChevronTexaco, figured in the 2003 list of the top 20 international companies with the largest reserves and that too in 12th and 19th place. With Saudi Arabia not allowing foreign companies to explore within the country, American oil companies have invested in other countries of the Middle East and Africa, Latin America, the Caspian region and in Russia. While the American government provides the necessary support to these companies through its diplomacy and influence as a global superpower, it has also frowned on or prohibited investments in Cuba, Iran, Myanmar or Somalia.

 

China’s primary energy consumption consists of oil (22%), coal (69%), gas (3%), nuclear (1%) and hydro (5%). China has been able to very rapidly increase its coal production which continues to be the mainstay of its energy requirements. The current oil consumption is 6.5 mmb/d, which is one-third that of the USA. It is one of the fastest growing economies in the world, with a 9% GDP growth rate. According to one estimate, the consumption will reach 14.2 mmb/d by 2025, equal to 70% of that of the USA today.

Though the domestic production of crude oil has been increasing over the years, from a situation of being an oil exporter 10 years back, China’s import oil dependency is now at 45% and growing. China imports its oil mainly from the Middle East followed by the Asia Pacific region, Africa and the Soviet Union. Two national oil companies, CNPC and CNOOC, have been very aggressive in searching for equity oil and gas in Russia, Kazakhstan, Iran, Indonesia, Ecuador and Australia. However, the total equity oil currently being produced is only 0.3 mmb/d, representing 5% of consumption. The companies enjoy strong support by the Chinese government which has offered development aid and other ‘sweeteners’ to host governments to secure exploration acreage. The president and the prime minister have personally led delegations to countries to clinch oil deals.

 

India’s fuel share consists of oil (32%), coal (54%), gas (8%), nuclear (1%) and hydro (5%). The share of oil is greater than that in China. Oil consumption at 2.2 mmb/d is one-ninth that of the USA and one-third of China. By 2025, India’s oil consumption is estimated to grow to 5.8 mmb/d, which is less than China’s current consumption. India’s domestic crude oil production volumes remain static. Crude oil from new fields is offsetting the decline in mature oilfields. India’s imports are mainly from the Middle East and Nigeria, representing 77% of total imports. In its quest for equity oil India has been a late starter compared to China, USA and other countries. Production from ONGC Videsh’s share of investments in Sudan and the Sakhalin Islands of Russia will in a year’s time yield 0.11 mmb/d, representing 5% of India’s consumption, the same as China. ONGC Videsh also has interests in Iran, Iraq, Qatar, Egypt, Libya, Syria, Cote d’Ivorei, and most recently Cuba.

The Middle East with its vast reserves of 70% of the world’s oil, will continue to be the main energy supplier for many years to come. The USA, China and India along with other countries are trying to reduce their dependence on the Middle East and therefore looking at other regions and countries. Venezuela, Russia and the Caspian Sea region respectively hold the greatest oil reserves after the Middle East and a review on their reserves, exports and supply logistics merits discussion, particularly as they too are trying to reduce risks by diversifying their markets and not depending too much on a single country or region.

 

Venezuela has 77 billion barrels of proven conventional oil reserves. It is the world’s fifth larger exporter. In 2004 it produced 3.0 mmb/d and exported 2.0 mmb/d. Nearly 70% of the exports are to the USA, though relations between the two countries are frosty. The balance 30% is exported to countries of the Caribbean under preferential terms and prices, much of which is re-exported to the United States as refined products.

The national oil company PdVSA is responsible for 50-60% of domestic production. PdVSA also has joint ventures and service agreements with Petrobras of Brazil, ConocoPhilips of the USA and ENI of Italy. PdVSA has reportedly signed an agreement with CNPC of China to develop an area in eastern Venezuela, which contains an estimated 400 million barrels of crude. Discussions have taken place with Chinese oil firms to finance a pipeline through neighbouring Colombia to a port on the Pacific Ocean. This would allow exports to Asia, bypassing the Panama Canal which can take only small tankers. It would also avoid the much longer routes around the southern tips of South America and South Africa.

During the visit of Venezuela’s President, Hugo Chavez, to India in April 2005 it was agreed that India would be given a 49% stake in the San Cristobal oilfield. Venezuela would also invest in the Mangalore Refinery, but no further developments have been announced.

 

Russia has proven oil reserves of 60 to 70 billion barrels most of which are located in western Siberia with 14 billion barrels in Sakhalin Island, north of Japan. After a steep decline in production following the fall of the Soviet Union in 1991, production has again picked up and was 9.3 mmb/d in 2004, positioning Russia as the second largest producer after Saudi Arabia. In 2004, deliveries to Europe accounted for 83% through the major export pipeline Druzhba or shipped from the port of Primorsk on the Baltic Sea and Novorossiysk on the Black Sea. China was supplied 6% by rail.

A new ‘Far Eastern Oil Pipeline’ extending 4000 km is proposed to be built from the city of Angarsk in Siberia to the port of Nakhodka near the sea of Japan. This will enable Russian oil to be exported to Japan and other Asian markets and possibly North America. The pipeline will have a capacity of 1.6 mmb/d and is estimated to cost $18 billion. Japan has promised $8 billion for the project. However, financing the entire project is challenging and not yet decided upon. The pipeline will pass very close to the eastern border with China and it is worried that it would not have land access to the pipeline. A proposal to lay a spur line for China to receive Russian oil has been hanging fire for some time now. Meanwhile Russia’s Resneft has agreed to form a joint venture with China’s Sinopec to explore for oil and gas in the Sakhalin-3 block.

The Caspian region consists of littoral states surrounding the Caspian Sea. Kazakhstan, almost the size of India, is to the northeast, and Azerbaijan, a very small state is to the West, separated from the Black Sea by the equally small state of Georgia. They gained their independence from Russia in 1991. Between them they have the fourth largest oil reserves after the Middle East, Venezuela and Russia. They have, therefore, attracted considerable foreign investment since independence, mainly by companies from America, Europe, and China. Reserves are estimated at around 48 billion barrels. Production in 2003 was around 1.6 mmb/d, and is expected to reach 4.0 mmb/d by 2015. Much of this production will be exported as local demand is low.

Exploration and production in Azerbaijan is carried out by the state company SOCAR and AIOC, the Azerbaijan International Operating Company in which BP, ExxonMobil and others have shares. Crude oil is currently exported through two pipelines to ports on the Black Sea. However, the new BTC pipeline, Baku (Azerbaijan) – Tbilisi (Georgia) – Ceyhan (Turkey), built at a cost of $4 billion will allow exports directly to the Mediterranean, bypassing the Black Sea and the very congested Bosporus Straits. Aided by western capital, technology and diplomacy, this 1 mmb/d capacity pipeline of 1760 km length has been 15 years in the making. A consortium led by BP will be the operator.

 

Kazakhstan has more than double the reserves of Azerbaijan. Production from its three large fields including Kashagan (the largest oilfield outside the Middle East) is being developed by a host of western countries which include BP, ChevronTexaco, Exxon-Mobil, ENI and AGIP while a fourth field is still to be developed with Russian help. Exports are currently at the level of 1.1 mmb/d and till 2001 were routed by pipeline to Russia. Subsequently, a pipeline by the Caspian Pipeline Consortium was laid to connect Kazakhstan to the Black Sea. By 2010 exports could climb to 5.0 mmb/d. There are plans to lay a pipeline under the Caspian Sea to link with the BTC pipeline and give direct access to the Mediterranean. At some future date a pipeline may also be laid through Iran and Turkmenistan to allow crude to move to the Persian Gulf.

CNPC of China has been very active in Kazakhstan and bought stocks in two companies in 2004. CNPC was also able to edge out the ONGC Mittal combine to buy Canadian owned PetroKazakhstan for $4.2 billion. The company currently produces 0.15 mmb/d of crude oil. To evacuate the crude oil a pipeline is to be laid at a cost of $700 million from Atasu in Kazakhstan to a railhead at the border with China. However, as China’s demand is mainly in the eastern part of the country, the pipeline will be further extended by another 1600 km to feed three refineries.

 

To sum up, the effort to wean away Kazakhstan and Azerbaijan from Russian dominance has been very successful and with the full cooperation of the two countries.

Looking ahead at the next few years, the bulk of incremental Venezuelan crude oil is also likely to move to the USA and the Caribbean, with some exploration activities by China and India. If the pipeline from Siberia materialises, additional Russian crude oil will flow eastwards mainly to Japan and partly to China due to their proximity and need for oil. Japan would in any case be a serious buyer as its dependency on Middle East crude oil is as high as 80%. With the very strong presence of western oil companies in the Caspian region, increasing quantities will flow to the USA. Some crude oil will move by rail to China and the balance traded internationally. India has already agreed to buy Caspian crude oil.

The developments in Venezuela, Russia and the Caspian region and the strategies followed by the USA and China hold some lessons for India. Geographical continuity or proximity confers a distinct logistical advantage, e.g. supplies to the USA from Canada, Mexico and Venezuela.³ The ‘early bird’ strategy enabled the western oil companies to enter the Caspian region and not only get the oil out of the ground but out of the landlocked countries, avoiding the dependence on Russia and the Black Sea.

 

China has been very aggressive in terms of domestic production and sourcing of equity oil either by obtaining exploration acreage or buying companies. Private international oil companies examine each equity oil deal for its commercial viability under various crude price scenarios. The Chinese government, it seems, attaches more importance to energy security and gives soft loans to its companies, as was reported in the case of the failed bid for Unocal in the USA. The strategy seemed more to do with acquiring Unocal’s assets in Asia than establishing a beachhead on mainland USA. Again, the very long pipeline that China hopes to build to transport oil from Kazakhstan would most probably not pass the commercial test but has strategic value.

Where China and India have competed for equity oil in Angola, Iran or Kazakhstan, China has been able to edge out India or acquire a majority stake, even where the Indian bid was commercially better. Recently, Korea was awarded two deepwater blocks in Nigeria despite a higher bid by India. These examples go to show that India needs to further fine-tune its commercial bids to the way business is done in the host country and accompany it with some nimble diplomatic legwork. India also requires think tanks and analysts who can closely examine global issues including energy strategy and security and provide their independent views.

India has recently suggested to China that they jointly bid for oilfields instead of competing with one another. While China’s initial response has been positive, the question to be asked is that if China can get the whole cake by whatever strategy it employs, why should it settle for half, especially as its needs are much greater than that of India.

 

On the broader question of equity oil versus commercially traded oil, holding equity stakes in various parts of the world is a mixed blessing. It gives proprietary rights to the owner, can lead to reciprocal trade or investment and provides a psychological cushion in terms of reserves that it holds at home and abroad. However, it has several downsides. Should crude oil prices fall substantially, the original investment if made at a time of high prices, would yield a low or negative return. If transportation costs to the home country are very high or the quality of the crude oil is such that it cannot be processed by domestic refineries, it may need to be swapped with a third country’s availability. Investment in some countries could be riskier than others and a ‘due diligence’ exercise needs to be carried out in advance.

It can be argued that oil being a fungible and globally traded commodity, it makes better sense to deal in commercially traded oil from diverse sources and invest instead in improving shipping, ports, and the capacity of domestic refineries to handle sour crudes which are cheaper and more abundantly available compared to sweet crudes. Be that as it may, the alarm bells that have been ringing around the world, to what is seen as the rise of resource nationalism by China and to a lesser degree by India, has more to do with hype than substance. Production of equity oil to date, to the extent of just 5% of total demand by the two countries, can hardly be of global significance. Further, both will be hard pressed to increase this figure to 10% in future years, in view of their rapidly expanding consumption base.

 

The chairman of the USA based consulting firm Cera and a Pulitzer Prize winner, Daniel Yergin has put the matter in a proper perspective, both for China and India, when he says, ‘For the most part China is behaving the way any country starved for oil would, especially one with a well established domestic oil industry. China is participating in partnerships, acquiring reserves, contracting for future supplies of liquefied natural gas, selling oilfield services, developing projects around the world, and buying lots of oil.’

 

Footnotes:

1. One million barrels a day = 50 million tonnes per annum.

2. Renewables excluded for all three countries.

3. And at some future date Siberian oil to Japan and China.

 

References:

BP Statistical Review of World Energy 2005.

Energy Information Agency of the US Government: Country Briefs.

‘Oil in Troubled Waters’ – a Survey of Oil, The Economist, 30 April 2005.

FACTS Inc., Energy Briefs of September 2005, ‘India’s Overseas Investment in the Energy Sector.’

E. Jayashree Kurup, ‘India Outsmarted’, Financial Express, 3 September 2005.

Daniel Yergin, ‘Over a Barrel’, Fortune, 16 May 2005.