Unsteady Equilibrium in the Oil Markets

energy

Unsteady Equilibrium in the Oil Markets

By SRI ⋅ April 16, 2008 ⋅

The construction of the trans-Caspian pipeline across the bottom of the Caspian Sea is not a simple project. Kazakh oil destined for the Baku-Tbilisi-Ceyhan pipeline (BCT) is more likely to be shipped to Azerbaijan by tankers. This, at least, is the opinion of Mikhail Perfilov, director for development in CIS countries and the Baltics for Argus Media.

What, in your opinion, is the likelihood that the trans-Caspian pipeline Aktau-Baku will be constructed?

There have always been geopolitical considerations about the Caspian Sea. As oil becomes more and more expensive, the resource wars are becoming fiercer and fiercer. Every major oil-consuming country is trying to secure access to supplies. Therefore, in Kazakhstan, we are observing a rather difficult process of balancing the competing interests of China, Russia and the United States. Oil is an important geopolitical tool — a serious factor of influence. China is interested in having oil flow its way, Russia in the development of Kazakh oil transit through its territory. United States and Europe are interested in a route that bypasses Russia. And each of these countries tries in every possible way to establish transport routes more suitable to meet their own objectives. Today, Kazakhstan has routes that both bypass Russia - like the BTC pipeline, and go through Russia - the Atyrau-Samara and Caspian Pipeline Consortium (CPC) pipeline. A pipeline to China is being built as well. Kazakhstan is conducting a smart policy of an independent producer, and the President and the government are pursuing the greatest possible diversification of Kazakhstan’s export options.

Concerning the construction of the trans-Caspian pipeline — according to current agreements, such a decision needs to be agreed upon together with the other four littoral states. Russia has always been against the project arguing that it could seriously threaten the ecosystem of the Caspian Sea. Therefore, it will not be easy to come to an agreement regarding the trans-Caspian pipeline. But Kazakhstan has the possibility to export its oil even without the pipeline - it can be shipped by tankers to Baku and then transferred into the BCT pipeline. Yes, there are some unsolved questions between Kazakhstan and Azerbaijan regarding the transportation agreement, and the process is slow. But, it’s likely that the two sides will come to an accord on oil deliveries across the Caspian.

How far can the nationalization of energy resources in Russia and Kazakhstan go?

This tendency can be seen not just in our countries but globally. Every country conducts its own politics on the energy sector. Many countries in the Middle East, North Africa and South America prefer to create national companies. Major consuming countries like China have also created national companies that operate globally. These policies can have both a positive and negative impact on the market. Negative - because many countries with national companies do not allow foreign investors to develop their deposits. Doing that, they practically limit the available resources. As a result, a deficit in resources will be felt in the market.

Besides that, governments conclude long-term agreements for deliveries with producing countries. In that case, both sides win: the producers secure themselves a market shares for a long time period, and the consumers guarantee themselves uninterrupted supplies. It is impossible to say that such policy is good or bad. But the share of the spot market decreases. Decreased liquidity on the spot market worsens the process of price discovery. Therefore, the spot market will not disappear - without it there could simply be no production. The question of nationalization of oil and gas assets - that is a prerogative of the government. The governments themselves determine what its priorities are at a given level of the development of each country. In general, when the governments are flush with money and the commodity prices are high, the powers tend to attempt to nationalize the industry. And it does not necessarily have to be the energy industry. But as soon as investment draught begins, the privatization process starts.

How will the price setting policies of the energy markets develop?

Major producers are raising prices to a level which they believe to be acceptable to the economies of consuming countries. But one can seriously suffer from a policy of maintaining the prices at a maximum level for a prolonged period of time. The main objective is not to lose. The potential threat is that prices can become unsustainable. OPEC tries to make maximum profits from their sales of oil in order to develop their economies for future generations. But it is critical to maintain a balance to prevent the prices of oil from negatively impacting the growth of global economy.

It is difficult to say what the critical price level is. There are several aspects that need to be mentioned. One is a huge demand in China, and also the fact that the economies of many countries - major consumers - are relatively immune to high prices because their governments subsidize the prices of petroleum products. China, for example, subsidizes the prices of gasoline at gas stations, and therefore the high global price of oil does not affect the Chinese consumer. The Chinese economy would suffer only in a case that the demand for its products in major markets abroad diminishes.

Today, we don’t have a deficit in oil as such. The only major problem that the market needs to solve is the lack of refining capacity. Refineries can barely satisfy the demand for petroleum products. As the price for a barrel of oil exceeded $100 and several major refineries in Europe and the United States temporarily closed, the price of heating oil grew significantly compared to other petroleum products. The market finds itself in a state of unsteady equilibrium, and an accident or natural disaster could cause a sudden spike in prices. This year, two major refineries are expected to begin operations in India - with a total refining capacity of 1 million bpd, or around 50 million tons per year. There are several other projects in China and the Middle East. When there is more refining capacity and the refineries are able to satisfy the demand for high-quality petroleum products, only then can we talk about a stabilization of prices.

What is the influence of speculation on the prices? It has already been proven that speculators do not set prices but follow them. Speculators try to gain advantage of an increase in prices. But the real price setting mechanisms are supply and demand. Currently, there is a lot more liquidity coming into the markets as investors are divesting risky investments in other areas. That is connected to the credit crisis in the United States and the falling dollar. The oil and gold markets are much more stable. I would not call this speculation but rather rebalancing of investments. But this influx of money has caused increased volatility in the oil market and made the prices less predictable.

There are voices saying that the Extractive Industries Transparency Initiative is necessary for the West to bring down the price of oil. They think that speculators use the lack of transparency in the market to build up fears of coming energy deficits. When the plans of energy producers are laid out open, the number of speculators in the market should diminish. Do you think that the implementation of the Extractive Industries Transparency Initiative project will really have an impact on the price of oil?

The physical market is traditionally less transparent and more closed since it is an unregulated over-the-counter market. Therefore, any transparency initiative in the oil market is a great idea. As you know, with more transparency, all market indicators will be clearer and room for manipulation will be diminished. Current situation benefits the oil traders but has a negative impact on the refining industry, distorting profit margins and not allowing for adequate planning of budget and strategy. Surely, no refinery likes to see its profit margins move around depending neither on the market nor its operation. We, as an information provider, also support increased transparency. At the same time, however, the market will be as transparent as the companies want it to be. If the companies do not require transparency, they will simply stop sharing information with us and other independent analysts, and the market will be closed again. And the issue is, of course, that the companies themselves need a certain level of transparency. For example, the Russian oil export market has become significantly more transparent recently. The oil companies are interested in establishing transparent prices, close to the market prices. It is beneficial for them that our quotes of oil and petroleum products reflect their views of the market and what is happening in the markets. If other companies remember this as well, the market will become more clear, transparent and predictable.