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Abu Dhabi, UAEFriday 18 January 2019

For energy markets, geopolitical risk is the new normal

The rise of renewables and the US shale revolution are also contributing to oil price volatility

Pump jacks and a gas flare near Williston, North Dakota. In the short term, the three biggest drivers all come from the US: oil sanctions on Iran, the US trade war with China, and the US shale revolution. AFP
Pump jacks and a gas flare near Williston, North Dakota. In the short term, the three biggest drivers all come from the US: oil sanctions on Iran, the US trade war with China, and the US shale revolution. AFP

The Chinese economy. US trade wars. Iran sanctions. The role of Russia. The future of shale. Oil markets are having a turbulent time, and that shows no sign of ending. Geopolitics, economic uncertainty, and the risks and benefits of new technologies dominate the current energy conversation.

Though oil prices have recovered from dramatic lows in 2014 and 2015, recent volatility driven by countervailing geopolitical and geo-economic trends have left many wondering: “what is going on with the price of oil?” It’s been a wild ride and one that is perplexing those outside and inside the market. Don’t expect the uncertainties to dissipate: they are part of the market.

The rise of renewables and the US shale revolution led many to hope that geopolitics would play less of a role in the energy system. But as last year demonstrated, energy and geopolitics go hand-in-hand, perhaps now more than ever. The question we must answer in 2019 is not how to remove geopolitics from energy, but how to respond to the opportunities and challenges presented to us. That will be the key focus of the Global Energy Forum, which my Washington-based organisation, the Atlantic Council, is launching this week.

In the short term, the three biggest drivers all come from the US: oil sanctions on Iran, the US trade war with China, and the US shale revolution. As the world’s largest economy, the world’s largest military, and the world’s largest producer of natural gas and oil, it isn’t surprising that the US has an outsized impact on markets and geopolitics. However, the role the US is playing in the energy system would be a surprise for market watchers 10 years ago, when US oil production was in dramatic decline and the country was building liquefied natural gas importing – not exporting – terminals.

While many anticipated that Iran sanctions would drive prices up, a surprise number of sanctions exemptions, a slowdown in China (perhaps in part driven by the trade dispute with the US), and the continued remarkable growth of US shale oil production, has brought oil prices down $30 per barrel from highs in October. Even a planned Opec – non-Opec production cut of 1.2 million barrels per day did not do much for the market. Going forward, watch for ratcheting up of sanctions on Iran with the countervailing impact of a potentially dramatic economic slowdown in China – as evidenced by recent news from Apple – and continuing pressure on China’s economy from the US on trade and other issues.

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While the Opec+ group is already considering additional cuts, they risk running afoul of President Donal Trump, who has claimed credit for the power of his “social media statement[s]” in keeping the price of oil down. As prices dip below fiscal breakeven for a number of producers (increasing stress on the alliance’s cohesion), producers will soon find themselves stuck with contrary geopolitical and market priorities.

Longer term, the race for new energy technologies will fundamentally reshape the energy system and geopolitical order of the 21st century. But that is also deeply enmeshed in global politics, as the US differences with China show. While these new energy technologies will have huge potential to improve energy access and energy security while reducing greenhouse gas emissions, they also have the potential to usher in an era of global technological competition along geopolitical fault lines.

The first mover advantage from developing these new technologies will matter more than ever, driving countries to push industrial policy to establish leadership in key emerging technologies. Market acquisition, and market influence, will be key priorities as new technologies come to market. At the same time, the push for these new technologies will confront new resource challenges. The centrality of rare earth minerals and the countries which are endowed with them will create new geopolitical dynamics. Managing resource constraints, and the competition for access to them, will have characteristics similar to competition to fossils fuels, but with potentially more at stake.

Here, the US and China have again found themselves on opposite sides, resulting in a global competition to be ‘first’ which is reshaping alliances and markets. Where countries look for new nuclear technologies, carbon capture systems, 5G, blockchain, AI, and other clean energy technologies, they will become frontlines in the same realpolitik many thought they would supersede.

Thrown into these longer-term challenges is the prospect of a peak and decline in oil demand, which could destabilise a wide swath of countries dependent on oil revenue. The recent low oil price environment caused instability in Venezuela and Nigeria, suggesting that a peak-demand environment will leave higher-cost producers unable to compete. At a broader level, limited revenues from oil production will inflame fiscal deficits and foment internal instability. In some countries, this may interfere with the social contract that has underpinned domestic stability. Some countries are proactively looking to diversify their economies. In the UAE, for example, the government is putting an increased emphasis on petrochemicals, where they see opportunities for demand growth even as the role of oil as a transportation fuel declines.

Amidst all of this uncertainty, the threat of climate change becomes more real every year. Though action to mitigate greenhouse gas emissions is uneven and inconsistent, the impacts of climate change, the actions taken to mitigate it, and the politics of international climate negotiations have geopolitical ramifications.

Our task remains how to manage these geopolitical obstacles while still gaining ground on climate change, which remains the overarching challenge of our time. This will require the concerted and coordinated effort of all countries, including those leading on new technologies – and their willingness to transfer clean energy technology – and hydrocarbon producing countries and companies, many of whom have previously been recalcitrant on climate action. The Oil and Gas Climate Initiative and significant efforts from the oil and gas industry on carbon capture point to a possible way forward.

In this increasingly turbulent and multipolar world, while the US and China are competing for advantage, other countries, too, can do much to advance the debate. The UAE is doing just this through its work on the future of energy, which will be on show at next week’s Abu Dhabi Sustainability Week, and in the excellent work of many companies to advance sustainability. It is crucial that the rest of the world take notice.

Randolph Bell is the director of the Atlantic Council’s Global Energy Centre and Reed Blakemore is associate director

Updated: January 10, 2019 04:36 PM

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