Oil and Petroleum Products

Oil is a global commodity where prices adjust to a supply disruption in one place across all locations, no matter country or location where the problem started. To help people understand what that means, I like to use the analogy of a swimming pool. If one takes a giant bucket of water out of the deep end of a swimming pool, it affects the water level for the entire pool, not just the deep end. The larger the bucket, the more swimmers will notice changes in the water level throughout the entire pool. The upshot of this global nature to oil is that freedom of movement of oil through the Strait of Hormuz is a global problem. Countries might think that maintaining “good” relations with Iran might mean their ships won’t get attacked, but it is not truly relevant. If anyone’s ships are attacked, the oil disruption that could ensue will affect all oil importing countries. The International Energy Agency (IEA) was formed out of an understanding of this notion of the global nature of the oil market. Emergency stock releases need to be coordinated because if one country releases strategic stocks and other countries hoard oil instead, the net supply gain to markets can be cancelled out, hence coordinated stock release policy is advantageous. IEA announced this week that it is prepared to act if oil flows are disrupted from the Middle East. Iran may feel it is getting an upper hand by showing it has been wronged and is a nation to be reckoned with. The problem is Tehran is also showing the world what a problem it could become if it actually had nuclear weapons capability. This week, governments from the U.K. to Germany and to Japan will have to decide how much force to apply to protect oil shipments in their vessels and flag ships. But what if Iran were a nuclear power? The calculus would be quite different. The bargaining process for conflicts where parties have access to missiles with nuclear warheads is altered. Nuclear weapons add additional risk on the party that desires to change the status quo. One can expect the cost is higher for third parties who would want to intervene in regional conflicts. A future nuclear-armed Iranian declaration that only the oil Tehran dictates will be allowed to transit the Strait of Hormuz would present an even more complex situation than today’s geopolitical challenge of sanctions and shipping. The military problem of protecting shipping would become more dangerous and potentially require a military campaign to destroy any active Iranian nuclear warheads before engaging conventional Iranian forces that are blocking free transit of the Strait. The history of nuclear deterrence theory suggests Iran would never use a nuclear weapon, even if it had one because of the extreme consequence of enormous loss from a second strike. But the possibility of internal political instability can in itself alter a bargaining process. One might have imagined Iran would not have taken such a decisive act against British vessels for fear of attack by the North American Treaty Organization alliance. NATO did, after all, intervene in Libya in 2011 under a situation perhaps less clear than blockage of an international waterway.  That leads me to question whether Iran may have overplayed its hand. Now that the strategic risk of a nuclear-Iran is so much more transparent, would Europe still feel it can afford to provide nuclear technical assistance to Iran including equipment under the terms of the 2015 Joint Comprehensive Plan of Action (JCPOA)? China must also see the detriment to itself of a nuclear-armed Iran. It’s easy to facilely link the escalation of tensions with Iran on the Trump administration’s “maximum pressure” campaign, which has disturbed an already tense status quo but now thoughtful analysis needs to be made regarding what the current situation has taught about the war-ready nature of factions within the Iranian government. Some lessons are relevant to future diplomatic solution-building regardless of how we got here. The reality is that conflicts involving Iran throughout the Mideast proceeded – and in some cases escalated- even after the JPCOA took hold. The opportunity that signing the nuclear deal would moderate Iran’s foreign policy regarding regional conflicts and assassination plots in Europe was unrealized, even before the Trump administration reversed the U.S. commitment to the JCPOA. As Europe moves forward in trying to fashion a solution, Iran (and Russia) will need to consider the changing nature of the global oil business. Iran has to concern itself with the future geopolitics of stranded oil assets. Removing itself now from oil and gas commodity markets and direct foreign investment opportunities at this pivotal time in oil’s potentially declining future might have long lasting negative consequences for its energy industry. Moreover, any military exchange that raises oil prices sharply could become the impetus that the West and China needs to accelerate the shift to low carbon energy more decisively. Such a result would reverberate in Moscow whose natural gas giant Gazprom is already struggling against a rise in renewable energy in Europe. China, which has never participated in a large global oil supply cutoff as a giant oil importer (it was self-sufficient in energy in 1973, 1979, and 1990), may also need to educate itself about the consequences of having one fifth of its oil supply have to traverse the Strait of Hormuz. China has more to lose from a poor outcome between the West and Iran than the West does given its lesser dependence on Middle East oil. Tehran may decide that its resistance economy is good enough for regime survival and choose the path of continued confrontation. That would be a tragedy for the entire region and present a serious challenge for the United States. The makeshift response to allow Britain to protect its own shipping calls into question whether the U.S. could abdicate (either on purpose or by accident) its vital superpower naval role which regulates sea lanes and, in effect, facilitates global trade. The consequences of the U.S. withdrawing from such a role is unthinkable for all concerned, even for the Chinese, who may seem to object to U.S. ships in the South China Sea, but, in reality, free ride off of U.S. air and naval power in so many aspects of their economic life. China should be careful what it wishes for. The Trump administration must avoid reconsidering this critical naval role nonchalantly. It is central to the United States’ global authority.  Just the appearance of U.S. hesitation about that role could invite unwanted seafaring military incursions and piracy across the globe. If Iran decides that conflict is better to regime survival than concession, the Trump administration’s lack of a well thought-through, implementable strategy regarding Iran will become an even larger problem. Oil markets will increasingly lose their imperviousness to risk as more speculators bid oil prices up. Regional allies could also become more insecure. All this means that now would be a good time to move away from ideological bents and study up on years of U.S. military gaming exercises regarding the Strait of Hormuz. The U.S. military has years of study and knowledge to fashion and lead an effective international coalition for diplomacy and deterrence in the Strait of Hormuz. It should use it.

In a sign that anxiety about oil security of supply isn’t what it used to be, the Group of Twenty (G20) meeting broke up this week with no big joint statements regarding how to protect the freedom of navigation in the Strait of Hormuz. From the sidelines, U.S. President Donald J. Trump said there was “no rush” and “no time pressure” to ease tensions with Iran. German Chancellor Angela Merkel said she advocated “very strongly” to get into a negotiating process on the Iranian situation. Chinese President Xi Jinping noted that China “always stands on the side of peace and opposes war.” The latter statement was a pretty mild one given that approximately one-fifth of the oil that passes through the Strait of Hormuz is destined for China. China has given no public indication that it plans to protect its own shipping. Roughly 60 percent of crude oil passing through the Strait goes to China, Japan, South Korea, and India. The biggest statement about oil that emerged from the G20 came from Russian President Vladimir Putin who announced at the sidelines that Russia had agreed with Saudi Arabia to extend by six to nine months a deal with the Organization of Petroleum Exporting Countries (OPEC) to restrain oil output to support oil prices. OPEC then announced at its July 2 meeting in Vienna it had agreed to extend the deal for nine months into the first quarter of 2020. In speaking about OPEC’s deliberations, Iran’s oil minister said OPEC was being used as a “tool against Iran” jeopardizing the cartel’s survival. Last year, Iran told other members it was considering quitting OPEC. These various events say a lot about how the geopolitics of oil has changed and the huge implications those changes have for Iran. A decade ago, countries from the Gulf Cooperation Council (GCC) were of the mindset that they would never let Russia become a member of OPEC. At the same time, Iran was also a major rival to the GCC countries in its overall influence on OPEC outcomes, and both Russia and Iran boasted of their relations with each other in bolstering their respective positions in Mideast regional conflicts. But the new reality is that countries like Saudi Arabia now feel that they can basically ignore Iranian sensitivities at OPEC gatherings and have increased incentive to align with Russia on oil, not only because of the pressing need for revenue but also because of the geopolitical benefits of driving a wedge between Russia and Iran. In turn, Iran may have less to offer Russia as Moscow’s relations with the Arab world continue to improve, except perhaps the possible threat Tehran can make trouble for Russia in Syria or along susceptible pipeline routes. U.S. sanctions against Iran have long been in Russia’s interests to prevent Iranian oil and gas arriving in Europe to compete for its market share. But, Russia has a difficult road to navigate in its relations with Iran and Saudi Arabia since it will want to keep itself an important power broker around many of the Mideast’s current conflicts. This keeps U.S.-Russian interactions on the topic of Iran a challenging one.  The results of the G20 and subsequent OPEC meetings highlight the bind Tehran is in. What will be its geopolitical lever if oil and gas, which might have provided in years past, is no longer working? The large market surplus of natural gas is working against Iran. Japan’s state firm Japan Oil, Gas and Metals National Corporation (JOGMEC), for example, just signed on to Russia’s Arctic liquefied natural gas (LNG) expansion, in a sign that many countries that might have bought natural gas from Iran are looking elsewhere. The expected rising supplies of U.S. LNG are another. Chinese firms have also slowed new rounds of investment in Iran’s oil and gas sector and are increasingly investing in China’s own clean tech industry instead. Iran has to concern itself with the fact that as the United States, Russia, and oil producers in the Persian Gulf region expand capacity, its own reserves may become more likely to become obsolete or devalued if oil demand peaks over time. All this raises the question about how a petro-state like Iran reacts to the possible weakening of oil as a strategic tool. Iran will want to show the world that it still has a bargaining chip beyond its own oil resources. Some analysts are suggesting that by boxing it into a corner, the Trump administration might actually incentivize Tehran to lash out to make clear it is too important to ignore in an effort to drive the United States and others to the negotiating table, much the way North Korean missile tests got President Trump’s attention. Most recently, Iran’s response has focused on restarting its nuclear program. Iranian President Hassan Rouhani announced Tehran would return to its previous activities at the Arak nuclear reactor if the remaining signatories to the nuclear deal do not fulfil their promises. Iran might decide to focus on fast tracking its nuclear program to assert itself and gain leverage at a future negotiation. Alternatively, if it gets no geopolitical traction from restarting its nuclear program, Iran could stick with its grey area attacks on energy facilities to make the point it still has hard power to bring to bear. To date, the rules of engagement on cyber warfare against such targets have been harder to establish. A cyber escalation would be a dangerous outcome that would leave the United States with hard decisions about what kind of precedents to set in an active cyber conflict since a large escalation could lead directly to attempted cyberattacks against the U.S. homeland. Oil markets are betting that Iran will not choose to continue to disrupt shipping through the Strait of Hormuz since doing so would clearly escalate into a military confrontation with the United States. A second possibility, which would require much more diplomacy, is that Iran’s oil woes could prompt its leaders to look at the world with colder realism and come directly to the diplomatic route. One reason that approach could be compelling is that perhaps the real lesson for Iran is not that of North Korea, but of Venezuela whose oil industry is now decimated from years of corruption, lack of financing for maintenance, and an exit of foreign investors. As Mideast oil expert Sara Vakhshouri wrote in a report for the Atlantic Council in 2015, “Most of Iran’s oil fields are old and mature, which means they require further investment and treatments like gas reinjection, in order to maintain current production levels. The country’s oil wells are mostly in the second half of their lives, and are facing continued natural depletion of production capacity at the rate of 8-11 percent per year. It is estimated that Iranian oil fields lose between 300,000 to 500,000 b/d of natural reduction every year due to maturity of fields.” With its oil exports further curtailed this year, Iran should worry about not only losing market share today (and for however long it takes to restore its position in the global economy), but also the possibility that output drops could cause it to lose productive capacity more permanently if oil fields are damaged from forced production curtailment or reduced spending on maintenance over time. As Iran can see from its current failure to incentivize relations with Europe, Russia, India, China, and Japan by offering future stakes in its oil sector—a strategy that worked in the past but is apparently no longer effective—time is not on its side when it comes to preserving its future oil and gas sector opportunities.

I woke up this morning thinking I would write a blog explaining just how challenging it would be for Iran to close the Strait of Hormuz for a prolonged period of time. This is not to say that there could not be a battle in the waterway: Iran has lots of conventional weapons, including mines, submarines, a large fleet of speed boats (think the USS Cole bombing), torpedoes, and missile batteries. But I thought to myself, why would Iran want to give the U.S. military the rationale to target Tehran’s largest military assets and destroy them? Then I saw a news report that a short range Katyusha missile hit a site very close to ExxonMobil’s operations center in southern Iraq, near the Zubair oil field, where Italian oil firm ENI is helping restore production capacity. Royal Dutch Shell also has personnel in the area. That brought me back to my father-in-law’s favorite expression “Too clever by a half.” For those of you who don’t know that term, the internet defines it as meaning “annoyingly proud of one’s intelligence or skill and in danger of overreaching oneself.” I don’t think that definition, though accurate, does the phrase justice. The formal definition doesn’t fully convey the high level of arrogance and stupidity involved when someone makes an incredibly large mistake because they think they are outsmarting someone when in reality they are about to create a huge disaster for themselves. Now you could be wondering: Am I talking about Iran or the United States? Let’s talk about both. Iran is so used to working through proxies with no consequences on its ruling elite or its physical motherland that it believes that it can offer these endless, faceless “sabotage” operations with impunity.  On the flip side, the United States is used to stationing an aircraft carrier somewhere and believing that it is a solution to small-scale attacks (e.g. weaker party doesn’t want an actual military engagement so they back down). This, however, fails to recognize that force projection in the age of asymmetric warfare may not be the most effective deterrent. It begs the question of “proportional” response. Iran is hoping for that messy debate. That is why it appears that Iran could be selecting discrete high-value targets with methods that are hard to fingerprint.  That brings me back to Iran’s original threat, when the United States announced it was withdrawing from the Joint Comprehensive Plan of Action (JCPA) nuclear deal and reimposing sanctions on Iranian oil exports. Iranian President Hassan Rouhani said “If one day they [America] want to prevent the export of Iran’s oil, then no oil will be exported from the Persian Gulf.” And that brings me to my favorite parenting advice for raising a two-year old. Don’t threaten something if you don’t intend to carry it through. As the United States considers the uncomfortable decision on how to convey diplomatically or, in the worst case, militarily that continued attacks on oil installations across the Persian Gulf will not be tolerated, it needs to acknowledge that Iran has many ways to harass oil exports to the international market. As I wrote previously, referring to all these efforts as “sabotage” underplays their significance. The inventory of oil attack events to date is starting to be extensive. It includes attacks on shipping via missiles from Yemen, attacks via missiles in Iraq, attacks on oil and petrochemical feedstock shipping with limpet mines, attacks on regional oil facilities using drones, notably in Saudi Arabia, several major cyber incursions against the Saudi oil and petrochemical industry, and sabotage activities that led to explosions on oil pipelines across the region, notably in Bahrain. Then there is the possibility that the contamination of oil coming from Russia to Europe was more malicious than it appeared. I have written a book with economist Mahmoud El-Gamal on the close linkages between the seminal business cycle, the oil price cycle, and Middle East geopolitical violence. We updated that work in a journal article that highlights how the more lasting impact of war-related damage to oil facilities is endemic to lasting oil price volatility. The problem for both the United States and Iran is that the global rules of engagement for asymmetrical attacks on energy facilities are extremely unclear. If the United States hits Iran with traditional fire power against Iranian military targets to deter further conventional attacks on oil exports, will that address the cyber domain or not? Does cyber have to address cyber? The patterns of engagement are unclear and that is dangerous for all concerned. That lack of clarity raises the stakes of a miscalculation, especially on the Iranian side. The anonymous declaration this week in the New York Times that the United States military is stepping up its digital incursions to Russia’s electric power grid highlights the challenge of deterrence. Iranian cyber incursions into U.S. infrastructure date back many years. There is a tendency among geopolitical commentators to dismiss the usefulness of diplomacy in stale conflicts. One often hears talk that there is little possibility for a reset of the Iran nuclear deal, hence no point to dialogue between the United States and Iran either directly or through intermediaries. This is clearly incorrect. The problem with that logic is that diplomacy is often needed so countries do not misunderstand the progression of events that could result from a string of ambiguous situations. In the case of asymmetric attacks on energy, diplomacy is sorely needed to define those ambiguities and bring transparency to what constitutes a clear and present danger.   

The narrow and congested Mideast waterway has become a site of escalating U.S.-Iran tensions. Conflict in the wake of tanker attacks there could jolt global oil supplies.

In 2015, Muhammadu Buhari defeated incumbent President Goodluck Jonathan. Buhari ran on two major issues: improving the deteriorating security situation associated with the Islamist insurrection Boko Haram and cleaning up government corruption. In 2019, President Buhari was re-elected, again on an anti-corruption ticket.  Jonathan and his former oil minister, Diezani Alison-Madueke, have long been thought “on the street” to be implicated in the theft of oil revenue. While their associates have had assets seized and are under investigation by British and U.S. authorities, up to now, neither has been charged. But in a court case in London involving international oil companies and the oil block designated OPL 245—thought to be one of the largest untapped reserves in Africa—lawyers for the Nigerian government accused Jonathan and Alison-Madueke with plotting to “receive bribes and make a secret profit.” According to the court filing, “the receipt of those bribes and the participation in the scheme of said officials was in breach of their fiduciary duties and Nigerian criminal law.” The oil block has been at the center of controversy since 1998, when, it is claimed, the oil minister at the time, Dan Etete, essentially awarded it to himself. It has since pulled Royal Dutch Shell and Eni into its orbit, both of which are the subject of an Italian investigation.  All parties are refusing to comment or are denying any wrongdoing. Nevertheless, it is hard to believe that Nigerian government lawyers would charge Jonathan and Alison-Madueke with receiving bribes without clearance of some sort from the Buhari presidency. Now re-elected, President Buhari may be emboldened to move against the “big fish” of corruption.

The United States keeps signaling that it has hard power. Most recently, the United States made known that it was deploying additional ships, the USS Abraham Lincoln and USS Arlington, to the Middle East. The USS Abraham Lincoln is now said to be in the Red Sea. This deployment follows a similar U.S. movement in the South China Sea. There appears to be a lot of hard power on display these days since China and Russia have also been moving military assets around the globe in a similarly transparent, public manner. You would think that all this bravado of big military hardware would be minimizing risky actions by small players. But, ironically, all this symbolism isn’t achieving much where oil security is concerned. That’s because state and non-state actors alike have learned that “sabotage” is hard to react to. But just because these acts of sabotage to date have seemed minor, it doesn’t mean that they are not geopolitically significant. Taken en masse, they are a symptom of an increasingly unstable setting at a time when spare oil production capacity in and outside OPEC is quite limited. The point is that as tensions rise among large and mid-size global powers, the list of recent and unusual oil sabotage acts is growing, and they could eventually add up to a major problem for oil markets. First, there was the mysterious contamination of Russia crude shipments to Belarus. That “sabotage,” now reportedly under investigation by Russia’s Federal Security Service (FSB), will reduce the availability of the physical storage tanks for some refineries along the Druzhba pipeline since removing the tainted oil by slowly diluting it in small amounts into clean oil will take months. The explanation of corruption should give little comfort. If the Kremlin cannot control its local corruption problems, or if it so wanted to teach a lesson to Belarus that it was willing to disrupt the reputation of its own oil exports, or if some technical production and collection problem was hard to solve, it’s not good news for European oil consumers. The Russian problem was followed by this week’s “sabotage” in the Persian Gulf which seemed to traders similarly penny-ante. First, a handful of ships near the port of Fujairah appeared to be bashed in with a sharp object like a limpet mine or ramming by another vessel or weapon on Sunday. Oil traders joked on twitter that the attack was not aimed to be serious since it is hard to move oil prices on a Sunday. Still, the location of the attack was significant because the United Arab Emirates has been investing to capitalize on the port’s location outside the Strait of Hormuz to expand crude oil storage facilities. Fujairah is also the location Arab countries held floating storage of over 70 million barrels of crude oil back in the mid-2010s as a precaution against oil disruptions following Russia’s invasion of Ukraine and Iranian statements threatening to close the Strait of Hormuz. The head of Iran’s Parliament’s national security committee tweeted that that “explosions” of Fujairah showed that the security of the south of the Persian Gulf is “like glass.”  Initial rumors that Saudi oil tankers were on fire or that the Fujairah port was on fire turned out to be fake news. A day later on Monday, Saudi Arabia confirmed that a drone attack had damaged two pumping stations on its East-West pipeline that carries oil from large eastern Saudi oil fields to the kingdom’s west coast where it can be exported to circumvent the Strait of Hormuz. Saudi Arabia also has export-oriented refineries on its west coast that typically serve Europe and utilize crude oil shipments from the East-West pipeline. Saudi Aramco had recently announced plans to expand the East-West pipeline and keeps chemical drag reduction agents on hand at the pipeline that mean the pipeline could handle up to 6.5 million barrels per day (b/d) of exports of crude oil via the Red Sea in an emergency, thereby bypassing the Strait of Hormuz. Last year, over 2 million b/d of oil were sent along the pipeline as part of normal logistical operations. To date, the oil market has reacted with a relative yawn to all these various sabotage reports. But the breakdown in norms across the globe – whether those norms are the free and clear operations of sea lanes, respected guarantees of oil quality, or most importantly, the safety and security of citizens, workers and vital energy infrastructure inside national borders-- is bad news for an internationally traded commodity like oil. A typical trader response is that the U.S. trade war with China takes precedence over these small sabotage events, given that trade conflict’s long run potential to harm global economic growth. However, analysts say China may be willing to add to its stimulus plans at least for now and so far, few are predicting a U.S. recession any time soon. By contrast, oil analysts from Wall Street firms such as Cornerstone Macro and Citi caution that the number of recent geopolitical events with implications for oil markets are running unusually high. The idea that U.S. production exists as a safety net seems equally spurious, even under the best of circumstances. U.S. output growth in any given month faces real limitations. Optimistic predictions for the Permian Basin that it could someday reach 8 million b/d might be possible, but for now, U.S. crude oil production is less than 15 percent of total global supply. Trump administration officials hint that Washington is prepared to use the U.S. Strategic Petroleum Reserve (SPR) and Washington-watchers figure the White House might ultimately be slow to turn any screws intended to stop China from buying Iranian oil. But as internal pressures on a wide variety of petro-regimes from around the world mounts, it might become harder and harder to stave off an upward march for oil prices this summer as small scale “sabotage” takes its toll on oil facilities in multiple locations at the same time internal conflicts continue to loom in major producing countries like Venezuela and Libya. The White House shouldn’t take great comfort in the fact that oil traders are relaxed. They (and their algorithms) could be simply wrong.

With significant risks now looming over global energy markets, the United States should be careful in evaluating any future oil sanctions, Amy Myers Jaffe writes in the following Q & A which first appeared on CFR.org.  Oil prices ticked up a few percentage points after the announcement. Do you expect prices to remain higher, or is there enough supply in the market to cover a drop in Iranian exports? U.S. sanctions had already curbed Iran’s oil production substantially earlier this year. The Trump administration’s tough stand on waivers could remove an additional five hundred thousand barrels per day or more from the market in the coming weeks. This would come on top of production cuts planned by the Organization of the Petroleum Exporting Countries (OPEC) and ongoing production and export problems in Libya and Venezuela. Oil prices will continue to be sensitive to any supply disruptions, despite expectations of rising U.S. oil production and possible production increases from Saudi Arabia. Should prices begin to rise precipitously, the Trump administration could make sales from the United States’ strategic petroleum reserve. How has the United States’ growing role as a major crude oil exporter changed its attitudes when it comes to sanctions?  There is no question that rising U.S. oil production has emboldened U.S. policy regarding oil sanctions. U.S. crude oil exports reached record levels, above 2.5 million barrels per day, in recent weeks and are expected to rise further this year. However, the administration should take care not to impose too many complex sanctions in the oil market at once because surprise events such as hurricanes, accidents at major oil fields, or geopolitical strife can create sudden disruptions in oil supplies and leave markets more vulnerable to price spikes. U.S. crude oil production is still less than 12 percent of the total global crude oil supply. It can only go so far in hedging against the multiple risks now looming in the market. Iran has threatened to stop the flow of oil from other big suppliers via the Strait of Hormuz. Could it do that? How exposed is the U.S. economy to oil disruptions in the Middle East? The Strait of Hormuz is more than twenty miles wide. It would be extremely difficult for Iran to close it completely for an extended period of time. There is the question of whether Iran could use asymmetric warfare tactics, such as swarming speedboats and missile attacks, but the possibility of a decisive international military response led by the United States makes such an endeavor extremely risky for Iran and its military. Iran would likely use more clandestine approaches, such as cyberattacks on neighboring state oil facilities. Saudi Arabia and the United Arab Emirates have alternative pipeline routes that can bypass the Strait of Hormuz. In the case of Saudi Arabia, upward of 6.5 million barrels per day in exports could bypass the Persian Gulf. The U.S. economy is less exposed now to oil price shocks than in past decades due to the lower oil intensity of the U.S. economy. Still, high gasoline prices can derail consumer spending, especially on durable goods such as cars. At the same time, an oil price shock in the developing world could cut into countries’ appetites for U.S. goods and services. China is the largest purchaser of Iranian crude. How do you expect it to respond to the Trump administration’s decision? China said that Iran’s discounted oil was too cheap to pass up, and it has been increasing its purchases of Iranian crude in 2019, reaching over seven hundred thousand barrels per day this month. In the past, China attempted to circumvent these sanctions by purchasing Iranian crude on a barter basis or by promising to pay Tehran once sanctions are lifted. In the end, the United States and China have many bilateral issues of greater salience, so both sides will be reluctant to fight over Iran policy. What will this additional pressure on Iran achieve? Iran has little incentive at this point to negotiate with the Trump administration so close to the U.S. presidential election cycle. Iran has a policy it calls strategic patience, which is simply waiting to see if a new administration might reinstate the Iran nuclear agreement or take a less aggressive posture. The International Atomic Energy Agency maintains that Iran has continued to comply with nuclear inspections set up by the deal, which is still being honored by European signatories.

Since Russia’s 2014 invasion of Ukraine, Western powers have hit Moscow with economic sanctions, hoping to put a stop to President Vladimir Putin’s aggression. Have they worked?

On April 25, the managing director of the Nigerian National Petroleum Corporation (NNPC), Maikanti Baru, said that Aliko Dangote's new Lagos oil refinery is central to the government meeting its ambitious plan to triple Nigeria's refining capacity to 1.5 million barrels per day (bpd). When complete, the new refinery is estimated to be able to refine 650,000 bpd, which alone would more than double the current capacity.  Africa’s largest oil producer has long been forced to import refined petroleum products because of a lack of refining capacity. These imports are a significant drain on the country’s foreign reserves. At present, there are four sate-owned refineries, but they rarely meet their combined 445,000 bpd capacity because of neglect, mismanagement, and periodic attacks on the oil industry by militants.  Dangote is a highly successful businessman with broad political connections. Forbes named him Africa’s richest person in 2019 with an estimated net worth of $12.2 billion. He is, apparently, investing massively in his new Lagos oil refinery and its associated real estate development. Given his track record, chances are good that his new refinery, will, indeed, be able to meet the 650,000 bpd target. The Buhari administration has also revived the goal of doubling Nigeria’s oil production to 4 million barrels a day. That goal, formulated during the administration of Olusegun Obasanjo (1999–2007) has been stalled by a variety of factors, including investor uncertainty, security issues, and the vagaries of the international oil market. With Dangote’s involvement, increasing refining capacity may be easier to achieve than doubling oil production, even if the goal of 1.5 million barrels a day is a stretch.

With significant risks now looming over global energy markets, the United States should be careful not to go too far with oil sanctions.  

Iran appears increasingly boxed in by intensifying U.S. sanctions, the latest of which will effectively cut it off from its main oil customers.

Sadly, they also help keep the country’s repressive regime in power.

It’s a geopolitical jungle out there in the oil world right now and only the fittest will survive. The new oil Darwinism is replacing the older thesis that all producers can succeed over time because the current lack of adequate capital investment is going to create an oil supply gap in the future that will once again boost oil prices (the so-called supply hole thesis). There are still some active looming supply crunch proponents who are talking down the potential of U.S. unconventional oil and gas, but recent announcements by ExxonMobil and Chevron about robust plans for U.S. onshore drilling appear to dispel the notion that a debt-ridden U.S. industry is on the verge of potential failure. Projected Permian oil production for the two American oil majors alone is 1.9 million barrels a day by 2024, on top of already robust output from U.S. independent oil companies. Citi estimates that U.S. oil production increases could fill most of the expected increase in oil demand for the next five years. That could leave OPEC in a bind, Citi suggests, since the producer group could lose up to three million b/d of market share to U.S. producers if it chooses to cut production to defend $65 oil prices, according to Citi estimates. The unexpected success of U.S. shale has - for the time being - been ameliorated by the dramatic demise of output from within OPEC’s ranks. A variety of ongoing problems from civil unrest to sector mismanagement have created supply disruptions from Nigeria, Libya, Algeria, Venezuela, and Iran, the latter two impacted additionally most recently by U.S. sanctions policy. The situation prompted one Middle East oil leader to note privately that OPEC’s stronger members will take market share from smaller, more troubled OPEC members whose sectors are continuing to stumble. In the past, OPEC’s largest producers Saudi Arabia, the United Arab Emirates, and Kuwait have stepped in to replace fellow OPEC member oil exports disrupted by sanctions or war. The process has often created acrimony inside the producer group, especially when new production sharing agreements are required when and if a disrupted producer’s oil output is restored. This time around is no different. Iran, whose oil exports have recently been curtailed by U.S. sanctions, threatened to quit the organization at OPEC’s end of year meeting last December in Vienna amid accusations that Saudi Arabia and Russia were taking advantage of its conflict with the United States. A last minute compromise, orchestrated by Russian energy minister Alexander Novak, salvaged the tense situation by promoting a compromise, which exempted Iran from the wider OPEC-Russian production cut agreement. In the longer run, cohesion might become more difficult for the current OPEC grouping as divisions arise between members whose industries are deteriorating and need sharply higher prices to offset declines and those who can cope with new competitive forces and still be able to expand. For the time being, OPEC’s larger members are trying to preserve the organization while at the same time, embarking on strategies to cope with future challenges. Abu Dhabi’s national oil company (ADNOC) is partnering with Western firms to apply new technologies to boost capacity to five million b/d by 2030 and is looking for refining assets abroad. Saudi Aramco is pursuing a sophisticated strategy that includes diversification into natural gas, petrochemicals and trading as well as making sure to keep its production costs low to extract as much revenue as possible from legacy assets. But beyond diversification strategies, officials from OPEC’s big guns - Saudi Arabia, Kuwait, UAE and Iraq - have such low cost production that they are assuming that they can be the last ones standing. But while it might be tempting among Middle East producers to forge a policy to wait for U.S. shale to peak and sputter out in the coming years, it is early days on drilling technology innovation with new ideas on how to tap improved data, automation, lasers and CO2 injection to improve recovery rates not only in the United States, but around the globe. All that technology might mean that pure geology (e.g. ultimate size of reserves) might not matter as much as stable access to capital as a new winning characteristic of the future Darwinian challenge in oil. Thus, in the new Darwinian oil world, we can expect to see continued announcements about how low the largest players can go on costs. ExxonMobil threw down the gauntlet recently by stating its next Texas Permian oil increment will come at price tag of $15 a barrel, substantially below break evens for some of the smaller U.S. companies operating in the Texas shale. It’s also well below the kind of oil prices needed for OPEC’s member fiscal budgets which require oil prices to range from at least $45 to as high as $80 a barrel, depending on the country. As a new report published by Council on Foreign Relations on the Tech Enabled Energy Future notes, the convergence of automation, artificial intelligence, advanced manufacturing and big data analytics is poised to remake the transportation, electricity, and manufacturing sectors in ways that could eliminate oil use just at the same moment when those same technologies could make it easier and cheaper to extract oil and gas. As digital energy technologies take hold, large oil producers will have to consider whether their reserves could depreciate in value over time if they delay oil production and development in an effort to hold up prices in the present and garner short-term revenues. This reality is adding to the challenges many oil producer governments already face from mounting budgetary stress, prompting widespread calls for energy sector reforms in a host of oil states around the world. In the new digital energy world, fittest is being redefined and access to the largest reserve base will no longer be the overwhelming metric for success. The winners and losers could prove surprising.

Elizabeth Munn is the Spring 2019 volunteer intern with the Africa program at the Council on Foreign Relations in Washington, DC. She is a student at George Mason University, studying global affairs and African studies. On February 20, the UN Commission on Human Rights in South Sudan issued its third report. Despite the peace deal signed six months ago in September, it documented an increase in cases of rape and sexual violence over the past year, concluding that the crimes had “become quite normalized” in South Sudan. Driving much of this is oil.  According to the report, the state-owned oil company, Nile Petroleum Corporation (Nilepet), has demonstrated a “total lack of transparency and independent oversight” in its diversion of oil revenues into the hands of government elites. The structure of the company is deliberately designed to allow for autocratic control: it is run by a managing director who is accountable to a board of directors whose members are appointed by the president. To the board, the government has appointed loyalists, particularly individuals from the National Security Services (NSS), which has been accused [PDF] of human rights abuses. This process has allowed Nilepet‘s oil revenue to be diverted to the security services, who in turn purchase weapons and other military equipment. In fact, a majority of Nilepet’s revenues in 2015 were used to fund over two hundred thousand soldiers stationed in conflict areas near oil fields. Further, Nilepet received a letter from government elites asking for $1.5 million for military expenses in 2016. South Sudan produces around ninety million barrels of oil a year and the vast majority of the revenue finds its way back to political and economic elites, while, according to 2016 data from the World Bank, the poverty rate stands at 82 percent. With oil income accounting for about 98 percent of the government’s budget, the parties in conflict have targeted oil-producing states and facilities in efforts to gain money and power. The struggle has entirely neglected the needs of the average citizen. A report by Global Witness documented how some South Sudanese must resort to the black market to obtain fuel, where prices can reach 300 South Sudanese pounds ($2.30) just to fill a one-liter plastic bottle, equivalent to almost $9 a gallon. Although Nilepet is under the complete control of the government, it is considered a private company, meaning it is not subject to the same oversight as a government agency. The UN Commission on Human Rights in South Sudan advocated for increased accountability and transparency in oil companies, such as Nilepet, to overcome deeply-rooted corruption in oil-rich nations. This likely requires international support against corrupt practices.  The U.S. Commerce Department has designated foreign and domestic oil entities operating in South Sudan as threats to U.S. national security because of their role in the conflict. These other state-owned companies, which dominate oil production in South Sudan alongside Nilepet, are the Chinese National Petroleum Company, Petronas of Malaysia, and the Indian Oil and Natural Gas Corporation. Unlike those of China, Malaysia, and India, many other international companies have abandoned oil production in South Sudan altogether.  South Sudan is home to one of the worst humanitarian crises in the world. International efforts, such as those of the U.S. Department of Commerce, are needed to call attention to the severity of the issue and push South Sudan to implement accountability and transparency in the oil industry and among the security services.   

Amin Nasser, Chief Executive Officer of Saudi Aramco, whose shareholder is a sovereign nation, weighed in this week with a warning against U.S. and European activist shareholders who are making demands of the world’s largest publicly traded oil companies. Nasser told an industry audience in London that the oil industry faces a “crisis of perception” among its stakeholders that puts at risk its ability to supply energy to billions of customers around the world. In a speech to International Petroleum Week in London Tuesday, Nasser outlined “urgent, collective effort” the oil industry must take to counter the perceptions crisis. Such steps would include pushing back on narratives that oil is a bad financial investment because demand might peak soon and offering the development of cleaner fuels that respond to consumer concerns about environmental, social, and governance issues. The speech comes on the heels of an active proxy season in the United States and Europe where shareholders of the largest oil companies, whose stocks are publicly traded, have asked the firms for transparent reporting on  how they will reduce the carbon footprint of their products and operations in line with the 2 degrees Celsius Paris climate accord goals, including setting concrete short, medium and long term targets for reductions. ExxonMobil has formally asked the U.S. regulatory agency, the Securities and Exchange Commission (SEC), to reject the shareholders efforts to bring the resolution to a vote at ExxonMobil’s annual meeting in May. Royal Dutch Shell has already adjusted its strategies to reflect similar requests and will link future executive pay to emissions reductions achievements. The company announced recently that it was buying German residential solar battery maker Sonnen and investing in electric vehicle charging stations in Europe in addition to its hydrogen fuel business in Germany. BP is also moving into the EV charging business, and has agreed to demonstrate how its business will align with Paris climate goals including executive remuneration based on emissions reductions. Chevron’s shareholders are asking for information on the company’s strategic vision and response to climate change risks and opportunities. Goldman Sachs is under pressure from activists this year to reduce the carbon footprint of its loan and investment portfolios. France’s Total whose stock performance has outpaced others in the last year, tweeted today that “It’s not about putting a green paint on @Total’s logo but a real evolution of our energy mix”, projecting that the company will hit 10 to 20 percent low carbon electricity by 2040 on top of 45 to 55 percent natural gas, leaving liquid fuels (oil and biofuels) at only about a third of the company’s product mix by 2040. The oil industry has trendlines to point to in its narrative that oil is hard to move away from. Global oil use climbed 1.3 million barrels a day in 2018, according to the International Energy Agency, amid stronger oil use in China and India. IEA projects similar growth for 2019. China’s oil use rose by 440,000 b/d last year, despite a 17 percent decline in car purchases. More surprising was higher U.S. oil use, which topped 540,000 b/d in growth last year as the American economy expanded. New academic studies reveal that economic expansion is once again linking to a rise in U.S. vehicle miles traveled (VMT) since 2012, dispelling the notion that millennials might drive less. U.S. Federal Reserve Bank economists are finding that millennials have the same consumption preferences as past generations, including interest in buying cars, but are less well off than members of previous generations. Some U.S. cities are also finding that use of ride hailing services can potentially increase VMT, rather than lowering it. These latest trends suggest that wild predictions that global oil demand would peak by 2020 will likely be off the mark. Still, the possibility that oil demand will plateau or even decline in the long run cannot be dismissed out of hand. That’s because in multiple sectors – across vehicles, manufacturing, freight and even plastics – digital technologies are transforming the way things are made, shipped and used, with large disruptions to current use patterns possible. Last summer, Citi published a report suggesting countries across the globe are beginning to strengthen restrictions on single use plastics, noting that China’s decision to stop imports of plastic waste last year. “With China no longer importing plastic waste and other countries unable to absorb the high level of supply, exporters will likely be forced to expand on domestic recycling infrastructure and/or cut back on the level of waste being produced,” Citi noted in its report. McKinsey & Co. estimates that recycling and substitution of biomaterials could shave 2.5 million b/d off rising oil demand for plastics manufacturing by 2035 and that 60 percent of plastics used by 2050 could come from production based on previously used plastic. Changes in global trade and freight practices could also substantially lower oil use in the future. In its “Less Globalization” scenario, BP projects that the rise in global economic expansion would lag about 6 percent, compared with a business as usual projection for 2040, translating into about a 2 percent loss of oil demand, if tariff wars and rising populism were to continue to dent global trade. That estimate for a minimal effect on oil use could prove optimistic, since next generation manufacturing technologies, increased use of optimization programs for logistics, increased use of alternative fuels in trucks and delivery vehicles and rising protectionism for jobs could mean bring much larger changes in oil use for aviation, shipping and on-road freight. Our modeling, in partnership with University of California Davis researchers, indicates that there are still many policy levers that could change the trajectory for oil use in transportation. We found, for example, that the possibility that proposed bans on new sales of internal combustion engine cars by 2040, mooted in Europe and even discussed in China and India, could shave 5 million b/d from future oil demand, if implemented broadly. In one scenario, utilizing the International Energy Agency’s mobility model, we defined the parameters of an internal combustion engine (ICE) sales ban policy as one where non-plugin, ICE-powered new vehicle sales go to zero in Europe, China, India and California by 2040. Plug-in hybrids are assumed to be exempt from the sales ban, as well as commercial freight vehicles, emergency vehicles, and 2/3 wheelers. Closing geo-fenced areas of major global cities to gasoline-powered cars, potentially in favor of electric vehicle ride sharing or greater use of public transit, could double this effect, our research concludes. New policies that promote use of alternative fuels for buses and in on-road trucking, a policy already underway in China, would also curb growth in oil use significantly. The bottom line is that a combination of rapid technological disruption and shifting geopolitics has the potential to adjust the trajectory for oil demand, potentially downwards, but also, without strong policy intervention, possibly upwards. That is creating great uncertainty for investment in the oil sector. Historically, investors have favored oil company shares and oil commodity financial derivatives because they felt that the sector would face future scarcity of both produced supplies and physical reserves. This view of peak oil supply propelled billions of dollars in capital investment in search of new reserves. Oil company reserve replacement was highly valued and rewarded. Now this presumption that oil demand could only flow one way – upward – is more uncertain and notions of long run oil scarcity look more doubtful as the industry unlocks the technical ability to produce more oil and gas from “source” rock, rather than from large already discovered reservoirs. These two new realities are not fantastical “perceptions.” They are the outcome of new uncertainties created by rapidly accelerating changes in technology. As shareholders pressure international oil companies (IOCs), they are increasingly positioning themselves to respond. A recent Wood Mackensie consultants report suggests that renewables could represent one fifth of total capital allocation for the major oil companies most active in the alternatives sector after 2030. That should be a cautionary note for national oil companies (NOCs) thinking that the oil majors can be the financing backup plan if their own attempts to expand (or possibly just to maintain) oil production capacity fail in the next few years. Increasingly, the majors will judge possible long-range mega-projects with a tougher eye, now that booking large reserves is not currently rewarded as it once was by Wall Street. That could create future difficulties for countries like Venezuela that are counting on foreign direct investment to bail it out of mismanagement of its oil sector. Thus, Mr. Nasser may be correct. Oil supply could prove volatile in the coming years (or even in the next few months) as national oil companies face increasing problems. But that problem won’t likely be tied to misperceptions by the shareholders of the IOCs. It is more likely to be related to how Saudi Aramco and its peers manage their current revenues and future investments.