Oil and Petroleum Products

For over a decade, U.S. efforts to promote stability across the Middle East have run afoul of many complexities. The recent independence referendum in the Kurdish Regional Government (KRG) territory of Iraq is no exception. Both the sudden actualization of the referendum and some of the related geopolitical maneuvering associated with it, could provide new challenges for the United States in the region and harken back to a repeating failure of even seasoned American diplomats to head off conflicts over the final dispensation and control of important disputed oil and gas assets. The idea that Iraq’s Kurdistan region meets the prerequisites for nationhood is compelling. An independent Kurdistan was, in fact, drawn into the Treaty of Sevres almost a century ago in 1920. But the devil will be in the details of how the long-term status of the KRG gets resolved. Many complicated variables have to be navigated in the post referendum equation. Seasoned experts will weigh in on the complicated politics that has led to the KRG action and how it should be handled by the United States. This blog is aimed to underline specifically how any effort to mediate conflicts arising from the referendum will need to consider carefully the oil geopolitical aspects to the crisis. At issue is not just the possible loss to the global oil market of 500,000 to 600,000 barrels a day of Iraqi oil exports from KRG controlled territory via Turkey. In today’s oil world, this volume would eventually, if not quickly, be replaced. Rather, it is the dangerous precedent of letting subnational political and military “events” and shifting regional geopolitical alliances dictate the final dispensation of the Kirkuk oil field, which sits in historically disputed territory, before an adequate effort at a negotiated (read, internationally legally binding) resolution can be attempted. The History of Kirkuk The area surrounding the Kirkuk oil field houses many different regional peoples, including Arab, Kurdish, and Turkoman communities, the latter of which historically represented roughly 8% of Iraq’s total population according to some estimates. During the reign of Saddam Hussein, “Arabization” of the region changed its complex mix amid efforts by the Baath regime to guarantee its better access to the oil region, which in the 1980s represented close to 1 million b/d of Iraq’s total oil output of 2.0 to 2.5 million b/d. Kirkuk field holds reserves of 9 billion barrels. ISIS began to encroach on the area of the field in 2014 and when the Iraqi army’s defense of the region collapsed in June of that year, Kurdish Peshmerga forces interceded and took control of most of the oil producing region. Production at the oil fields in and around Kirkuk have been producing about 400,000 b/d of which 160,000 b/d come from three fields, Baba Dome, Jambur, and Kabbaz, which were at one point administrated by the central Iraqi government controlled North Oil Co. With Kirkuk squarely under Kurdish control, it remains unclear what the long-term status of the oil producing assets will be. The KRG has for years made its claim to Kirkuk clear in words and actions. U.S. oil companies, including ExxonMobil, have given stature to such claims by signing oil exploration deals with the KRG for oil fields in disputed territories, including blocks in and around Kirkuk. Notably, one ExxonMobil block attained from the KRG, the Bashiqa block, was taken over by ISIS militants. The firm has since relinquished several of its exploration blocks in Northern Iraq given both political and geological difficulties. Baghdad maintains all Northern region fields should be under Iraqi central government control, and especially the Kirkuk fields, and Iraqi prime minister Haider al-Abadi is forced to stake his reputation on it, with negative consequences for the unity of Iraq if he cannot prove to the KRG, and by extension, other oil and gas regions, such as Anbar and Basrah, that they cannot go their own way. Iraq’s parliament is calling upon Al-Abadi to deploy national security forces in disputed areas. Iraq’s oil ministry recently ordered North Oil Company to take immediate steps to rehabilitate the Nineveh fields set ablaze by retreating ISIS troops in a possible effort to try to reassert claims to oil resources in the region. For the past several years, Turkey has supported, financially and through transit for exports, the KRG’s oil and gas industry. But the changing domestic political landscape inside Turkey has made such positions more difficult of late for Turkey’s President Tayyip Erdogan. Last March, the leader of Turkey’s Nationalist Movement Party (MHP) stated the territorial integrity of Iraq was indispensable to Turkey’s national security and called claim to Kirkuk, “Historically, Kirkuk was Turkish. It remains Turkish even now and will become one of the most glorious Turkish cities in the future.” Erdogan has been more circumspect on the referendum saying Kurdish authorities would pay the price for the independence referendum and threatening economic sanctions. Turkey has held joint military exercises with Iraqi national troops on the border. So far, Ankara has not made good on its threat to shut down Kurdish oil exports which also are critical to Turkey’s economy. Enter the Russians Finally, ever opportunistic, Russia has recently expanded its influence into the controversy about who should control Kirkuk in the long run, via moves by state oil firm Rosneft, run by U.S. sanctioned Putin crony, Igor Sechin. Rosneft in recent weeks accelerated its negotiations of a major energy collaboration with KRG. The mooted deal is said to include a possible stake in the Kirkuk oil field, investment in the expansion of the Kirkuk to Ceyhan oil export pipeline, and a possible investment in a natural gas pipeline from the KRG to Turkey and Europe. Last June, Rosneft took five exploration blocks in the KRG and signed a memorandum of understanding to create a 300,000 b/d oil offtake agreement. The KRG reportedly discussed the Avana, Baba, and Khurmala domes as part of the deal, which include areas previously operated by the Iraqi state’s North Oil Company. Rosneft has also stepped in as a white knight to Kurdish finances, offering a capital injection of up to $3 billion in part to refinance debt coming from $1 billion in pre-financed oil sales deals with international traders. Firms Glencore, Vitol, Trafigura, and Petraco had loaned the KRG finance based on future oil sales. The trader oil has been going to Spain, Greece, Germany, Italy, and Croatia. The KRG’s annual oil revenues are projected at roughly $8 billion. With so many parties affected by any decision to stop oil exports from the KRG, Turkey’s Erdogan finds himself boxed in by domestic and international concerns. The involvement of Rosneft in KRG oil affairs adds additional tricky dimensions to any negotiation about the future of the KRG and purposely so. The Kurdish referendum gave the Kremlin a convenient possible out to peace negotiations in Syria by disincentivizing the Syrian Kurds from voicing cooperation. It also allowed Russia to counter checkmate Turkey, which saw energy cooperation with the KRG as a means to break the vice Moscow had on its own Turkish national energy supply. For the past several years, Ankara has been offering Turkish finance and technical support to promote KRG oil and gas export pathways to Turkey. Ankara had hoped to diversify itself from Russian energy and by extension, Europe, through its own link-up to the KRG energy supply. But the cost to Kurdish leader Masoud Barzani of high dependence on Turkey must have proved too restrictive. In effect, for the Kurds, the offer to sell oil assets to Russia would potentially solidify Russian assistance at the United Nations Security Council, should Baghdad or other regional powers seek to solicit U.N. sanctions against the KRG. What’s left is a geopolitical mess that will take skill and patience to disentangle. Possible outcomes that displease Iran could propel it to back local Shia militias to try to defy Kurdish Peshmerga control of Kirkuk. Iran has its own concerns, given its own restive Kurdish population which numbers 6.7 million or a little under 10% of Iran’s population. Iran was the first to move against the KRG after its referendum, closing its air flights and borders to the KRG. In other words, through Rosneft’s activities, Russia has gained leverage over Turkey and Iran’s interests in the Kurdish question and potentially reasserted oil and gas export leverage over not only Turkey but also major economies in southern Europe. The Oil Element and U.S. Interests The geostrategic element of Kirkuk as an oil producing province nearby to Turkey, Iran, and the Syrian conflict, makes the stakes higher than just the kind of economic conflict that has spurred localized military action by warring factions in South Sudan or Libya. The fate of Kirkuk will also be closely watched by other parties from contested oil regions who will look to U.S. and U.N. responses towards the KRG for some hints to their own aspirations. The United States has long kicked the can regarding the arduous task of navigating the finer details of oil revenue sharing shuttle diplomacy in failing states. The consequences of this failure has turned out badly in several locations, including Libya. Now, in the case of the aspirations of the KRG, is the time to redouble efforts to establish sustainable precedents. The principal of revenue sharing geographically by census/population count was rejected in the early days of reconstruction in Iraq, in my opinion, to the detriment of the entire experiment of trying to re-forge a national identity. To help the KRG and Baghdad create a viable path forward, the oil resource control and revenue sharing issue should be settled once and for all, peacefully and through binding negotiation that can include a payout or ongoing revenue sharing, depending on final deliberations. The consequences of a failure to diplomatically steer this “whose-oil-is-it” struggle to a successful outcome have been devastating for the people of the region. Militias throughout the Middle East have learned that they can undermine the authority of established political leaderships by overtaking oil producing areas. So far in the process of such conflicts, the oil and gas industries of Syria, Yemen, and to a certain extent Libya, have been destroyed. The United States should consider more active diplomacy on the resolution of the future of Kirkuk in hopes that persistence this time around might show better results than past efforts. Such an investment of diplomatic time, effort, and prestige could yield long-term benefits, not only for the people of Iraq and the KRG but also in other regions around the Middle East where oil revenue sharing and border fields remain in dispute. A win for a diplomatic settlement on the future dispensation for Kirkuk would offer a productive path for many other oil producing regions. This is not to say that the task is not a gargantuan one, but just that it is one well worth pursuing.

Inventories play a crucial role in oil and gas commodity markets by smoothing out short term dislocations and sudden changes in demand. The historically high inventory levels lingering from the after effects of a global market share war that has been raging since 2014 helped mute potential shortages from emerging in the wake of Hurricane Harvey. The hurricane initially knocked out roughly four million barrels a day (b/d) of U.S. refining capacity, pipelines, and over a million b/d in U.S. domestic oil production, including offshore output as well as 300,000 to 500,000 b/d from south Texas onshore fields inhibited by flooding for several days. Oil and gas infrastructure requires electricity, workforce availability and safety conditions to operate. While some of the shuttered oil and gas facilities are now coming back on line, the broad physical toll of Harvey’s severe weather event warrants revisiting of the policies surrounding both commercial and strategic inventory management. Just over half of all U.S. refining capacity is located on the U.S. Gulf coast, which is seasonally prone to hurricanes. A reevaluation of inventory policy is particularly important given the United States’ newfound role as a major exporter of oil and gas. In preparation for the storm, close to fourteen refineries fully shut down production around the Houston area. The geographic range of the shutdowns ranged from Corpus Christi, where five refineries were shut down, to Beaumont and Port Arthur, where three refineries went offline. This included Motiva’s 603,000 b/d Port Arthur facility, which is the nation’s largest refinery. As of September 7, the U.S. Department of Energy [PDF] reported that six refineries in the Gulf coast were still shut down and five were just in the process of restarting. At least two ExxonMobil refineries suffered structural damage during the hurricane. U.S. national security can be enhanced by embracing the country’s emerging export role. The Donald J. Trump administration is looking to leverage the opportunity created by U.S. oil and gas exports to assert global energy “dominance.” But for U.S. industry and the United States to benefit to the fullest from its status as a major global oil power, it needs to shore up its bonafides as a secure and reliable supplier. That means forging a stronger link between private and public management of inventories needed to keep oil and gas flowing even in the face of natural disasters and other kinds of supply emergencies. My research with co-authors Colin Carter and Daniel Scheitrum shows that there has been a significant substitution effect between private commercial crude oil inventories and public inventories over the past two decades in the United States. We also found that inventory patterns are changing rapidly as the shale revolution and related export flows have altered oil, gas, and refined products pipeline flows around the United States in ways that are changing the calculus between public and private oil stockpiling activities. For example, reversed pipelines to bring U.S. domestic production down to Gulf coast refiners have meant that access to the Strategic Petroleum Reserve (SPR) for mid-continent refineries is now limited, propelling local refineries to carry higher working inventory. California’s pipeline access to SPR releases is similarly inhibited and has been under study at the federal level. California’s refiners have not increased inventory holdings to sufficiently cover for occasional accidental supply outages, leading to billions of dollars in burdensome fuel premiums being paid by the public. The brief Harvey-related cut off of the Colonial Pipeline, a main artery to bring gasoline to the northern United States from the Gulf coast, turned out to be less severe than similar problems during Hurricane Rita and Katrina partly due to its brevity and availability of local buffer commercial inventories but also given changing trade flows. Earlier this summer, Colonial Pipeline was experiencing lower than usual shipments to the U.S. Northeast as rising oil demand from Mexico and Latin America pulled more U.S. Gulf coast gasoline and diesel exports southward. In other words, a significant portion of the U.S. Gulf coast refining disruption affected U.S. refined product export volumes, which had been averaging 532,000 b/d for gasoline and 1.1 million b/d for diesel in July. The U.S. Department of Energy (DOE) and the General Accounting Office (GAO) have been studying how best to upgrade current SPR infrastructure given changes in the U.S. oil industry and the fact that some of the SPR’s current surface equipment is approaching its technical end of life, raising the chances of equipment failures. Among the questions being asked are: what is the appropriate size for the SPR over time as U.S. oil import levels shrink and also what kinds of upgrades are needed to maintain the system’s broader regional effectiveness. What will help the Trump administration in its current efforts to rethink SPR policy will be the fact that industry now has a greater incentive to ensure that its global image as a secure and reliable supplier is not damaged by poor logistics planning. In other words, policy makers may now have a unique opportunity to reshape the public-private partnership role in inventory management, taking into account the rising importance of the United States’ new role as a global energy exporter. A 2014 National Petroleum Council study entitled Enhancing Emergency Preparedness for Natural Disasters highlighted the importance of coordination between government and private sector leadership in emergency fuel preparedness and implementation. An important lesson from Hurricane Harvey may be that the U.S. emergency preparedness system, including the SPR, needs more flexibility, regional diversity, and enhanced private sector participation. As the Trump administration looks to consider how privatization could best be applied to emergency fuel management, it can look to Europe’s paradigm of combining coordinated mandated requirements for minimum private sector holdings of refined product stocks with more limited public holdings of crude oil for insights on how the SPR system could be reformed to meet the changing U.S. energy outlook. The European system allows for a more interactive coordination between private industry holdings and public policy. There is no question that a more flexible system that combines refiner products stocks and federal government crude oil stores would be beneficial, especially if U.S. import levels decline as expected. The Trump administration could also investigate whether any shale producers around the country could serve as flexible suppliers during a long term national emergency, perhaps through a public tender pre-payment system to purchase incremental local production for emergency release through a funding system for incremental drilling and well completions. Flexibility and public private partnership should be important elements to improving the SPR system. The current Congressional authorization targets up to one billion barrels to be held in the SPR, a level which may now seem arbitrary in light of changing market dynamics. The Trump administration has proposed selling off 270 million barrels of the reserve's current 687.7 million barrels over the next decade as part of a budget plan. The ultimate size of emergency stocks must represent enough to replace U.S. oil imports for 90 days in order to meet its obligations—together with U.S. allies such as Europe, Canada, Japan, and South Korea—under the International Energy Agency’s (IEA) coordinated emergency response measures for the Organization for Economic Cooperation and Development (OECD) membership. There is currently much uncertainty about what level U.S. imports will average in ten years. In light of recent experiences from natural disasters, which can range from hurricanes to flooding events to wildfires, geographic distribution of national emergency stockpiles needs to be given higher consideration in any revamp of the future U.S. preparedness system. Upgrades to the existing public-private emergency preparedness partnership should also consider how to protect the United States’ oil and gas export role to avoid losses in market share during outages. By thoughtfully rejiggering the existing system, the Trump administration might be able to save the tax-payer money, protect U.S. export market share, and wind up with a better, more reliable emergency response.

Natural gas markets in the Asia-Pacific are on the cusp of an extraordinary transformation thanks, in part, to the rise of liquefied natural gas (LNG) exports to the Asia-Pacific from U.S. suppliers. If gas displaced coal, it would give a big boost to the world’s critically needed transition to a low carbon future.

The Venezuelan constitutional chamber’s decision last week to dissolve the National Assembly has made it abundantly clear that Maduro’s Venezuela is an authoritarian regime. The judiciary is at the beck and call of chavista forces, the military is corrupt and co-opted, and despite a last-minute reversal of the court’s decision, the continued dilution of the Assembly’s powers means that there are effectively no independent institutions left with the power to check the regime. Venezuela, meanwhile, is confronting a humanitarian catastrophe. The regime has run up against the limits of its economic policy: foreign currency is too scarce to cover both debt obligations and desperately needed imports. Three quarters of Venezuelans have lost weight under the “Maduro diet”; more than two-thirds of basic goods are scarce. The regime seems willing to play out the clock, at grotesque human cost, guided by one core strategy: waiting for global oil prices to recover. But the hole is now so deep that a modest increase in oil prices— of the sort predicted for 2017— may be insufficient: debt payments due in 2017 outstrip foreign currency reserves. Dictatorships sometimes crumble under the weight of their own contradictions, and this could yet be the case for Chavismo, given the depth of the crisis. Indeed, the uncertainty generated by the court’s action last week may be a sign of fissures within the regime. But as John Polga-Hecimovich and I noted last year, the Maduro regime has a clear strategy for repressing domestic opposition. Leaders who have mobilized against the regime are in jail. The military is fully in control of food supply and appears united against any regime change that might expose leading officers to prosecution for corruption or human rights abuses. The opposition has been fractured by the regime’s delay tactics, including the simulacrum of negotiations over the past year. Venezuelans are exhausted by the daily search for sustenance which, alongside regime repression, saps their ability to protest. Although Maduro walked back last week’s court decision, he retained the power to negotiate oil deals without congressional approval, a tool which may prove very important. China or Russia could yet help Venezuela out of its hole. But China does not seem eager to play a geopolitical role and it has little to gain from saving a crisis-ridden regime in the Western Hemisphere from seemingly inevitable collapse. Russia, on the other hand, seems to be doing what it can to help Maduro through his hard spell: it is reported to be negotiating loans and further investments by Rosneft that might help the regime through a heavy bout of April debt payments. The region has been slow to respond, but is at last finding its voice. Several countries withdrew their ambassadors over the weekend. Mercosur has been proactive: it suspended Venezuela from the trading bloc last year, and invoked its democratic clause over the weekend, which could culminate in Venezuela’s expulsion. The Organization of American States (OAS) has been proceeding more slowly, despite Secretary General Luis Almagro’s hectoring. Almagro’s hopes that Venezuela might be suspended under the Inter-American Democratic Charter continue to run up against simple math; although a few countries seemed to shift their stance last week, many Caribbean nations remain beholden to Maduro, meaning that Almagro may still be short of the votes he needs, even if a special session of the body meets today as originally planned (early reports suggests that the new Bolivian chair of the Permanent Council may suspend the session). The Trump administration so far appears to be following the policies adopted by its predecessor. The United States has imposed targeted sanctions against individual Venezuelans, including Vice President El-Aissami, but has wisely avoided the temptation to more directly and unilaterally confront the regime, allowing Latin America to lead. But patience is wearing thin in Washington. A flurry of congressional declarations last week could presage more muscular legislative action in the months ahead; Senator Marco Rubio suggested that he would lean on recalcitrant OAS members, including by withholding assistance to countries that failed to support OAS action. Policymakers hoping to encourage a peaceful resolution of the crisis must pinch their noses and maintain a channel for dialogue with the regime while giving regime hardliners guarantees of non-reprisal if— but only if— they facilitate a rapid transition. Dialogue has been unproductive in the past, but keeping talks open at least offers the possibility of a strategic exit for regime members. UNASUR has been playing a key role in encouraging dialogue; it may yet be an effective good cop to the OAS’s bad cop, provided it does not allow itself to be used as a convenient pretext for the Maduro regime to string out talks endlessly. Guarantees for regime members who cooperate in finding a way out of the crisis are needed to ensure that negotiations are not seen as a zero-sum game. But the regime has played games for far too long to be trusted to negotiate in good faith. Simultaneously, therefore, regional governments must tighten pressure on the regime. The symbolic weight of an OAS suspension would be great— as Almagro said, “peer condemnation is the strongest tool we have.” But in addition to declaring the Venezuelan regime a pariah, regional and global allies could also help to keep hardliners over a barrel. Prosecutions, asset seizures, visa restrictions, and other sanctions would be most effective if they were employed not only by the United States, but also by Latin American and European allies.