The Soviet Union changed the region’s political dynamic, especially around energy, when it brought the five “stans” and the Caucasus within its sphere.  Under Soviet rule, the energy trade developed in a north-south pattern, with all pipelines moving north into Russia and avoiding the traditional east-west paths of the Silk Road.

Since the demise of the Soviet Union in 1991, many cracks developed in Russia’s energy hegemony over Central Asia and the Caucasus.  Diversification of oil routes occurred first, starting in the mid-1990s and continuing to the present.  Diversification of gas routes occurred much later and is only now resulting in multiple gas export routes.

Today, the players in the region are numerous: Russia, which is attempting to maintain its political and economic hegemony over the region; China, which is entering into long-term relationships to sustain economic growth and energy security; the European Union, which is developing new sources of gas to meet future demand and to enhance its energy security; the United States, which is seeking to augment its influence to counterbalance Russia and China; and the nation’s that make up the region are attempting to forge a delicate balance among these competing interests.

The international effort to break the Russian monopoly on transport routes is at the forefront of the new energy politics in the region. In this heightened political atmosphere, the oil and gas pipelines crisscrossing the area have become, in effect, the modern version of the Silk Road.

OIL PIPELINES

In the post Soviet era many cracks developed in the Russian oil pipeline monopoly.  The United States, with European backing, supported this diversity with its multiple pipeline strategy.  Today, route diversity and competition undermine Russia’s former monopoly.

The first crack developed in Azerbaijan in the 1990s with pipeline and rail routes starting in Baku, Azerbaijan and transiting Georgia carrying oil to the Black Sea ports of Supsa and Batumi.  The second crack, the Caspian Pipeline Consortium (CPC) pipeline, opened in October 2001 carrying oil from Kazakhstan’s Tengiz oil field to the Black Sea via Russia. CPC was the first and remains the only oil pipeline within Russia not controlled by state-owned Transneft, Russia’s oil pipeline monopoly.  The third crack, the Baku-Tblisi-Ceyhan (BTC) pipeline open in July 2006, from Baku to Ceyhan, Turkey, a deepwater port on the Mediterranean.

The next crack was the completion of the Kazakhstan to China oil pipeline in July 2006, now extended across Kazakhstan to Atyrau to link up with its western oil fields.  Finally, Kazakhstan developed a trans-Caspian barge system shipping oil from the port of Aktau via barge to the BTC pipeline.

GAS PIPELINES

In Soviet times, all gas pipelines went north and connected with the Russian gas system. The emergence of Gazprom in the 1990s as Russia’s state controlled gas monopoly continued Russia’s domination of Central Asian gas transportation. The Central Asia Center Pipeline (CAC) connected Kazakhstan, Turkmenistan, and Uzbekistan for distribution of gas within the region and export to Russia. Gazprom contracted with the three countries to buy all the available capacity in the CAC system maintaining Russia’s dominance.

Alternatives are dissipating Russia’s gas monopoly.  Azerbaijan’s Shah Deniz Caspian gas field development led to the South Caucasus Pipeline (SCP) that carries gas from Baku through Tbilisi, Georgia to Erzurum, Turkey (or BTE pipeline), connecting to the Turkish gas pipeline network.  SCP began gas exports in 2007, marking the change of Azerbaijan from a net importer of Russian gas to a net exporter of its own gas.

In June 2009, Azerbaijan’s President Aliyev signed an agreement with Russia’s President Medvedev for Azerbaijan gas exports to Russia.  An implementing agreement was signed in October 2009 running from 2010 to 2014 for the sale of 500 million cubic meters per year.

Russia thought it staged a coup by buying Azeri gas precluding Azerbaijan’s commitment to Nabucco.  Closer analysis revealed that Azerbaijan did better since it sold its surplus gas for a limited period of time at world prices, but retained the ability to commit gas in the future to Nabucco since Nabucco is not expected to begin operations until 2015, a year after the Russian contract expires.  Azerbaijan continues to seek gas export alternatives and is working with Bulgaria for pipeline and tanker movements of compressed natural gas for additional gas exports.

Turkmenistan is opening another wedge in Russia’s dominant gas position.  Gazprom turned to Turkmenistan when its own Russian production leveled off and found that it was cheaper to buy Turkmen gas than to develop its own Yamal gas fields.  Under President Niyazov, Turkmenistan sold its gas to Russia or Ukraine, while making overtures to the west about a trans-Caspian pipeline.  This situation continued until the death of Niyazov in December 2006.

Turkmen President Gurbanguly Berdymukhamedov was elected in February 2007.  Later in 2007, he signed an agreement with Russia to expand the Prikaspiiski pipeline system running along the eastern shore of the Caspian.  With Gazprom’s contracts for all the capacity of the CAC gas pipeline system and the expansion of the Prikaspiiski pipeline, it appeared that Russia re-asserted its hegemony over Central Asia gas.

This illusion did not last long.  Turkmenistan and China signed a gas export deal in December 2006 (weeks before Niyazov’s death) for the export of gas to the east.  Construction of the Turkmen section began in August 2007 and completed in November 2009.  The Uzbek section began construction in June 2008, while the Kazak section began construction in July 2008.  The Chinese National Petroleum Company (CNPC) is providing most of the financing for the pipeline.  China and Turkmenistan expect that gas will start flowing in the Turkmen section in December 2009 and small volumes of gas will reach China in early 2010. The initial agreement was for 30 billion cubic meters per year for 30 years, now increased to an additional 10 billion cubic meters per year.

In the meantime, negotiations with Gazprom over the expansion of the Prikaspiiski pipeline continued and still have not been completed primarily due to lack of agreement over price terms. A 600 km east-west spur line also was to be built and financed by Gazprom to connect central Turkmenistan gas fields with the expansion.  Rather than rely on Gazprom financing, Turkmenistan requested tenders from international companies for the pipeline’s construction. Turkmenistan now thinks that Gazprom lacks the financial capacity to complete the east-west spur.

The recession of 2008-2009 changed Gazprom’s situation. Gas demand from Europe, Gazprom’s prime export market, fell by 25-30% or more.  In 2009, Gazprom’s gas prices fell as its gas contracts are oil price linked following oil prices with a six to nine month lag.  With Gazprom paying “world prices” for Turkmen gas in Central Asia, Gazprom was losing significant amounts of money on every cubic meter of Turkmen gas it was selling in Europe or at home.  Gazprom needed relief from its Turkmen gas contracts.

On April 9, 2009, a blast occurred on the CAC-4 section of the Turkmen-Russian pipeline stopping all Turkmen gas shipments to Russia. Whatever the cause, no gas flowed from Turkmenistan to Russia since the explosion.  On April 24, 2009, at a two- day international energy conference in Ashgabat, President Berdymukhamedov declared Turkmenistan’s energy independence from Russia.  Berdymukhamedov’s statements have important implications for China, EU and the US.  He said, “Today we are looking for conditions to diversify energy routes and the inclusion of new countries and regions….Turkmenistan must create a new system of relations with Europe.  In the current situation, the diversification of energy routes could help to stabilize the global economy.”  He continued  that “it is normal and absolutely justified…for any energy producer country wishing to maintain its economic and energy security to assert its national interests….Energy security has been the cornerstone of the foreign economic strategy of Turkmenistan.”

Representatives from the United States in attendance at the conference expressed interest in having Turkmen gas committed to a trans-Caspian pipeline route.  European representatives also in attendance were seeking commitments to supply gas to Europe.

Turkmenistan is working with China to develop its South Yoloten gas field in eastern Turkmenistan.  Some estimates have placed the reserves in this field as high as 14 trillion cubic meters, which is about twice current total Turkmen reserves.  CNPC is the first foreign company to develop a major onshore field under license in Turkmenistan. China has provided a $4 billion line of credit for the development of South Yoloten. China also is financing a fertilizer plant that will export its output to China.  Additional incentives have been offered as well.

The EU is seeking commitments from Turkmenistan for its proposed Nabucco pipeline, from Azerbaijan through Turkey to Europe. President Berdymukhamedov indicated  recently that South Yoloten has enough gas to also supply Europe through Nabucco. On July 13, 2009, Nabucco and its partners signed transit agreements with Turkey and European countries (Bulgaria, Romania, Hungary, Austria) to permit Nabucco to carry gas across each country’s territory.  The EU is now more optimistic than at any other time that Nabucco will be built.

A relatively new pipeline proposal, White Stream, a private venture, may provide an opportunity to carry Azeri gas directly to Europe, bypassing Turkey.  The private companies would transport gas across Georgia (relying on a 100 mile pipeline from the South Caucasus Pipeline to Supsa), then under the Black Sea to the Romanian coast near Constanta and then using Romania’s gas transmission on to EU markets.

Since the demise of the Soviet Union in 1991, many cracks developed in Russia’s energy hegemony over Central Asia and the Caucasus.  Diversification of oil routes occurred first, starting in the mid-1990s and continuing to the present.  Diversification of gas routes occurred much later and is only now multiplying gas export routes.  All the countries of the region rely on pipelines for their energy trade, the modern day version of the old silk routes.

Analysis by Abraham Energy Report Contributing Editor Leonard L. Coburn

Even without a formal, legal agreement emerging from this month’s climate negotiations in Copenhagen, the historic gathering of 192 nations still could provide important signals of what a future international accord may look like.

Coal and oil will still be kings for at least a few more decades, to be sure. The International Energy Agency (IEA), in its annual World Energy Outlook report last month, estimated a 40 percent rise in energy demand by 2030, with 77 percent of the increase being met by fossil fuels.

The United Nations’ Intergovernmental Panel on Climate Change (IPCC) has urged developed nations to reduce emissions as much as 40 percent from 1990 levels by 2020 so that climate change can be stabilized, and in the long term, to reduce emissions at least 80 percent by 2050.  Advocates for action on global warming have long hoped that the talks in Copenhagen, being described as the largest environmental meeting in history, would result in a treaty that put the world on track to reach those goals.

However, all the goals set by industrialized nations heading into the conference fall short of the IPCC targets.  The Obama Administration recently pledged to cut U.S. emissions 17 percent below 2005 levels by 2020, which amounts to a 4 percent reduction from 1990 levels. China, which recently surpassed the United States as the biggest emitter of carbon dioxide, has pledged to reduce its “carbon intensity,” or the amount of CO2 released for each unit of GDP, by 40-45 percent from 2005 levels by 2020, but the result could be little actual reduction in emissions, considering the expected growth of China’s economy.  The European Union, the third-largest source of emissions, proposes cutting 20 percent below 1990 levels by 2020, and by 30 percent if other wealthy nations follow suit.

Leaders of the Copenhagen summit have already conceded that a binding agreement will not be reached before the talks close Dec. 18. The head of the host country, Danish Prime Minister Lars Lokke Rasmussen, has proposed that participants instead negotiate a political deal, and then set a firm deadline for writing a formal treaty.  “We are not aiming to let anyone off the hook,” Rasmussen said when he unveiled his plan in mid-November.

In addition to developing a scheme for reducing emissions, negotiators need to address how mitigation efforts will be verified, how much money rich nations will provide poorer nations to deal with climate change, and how intellectual property rights will be protected in technology transfers.

Many climate advocates cite as a chief reason for the lowered expectations at Copenhagen as the failure of Congress to enact climate legislation, leaving U.S. negotiators with nothing to back up their verbal promises. President Obama plans to attend the start of the summit on his way to Oslo to pick up his Nobel Prize, but his presence alone cannot guarantee to other nations that U.S. action will follow.

“The administration has spent the last month or so really reducing the expectations for the conference,” says Bracewell & Giuliani partner Scott Segal, who represents energy companies on climate issues. “They are expecting limited results, and I am not sure the pieces are in place to change that.”

In fact, the U.S. pledge to cut its emissions by 17 percent below 2005 levels is merely a statement of the goal established in the climate bill that passed the House in May.  A 20 percent goal is outlined in legislation pending in the Senate, but the administration’s use of the House number in its announcement that Obama would go to Copenhagen implied a lack of confidence that the Senate will pass a stronger bill.

Some observers believe a dose of reality in the lead-up to Copenhagen is not all bad.  “A year or two ago, people expected Copenhagen to produce the equivalent of the Kyoto Protocol—a comprehensive climate roadmap for the next decade or more,” said Dan Farber, director of the Environmental Law Program at the University of California, Berkeley, on his blog.  “It seems unlikely that the Copenhagen meeting will live up to those expectations, although there’s always the chance of a last-minute surprise.”

At the same time, Congress is inching ahead on legislation, many states are adopting climate programs, the EPA is strengthening regulations, and major developing nations like China and India are showing signs of flexibility on mitigation efforts, Farber noted.  “So there is reason to be optimistic looking forward, even if nothing major comes out of Copenhagen,” he said. “One way or another, Copenhagen is just one stopping point on a long road.”

The big question is whether that road will lead to more of the same policies that doomed U.S. participation in the Kyoto agreement—caps on emissions for developed countries; no limits on emissions from developing nations like China and India—or whether a genuine transition from carbon-based energy to cleaner sources can be engineered.

Top U.S. climate negotiator Todd Stern has made clear that any framework based on Kyoto will be rejected again. “We have to send the message, in word and deed, that the effort to reach a new climate change agreement is not simply about putting a cap on emissions, it is about development—low-carbon development,” Stern told the House Foreign Affairs Committee in early November.

Numerous studies this year have argued for wholesale restructuring of the global energy economy. One by the office of former British Prime Minister Tony Blair and the London-based Climate Group said direct investment in clean-energy development on a worldwide collaborative basis would be less costly and more effective than capping emissions and spending on mitigation.

Another report in November by World Wildlife Fund International concluded: “Runaway climate change is almost inevitable without specific action to implement low-carbon re-industrialization over the next five years.”  The study conducted by Climate Risk Pty. Ltd. of Great Britain and Australia said achieving an 80 percent reduction in greenhouse gases by mid-century will require worldwide investment of $400 billion annually until 2025 in energy efficiency and clean generation technologies, low-carbon agriculture and sustainable forestry.

The IEA made a similar estimate in its World Energy Outlook 2009 report. The agency said “cumulative incremental investment of $10.5 trillion is needed” in low-carbon energy technologies and energy efficiency by 2030, but it said those costs would be mostly offset by $8.6 trillion in savings on energy costs in transportation, buildings and industry from 2010 to 2030.

None of this means investments in fossil fuels will decline in the coming decades as the oil, gas and coal industries scramble to meet energy demands that will begin rising quickly once the global recession ends.

The head of British Petroleum, Tony Hayward, projects that $1 trillion a year will be invested in energy development worldwide until 2030, with much of the money going for crude oil and other fossil fuels. “I don’t believe there’s a shortage of fossil fuels…We have around 40 years of oil and 60 years of gas at the current consumption rates,” Hayward told the Commonwealth Business Forum, a meeting of more than 50 countries, in late November.

Peter Voser, CEO of Royal Dutch Shell, made a similar forecast in an October speech to the World Business Forum in New York, saying that “even with rapid growth of renewable energy, fossil fuels and nuclear power will still supply at least 70 percent of the world’s energy in 2050.”

The transition to cleaner forms of energy will take decades, Voser said, noting that it typically takes 25 years for a new source to capture just 1 percent of the energy market.

China provides a perfect example of the problem. While the government’s goal in the world’s largest and fastest-growing nation is to have 20 percent of its energy come from renewable sources by 2020—and it has doubled the number of wind-energy plants in each of the last four years and committed to building 30 new emission-free nuclear power plants—China also has plans to build more than 550 new coal-fired power plants over the next eight years. As a result, some experts expect China to account for half the world’s growth in greenhouse gas emissions over the next 20 years.

To help address that dilemma, the IEA in a separate report this fall called for construction of 3,400 carbon-capture and storage projects by mid-century, mostly in developing nations that will account for 97 percent of the growth in emissions. The cost would be more than $5 trillion, with $275 billion needed in China and India just for construction of 62,000 miles of underground pipelines. Indeed, one of President Obama’s key achievements on his recent Bejing trip was the establishment of a robust new initiative with U.S. and China cooperation on clean coal research and development.  Norway has suggested a World Bank trust fund should finance CCS projects, as a way to meet the demands of developing nations and that the industrialized world bears the brunt of climate change mitigation costs.

Yvo de Boer, executive secretary of the United Nations Framework Convention on Climate Change, has called for global spending of $100 billion annually to help vulnerable nations adapt to climate change and $200 billion annually to develop clean energy sources.

Thanks largely to the recognition of de Boer and other negotiators that there is insufficient time and consensus among nations to craft a legally binding agreement, it seems more realistic to develop something akin to a political agreement—one where the President’s and China’s aspirational limits on carbon emissions can set the stage for longer-term negotiations.  In the meantime, the U.S. and global economies need time to recover.  Until the U.S. economy is growing again and the 2010 elections are completed, it is highly unlikely that Congress will take any action on climate legislation.

The “U.S.-China Joint Statement” highlighted a panoply of areas in which bilateral cooperation would be increased:  military, civilian aviation, space, health, agriculture, culture and education, legal, economic, trade and investment, counter-terrorism, nuclear non-proliferation and security.

But an entire section of the Statement was reserved for “Climate Change, Energy and Environment.”  This is hardly surprising, given the leading roles of the U.S. and China in the global climate change debate, particularly since the U.S. never joined the Kyoto Protocol and China, as a developing country, was not obliged to do so.

Yet, China is the world’s largest coal producer and consumer and the U.S. is second; combined, the two countries account for more than 60 percent of worldwide coal production and use.  China recently surpassed the U.S. as the largest source of greenhouse gas emissions.

With so much at stake, the two sides reached agreement on cooperation in seven specific areas:

1. A U.S.-China Clean Energy Research Center.  The two presidents announced the establishment of the center to facilitate joint research and development of clean energy technologies, with public and private funding of at least $150 million over five years.  Initial research priorities will be energy efficiency in buildings, clean vehicles and clean coal technology, including carbon capture and storage.
2. A U.S.-China Electric Vehicles Initiative. The initiative will include demonstration projects in more than a dozen cities, joint standards development, technical road mapping and public education projects.
3. A U.S.-China Energy Efficiency Action Plan. Under the plan, the U.S. and China will work on improving the energy efficiency of buildings, industrial facilities and consumer appliances.  They will develop, with their business sectors, energy efficient building codes and rating systems, benchmark industrial efficiency, train building inspectors and industrial facility energy auditors, harmonize test procedures and performance metrics for consumer products and exchange best practices in energy efficiency labeling systems.  A new U.S.-China Energy Efficiency Forum will be held annually, rotating between the two countries.
4. A U.S.-China Renewable Energy Partnership. They will develop roadmaps for widespread renewable energy deployment in both countries, including support for state and regional efforts.  A new U.S.-China Renewable Energy Forum will be held annually, rotating between the two countries.
5. 21^st Century Coal. In addition to efforts under the Clean Energy Research Center, the two countries are actively engaging industry, academia, and civil society in advancing clean coal and CCS solutions.  The two presidents also welcomed a number of bilateral commercial clean coal technology efforts.
6. A Shale Gas Initiative. Both countries will use experience gained in the U.S. to assess China’s shale gas potential, promote environmentally sustainable development of shale gas, conduct joint technical studies, and promote shale gas investment in China through the U.S.-China Oil and Gas Industry forum and other venues.
7. A U.S.-China Energy Cooperation Program. The program will leverage private sector resources for project development work in China on renewable energy, smart grids, clean transportation, green buildings, clean coal, combined heat and power, and energy efficiency.  More than 20 companies are founding members of the program.

During the Asia-Pacific Economic Cooperation (APEC) Leaders’ Meeting in Singapore,  President Obama joined in a statement that lowered expectations for Copenhagen.  The President expressed support for a proposal from Danish Prime Minister Lars Lokke Rasmussen to pursue a two-step process at the Copenhagen summit:  formulation of a nonbinding, but comprehensive and operational agreement by the 192 nations at the summit for reductions in greenhouse gas emissions and aid for developing nations to adapt to climate change, while also promising to work toward a binding global pact in 2010.  The binding pact would include firm emissions targets, enforcement mechanisms and specific pledges of aid to poorer nations.

A week after his return from Beijing, President Obama announced that he would attend the Copenhagen climate talks and pledge a provisional target for a reduction in U.S. greenhouse gas emissions.  According to Administration officials, the pledge would be to reduce GHG emissions 17 percent below 2005 levels by 2020 and 83 percent by 2050.

The day after the President’s announcement, China’s Foreign Ministry spokesman Qin Gang announced that Chinese Premier Wen Jiabao also would attend the Copenhagen climate summit.  The same day, China’s State Council, its highest policy-making body, stated that China would reduce the intensity of carbon dioxide emissions per unit of GDP in 2020 by 40 to 45 percent compared with the 2005 level.  Since China’s economy is expected to continue its strong growth, the “carbon dioxide intensity” reduction does not imply any actual reduction in carbon dioxide emissions.  Perhaps China learned from the U.S.  Reducing carbon dioxide intensity, rather than carbon dioxide emissions, was an alternative solution that then President George W. Bush unveiled to skepticism in February 2002.  But unlike the Bush plan, the Chinese energy intensity proposal is receiving positive reviews.  The White House reportedly welcomed “China’s intention to cut the growth of their emissions” and noted “the international community will be closely analyzing this proposal.”

Connie Hedegaard, Danish minister for the UN Climate Change Conference in Copenhagen and, until Nov. 24, Danish climate and energy minister, observed that the “U.S. and China have come forward.   This is good news.  However, we must analyze more carefully what the new Chinese announcement translates to” compared to business as usual. On the U.S. targets, she commented that they “might not be what the world has been hoping for, but that the U.S. seems to know that the price for coming late is that the pathway for reductions after 2020 will be extra steep.”  Hedegaard has been named the next EU climate commissioner.

The President had to navigate treacherous waters between China and the U.S. Congress on climate change.  While the U.S. House of Representatives already has passed a climate change bill with cap-and-trade provisions and U.S. emissions targets, consideration of a bill by the U.S. Senate will not occur until next year.  China has made clear that developing nations, including China, should not be asked to take on binding targets before developed countries, including the U.S., who contributed most of the existing greenhouse gas concentrations do.  Congress, especially the Senate, has made it equally clear that the U.S. should not be expected to take on binding emissions targets—and the trade disadvantages that could ensue—without binding targets on the large developing countries—particularly coal-dependent China and India, both of which will account for the bulk of emissions growth.

Whatever the outcome at Copenhagen, both the U.S. and China, in their national stimulus programs and in the joint efforts announced during the President’s visit in Beijing, are committing their countries to lower-carbon futures. Those commitments have come in economic and policy incentives to become more energy efficient, to advance the penetration of renewable and nuclear energy, to foster alternative fueled vehicles, to use coal more cleanly, and to promote domestic production and use of natural gas.

The extensive effort put forward by the Administration on energy and environmental cooperation with China is unprecedented, and it opens up a realm of possibilities going forward for both nations in terms of their economic, energy and environmental futures.

Analysis by Abraham Energy Report Contributing Editor Robert Price

The hostile rhetoric directed at OPEC during last year’s surge in prices and the ensuing financial crisis has diminished, and the speculative pressures on oil prices appear to be remaining in check, in spite of long-term inflation fears and renewed capital inflows to commodity markets. The global push to reduce consumption of fossil fuels in the name of climate change has been muted by the economic effects of the recession and the apparent lack of a national and international consensus on the path forward.  OPEC has just moved its headquarters to a new state-of-the-art facility in Vienna, just in time for the 2010 celebration of the 50^th anniversary of the founding of OPEC in 1960.

While prospects are clearly better than last year, not everything is rosy.  The strength of the recovery is still in doubt in several parts of the world and, as the Dubai debt crisis demonstrates, the full effects of the credit bubble are still playing themselves out.  The gradual unwinding of government stimulus programs and the global economy’s ability to deal with long-term debt in a sustainable manner remain in question.  Financial sector reforms are being formulated that could dramatically affect how oil and energy trades are conducted in the future.

New technologies are adding to oil, natural gas and other clean and renewable energy supplies while helping to reduce global demand.  A renewed push to deal with global climate change and reduce fossil fuel consumption is probably only a matter of time.  Finally, regional stability in the Middle East remains a problem, and Iran appears to be on a collision course with the rest of the world.

Recap. OPEC met every month from September to December in the fall of 2008 in a concerted effort to understand the rapid deterioration in the economic outlook, and the demand and price for oil.  They pledged to cut output several times in the fall of 2008 in an attempt to keep up with declining demand. The outlook at that time was gloomy, and analysts couldn’t revise their forecasts downward fast enough to keep up with the reality of the marketplace.

In spite of their efforts to trim output last fall, the downward momentum in prices related to the decline in oil demand and economic news, creating a perfect set of circumstances for traders to short the market.  This put additional downward pressure on prices in what became a self-fulfilling prophecy.  The front-month contract for WTI on the NYMEX fell to near $40 per barrel during the week before the December 2008 OPEC meeting, and to a low of $33.87 per barrel at the close of the market on Dec. 19, 2008.  At its meeting last December, OPEC agreed to cut 4.2 million barrels per day (mmbd) from its actual September 2008 production levels. At the time, this was the largest production cut the organization had ever attempted at any one time in its history.

After last December’s OPEC meeting, the Abraham Energy Report concluded (see “December OPEC Meeting: Shock Therapy for Declining Demand,” AER January 2009) that OPEC hoped to deliver a dose of shock therapy to the market in an attempt to stem the decline in prices. We said that the financial crisis was evolving into a synchronized global recession of uncertain magnitude and duration, and that 2009 would be a very difficult year.  We wrote that the inventory overhang would be particularly troublesome, especially in the first half of the year, and that the supply overhang could persist throughout and possibly beyond 2009.

Given how far prices had already fallen, we expected OPEC would have some limited success in preventing oil prices from falling much further. We also thought that it was doubtful that OPEC would have any immediate success in raising prices to anywhere near the $75-per-barrel level that many OPEC Ministers were calling a “fair” price for oil at the time. Sustained higher prices would only be possible when the global economy began to show definite signs of recovery large enough to produce renewed growth in oil demand, we concluded.

In retrospect, 2009 unfolded in some ways as expected, and in other ways that were unexpected, but eventually with great clarity in the rearview mirror called hindsight.  The G-20 process produced unprecedented levels of economic stimulus that began to have an effect on the real economy in much of the world by the beginning of the third quarter.  At the same time, however, the deficits accompanying the stimulus gave rise to inflation fears and a flow of money into gold, equity and commodity markets as a hedge.

This helped to pull oil prices up in spite of continuing weakness in the supply and demand fundamentals.  The front month closing price of WTI on NYMEX rose gradually from about $43 per barrel in the first quarter of 2009 to $60 and $68 per barrel in the second and third quarters, respectively.  If prices remain in the $75 to $80-per-barrel range where they have been trading for the last five to six weeks, the fourth quarter price will average around $77 per barrel, and the average price for the year should come in at about  $62 per barrel.  This is slightly above the $60-per-barrel high-end of the range we expected at the beginning of the year.

OPEC’s compliance with the announced production cuts was largely delayed last fall and it improved only marginally in the early months of 2009.  The production cutbacks were finally implemented with a good (70 to 80 percent) degree of compliance from March 2009 onward, but not before inventories grew to levels way above the 5-year average range.  The upward move in oil prices from May to August did little to induce higher levels of OPEC output and greater non-compliance as some had expected, but weak demand kept inventories at record-high levels.

Demand prospects for 2009 continued to be marked down through mid-year, and have just recently been ticking upward in the last few months, with robust growth reappearing especially in Asia.  Oil prices remained volatile through much of the year until late August, but have settled in to a relatively calm trading range of $75 to $80 per barrel since then.  By some measures, the volatility of oil prices has been at its lowest level in years in the past month.

Unlike the fall of last year, OPEC hasn’t met since its September meeting in Vienna, and the relative calmness in the oil market and gradual, if slight, improvements in the underlying fundamentals have encouraged the members to stick with their current production agreement.  In fact, OPEC has been fairly quiet lately.  With the OPEC basket price and WTI trading in a fairly stable and acceptable band of $75 to $80 per barrel, there hasn’t been much reason for OPEC to intervene.

In addition, as OPEC approaches its December meeting, the economic and energy outlooks this year are as different as day from night when compared to last year.  Production costs have come down, demand is starting to grow once again, albeit slowly in the OECD area.  A comfortable margin of spare oil production capacity has opened up, and OPEC seems more than willing to stay out of the spotlight and watch the recovery unfold.

The latest (November) round of short-term oil market forecasts—coming from the International Energy Agency (IEA), OPEC and the U.S. Energy Information Administration (EIA)—now expect world oil demand to decline by an average of 1.5 mmbd in 2009, following a decline of about 0.3 mmbd in 2008.  All three forecasts now expect oil demand to show year-on-year growth in the fourth quarter of this year, and to grow by an average of 1.1 mmbd in 2010.  The next round of monthly short-term forecasts, which will be available in the second week of December before OPEC meets, is expected to confirm these trends.

The return of robust oil demand growth is much more pronounced in China, and Asia in general, than in the OECD area.  OECD oil demand, which has been declining since 2005, could falter once again next year if the economic recovery loses steam, as additional carbon-reduction policies are implemented (with or without agreement in Copenhagen), and as competition from cheap natural gas supplies puts pressure on the middle of the barrel.  Nevertheless, in spite of possible continued declines in the OECD, oil demand for the world as a whole seems set to rebound.

The inventory overhang continues to be a problem, though.  The IEA and the EIA show commercial inventories in the OECD at nearly 61 days of forward consumption coverage.  This is well above the 54 to 56 days of forward cover considered normal for this time of year.  As a result, OPEC will probably once again pledge to “strictly adhere” to its existing production targets at its upcoming meeting.  The demand for OPEC crude oil fell by 2.3 mmbd in 2009, and it is expected to remain relatively flat in 2010.  All three of the monthly outlooks expect inventories to gradually come down during the course of next year.

OPEC oil production is rising in Nigeria as a result of the cease-fire in the Niger Delta, as well as in Angola as a result of new developments. Production appears set to rise somewhat in Iraq over the next few years as the security situation improves.  However, none of these developments are likely to upset the organization’s production agreement.  Production has been higher than expected this year in Russia and in the U.S., but lower in Europe, Mexico and Canada.

There will be plenty of issues for OPEC Ministers to discuss on the margins of the formal meeting, covering the prospects for economic recovery, Copenhagen, the IEA’s latest World Energy Outlook, the emerging surplus of natural gas in some markets, the continuing emergence of China as a powerhouse in the oil demand market, prospects for the dollar, and the declining usefulness of NYMEX WTI as a benchmark for crude oil prices.  Above all, we believe that the Ministers will be thankful to have the past two years behind them, and to be looking forward to better times in 2010, with a comfortable degree of confidence that OPEC as an organization has once again served them well, as it has for much of the past 50 years.  The events of 2009 demonstrated to OPEC once more the veracity of the old adage “united we stand but divided we fall.”

Analysis by Abraham Energy Report Contributing Editor John Brodman