In just the first three weeks of the year, one of the key players on energy policy, Sen. Byron Dorgan, D-N.D., has announced his retirement and the special election to replace the late Sen. Edward Kennedy, D-Mass., has sent shock waves through the Democratic Party.

Republican state Sen. Scott Brown’s stunning victory over Democrat Martha Coakley not only takes away the Democrats’ 60-vote majority in the Senate, it puts a chill on major initiatives in this Congress. The unexpected result in the bluest of blue states sent a strong message against the current direction in Washington and is likely to make Democrats very nervous about enacting any new big government programs like a cap-and-trade law.

The retirement announcements by Dorgan, chairman of the Senate Appropriations Subcommittee on Energy and Water Development; Sen. Christopher Dodd, chairman of the Senate Banking Committee; and a half dozen Democrats in the House, including Science and Technology Committee Chairman Bart Gordon, D-Tenn., and Rep. Brian Baird, D-Wash., chairman of the Science and Technology Subcommittee on Energy and Environment, have added to a sense of turmoil in the Democrat majority.

Dorgan’s decision not to seek a fourth term in the Senate this year is especially unsettling for energy policy. Dorgan, a House member for 12 years and a senator for 18, was among the top candidates for Energy Secretary at the start of the Obama administration. In his retirement announcement, Dorgan said that after Congress he would “like to work on energy policy in the private sector.” The odds are it would be for the coal industry, since North Dakota is a major coal state.  That makes it even more likely Dorgan will oppose a cap-and-trade system to control greenhouse gas emissions, which would be costly for coal-fired power plants.

Dorgan has already come out against an emission-trading system run by the financial markets.  “I want to find ways to protect our environment and I support reducing carbon,” he said in a recent op-ed for North Dakota newspapers. “But it makes no sense to me to hand Wall Street a new trillion-dollar carbon securities market so they can engage in the kind of speculation that steered our economy into the ditch.”

Opposition from key Democrats like Dorgan makes one thing crystal clear: Climate-and-energy legislation passed by the House last summer is a non-starter in the Senate.  Even some House Democrats who voted for the bill, including Agriculture Committee Chairman Collin Peterson, D-Minn., now say they would oppose the measure if it comes back for final action.

Senate Energy and Natural Resources Committee Chairman Jeff Bingaman, D-N.M., has acknowledged there is little chance of the Senate approving the kind of cap-and-trade program included in the House bill.  “I do think opponents of cap-and-trade legislation have done a pretty effective job of portraying the proposal as a tax on energy use,” Bingaman told New Mexico reporters on Jan. 11.

“My own sense is at this time that we have strong support in the Senate to do something significant to move toward more use of renewable energy and more efficient use of energy,” Bingaman said.  “I don’t know that we have the votes for any cap-and-trade proposal that I have seen floated here in the Senate.”

Bingaman and Dorgan want the Senate to at least move forward on the bill approved by the Energy and Natural Resources Committee last June, with provisions for more alternative energy, grid development, carbon-storage technology and conservation. Dorgan also added a section to expand drilling in the eastern Gulf of Mexico, which geologists say includes at least 21 trillion cubic feet of natural gas and 3.7 billion barrels of oil.

Of course, many Democrats are still advocating for a broader approach that includes some effort to tackle climate change. Sen. John Kerry, D-Mass., a chief sponsor of the bill approved in November without Republican participation by the Senate Environment and Public Works Committee, acknowledges it will be difficult to move the measure, largely modeled after the House-passed bill.  But Kerry argues that the pressure for an international agreement on climate change—even the minimal goals outlined in Copenhagen in December—“can be a catalyzing moment” for the Senate.

Environmentalists like Daniel Weiss, a former Sierra Club lobbyist now with the Center for American Progress, note that China and India made their first real commitments in Copenhagen to reduce rates of pollution growth relative to their economies, which should help convince skeptics that the United States needs to show leadership, too. Weiss also said on the environmental news Web site Grist that with the EPA poised to act on greenhouse gases if Congress does not, there is a “sword of Damocles hanging over the Senate should it fail to act.”

Sen. Lisa Murkowski, R-Alaska, the ranking member of the Energy and Natural Resources Committee, has pledged to bring a bill to the Senate floor soon aimed at blocking EPA regulation of greenhouse gases for at least a year. Murkowski appears to have some support from Democrats who prefer that Congress act first, but even if her measure passes it would be difficult for both the House and Senate to muster the two-thirds majority needed to overcome a certain veto by President Obama.

But the biggest obstacle to climate legislation is probably the struggling economy. After the wrenching and divisive debate on health care, it is unlikely many Democrats have the stomach for another bruising battle in which they would be accused of killing jobs and hindering economic growth.

The anxiety will only intensify in the buildup to the November elections. Democrats know that the party in the White House historically loses congressional seats in midterm elections, and political analyst Charlie Cook says Democrats hold 40 of the 50 most competitive House districts at the start of the 2010 campaign season.

In the Senate, Majority Leader Harry Reid is well down in the polls as he seeks a fifth term in Nevada.  And several strong GOP candidates—former Hewlett Packard CEO Carly Fiorina, state Sen. Chuck DeVore and former U.S. Rep. Tom Campbell—are vying to take on Sen. Barbara Boxer, D-Calif., leader of the Environment and Public Works Committee.

While Republicans have worries of their own in the Senate with six announced retirements, none of them are game-changers on the climate change legislation. The six retirements are Sens. George LeMieux of Florida, Sam Brownback of Kansas, Jim Bunning of Kentucky, Kit Bond of Missouri, Judd Gregg of New Hampshire and George Voinovich of Ohio.

What spells more trouble for climate change proponents are recent and continuing developments at the state level. The election of Republican Gov. Bob McDonnell in Virginia signals the kind of changes that may be in store for the states, as well. McDonnell pledged in his Jan. 16, 2010, inaugural speech to open more offshore areas to drilling in his administration.

And California Gov. Arnold Schwarzenegger, a Republican who has made action on climate change a hallmark of his administration, is on his way out this year after opting not to seek another term. He won a special recall election in 2003 and a full term in 2006. During his tenure Schwarzenegger pushed through a law capping the state’s greenhouse gas emissions at 1990 levels by 2020, with a goal of cutting emissions to 80 percent below 1990 levels in 2050.

Critics say the climate effort is one reason California has an unemployment rate over 12 percent, but it remains to be seen whether state leaders will try to backtrack on climate regulations once Schwarzenegger leaves office.

With an uncertain electoral future ahead, Democrat leaders are still clinging to the notion that a climate bill can be passed by this spring. The Abraham Energy Report believes it is unlikely as the election heats up in states that have been hit hard by the economic crisis and that are still powered by heavy industry.

The more likely scenario is that the renewable and other clean energy provisions pushed through Bingaman’s Senate Energy and Natural Resources Committee will pass as a stand-alone bill or be attached to the Senate “jobs” stimulus bill, which is currently being assembled by Majority Whip Dick Durbin and Dorgan.  Without such an innovative compromise, energy legislation—and most certainly a climate bill—will be on hold until 2011 at the earliest.

The Economy.  According to the World Bank and others, global real GDP contracted by approximately 1.5 percent in 2009.  Hopefully the worst is behind us. Expectations now put global real GDP growth at around 3.2 percent in 2010, but the growth is likely to be very uneven, with the BRIC countries (Brazil, Russia, India and China) and emerging markets rapidly establishing their dominant position in the global economy.  High and rising government deficits, high unemployment and growing protectionism increase the possibility of a slower than normal economic recovery in the Organisation for Economic Co-operation and Development (OECD) nations.

The positive initial effects of the G-20’s coordinated response to the financial crisis and the ensuing economic meltdown may not be sustainable in all countries.  Many problems persist, particularly in the developed world, in housing, autos, household expenditures, and public sector balance sheets.  This coincides with a rapid rebound in economic activity in the emerging economies in the past two quarters. This growth has already sparked fears of a new economic bubble in some areas and talk of mounting international imbalances.  Just how these divergent paths will interact to steer global economic prospects is largely unknown and a major source of uncertainty for the year ahead.

Oil Market.  The oil market has weathered another boom-and-bust cycle, and global oil demand, after declining for two years in a row (the first time in 25 years), appears set to grow once again.  Commercial oil inventories are high, and there are comfortable margins of unused production capacity both upstream in crude oil production and downstream in the refining sector.  Peak oil fears about supply constraints have been pushed to the back burner for the time being, and there is enough supply around to fuel even the most wildly optimistic economic growth scenarios for the next two to three years at the very minimum.  How peak oil scarcity plays out in the medium- and long-term is still an open question, but in the absence of some outside shock to the system, it shouldn’t be a factor in 2010.

On the basis of market fundamentals alone then, 2010 should be a fairly calm year for the oil market.  Demand prospects should gradually turn around and are likely to strengthen throughout the year.  Oil prices (average NYMEX closing price for the front-month WTI contract), which were about $62 per barrel on average in 2009, could be expected to gradually strengthen further as the global economy continues to transition from recession to renewed growth.

While the demand side could be expected to exert some upward pressure on prices, high inventory levels and ample margins of spare production capacity should keep any price increases to moderate levels.  Oil futures prices indicate that investors generally expect oil prices to rise in 2010, but in the absence of any major unexpected shock to the system, which could turn out to be an understated qualification, an oil-price spike seems unlikely.

The market appears set to support an oil price this year that is higher than 2009’s average of $62 per barrel, but not as high as the $99 per barrel average seen in 2008.  Prices at the higher end of this range may not be sustainable.  They could undermine the economic recovery and oil demand.  They are also likely to provoke additional regulatory responses aimed at restricting “speculation” in the oil-futures markets.

Other Views.  As economic growth and oil demand recover, most large investment banks expect oil prices in 2010 to average between $75 and $92.50 per barrel, a 20 percent to 50 percent increase year-on-year.  The latest U.S. Department of Energy Short Term Energy Outlook predicts prices will average about $79 per barrel in 2010, which is close to but higher than the pre-crisis average of $73 per barrel of 2007.  Most analysts expect the first half of the year to be weaker than the second half.

The more bullish members of this group see the market’s preoccupation with weak demand and surplus inventories gradually turning, once more, into supply-side concerns about the oil market’s ability to fuel rising global demand in the years ahead.  They believe that traders and investors will begin positioning themselves to take advantage of tighter markets in the future, and that supply-side concerns will again dominate market expectations and oil price formation.  The most bullish of these analysts say they would not be surprised to see oil prices make a few, brief excursions to $100 per barrel or more in 2010.

The role that geopolitical concerns and other developments play in these forecasts of potential price spikes in 2010 is unclear at best.  In addition, while it is clear that a transition is underway and that demand is set to resume its overall growth path, the strength of this transition and its exact arrival will depend on a number of factors.  The timing and magnitude of inflows to oil and commodity futures markets in the period ahead will mark the strength of investors’ belief in future supply tightness and higher prices.  These flows of funds will depend not only on the forecast for the recovery itself, but also the outlook for major geopolitical upsets, inflation, the status of the dollar, and equity and bond market performance across a diverse group of investment vehicles.

Expect the Unexpected.  Most forecasts are predicated on the absence of unforeseen developments or unexpected shocks to the global oil market, of which there could be plenty in 2010.  In the first few days of trading in 2010, oil prices broke out of their fairly stable trading range and rose to a 15-month high of more than $83 per barrel.  Prices were being driven by news that Russia had cut off oil shipments to Belarus, that production in China’s industrial and manufacturing sectors was exceeding all growth expectations, and that persistent, colder-than-normal temperatures had overtaken much of the Northern Hemisphere in North America, Europe and Asia.  A declining dollar and expectations of a stock market correction also fueled the flow of funds into oil futures.

These day-to-day fluctuations are to be expected, but they accumulate and affect our view of the long-term outlook. The volatility in the first week of trading could be only a sneak preview of the uncertainties that lie ahead in 2010—uncertainties that could turn what otherwise might be a fairly stable-but-growing market into a wildly schizophrenic, volatile ride.

On the economic side, 2010 is likely to be affected by persistent declines in home prices, tight credit, and high unemployment, which will plague household balance sheets, particularly in the U.S. and the European Union.  Business investment and confidence will continue to be shaken by uncertainties over high and rising government deficits, and unresolved political issues related to future taxation, revenue shortfalls, social entitlements, carbon mitigation policies, financial sector regulatory reform, and growing protectionism in trade policy.  G-20 governments all face issues regarding the future timing and pace of their fiscal and monetary stimulus programs.  On the political side, upcoming elections in Iraq, Brazil, the U.S., U.K. and many other countries are looking more and more contentious, with outcomes that are highly uncertain.

On the geopolitical side, even the unthinkable is quickly becoming possible in 2010.  Most of the uncertainty here stems from escalation of the war in Afghanistan, and the start of new efforts to rein in terror, not only in Yemen, Pakistan, Iraq and other parts of the Middle East and Africa, but across the globe.  Potential developments in Iran are likely foremost on everyone’s mind.  Negotiations over its contentious nuclear program could come to a head in 2010 and possibly lead to responses as diverse as increased sanctions and outright military confrontation, which could have direct and possibly severe consequences on global oil markets.  Growing dissatisfaction with the clerical government could also lead to major internal strife, a leadership crisis, possible regime change, and a temporary crippling of Iran’s already weakened economy.

Depending on how all these things play out, 2010 could go from being an orderly transition from recession to growth to a wild, volatile ride.  That’s the question, and it all depends on a large number of unknowns that more than stretch human ability to see around corners and into the future.  While admitting that anything can happen, and that 2010 will bring its own share of surprises to the market, it is nevertheless useful to review what we think we do know about the things most likely to affect the market in business as usual circumstances.

Economic Outlook.  World real GDP now appears to have contracted by 1.5 percent in 2009, with the industrialized OECD economies contracting at –3.5 percent and accounting for most of the decline.  Global growth is expected to return to positive territory in 2010, and register real GDP growth of around 3.5 percent, which is fairly anemic when compared with past recoveries.  Again, BRIC countries and emerging markets are expected to lead the expansion in both the timing and pace of recovery, with real GDP growth rates of 5 percent to 6 percent for the group.  China is expected to grow by 9 percent or more in 2010.  The Middle East, parts of Africa, and Asia (except Japan) are all expected to experience the most robust growth.

The OECD recovery is expected to begin a bit later, with real GDP growing somewhat slower than in past recoveries, at less than 2 percent in 2010.  The U.S. is expected to grow the fastest, at nearly 2.5 percent, with EU growth of less than 1 percent and Japan somewhere in between.  If anything, we entered the New Year on a positive note, with fresh reports of inventory rebuilding and industrial output around the globe generally exceeding expectations.  Unemployment in the OECD is likely to remain persistently high in 2010.  Views about the strength of the economic recovery in the OECD nations shift almost daily from optimism to pessimism and back again, depending on the latest economic reports.  Expectations of a double-dip back into recession or a prolonged L-shaped recovery still abound, but they’re not as prevalent as before.

Oil Demand.  World oil demand reached a peak in 2007, and has declined for two years in a row in 2008-09—a first in 25 years.  Most forecasts expect world oil demand to turn around and grow in 2010 by somewhere in the range of 0.5 to 1.5 million barrels per day (mmbd).  If demand grows at the midpoint of this range (1.0 mmbd), global demand in 2010 will rebound to about the same level last seen in 2006, but it will still be about 1.0 mmbd below the previous peak in 2007.

The BRIC countries alone were responsible for almost 60 percent of the entire growth of world oil demand in the last decade.  Together the BRIC countries and emerging market economies are the new epicenter of oil demand, and they are expected to account for virtually all of the growth in global oil demand in the years ahead.  It is interesting to note that more than 13 million new cars were sold in China alone in 2009, compared with about 10 million in the U.S.

Oil demands in the U.S. and in the OECD as a whole have been declining at a rate of just over 1.0- percent per year for the last four years from the peaks reached in 2005.  Some forecasts expect this long-term trend away from oil to continue in 2010, with OECD demand falling by 0.2 mmbd, in spite of the projected economic recovery. Others expect demand to recover and grow by about 0.2 mmbd.  Most forecasters see demand in Europe and Japan continuing to stagnate or decline, so the disparity is largely due to differences in opinion about the strength of U.S. oil demand in 2010.  We are inclined to take the middle road and assume that OECD oil demand (and U.S. oil demand) will remain flat in 2010.

Oil Supply.  Non-OPEC supplies of all conventional and non-conventional liquid fuels rose about 0.5 mmbd in 2009, and are expected to grow by about 0.2 mmbd in 2010.  Biofuels and other non-conventional fuels have managed to slightly offset the trend decline in non-OPEC conventional crude output for the past five years.  Near the end of 2008 and early 2009, biofuels briefly lost some ground during the oil price collapse, but appear set to recover in 2010 and beyond.

Exploration and development expenditures are on the rise again, stimulated in part by the decline in the prices of oil field equipment and services.  Natural decline rates in many oil-producing countries are a force to be reckoned with. Nevertheless, the eventual production of new offshore reserves in West Africa, Brazil and many other places, plus planned expansions of biofuels and unconventional resources, could hold the overall non-OPEC supply curve level for some time to come.  Brazil is set to pass Venezuela as Latin America’s largest producer this year.  They have been invited to join OPEC but declined.

OPEC crude oil production fell by about 2.2 mmbd from 2008 to 2009, while its overall production capacity, as a result of ongoing investment, continued to rise.  As a result, OPEC’s surplus crude oil production capacity rose to near 4.5 mmbd by the end of 2009, a level not seen since the beginning of the last decade.  OPEC’s crude oil production capacity is expected to rise again in 2010 and beyond, due to ongoing expansion projects in Qatar and Angola, and new contracts in Iraq.  Extra production from Nigeria is also possible as a result of the cease-fire in the Niger Delta.   In addition, OPEC production of natural gas liquids (NGLs), which falls outside its production quota system, has been rising by about 0.5 mmbd per year in the past few years.

This trend is expected to continue in 2010 and beyond as OPEC members exploit their gas reserves for both domestic consumption and liquefied natural gas (LNG) exports.  Total liquids production capacity (crude and NGLs) in OPEC, including Iraq, could rise by 1.0 mmbd in each of the next several years.  This would just about meet the expected increases in world demand over that period while allowing OPEC to maintain its current level of spare production capacity.

OPEC. As expected, OPEC Ministers meeting in Angola on Dec. 22, 2009, on the heels of the Copenhagen climate talks, decided once again to roll over their previously agreed production quotas and keep output for the OPEC 11 unchanged at 24.845 mmbd.  In the communiqué issued following the meeting, it was clear that OPEC believed that the world economic recovery and the demand for oil was still weak, saying that its decision was intended to strike a balance between oil price stability and the needs of a growing world economy.

Declining compliance with the quotas was one of the major topics of the meeting, and the Members once again pledged to do their share for the common good.  They also called upon non-OPEC oil producers to become more involved in the process and undertake cooperative action with OPEC.  The non-OPEC countries of Egypt, Bahrain, Indonesia, and Oman attended as observers.

For the most part, OPEC members were happy to see a resumption of gradual and steady growth in oil demand, and most were satisfied with the price recovery that took place in 2009.  Saudi Minister Ali Naimi said after the meeting that the market was good and that “the price was excellent.”  It seems clear that as long as the price stays in a comfortable range above $70 per barrel, most OPEC Members are unwilling to risk the appearance of unity for an internal fight over compliance.  It also appears that rising production in Iraq, Angola, Qatar and Nigeria may eventually push the group to revise its quotas, but with some luck and growing demand, this is unlikely to happen in 2010.  OPEC’s own forecast expects the demand for OPEC oil to rise slightly in 2010.

Copenhagen and Carbon Mitigation.  The failure of the Conference of the Parties (COP) to agree on binding targets for carbon mitigation provided many oil producers with a temporary sigh of relief.  The upcoming elections in the U.S. are also likely to forestall any congressional action on cap and trade or new energy taxes this year.  Nevertheless, the energy policies already in place to promote energy efficiency and the development of new and renewable energy resources will continue to nibble away at the demand for oil and other carbon-based fuels this year and in the foreseeable future.

The automobile companies are slated to introduce plug-in electric and electric hybrid vehicles this year, and government incentives to scrap less efficient vehicles (like “Cash for Clunkers” in the U.S.) are ongoing in many countries.  In the medium- and long-term, a race is developing between rising oil and other energy demands, and the ability of the global economy to both improve efficiency and develop clean and affordable supplies of conventional and new energy.  In this environment, global oil demand is likely to grow more slowly than it has in the past.

Admittedly, the outlook contains a large number of unknowns on both the political and economic fronts.  Depending on how these factors play out, 2010 could turn out to be anything from a calm orderly transition from recession to growth to a wild, volatile ride.

Analysis by Abraham Energy Report Contributing Editor John Brodman

Key Concepts:

• The global economic recovery is underway, but growth is likely to be very uneven between the emerging and developed countries.  The possibility of a slower than normal economic recovery in the OECD is a major concern for the outlook.
• On a business as usual basis (that is, based on the assumption of no major, unexpected economic or political shocks to the system), global oil demand should recover and grow once again in 2010, with virtually all the gains registered by the emerging markets.
• Commercial oil inventories are high, and there are comfortable margins of spare production capacity in both crude production and refining. In the absence of some outside shock to the system, peak oil concerns should not be a factor in 2010.
• The market appears set to support a price higher than 2009’s average annual price of $62 per barrel, but not as high as 2008’s average price of $99 per barrel. Prices could wind up somewhere in the $80 to $90 per barrel range on average for the year.

Much of the country’s fate over the last decade has been tied to the ascendancy of Vladimir Putin, of course. His Presidency started on Jan. 1, 2000, and lasted eight years before he “stepped down” to serve as Prime Minister in 2008.  Russia’s fortunes changed dramatically during Putin’s tenure as the economy stabilized and grew significantly in the last 10 years, reflecting the rapid rise of the oil and gas markets on which so much of Russia’s economy is based. Not surprisingly given its over-dependence on energy markets, the global economic crisis and the collapse of energy prices had a disproportionate impact on Russia, causing its economy to falter and natural resources production to slow.

While the roller coaster ride is likely to continue in Russia and its energy markets, it does beg the question: What can Russian leaders do to encourage stability in its volatile oil and gas markets today and into the future?

Russia: The Past

Russian oil production showed tremendous growth early in the decade and then reached a plateau as it neared 10 million barrels per day.  Russian oil production averaged 6.9 million barrels per day for 2001 (the first year of the new century and decade). By the beginning of 2010, Russian oil production crossed the 10 million barrels per day threshold.  Growth was quite uneven, with annual average production surging in the early years between 500,000 and 700,000 barrels per day (2001-2004), and then tapering off to annual average increases of 200,000 barrels per day (2004-2007).  This high growth was due to a number of key factors, including:

• The significant increase in oil prices. World oil prices increased from an annual average of about $26.00 per barrel in 2001 to a high of an annual average of $100 in 2008, declining to an annual average of $62 in 2009. Today, the current oil price is just over $80 per barrel;
• The application of modern technology to Russia’s aging West Siberia oil fields; and
• The devaluation of the ruble, which lowered production costs.

Russia’s economy surged during this period as high taxes on oil production and exports contributed significant revenues for Russia’s expanding state budgets.  In 2004, a new oil export tax was imposed. Marginal tax rates on oil exports exceeded 90 percent, adding to the already-burgeoning monies in the oil trust fund and allowing Russia to use these tax funds for its growing annual budgets. With oil reaching a peak of $147 per barrel in July 2008, future prospects seemed rosy.

Yet the precipitous decline in oil prices in December 2008 to about $35 per barrel in conjunction with the world economic crisis led to a shift in Russian oil production.  As discussed in a previous article in the Abraham Energy Report [Russian Oil Production Slides, April 2009], the impact of lower oil prices and the high Russian oil export duty led to a decline in oil production starting in September 2008, lasting six months through February 2009.  By March 2009, Russian oil production increased year-on-year and has continued to increase to the present.

As increases in Russian oil production slowed and reversed in 2008, Russia enacted tax incentives to encourage new production in high-cost producing areas, especially in the northern provinces and in East Siberia.  New production from Sakhalin Island came on line in 2007-2008, which masked the decline in Russia’s old West Siberian oil fields.  The combination of new incentives, Sakhalin production and a small number of new fields in East Siberia led to the marginal increases in Russian oil production during the remainder of 2009 to the present.  As of January 2010, Russian oil production has increased nearly 45 percent since 2001.

Russian gas production did not fare as well, although it did grow over the same period by about 14 percent (latest annual figures are for 2008).  Since Gazprom accounts for about 85 percent of Russian gas production, the industry’s fortunes are tied strongly to Gazprom.  Growth in gas production and exports to Europe, Russia’s primary market, grew consistently from January 2001 until 2007.  A warm winter in 2007 in both Russia and Europe led to a decline in consumption and production.  Russian production rebounded in 2008, although Gazprom’s production hardly increased that year.  While figures for 2009 are not available, Russian gas production in 2009 is likely to decline precipitously because of the two-week disruption in gas supplies to Europe due to the Russian-Ukrainian gas dispute in January 2009 (80 percent of European gas supplies transit through Ukraine) and the sharp decline in European gas demand stemming from the economic crisis.  Gazprom has been stretching production at its existing gas fields and has postponed investments in new gas fields in Yamal (Bovanenko) and offshore (Shtokman).  As an interim strategy Gazprom buys large volumes of gas from Central Asia (66 billion cubic meters in 2008).

A December 2009 article in the Abraham Energy Report [Central Asia: Pipelines are the New Silk Road] examined the fight over natural gas hegemony in Central Asia. The article concluded that Russia’s dominance was dwindling as Azerbaijan, Kazakhstan and especially Turkmenistan sought alternatives to Russia for selling their natural gas.  In December 2009, Turkmenistan opened its gas pipeline to China.  The opening of the pipeline was a wake-up call for Russia.  Within weeks, Russian President Dmitry Medvedev was in the capital of Turkmenistan, Ashkabad, seeking to improve relations with Turkmen President Gurbanguly Berdymukhammedov.  At the same time, Gazprom indicated that it had smoothed over its gas pipeline dispute with Turkmenistan stemming from an April explosion that halted all Turkmen gas exports to Russia.  Gazprom’s Alexander Medvedev said that it will resume purchases of Turkmen gas in 2010.  Gazprom also agreed to expand the Prikaspiiski pipeline running along the Caspian to Russia and to build the east-west pipeline linking eastern Turkmen gas fields to the Prikaspiiski pipeline route.  Obviously, the fear of losing Turkmenistan’s natural gas market to China and possible western routes spurred Gazprom and Russia to renew its energy relationship with Turkmenistan.  The open question is whether Russia’s effort is too little, too late.

A previous Abraham Energy Report article [The EU and the Great Pipeline Game, June 2009] discussed the many new pipelines (oil and gas) that Russia is proposing to construct to enhance its export opportunities or to bypass recalcitrant partners.  The proposed Nord Stream natural gas pipeline to carry gas from Russia to Germany under the Baltic Sea now has garnered all the construction permits required by the affected states—Finland, Sweden and Denmark—with German and Russian permits either in hand or to be issued soon.  The U.S. also appears to have scaled back its criticism of this pipeline as it increasingly becomes a reality.  On the other hand, the South Stream pipeline that would carry gas across the Black Sea to Bulgaria and then into Central Europe still appears mired in problems, including its astronomical cost, and does not appear to be any closer to reality.

Russia is proceeding with its oil pipeline across East Siberia to the terminal at Kozmino, near the port city of Nakhodka and near Vladisvostok in Russia’s Far East.  The first phase of the East Siberian Pacific Ocean (ESPO) is some 1,700 miles long. It is complete from the existing West Siberian pipeline system connecting at Taishet in the Irkutsk region and extending to Skovorodino, 45 miles from the Chinese border.  Transneft, Russia’s oil pipeline monopoly, is building a pipeline connection to its border with China in order to connect with China’s oil pipeline system. The pipeline will be able to carry up to 300,000 barrels per day, supplementing rail shipments of oil to China. This oil pipeline connection is part of the deal worked out earlier in 2009 between Russia and China in which China loaned Russia $25 billion for future oil deliveries. The remaining 1,300-mile section of the ESPO pipeline is under construction and expected to be completed by 2012.  Total cost of the pipeline is about $22 billion. Until the pipeline is completed to Kozmino, Russian oil will move by rail from Skovorodino to Kozmino, with Rosneft, TNK-BP and others planning to use this new port for oil exports to Far East customers.

Russia: The Present

The start of a new year almost invariably brings another crisis between Russia, Europe and its transit countries.  In January 2006 and January 2009 Russia created turmoil in natural gas markets when it halted gas deliveries to Ukraine.  Ukraine’s natural gas pipelines, built during the Soviet era when it was part of the USSR, carry 80 percent of Russia’s natural gas exports to Europe.  Russian gas accounts for between 25 percent and 30 percent of European Union gas consumption and about 35 percent of its natural gas imports. Some European countries depend on Russia for most of their gas supply, so any disruption has serious repercussions.  A similar gas disruption was averted this year as Russia and Ukraine agreed on terms of a new gas agreement, including market pricing. However, Ukraine’s ability and inability at times to pay its gas bills has left many Europeans on edge since Russia threatens to cut off Ukraine if it fails to pay its bills. Serious economic problems exist in Ukraine due to the world economic crisis, and it remains on IMF life support to prop up its economy. Another factor is the Presidential election in Ukraine. Incumbent President Viktor Yuschenko of Orange Revolution fame lost in the first round of voting. Opposition leader Viktor Yanukovych and Prime Minister Yulia Tymoshenko face each other in the run-off on Feb. 7. All these factors leave Europe in suspense as to whether Ukraine can meet its monthly gas bills.

Even as a crisis was averted in Ukraine, Belarus reared up to present additional problems.  On Jan. 1, 2010, Russia cut off oil shipments through the Druzhba pipeline (Druzhba means “Friendship”) that transits Belarus and provides about 10 percent of Europe’s oil supplies.  This stoppage is reminiscent of a similar dispute in January 2007, when Russia halted similar oil shipments.  Oil flows to Europe (primarily Germany and Poland) continued despite the Jan. 1 stoppage, while supplies to refineries in Belarus were directly affected. Why cut off the flow? Belarus refiners pay about one-third of Russia’s export tax rate due to previous tariff agreements between Russia and Belarus, so surplus products refined in Belarus are sold in Europe at a lower price than products from Russian refiners.  Russia wanted to raise tariffs for the Belarus refiners after the tariff agreements expired on Dec. 31, 2009, so that Belarus refiners would pay the same export tax rate as all others.  The new tax could cost Belarus as much as $5 billon annually, more than 10 percent of its gross domestic product.  The dispute escalated on Jan. 4, 2010, when Belarus threatened to cut off electricity to Russia’s Kaliningrad region, a small Russian enclave sandwiched between Poland and Lithuania and adjacent to Belarus. Russia immediately resumed all oil shipments. Negotiations between Russia and Belarus are ongoing. For the EU, the stoppage came as an unexpected and unwelcome New Year surprise, despite the EU and Russia putting an early warning mechanism into place last year to avoid these kind of bombshells.

Russia: The Future

For the future, Russian energy will continue to be an important part of the country’s domestic economy until it finds a way to diversify away from oil and gas.  Russia is pulling out of its economic crisis, assisted by higher oil prices in the last six months.  Oil production has stabilized and is increasing slowly, surpassing the 10 million barrel-per-day level in late 2009 and headed for 10.2 to 10.5 million barrels-per-day by the end of 2010, due to increasing production from East Siberian oil fields. Natural gas prices are likely to increase in 2010 since natural gas contracts with European buyers are linked to oil prices, although with a six to nine month lag.  If oil prices stay in the $70 to $80 range (or higher), expect European prices for Russian natural gas to rebound later this year.  Russia is keeping a careful eye on developments in Central Asia, its economic backyard, and is working to offset gains made by China and the EU.  Russia is slowly moving forward with its natural gas pipelines, with Nord Stream the most advanced.  In oil, it is moving rapidly ahead on its pipeline to the Far East, which can give Russia another outlet for its oil and will lessen its reliance on western oil markets.  It also is working to complete oil pipeline bypasses to Belarus, eliminating another thorn in its energy picture.

As the nation with the largest natural gas reserves and the eighth largest oil reserves, Russia’s energy future appears more than stable. The question is whether Russian leaders are able to leverage their natural resources to keep their economy afloat, maintain a reliable level of oil and gas production, and preserve viable trading relationships. In oil, after almost a decade of rapid growth, its oil production is reaching a plateau, and its success going forward will depend on its ability to provide sufficient incentives for development to occur in East Siberia and its Arctic offshore tracts. At present, its strategy appears to be working.

In natural gas, Gazprom continues to delay investments in new production, seeking to buy gas from other countries or from other domestic producers.  How long it can continue to play this game is an open question.  Its delays are worrisome to its long-term stability and to its ability to meet its long-term export commitments.

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

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

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.

In the last months, and in the wake of the May OPEC meeting, many market analysts were somewhat surprised by the run-up in oil prices (see Abraham Energy Report story on Oil Prices: How High Can They Go?). It appeared to some that the market was looking way ahead of itself to the day when the world economy and oil demand would recover, leading once more to tighter markets and higher oil prices. We look at the factors that have influenced the market in recent months in advance of the Sept. 9, 2009, OPEC meeting in Vienna.

Cloudy Skies Ahead for Climate Bill

The climate change steamroller hit a roadblock in Congress in late July and then received a near-death blow in late August as Democratic leaders in the Senate announced they were postponing the introduction of comprehensive cap-and-trade legislation until the end of September. Citing of series of factors—the death of Sen. Edward “Ted” Kennedy, Sen. John Kerry’s health woes and the problems around health care reform, the chief sponsors—Kerry, D-Mass., and Barbara Boxer, D-Calif.—decided to delay the bill’s introduction again.

More headlines from this issue:

» Japan Maintains Influence on Global Energy Policy and Markets
» U.S. Sen. Max Baucus: Power Player in Climate Bill
» Canadian Oil Sands Pipeline Secures Stable Energy Supply
» Reins Could Tighten on Energy Futures Trading
» Russia and LNG: A new Supplier in the Market

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The factors at work in the marketplace determining the level of oil prices in the short-term and long-term are a never-ending source of fascination and mystery. After sliding from a peak of $147 per barrel last July to a low near $33 per barrel in December, oil prices are now on the rebound.

With global demand still contracting in 2009, any real tightening of the fundamental supply/demand balance is unlikely to occur in the short term. Despite that, the price of oil has doubled to near $70 per barrel today, from the 2008 year-end lows.

Offshore Wind Must Be Integral Part of Nation’s Energy Mix

As Congress works on the issues of carbon emissions and energy security, one of the measures that has moved to the forefront in both the House and Senate bills is a provision that would establish a national renewable energy standard (RES). If it becomes law, the RES would require power companies to generate approximately 15–20 percent (depending on the legislation’s final outcome) of their energy from renewable sources and energy efficiency by 2021.

More headlines from this issue:

» CCS Technology Seen as Key to Resolving Climate Change Concerns
» Climate Change Update: Economy Looms Large Over Climate Bill
» OPEC: Looking Past the Fundamentals and Hoping for Recovery
» NRC Chairman Jaczko Redefining Role at Important Juncture
» The EU and the Great Pipeline Game
» Water: Rising as a Major Energy Industry Concern

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Looking back over the last 50 years, annual motor gasoline demand in the United States rose from 2.4 million barrels per day (mmbd) in 1949, to a peak of 9.3 mmbd in 2007, an annual average growth rate of nearly 2 percent. This analysis reviews the forces at work that are likely to affect U.S. motor gasoline demand, supply and prices during the 2009 summer driving season and beyond.

Climate Change Legislation Blocked Despite Concessions

Despite months of intense negotiations, and ongoing encouragement from President Obama, cap-and-trade legislation continues to be a difficult sell in Congress, and it remains unlikely it will be ready for the President’s signature in 2009.

In recent weeks, it’s apparent that members of the U.S. House—Republicans and Democrats alike—share the U.S. Senate’s concerns about the cost of cap-and-trade legislation and are proving a serious impediment to passage, despite optimistic forecasts from Energy and Commerce Chairman Henry Waxman (D-Calif.) that the bill would pass the House by Memorial Day.

More headlines from this issue:

» Russia: Resource Nationalism Waning?
» Salazar’s Expanded Role in Obama Energy Policies
» Energy Investments Down, Prices to Rise
» State Energy Policies Roundup
» GHG Registry Facing Criticism

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OPEC Ministers met in Vienna on March 15 to review trends in the oil market, the global economy, and the adequacy of their three previous attempts to reduce oil production in line with declining global demand. They also examined the degree of each OPEC member’s compliance with the existing production quotas set at their last meeting in December 2008.

Energy Challenges Call for Bold Action from President

In his recent speech to Congress and in his various actions since taking office, President Obama has suggested that one of his foremost priorities is to transform America’s energy landscape and move us away from high levels of carbon emissions and imported energy toward clean energy and energy independence.

These goals are commendable, and in terms of the President’s commitment to expanding America’s energy research efforts and providing broad incentives for the development of renewable energy such as wind, solar and geothermal, his policies have been highly consistent with these objectives. The truth is, though, there is nothing very bold about advocating for more renewable energy, which has enjoyed bi-partisan support in Washington for decades.

More headlines from this issue:

» EPA: Carbon Ruling Coming
» FutureGen Revival Signals New Opportunity
» US LNG Import Preview—2009
» Russian Oil Production Slides
» Climate Change Update: New Revenues Challenge
» IRENA: New NGO for Renewables
» Electricity Grid Improvements Moving Forward

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The Abraham Energy Report is pleased to present a wide-ranginginterview with Dr. Chakib Khelil, immediate past President of the Conference of the Organization of the Petroleum Exporting Countries (OPEC) and Minister of Energy and Mines for the People’s Democratic Republic of Algeria.

As immediate past President, Dr. Khelil has overseen OPEC at one of the most volatile periods in the organization’s history. Over the past year, OPEC has seen oil price fluctuations that have challenged historic trends, government expectations and public perceptions. The unpredictable nature of the international economy further destabilizes the oil markets and demands cautious and reasonable leadership.

Launching an Energy Tech Revolution

The Big Three automakers teeter on the edge of bankruptcy, the economy continues to slide, jobs are lost and credit remains elusive. In the midst of all the bad news, one economic number is giving people hope—the price of oil, which is around $100 cheaper than just a few months ago. This bright spot is, however, a mirage that could create a false sense of ease for consumers. Bottom line: The energy crisis is not going away. It will come roaring back once the world economy starts growing again.

More headlines from this issue:

» Russia-Ukraine Gas War
» Can China and India save OPEC?
» Nuclear Power: Untapped Potential
» President Obama’s First 100 Days: Energy Opportunities
» OPEC Update
» Climate Change Delay Likely

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While the first Cabinet posts announced were naturally President-elect Obama’s economic team, there is already great speculation about (and quiet campaigning for) the post of Energy Secretary. The President elect has ambitious plans when it comes to energy and climate change, and the person selected tolead the department will be central to the new administration’s success.

The Economy, Oil and the Fundamentals of Demand

The substantial reduction in the price of oil in recent months suggests that the global oil bubble may have finally burst, allaying once persistent fears that the demand for oil and its price would rise unabated far into the future.

That the hand-wringing over oil has come to an end is not surprising. After all, oil prices peaked at a historic $147 per barrel in July; today they hover near $55. For now, the flagging economy promises to put a damper on both demand and prices.

More headlines from this issue:

» SEC Proposes New Oil & Gas Rules
» OPEC Update: Chasing Demand Downward
» Carbon Capture & Storage: A Viable Solution for Climate Change
» China Moves Toward Reform
» Russia’s Strategic Asset Law

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As the world’s energy consumers consider the future—one where oil prices continue to rise and coal remains a less environmentally friendly option—liquefied natural gas (LNG) is quickly becoming a credible and likely alternative to meeting long-term global energy needs.

At the top of the list of nations poised to satisfy those needs is Qatar.

In an interview with the Abraham Energy Report, Qatargas Chairman and Chief Executive Officer, Mr. Faisal Al-Suwaidi, discussed the future of Qatargas and its role in supplying worldwide LNG production and demand.

Global Markets: A Sense of Urgency and Opportunity

As we launch the Abraham Energy Report, it is with the knowledge that global energy markets are at a critical juncture and the staggering challenges ahead demand both a sense of urgency and opportunity.

The urgency is unambiguous, confirmed by the International Energy Agency (IEA) in its most recent World Energy Outlook: The world faces a perfect storm of constrained fossil fuel supplies, unbounded energy demand and a new resolve to reduce greenhouse gas emissions—all of which qualify as significant economic and political stressors today and in the future.

More headlines from this issue:

» Europe Eyes AGP as Alternative to Russian Natural Gas
» No Matter the Election Results, Climate Change at the Top of New President’s Agenda
» Russia: Different Dance; Same Dance
» Why OPEC Won’t Raise Oil Production
» NRG Energy’s Nuclear Gambit
» US LNG Imports to Remain Strong

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