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Global energy security
Publication Date : 15-06-2012
Modern society is hugely dependent on energy. Different forms of energy are essential in the residential, industrial and transportation sectors. Energy is also crucial in carrying out military operations.
The attempt to control oil resources was a major factor behind World War II. When Japan moved into the southern part of French Indo-China (now comprising Cambodia, Laos and Vietnam), the USA stopped oil shipments which used to supply 80 per cent of Japanese oil imports.
The Netherlands and the UK followed suit. With oil reserves only for a year-and-a-half during peace time, Japan opted to seize the oil fields in the East Indies (now Indonesia) from the Netherlands. Had Japan heeded the USA’s advice to withdraw from Indo-China, the course of the war would have been different. Man’s increasing reliance on energy has heightened the importance of energy security.
Oil is a primary input with no substitutes. When prices rise, most consumers have little choice but to pay more rather than buy less. It takes years to develop new resources and it is difficult to turn production on or off at short notice. When fresh supplies, usually years in the making, threaten to flood the market or when a sudden drop in demand, due to recession, leaves sellers without ready buyers, the prices can plunge before producers start shutting the taps. That explains the volatile nature of oil prices.
Greater volatility can impede macroeconomic policy. Policy-makers have to compensate for depressed demand by lowering interest rates or pursuing a fiscal stimulus. On the other hand, rapidly rising oil prices could fuel inflation, prompting the central bank to raise interest rates that could further hamper economic growth.
The precise causal links between oil prices and the growth of national economies are obscure and much debated. One report has pointed out that almost every recession that the US economy has experienced since World War II was linked to a rapid increase in the price of oil. It is a nagging worry for all policy-makers that greater swings in oil prices translate into greater macroeconomic imbalances for which an immediate response is required.
The oil shock following the 1973 Arab-Israeli war put energy security, and more specifically the security of supply, at the heart of the energy policy agenda of most industrialised nations. The Arab oil embargo that resulted from the war, caused oil prices to jump from US$2.50 a barrel to about $12 a barrel in 1974.
Eager to capture the windfalls, virtually all oil producing countries in West Asia expropriated the foreign oil companies operating on their soil and set up national oil companies to manage them. Such nationalisations brought in its wake a massive influx of new wealth. Economic power, that was once held by foreign corporations, passed into the hands of political leaders.
Since then, policy-makers have sought to define the concept of energy security and its implications.
The European Commission defines energy security as “the ability to ensure that future essential energy needs can be met, both by means of adequate domestic resources worked under economically acceptable conditions or maintained as strategic reserves, and by calling upon accessible and stable external sources supplemented where appropriate by strategic stocks”. In short, energy security refers to sustainable and reliable supplies at reasonable prices.
Energy security should distinguish between geological and geo-political threats. There are enough physical reserves to meet the global demand for energy. The exploration, development and transportation of these resources, however, pose significant financial and political challenges that need to be addressed. In respect of price, security involves achieving a state where the risk of rapid and severe fluctuation of prices is reduced or eliminated.
Oil prices vary from country to country depending on several factors, such as quality of crude, destination, taxes, exchange rates and refining capacity. Sustained high prices can affect both the consuming and producer countries in the long run. Higher prices bring higher profits for oil producers for immediate gains but tend to slow down global economic prosperity, encourage conservation and prompt the switch-over to other fuels.
Energy security depends on sufficient levels of investment in resource development, generation capacity and infrastructure to meet demand as it grows. The availability of funds for such investment is strongly linked to prices, but the flow of private and foreign investment depends to a great extent on political stability in the producing country. Some of the OPEC countries, notably Saudi Arabia, have maintained spare capacity to ensure stability in global markets.
Economic growth, particularly in China, India and countries in the Asia-Pacific region, has subjected the oil market to an unexpected demand shock that has almost threatened the elimination of spare capacity which is at one of its lowest recorded levels. Security of supplies can be enhanced by an overall diversification of supply. The development of several producing regions leads to more stability in international oil markets. Increasing supplies from Russia, the Caspian Sea, West Africa and other regions will reduce the vulnerability associated with over-dependence on the Persian Gulf.
From the producers’ perspective, major oil producing countries have been expressing their concern over the long- term security of demand.
This concern is based on two grounds--growth fluctuations in developed countries that reduce the demand for oil; second, the failure of OPEC countries to diversify their economies and their continued dependence on oil revenues. One lesson of the Arab Spring is that West Asian countries, with plenty of oil, have been more effective at fending off attempts to unseat their regimes.
Rulers across the region have been using some of their oil wealth to fund social programmes to improve public services and appease their people. These authoritarian rulers, who get most of their funding from national oil companies, keep their countries’ finances under wraps.
The oil-funded leaders respond to demands for greater accountability by offering new handouts and lowering taxes and this usually works. That has helped them survive the wave of democratisation that has swept the globe and chased other dictators out of office. Energy security is an international issue that entails growing inter-dependence between major producers and consumers.
No country or region can alone achieve a state of energy security. Neither can it protect itself from oil price swings or from the consequences of interruptions in oil production, wherever they occur.
Diversification of both energy mix and energy sources is the main route to energy security. Major industrialised countries should seek to enhance the reliability of those producing nations on which they are bound to depend for many years to come. It is a win-win opportunity.
Given its geological advantages, West Asia will always be a critical player in energy security as the main source of crude oil supply to all major consumers across the world. It is well connected to consuming markets in Europe, the United States and the Asia-Pacific and enjoys the lowest production costs for hydrocarbon resources. This is the blessed geography of the region. It is at the same time a politically volatile region.
Oil wealth is a major obstacle towards democratic reform. The revenue from oil accounts for more than 85 per cent of their earnings. These countries, irrespective of their political regimes and affiliations, will try to secure the markets for their oil. It is not entirely a case of dependence of oil consumers on producers. The degree of inter-dependence between energy producers and consumers will be in the overall interest of all countries. Inter-dependence is the cornerstone of the energy landscape of the 21st century.
The writer is a retired officer of the Ministry of Defence and a former consultant to TERI.