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Out with the old

MUTUAL IGNORANCE, antipathy and mistrust characterise the relationship between the world's greatest oil-producing region and its greatest oil-consuming country. Strategic and commercial necessity bind them together, but the links are weakening. Something must give.

The US and Russia seem increasingly close, in a sharp reversal of recent history. In central Asia, crushed Afghanistan, a year ago the most talked-about place on Earth, is slipping from the world's consciousness. A form of global legislation on the environment is progressing, but emasculated by disagreement between some of the world's biggest polluters.

The terrorist threat in the wake of 11 September continues to simmer, Kuwait is tightening security and is concerned about attacks on oil infrastructure, which could damage world oil supplies. Further attacks in Western countries seem increasingly likely.

Changing geopolitics

The geopolitics of oil have seldom faced such drastic and rapid change. More is to come. The US' determination to free itself of dependence on the Middle East is taking shape. By striking special deals with Russia, Mexico, Canada and possibly Venezuela (if wild-card President Hugo Chávez behaves palatably), breaking free from Saudi Arabia is achievable.

In the first nine months of 2002, according to the EIA, the US' total gross crude and products imports averaged 11.2m barrels a day (b/d). Of that, around 40% came from Opec countries and about 20% from the Mideast Gulf, including 1.5m b/d from Saudi Arabia (just over 13%). The EIA says that, in the nine-month period, the US' main suppliers were Canada (1.9m b/d), Saudi Arabia, Mexico (1.5m b/d) and Venezuela (1.4m b/d).

Russian deliveries were, and remain, negligible. But Russia can and will start doing something about this. Simon Kukes, president of Tyumen Oil, Russia's fourth-largest oil producer, claims Russia's export capability may almost rival Saudi Arabia's by 2010.

An acceleration in production from the vast oil sands of Canada, already one of the US' key oil suppliers, could further erode the Middle East's and primarily Saudi Arabia's share of the US market.

A US-friendly Iraq in a post-Saddam Hussein era, Mexico, Venezuela and west African nations, most notably Nigeria, but also Angola and Equatorial Guinea, could complete the picture.

The US' resolve will have been reinforced by President George Bush's showing in the US' mid-term elections. His strengthened mandate will enable him to pursue his cherished energy policy with more vigour. The importance of energy policy to the US is immense, as the record shows. Energy accounts for three of the defining features of Bush's government, Kyoto, a controversial energy policy and pushing towards war with oil-rich Iraq.

There is also the question of what will happen to Iraq's oil if Saddam is kicked out and sanctions are lifted. Iraq desperately needs money and must pump oil. Lots of it. The state of Iraq's oil infrastructure is impossible to ascertain, but it is reasonable to assume it is not in very good shape. It is certain that although still technically an Opec member, Iraq will be in no position to accommodate calls from other Opec members to keep a tight rein on production.

A swift increase in Iraqi output is probable, even if, for technical reasons, some estimates of its production and export capability appear outlandishly high (see p3). If the political conditions are right, Iraq will not lack financial support from rich foreign companies. This will put enormous pressure on oil prices. Opec would find itself in the dilemma of choosing falling oil revenues or loss of yet-more market share. With most of its members at the technical and financial limits of cuts in oil output, further reductions would be unlikely.

People love to say it, but Opec's influence and very existence in its present form could be under threat. Its power is leaking away.

Political and technological changes have already greatly widened the world's potential hydrocarbons supply sources. Oil traders tend to react less these days to one-off cuts in supply, because the resulting deficit can usually be made up from other sources fairly easily.

As Opec's influence fades, so will Saudi Arabia's. Increasingly isolated within Opec, out of favour with the US and with its own chronic social and economic problems, Saudi Arabia, which depends on oil for 70-80% of state revenues, is in trouble, even if it does own a quarter of the world's oil. Saudi Arabia would be tempted to force down prices further to protect its market share. In turn, this would threaten the economics of production in higher-cost provinces elsewhere.

Then again, assumptions about Iraq's rapid defeat and reconstruction are premature. A military campaign may fail to achieve its objectives quickly and cleanly. Even if successful, it is essential that foreign oil firms and governments that represent their interests must not and cannot be seen to be looting Iraq's natural resources. There is already too much talk about whether oil companies that have negotiated rights to oilfields might be squeezed out. Those contracts may not even be honoured by a new administration.

Dismal relations

Foreign investment will be needed to modernise Iraq's energy infrastructure, no small task, but it should be done in a way that puts the interests of the Iraqi people first. Any vulture-like snatching of assets will exacerbate already dismal relations between many Middle East and Western countries. A pragmatic, sensitive approach to rebuilding Iraq, by contrast, could have the opposite effect. If countries do not have friends or enemies, only interests, then commercial interests are subordinate to the interests of political stability.

Afghanistan could set an example. It is crying out for foreign investment. There is nothing surprising about that, but whether it gets it is a different matter. Afghanistan is different from Iraq. Proved liquids reserves are around 100m barrels, compared with Iraq's 112bn barrels, which is why foreign oil companies have not been falling over themselves to negotiate upstream rights.

However, some projects should generate investment interest.

Afghanistan's geographical position makes it an important potential transit route for oil and gas. A pipeline across Afghanistan could, for example, help Turkmenistan monetise its immense gas reserves by linking them with markets in Pakistan and India, as well as Afghanistan itself, bringing the country much-needed revenues and energy. But aside from the giant task of funding such a project security issues associated with any expensive infrastructure project in Afghanistan and Pakistan will also be a major concern for investors. Also, India is unlikely to allow Pakistan control over part of its energy supplies.

While change on a broad scale is altering the make-up of the world's energy scene, whether it reaches this kind of level remains to be seen, small interests may be forgotten for the sake of money and the vested interests of powerful governments and companies.

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