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Analyst Andreas Goldthau Says Oil Price Collapse Affects Europe’s Fragile Geopolitics

Oct 23, 2015

The year-long drop in crude oil prices has caused economic anxiety across the globe, especially in so-called “petrostates” that rely heavily on oil and natural gas to drive their economies.

“There’s not a lot those countries can do,” says Andreas Goldthau, an international energy analyst and professor Central European University in Budapest who’s also an associate with the Geopolitics of Energy Project at Harvard. “Venezuela is on the brink of bankruptcy. They're on the verge of collapse.”

Goldthau says the price of oil will rise only slightly over the course of the next year, leaving the international economic energy sector in disarray. It’s especially dire in Europe, where governments tend to back more environmentally conscious efforts when it comes to energy production. That forces them to rely heavily on imports from Russia. But Goldthau expects the Russian oil industry to be choked off by economic sanctions over the country’s actions in eastern Ukraine.

“That will affect how the industry is run, its effectiveness, its ability to have new resources, to maintain production,” Goldthau said.

He also argues Russia is deprived of foreign technology, which hurts an integrated industry like oil and gas production.

“You need partners. You need service companies,” Goldthau said. “You need certain companies with certain skills for offshore drilling, for shale drilling, and all these kind of things. Once you cut a company off from that, the company has a problem.”

If supply lines to Europe from Russian oil fields dry up, Goldthau says more technology, like hydraulic fracturing, could be imported to tap into European gas reserves. But that comes with a catch.

“So the tradeoff here really is do we want to do that and mess up our backyard and, essentially, deal with flow back water issues and all the things that have come up also here in Oklahoma - earthquakes and all that?” Goldthau asked. “Or do we actually accept the fact that we will retain high dependency on a supplier that's not very reliable? And this is a tradeoff that I think every country and nation has to decide and deal with on its own. There's no silver bullet. No one solution.”

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FULL TRANSCRIPT

REBECCA CRUISE, HOST: Andreas Goldthau, welcome to World Views.

ANDREAS GOLDTHAU: Thanks for having me.

CRUISE: Well you're an energy specialist, a political scientist by training but an energy specialist in that regard, and you wrote earlier this year on the international oil markets or energy markets, commenting of course that there's been a significant downturn in the last year, that we got used to about $100 a barrel for oil. Now we're looking at maybe half of that. What's going on here? I mean, we go to the gas pump, and we tank up, and for many of us it's pretty exciting that we're not paying as much, but there are consequences to that, and there are consequences here in Oklahoma but certainly on an international stage as well.

GOLDTHAU: Well indeed. We have seen a period of time where the $100 oil was the new normal, and that's what people thought. Obviously, that wasn't sustainable. There were a number of factors that kicked in including a surge in production in the U.S. that's the unconventional oil production here, plus staggering economy in Europe, less growth in China, and some strategic decisions taken by Saudi Arabia and OPEC. All of that gets us to a $45 barrel oil situation. The question now is what are the implications of all this? I think there are three elements that play an important role here. One is we'll certainly see a change in the industry. We'll see change in the American oil industry. They have started to kind of become innovative on the technology front. They cut costs, but still the question is out. Is that enough to sustain the unconventional oil revolution and the West? The call is still out. We'll see. The other thing is what do other producers do? That's Saudi Arabia, that's OPEC, that's non-OPEC producers, and some of them have been hit hard by low oil prices because production costs are as they are. So, they don't necessarily cover costs anymore at certain price environments which brings me to a third point which is some countries rely heavily on oil and oil revenues, and those are the countries that are hit hardest at the moment - that includes Venezuela, that includes a whole bunch of countries in the Gulf, and the reason why they're hit so hard is because the social price that they need for oil is way above the market price that they get. Some countries need a price of $100 or $110 to get the budgets balanced, and we're obviously a far cry off from that. Here the question really is how do those countries and economies deal with that situation and what implications does that have for societies there? These are open questions and, you know, the next couple of months, half year will tell us exactly where we're going.

CRUISE: Well maybe we could try to at least think about a couple of those. What are some of these countries that are dependent doing? What are they trying to do to make up the, as you say, social costs as opposed to the market costs?

GOLDTHAU: Some countries try and sit this through. Saudi Arabia, for instance, simply declared that they will keep on pumping no matter what. There's a strategy behind this. Obviously they're trying to target the American shale industry. Saudi Arabia is in kind of a positive, simply, still good situation and that's because they sit on vast reserves of foreign currency. That's because they don't have a lot of state debts and sovereign debts, and that's also because they have invested massively in programs that, for now, keep people happy on the ground. Other countries don't necessarily have these deep pockets and sit on a lot more debt. One of the countries that, indeed, has a big problem at the moment is Venezuela. They have made a couple of mistakes in the past. They have turned a functioning oil company into the social policy arm of the government which is not a good idea obviously, but they also have funded social policies based on debts and with a view to sustaining high oil prices which we're not as sustainable as. There's not a lot those countries can do. Venezuela is on the brink of bankruptcy. They're on the verge of collapse. There's a couple of other countries including countries on the Gulf that kind of pursue a mixed strategy. On the one hand they're trying to cut back on social expenditures on military expenditures, on the other hand they're kind of trying to sit this through with some adjustments in the oil industry. One of the main problems, or a similar problem that all of those countries have is that, essentially, the regimes in those countries and the governments in those countries, they rely on an implicit social contract which is essentially they tell the population that we keep you happy, we make sure you have all the social benefits that you want, we give you a good education, but you leave politics to us. Essentially that's the way they sustain their authoritarian regimes. Whether that's going to work out in the future with oil prices around 45 or less, that's a big question simply because they are almost incapable of bringing down the social costs of oil that they need to sustain that model.

CRUISE: Right, and when you have expectations built in, people begin to demand that those expectations be met. Is this what we need to get used to? $45 a barrel? Is that kind of the foreseeable future?

GOLDTHAU: There's this old saying in the oil business which is if you forecast, forecast often. It is hard to tell. I think there is differing voices out there. On the one hand you have people from the finance sector that keep on rambling on about $20 oil that may or may not be the case. NI, the telling company, came out with a projection a couple days ago that would suggest that we're back at $60, you know, in a year's time. So obviously you have a span in between. I think what will likely happen is that prices will go up, and that's simply because the low price environment will take its toll on the production side, on the supply side in the U.S. In other parts of the world we have worries of high production costs offshore. So, the market will react but we will not be back to the $100 oil any time soon. That's simply not in the cards given the international economic situation which doesn't look good neither in Europe nor in China nor elsewhere.

CRUISE: One of the other countries that obviously has been greatly affected by this as well as some geopolitical situations as well is Russia and the gas problem there, a state run company there. It's interesting cause Russia really seemed to escape, kind of, the global economic crisis of 2008-2009 because of oil and here they are significantly struggling with that and sanctions and some other things. What is the future of the oil industry there? Has Europe been able to become less dependent in Russian oil? Is that a situation that's going to continue as well?

GOLDTHAU: I mean there's a couple of things. First of all, Europe is as dependent on Russian oil as it has ever been. I think Europe imports about 75 percent of its oil from Russia That said, it's not a big deal simply because we have a global market. It's a functional commodity and even, in the event of a supply crisis, Europe will get oil from elsewhere. The much bigger question here is gas really because gas is a mutual game not a global game. You have long term contracts. You have infrastructure that ties a producer to consumer into long term relations, and if those relations sour you actually indeed have a supply problem. You don't necessarily only have a price problem. Here the Europeans have tried to kind of get their act together but they're not even half way, I would say. There's a move toward something that's called the Energy Union right now which would try and bring various elements of what still is a scattered EU and energy policy together into a common framework. The idea is essentially to not only to secure supplies elsewhere, but also to make the internal engine market robust which means you need to integrate that market, you need to kind of make sure that pipeline infrastructure is in place and reverse flow capacity and you need to bring regulation on a level playing field and all of that. If that works out, the European situation looks a lot better than it did in the past, and that's not because the share of Russian imports and European gas goes down but simply because the whole system is more robust against supply shocks. So, I would argue when it comes to oil, the European situation is that bad. When it comes to gas, there's still a long way to go. Turning to the Russian domestic situation in the oil sector and the energy sector, I think there's a couple factors that we need to bear in mind. One is, yes the oil price has come down, but at the same time the Ruble has fallen which gives an interesting situation because most of the expenditures in the Russian budget are denominated in Ruble not in dollars which, essentially, means once the oil price came down and the Ruble exchange rate came down as well, you have a situation where it almost balanced out in the budget. The budget, essentially, is not greatly affected. What's more important, probably, is how the Russian oil industry will react to the sanctions. This is the bigger issue I think because what happened is that the Western world essentially targeted the core of what constitutes the Russian economy, and that's the oil sector. So, they're deprived of foreign technology right now, and obviously the oil industry is a very integrated industry. It's not a national industry. So you need foreign technology. You need partners. You need service companies. You need certain companies with certain skills for offshore drilling for shale drilling and all these kind of things. Once you cut a company off from that, the company has a problem. So even giants such as the Rosneft which is Russia's biggest oil company is even state run. Even those giants, they will face some bottlenecks, and very, very soon actually, and on top of that they're deprived of money, of capital because they're cut off, essentially, of international capital markets. So, what I think is going forward in the next couple of years, we will essentially see a situation where the Russian oil industry will be choked and that will affect how the industry is run, it's effectiveness, its ability to have new resources, to maintain production and all that. So slowly but surely we'll see some decline going on in the Russian oil industry.

CRUISE: And that's a result of sanctions, of the cut-offs, as you mentioned, as well as, it seems, that the energy market seems to be cooperating with us in those efforts I suppose. Obviously we can see where the energy sector is related to national security, international security and obviously where it's also related to where it's also related to environmental concerns. Are there policies that they can put forward that acknowledges the environmental consequences, the security interests, as well as their national interest for making revenue off of the energy sector?

GOLDTHAU: Right, I think what's very important to bear in mind is that energy is not a commodity like any other. It is a traded commodity. It has a price. It's a private good, essentially, but it has public goods characteristics. So that's what we call the negative and positive externalities extending from energy production and consumption including positive externalities for national security or economy. Negative externality for environment and climate, and that makes energy a strategic good and that's exactly why it's so difficult to regulate that good, also why it's so interesting to look at that in academic terms. The question really is, how do you strike a balance between those goals? Countries and nations have found different answers to this. In America you can argue that the answer was put business in the economy first. I'm painting with a very broad brush stroke here.  Sit with individuals. You have stories such as the farmer turning into a millionaire, and that's exactly because regulation was geared toward a very simple goal: extract it, make money of it, market it because it has positive externalities for the economy and national security. Obviously there are mechanisms in place to hedge the negative sides of things. So you have the EPA in the U.S., you have state level regulation, but I think one still argue that the energy sector retains a very important role in the entire regulatory environment in the U.S. In Europe that's very different. You have environment focused regulatory regime, and that's part of the history because the place is a lot more populated and the history of the extractive industries is not that long in Europe. So the choice that European policy makers have taken is essentially to put environment first - for the better or the worse. The energy economy is not as pronounced and important in Europe as it is in the U.S. That comes with downsides. It comes with downsides on the energy import front and the energy security front. That's exactly what we've been talking about. So, you could, for instance, make the argument if the Europeans would import the fracking technology and deploy it widely in Europe, because you do have shale gas reserves, you do have shale oil reserves in Europe, then they could actually wean themselves off of Russian import dependency. So the tradeoff here really is do we want to do that and mess up our backyard and, essentially, deal with flow back water issues and all the things that have come up also here in Oklahoma - earthquakes and all that? Or do we actually accept the fact that we will retain high dependency on a supplier that's not very reliable? And this is a tradeoff that I think every country and nation has to decide and deal with on its own. There's no silver bullet. No one solution.

CRUISE: Well, as you say, obviously the energy sector is an international sector. We are all connected. So we will continue to watch and see how we go forward in this situation and see if you are correct in that the energy prices stay at the level that we're estimated right now. So thank you so much for joining us.

GOLDTHAU: Thank you very much for having me. It was a great pleasure.

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