The Relevant Role of the Middle East and the State Control of Hydrocarbons.

Introduction.

This paper has the objective of critically analyse if the State and OPEC have a relevant role to play in the upcoming years. This paper will consider three main arguments and then a conclusion stating that the State and OPEC have an essential role to play in the energy outlook in the upcoming years.

The first argument establishes that Saudi Arabi and OPEC play a relevant role in the supply side of the oil industry and Saudi Arabia is evolving and adapting to the present and future conditions to maintain its relevant roleplay. The second argument states that the energy transition towards low-carbon and renewable energy technologies is not negatively affecting the Hydrocarbons Industry. The third argument depicts that the State as, head of the energy sector in any nation does not receive any adverse effect from the liberalization process and the market-based policies.

Saudi Arabia and OPEC.

OPEC members and especially those located in the Middle East represent a critical producer’s zone According to British Petroleum (BP) as quoted next:

‘The Middle East maintains its role as a key source of energy, supported by the growth of OPEC oil production in the second half of the Outlook (pp 86-87), together with an expansion in gas production in Qatar and Iran (pp 94-95)’.[1]

In this instance, OPEC and more precisely Saudi Arabia controls the second-largest proven oil reserve in the world, according to the statistical information of British Petroleum,[2] therefore, the Kingdom’s petroleum policy is under heavy scrutiny, particularly after the controlled prices policy of 1973 and the administered prices system of 1980.[3] Additionally, the Kingdom faces severe geopolitical risks to the protection against disruptions in the supply and physical security of hydrocarbons infrastructure. Similarly, with the statement above, the Eurasia Group says in its 2018 report that the Middle East represents one of the ten most sensitive geopolitical risks.[4]

Despite these elements, Saudi Arabia has the recognition of a ‘swing and dominant producer’[5] which means that the Kingdom can influence the price of crude oil from the supply side, alongside with the power to enforce discipline within the OPEC, particularly when its members do not comply with the general policies.

Saudi Arabia, as stated before, is evolving in its oil policies according to the specific scenarios, for example, the competition of non-OPEC producers in the 1980 and 1990 such as Norway, UK and Russia began to gain market share the Saudi oil policy shifted from controlled pricing to administrated pricing. Nowadays, the competition of American Shale gas and Oil is forcing a new change in the Kingdom’s policies.

This new scenario for the oil industry puts new pressure points on Saudi policies, mainly because the USA shifted from importing oil to export it. Consequently, other producers (OPEC and non-OPEC members) require finding new markets for their production; these consumers are usually Asian markets like China and India. [6]

In this scenario, Saudi Arabia requires to allocate a specific demand to forecast its production. Therefore, the Kingdom’s policy of spare production capacity plays a relevant factor to dwindle the effect of the American Shale oil competition. Thus, the American producers are not so quickly responsive to changes in the oil price as Saudi Arabia, which have more proven reserves and spare capacity in its favour.

Under this scenario of greater reform,[7] Saudi Arabia launched the program “Vision 2030” which aims to develop the Saudi economy by diversifying the petroleum revenues contains 96 strategic objectives that follow the path of the three main postulates that states as follows: 1) strengthen the Arab and Islamic culture. 2) increase employment and diversify the economy. 3) enhance government effectiveness and social responsibility.

Additionally, to “Vision 2030”, The Saudi authorities are investing more in the natural gas production, with tax incentives like a reduced tax income rate in programmes related to natural gas investments in comparison with the tax rate for oil and hydrocarbon investments.[8]

Other actions to diversify the economy are the integration of midstream activities, particularly with the construction of a larger refinery capacity, which has the purpose of adding value to the oil industry and at the same time generating new sources of employment.[9]

The last regulatory actions that Saudi Arabia is setting is a more significant reform in the oil industry and the tax regimes. These actions have the purpose of attracting foreign direct investment and reduce the high dependence on oil revenue. [10]

This paper considers that the international public offer for a share in the Saudi Aramco Capital has a different background in which, the State is facing a reform on the energy sector and is trying to adopt a more open commercial setup in which the direct foreign investment (DFI) can add value to the industry. Related to the second question, the State will influence the production rates and levels. Thus, these decisions are in control of the different Ministries and Authorities.[11]

As stated before, Saudi Arabia is evolving and transforming to maintain its relevant role. The figure of dominant and swing producer, the shift from a closed economy to a market-based one reflects the evolution and the change of the general conditions in the petroleum industry. However, it cannot be inferred as a sign of defeat or despair thus according to the fundamental law of governance all the natural resources and revenues of them are still in control and ownership of the state.[12]

Energy transition and Petroleum resources.

The next statement summarises the effect of renewables on petroleum production and supply: ‘Less carbon does not imply less petroleum’. To support this argument is necessary to address the concept of security of supply and the role of electricity generation as a relevant factor for the demand side on the hydrocarbons industry.

According to Socavol’s definition of energy security, [13] the concept of Security of Supply and Reliability of Supply are the critical elements that define the energy transition and the effect of renewables in the energy industry.

In this sense, the security of demand[14] has its foundation in the consumer’s needs and demands. The low-carbon energy transition aims to reduce the consumption of fossil fuel and the generation of carbon emissions by reducing the consumption of petroleum products in the electricity generation. Despite this objective, low-carbon and renewable technologies face severe problems and challenges to address.

According to the BP outlook, the electricity generation is one of the most extensive and valuable destinations for petroleum products, alongside with transportation fuel needs [which represents the most common use of petroleum derivates].[15]

The production of electricity by renewables face two crucial challenges that limit or dwindle the economic value of the low-carbon technologies and the renewables. These challenges are the intermittency[16] and the missing money problem[17].

The intermittency in electricity production means that renewables face a challenge of reliability of supply. Hence, renewables depend on the variable source exposure to transform the energy; for example, solar panel production depends on the availability and the quantity of solar exposure to produce energy. Consequently, during night-time, energy production stops or dwindles. This characteristic carries a heavy burden on the distribution network operators; thus, they have to balance this irregular input into the grid with other reliable sources, in which the gas and coal generating facilities are the best options, due to the reliability and the feasible cost of their supply.

Consequently, this intermittency challenge generates what the author Francisco Gonzalez, defines as the ‘missing money problem’. The generation capacity gap created by the intermittency creates a price pressure on the fossil fuel electricity generators (especially in wholesale electricity markets operated by a regulator that incentivises the renewables as the primary vehicle to achieve the low-carbon transition). The fossil fuel producers must compete with the lower prices cap that renewable set and additionally they must supply energy (mostly generated and under production cost prices) due to the public services obligations that they face to fill the gap created by the same intermittency.[18]

These two challenges on the renewables and the low-carbon technology abate the intended effect on the fossil-fuel dependency. The role of petroleum in the world’s energy mix is not affected nor negatively or drastically by the renewables due to these effects, and one significant example of it is the ‘Energiewende’ transition model from Germany.

The Energiewende had the purpose of acting as a response from the German Government to prevent a nuclear incident and avoid an event like the Fukushima accident in Japan. The German authorities, under this scenario, decided to redistribute the energy generation mix, reducing the nuclear power and increasing renewable generation capacity.[19] Nonetheless, this plan had a significant failure. It did not consider the real availability of renewable resources and the location of the electrical transportation networks.[20]

In this context, the Energiewende did not consider the intermittency issues regarding electricity production by renewables. For example, the original plan considered to establish a considerable solar generation capacity in the northern region, but that particular region does not possess a sufficient solar exposure; additionally the system operators of the distribution networks do not own sufficient infrastructure to transport the electricity generated in the north to the southern region of the nation, where the main industrial complexes sits.[21]

Energy Markets and State participation.

The liberalisation process and the free-market approach do not automatically imply a withdraw of the State from the energy sector. In many cases, the State despite its level of interaction has a role of regulating the energy industry activities and can play a direct role when National Oil Companies (NOC) operates within the national markets, as in the case of Norway. No state should withdraw entirely from the energy sector. Thus an entire market-based industry can lead to non-desirable effects such as shortages of energy supply, electrical blackouts and energy poverty in the worst case, an example of this can be the case of Australia, in which the availability of natural gas to the domestic market is not fully secured. The gas pipelines are not enough to connect the production places with domestic consumers.[22]

In the demand side, legislation such as the European Union Third Energy package stipulates the objective to achieve long-term energy security (in the downstream sector and particularly in the electricity sector) by committing to the creation of a European Internal Market for electricity. This internal market will work on the unbundling of Vertically Integrated Monopolies (often operated by NOCs), the third-party access to the production and transportation facilities and networks and most importantly with a robust and well-designed regulatory framework and authorities.[23]

The State participation role in this consensus is critical and relevant, in the one hand to create the legal framework and the ex-ante regulations which will establish the levelled playfield for the producers to compete. In the other hand, to establish the regulatory authorities that oversee the competition, which ultimately will address the demand side of the hydrocarbons industry correctly.

Related to the supply side, the State must intervene ex-ante and ex-post in the definition of the energy security policies and directives. In such activity, the State (as titular of the Sovereignty Rights within its territory) shall define its objectives, the utilisation of its natural resources and the regulation of the productive and commercial activities to obtain profits and revenues from them.

Conclusions.

This paper concludes that the original statement is not correct. Contrary to this statement, the role of the State and OPEC is still relevant and valid. Thus, the energy and petroleum industries still rely on a significant base on the actions and directions these organisations can apply. Additionally, the renewable energy and low-carbon transition technologies are not negatively affecting the hydrocarbons production and supply. Consequently, these transition energy industries face critical challenges that affect the implementation of them as an economical and reliable supply alternative to energy production. This effect is similar in the liberalisation and free-market economies; thus, these economic institutions cannot aisle the State from the energy sector. Securing better and reliable energy supplies depend on the direction, regulation and the control that the State can provide to the industry.

Bibliography.

British Petroleum, ‘BP energy outlook edition 2019’ (BP, 2019)

 British Petroleum, ‘BP Statistical Review of World Energy’, (68) (BP, 2019)

 Dohmen F, Jung A, Schultz S, Traufetter G, ‘German Failure on the Road to a Renewable Future’ Der Spiegel (Berlin, May 13, 2019) < https://www.spiegel.de/international/germany/german-failure-on-the-road-to-a-renewable-future-a-1266586.html> accessed 1 October 2019

 Eurasia Group, ‘Top risks 2018’ (EG, 2019)

 Fattouh B , Sen A, ‘Saudi Arabia Oil Policy: More than meets the eye?’ (2015) 13 Oxford Institute for Energy Studies <https://www.oxfordenergy.org/wpcms/wp-content/uploads/2015/06/MEP-13.pdf> accessed 1 October 2019

 González-Díaz F, ‘EU Policy on capacity mechanisms’ in L. Hancher et al (eds) Capacity Mechanisms in EU Energy Markets (Oxford University Press, 2015) https://www.bloomberg.com/news/articles/2019-10-08/why-aramco-s-stop-start-ipo-is-no-ordinary-share-sale-quicktake

 Johnson P, Oliver M. ‘Renewable Generation Capacity and Wholesale Electricity Price Variance’ (2019) 40 (5) The energy journal <doi://10.5547/01956574.40.5> accessed 1 October 2019

Redgwell C, ‘International Energy Security’ in Barton, B., Redgwell, C., R?nne, A., & Zillman, D. N. (Eds.). Energy security: managing risk in a dynamic legal and regulatory environment (Oxford University Press 2004)

Socavol B, ‘Introduction: Defining, Measuring and Exploring Energy Security’ in Benjamin K Socavol (ed) The Routledge Handbook of Energy Security (Routledge, 2011)

Talus K, Introduction to EU Energy Law (Oxford University Press, 2016)

Taylor M, Soliman-Hunter T, ‘A paradox of plenty: the Australian domestic gas supply regulatory dilemma’ (2018) 11, Journal of World Energy Law and Business < doi: 10.1093/jwelb/jwy026> accessed 1 October 2019

Wald E, ‘5 Questions About The Aramco IPO That Really Matter To Investors’ Forbes (New York September 3, 2019) <https://www.forbes.com/sites/ellenrwald/2019/09/03/5-questions-about-the-aramco-ipo-that-really-matter-to-investors/#18090ff56bc6> accessed 1 October 2019

Table of Legislation.

Saudi Arabia, Basic Law of Governance, 1992.

Saudi Arabia, Income Tax Law, 2019

Footnotes.

[1] British Petroleum, ‘BP energy outlook edition 2019’ (BP, 2019)

[2] British Petroleum, ‘BP Statistical Review of World Energy’, (68) (BP, 2019)

[3] Bassan Fattouh, Anupama Sen, ‘Saudi Arabia Oil Policy: More than meets the eye?’ (2015) 13 Oxford Institute for Energy Studies <https://www.oxfordenergy.org/wpcms/wp-content/uploads/2015/06/MEP-13.pdf> accessed 1 October 2019

[4] Eurasia Group, ‘Top risks 2018’ (EG, 2018)

[5] Fattouh (fn 03)

[6] Ibid

[7] BP (fn 01)

[8] Income tax law article 7 (b) (c)

[9] Fattouh (fn 03)

[10] BP (fn 01)

[11] Ellen Wald, ‘5 Questions About The Aramco IPO That Really Matter To Investors’ Forbes (New York September 3, 2019) <https://www.forbes.com/sites/ellenrwald/2019/09/03/5-questions-about-the-aramco-ipo-that-really-matter-to-investors/#18090ff56bc6> accessed 1 October 2019

[12] Basic Law of Governance. Article 14

[13] Socavol B, ‘Introduction: Defining, Measuring and Exploring Energy Security’ in Benjamin K Socavol (ed) The Routledge Handbook of Energy Security (Routledge, 2011)

[14] Ibid

[15] BP (fn 01)

[16] Redgwell C, ‘International Energy Security’ in Barton, B., Redgwell, C., R?nne, A., & Zillman, D. N. (Eds.). Energy security: managing risk in a dynamic legal and regulatory environment (Oxford University Press 2004)

[17] González-Díaz F, ‘EU Policy on capacity mechanisms’ in L. Hancher et al (eds) Capacity Mechanisms in EU Energy Markets (Oxford University Press, 2015)

[18] Redgwell (fn 16)

[19] Paul Johnson, Matthew Oliver. ‘Renewable Generation Capacity and Wholesale Electricity Price Variance’ (2019) 40 (5) The energy journal <doi://10.5547/01956574.40.5> accessed 1 October 2019

[20] Frank Dohmen, Alexander Jung, Stefan Schultz, Gerald Traufetter, ‘German Failure on the Road to a Renewable Future’ Der Spiegel (Berlin, May 13, 2019) < https://www.spiegel.de/international/germany/german-failure-on-the-road-to-a-renewable-future-a-1266586.html> accessed 1 October 2019

[21] Ibid

[22] Madeleine Taylor, Hunter Soliman-Hunter, ‘A paradox of plenty: the Australian domestic gas supply regulatory dilemma’ (2018) 11, Journal of World Energy Law and Business < doi: 10.1093/jwelb/jwy026> accessed 1 October 2019

[23] Talus K, Introduction to EU Energy Law (Oxford University Press, 2016)