Geopolitics of Energy India Energy Forum New Delhi July 31, 2008

1. Geopolitics of EnergyIndia Energy ForumNew Delhi July 31, 2008 Sudha Mahalingam Member, Petroleum & Natural Gas Regulatory Board Member, National Security Advisory Board Sudha Mahalingam 1

2. What is Geopolitics? Science dealing with political, economic and strategic equations between countries defined by geography (and geology) Links and causal relationships between political power and geographic (geological) space Energy geopolitics refers to the defining role of energy in shaping political, economic and strategic relationships between nations Sudha Mahalingam 2

3. Factors affecting energy geopolitics Geology Geography Degree of Import dependence Resource Curse Peak Oil Pessimism Security of Transit Routes Political Power Sudha Mahalingam 3

4. The Haves Traditional players: US, Canada, Middle East, Soviet Union New players: Africa, Southeast Asia, Caspian Is Resource Curse aggravating? 53 countries have >5% GDP from mineral exports Half of them>20% of GDP from mineral exports Half of OPEC members poorer now than they were in the 1970s. Algeria & Nigeria unraveling 1/3 of all civil wars in oil producing countries � Algeria, Columbia, Sudan, Iraq; Inequality trap (Malaysia, Botswana, Chile exceptions) Secessionist conflict in Southern Thailand, Niger Delta Why does energy breed conflict between and within countries? Dutch disease � other exports decline. No fiscal discipline, profligate spending on new capital cities (Kazakh, Nigeria, Myanmar), islands etc Buy rich friends (Beijing) to block UN sanctions Sudha Mahalingam 4

5. Oil as Weapon No disruptions in the history of oil except for the Arab embargo of 1973 following Yom Kippur war Sanctions disrupt supplies � Iran, Libya, Syria, Myanmar, Sudan together drive out 6 mbd of oil Can oil be used as a weapon? Fungibility blunts the weapon, but tight demand-supply equilibrium could sharpen it Will Arab states enforce embargo if Iran is attacked by US? Sudha Mahalingam 5

6. The Have-nots Consumption & Imports-2007 USA - 20.6 mbd (23.9%); 10 mbd (48.5%) China � 7.8 mbd (9.5%); 3.2 mbd (41%) Japan � 5.1 mbd (6%) ; 4.2 mbd (82.3%) South Korea � 2.5 mbd (3%) 2.46 mbd (97%) Germany � 2.39 mbd (2.8%); India - 2.74 mbd (3.3%); 1.8 mbd (65.6%) (Source: BP) Acute sense of vulnerability, Perceptions, paramount Asia emerging as demand heartland Sudha Mahalingam 6

7. Source of Asia�s Crude Imports Sudha Mahalingam 7

8. Why do we believe peak is nigh?-1 Geology of hard minerals - Oil deposits are discrete World has already consumed 875 bn bbl (>50% acc USGS) Last major discovery (supergiant) in 1967 Quantum leaps in exploration tech in 1980s and 1990s Price increases no longer accompanied by substantial new finds. $8bn E&P inv produced only $4bn NPV Consumption growth outpaces reserve growth since 1980. Now only 20% of demand growth met by new reserves (IEA). 2% increase in demand vs 3% decline in production (Cheney) OPEC production declining; non-OPEC dwindling Sudha Mahalingam 8

9. Why do we believe peak is nigh? - 2 Many Indications Shell downgraded reserves by 35% in 2004 Ghawar (Matthew Simmons) Field-wise Saudi data unavailable; not a public company OPEC reserve claims questioned Depletion of North Sea oil (Britain � 1999, Norway -2001) Indonesia to exit OPEC; Net importer Offshore production now >50% Caspian reserves less than anticipated (4500 tonnes of sulphur daily in Tengiz) M&A and �Big oil� cannibalism (BP-Amoco, Chev-Texaco-Unocal, Royal Dutch Shell, Exxon-Mbl, Philips-Conoco) Sudha Mahalingam 9 December 1998: BP and Amoco merge; April 1999: BP-Amoco and Arco agree to merge; December 1999:� Exxon and Mobil merge; October 2000: Chevron and Texaco agree to merge; November 2001: Phillips and Conoco agree to merge; September 2002: Shell acquires Penzoil-Quaker State; February 2003: Frontier Oil and Holly agree to merge; March 2004: Marathon acquires 40% of Ashland; April 2004: Westport Resources acquires Kerr-McGee; � �� July 2004:� Analysts suggest BP and Shell merge; April 2005: Chevron-Texaco and Unocal merge; June 2005: Royal Dutch and Shell merge; July 2005:� China begins trying to acquire Unocal December 1998: BP and Amoco merge; April 1999: BP-Amoco and Arco agree to merge; December 1999:� Exxon and Mobil merge; October 2000: Chevron and Texaco agree to merge; November 2001: Phillips and Conoco agree to merge; September 2002: Shell acquires Penzoil-Quaker State; February 2003: Frontier Oil and Holly agree to merge; March 2004: Marathon acquires 40% of Ashland; April 2004: Westport Resources acquires Kerr-McGee; � �� July 2004:� Analysts suggest BP and Shell merge; April 2005: Chevron-Texaco and Unocal merge; June 2005: Royal Dutch and Shell merge; July 2005:� China begins trying to acquire Unocal

10. When will oil peak? Most optimistic forecasts � 2025 Paul Roberts Mathew Simmons � 2007-09 Hirsch Study - 2025 Deffeyes & King Hubbert - 2009 World Energy Council � After 2010 Campbell - 2010 CERA � 2017 (800 oilfields studied) BP- Can go upto 100 mbd. No peak (Peter Davies, Chief Econ) Yergin � Plateau in 2040 or 2050 EIA � 2016 Sudha Mahalingam 10

11. Trade Routes 1.9 billion tons of petro products or 62% through tankers, rest through pipelines, trains or trucks 30 mbd flow thru Hormuz and Malacca Saudi pipeline to Yanbu on Red Sea: 4.8 mbd 1983 Tanker War � only 2% affected Blocking Hormuz would block Iran�s gasoline imports Sudha Mahalingam 11

12. Geopolitics of Energy -1US Policy post 9/11 �For too long our nation has been dependent on foreign oil. And this dependence leaves us more vulnerable to hostile regimes, and to terrorists � who could cause huge disruptions of oil shipments, and raise the price of oil, and do great harm to our economy�. State of the Union address by Bush in 2007 US: 5% of world population, 25% of world energy consumption Total global oil consumption: 85 mbd The single largest consumer � 21 mbd Energy Profligacy difficult to contain/reverse Funding both sides of the war in Iraq? Wahabis, Hezbollah, Al qaida US Energy Policy Act 2005 � Tax breaks, Diversification, Federalization Drilling in the Arctic (90 bnbl oil, 1670 tcf gas, 144 bn bl natgas liquids) Rethink on nuclear energy(20,000 mw), corn to ethanol Imports from Gulf, 22%(Canada, S.Arabia, Venezuela ,Mexico & Nigeria make up 62% of US imports US troops out of Saudi Arabia � no longer buddies? Military Bases in Central Asia � Uzbekistan, Kyrgyzstan??? BTC, Nabucco pipelines to ferry oil and gas from Central Asia US turning away from West Asian suppliers Sudha Mahalingam 12

13. Geopolitics of Energy - 2Rise of the Russian Petrostate 5%(or is it more?) of Global Oil Reserves 11 mbd production in 2007. Largest producer in the world >12.9% of Global Oil Production; 7 mbd exported 32% of Global Gas Reserves (Gulf 39%) 670 bcm gas Production in 2006. 40% exported Importance of Energy in Russia�s Economy 40% of GDP,60% of Export Income,40% of Tax Revenues, Low Domestic Prices Incentivise Exports,Oil Revenues Fuel Economic Boom Energy-fascism � Energy as Patrimony and Instrument of foreign policy � Heads I win, tails you lose Yukos, Sakhalin-2, Shtokman, Gazprom�s growing monopoly Sudha Mahalingam 13

14. Geopolitics of Energy -2Rise of the Russian Petrostate (contd) Infrastructure Determines Destination Europe, the Biggest Beneficiary � Black Sea & Baltic terminals, CPC, Baltic Pipeline System for oil. Bluestream, Nordstream and South Stream for gas Germany & Greece breaking ranks with rest of EU? Nabucco and South Stream compete with each other. Japan to get oil & LNG from Sakhalin - 2. Now Oil Pipeline from Tayshet to the Pacific ESPO � Looking Beyond. China Gets Oil in Railway Tankers, possibly LNG from Kovykta and piped gas from Sakhalin-1 S.Korea a possible beneficiary By 2030, >50% of Europe�s gas needs to be supplied by Russia Russia to supply lion�s share of incremental energy demand � of Europe, Northeast Asia Sudha Mahalingam 14

15. Geopolitics of Energy -3The Caspian Darkhorse? Sea or Lake? Caspian as big as North Sea (15-40 bbl to 70-150 bbl - IEA) 5 to 6 mbd production capacity � 3-5% of world supply now. Maximum 10% of global supply by 2030 The elephant fields Tengiz, Karachaganak & Kashagan (9-18 bbls of oil, 1.2 Tcm of gas) Energy Charter Treaty History & Geography determine transportation routes, but new ones planned. BTC operational -1 mbd 2010 Now Kazakhstan-China oil pipeline Nabucco gas pipeline (3300 km, 30 bcm/y) from Central Asia to Austria Caspian no longer the dark horse �out of the box solutions for tapping Caspian oil Sudha Mahalingam 15

16. Geopolitics of Energy - 4Enter the Dragon � The Rise & Rise of China GDP growing around 9.5% 7.8 mbd of oil in 2007; Projected to increase to 11 mbd by 2020 acc NDRC (IEA=12 mbd) 50% imported; Oil imports growing at 7.5% Building SPR Aggressively acquiring oil acreages -15% to come from overseas acreages Oil Industry Restructuring, Price Reforms Diplomatic, Strategic, Political Initiatives Oil pipeline to Yunnan from Sittwe (2380 kms) West-east gas pipeline, Shwe-Yunnan gas pipeline, LNG projects Quantum jumps in trade with Middle East ($20b in 2005 to $135 bn in 2006) Devt of Gwadar and Sittwe ports Emerging Non-GCC Options to supply China�s incremental demand Sudha Mahalingam 16

17. Geopolitics of Energy � 5Kyoto & Its Implications Kyoto clock ticking away for EU Combustion, the biggest polluter (coal-based generation & oil refining=83% of CO2) Kyoto, Asia and Life after 2012 Nuclear as a clean fuel option? Coal to drive Asian economies Gas competing with nuclear, coal in Asia Sudha Mahalingam 17

18. Transparency Initiatives EITI 2002 � 24 signatories. But compliance voluntary PWYP also publish what you pump National Resources Charter �credit ratings Barter trade for infrastructure? Sudha Mahalingam 18

19. Energy Independence Neither feasible nor necessary Two thirds of oil and a quarter of gas consumed in the world supplied by imports. No disruptions in the history of oil Countries cannot carve out protected supply through bilateral contracts Are foreign supplies more risky than domestic supplies? What about local disruptions? Can there be local energy security without global energy security? If the global markets fail, can one country be secure? For suppliers, national independence is linked to allowing global players access to their energy sources through the market. Interdependence is ineluctable Sudha Mahalingam 19

20. Unscrambling Risks Most risks are local, not global especially in gas and electricity, but also for oil - Katrina Diversification of supply will mitigate risk only when supply disruption is localised and there is spare capacity elsewhere. Overseas oil equity may mitigate risks if one is also operator? SPR will mitigate risk only when disruption is of short duration Reducing energy use through efficiency measures will reduce all risks considerably Distributed generation will confine risks to localised users Ability to switch fuels will mitigate risk of supply disruption to some extent Policing SLOCs could mitigate disruption Sudha Mahalingam 20

21. Mitigating energy risks Short-term risks � Operational responses Medium term risks � Capital investments Long-term risks � Structural Changes in economy Sudha Mahalingam 21