Carrot or stick?

A Subsidy could be considered as a carrot for oil producers and a sanction as the proverbial stick which can be used to bombard and punish petroleum companies and certain countries for their misdemeanors. But how are they used as a control mechanism and who are the controlling powers that wield them? Firstly let’s define a sanction. Where international law has been broken a court can apply a sanction to restrict trade in an attempt to control certain behaviour or reverse policies that have a negative effect on another group. The sanction will then be lifted once a balance has been restored to the point prior to where the unfavourable behaviour started.

For example Iraq invaded Kuwait to control the flow of oil. The first course of action is to impose economic sanctions by stopping the trade in oil. Iran builds a nuclear facility which some believe would cause a danger to others, again prompting oil sanctions. The same thing happened to Libya until the sanctions caused the desired change in behaviour. The reason oil sanctions are used with increased regularity is that countries generally rely on oil production to fund the majority of the state budget. This is seen clearly with new oil producing countries, they may have a very good cotton, tea or coffee exports, then oil comes in as the major revenue leader and the government starts to rely more on the oil exports than the cotton, tea or coffee production. Over time as the economical wealth of the country and citizens increases, petroleum becomes the only viable source for revenue growth within the country and when a sanction is applied to alter the behaviour of a government or leader, it can have a marked effect on the quality of life for those who live there.

So actions and implements the sanctions? The United Nations Security Council imposes the sanctions and the European Union (EU) implements them. Occasionally the EU may impose their own sanctions if they deem it necessary. Commonly assets can be frozen, travel bans implemented but these can have limited results. Therefore the flow of income through the curtailing of exports can produce a quicker and deeper impact. It can be argued sanctions imposed by the U.S alone do not have the same legitimacy and as a result the U.S will usually try to obtain EU agreement and backing. Recently such combined sanctions were being considered against Russia’s oil industry. This is due to Russia’s military involvement in Ukraine and the issues surrounding Yukos. The international court of arbitration ordered the Russian government to pay Yukos shareholders $50 billion. Why has this happened? Yukos was Russia’s major oil producer generating over 20% of the country’s petroleum requirements and as a result the owner Khodorkovsky became extremely rich. It has been argued that the Russian government broke up the company and transferred assets to Rosneft an oil firm, of which the majority is owned by the government, passing wealth from the private shareholders to the state. Recently as the West imposes these sanctions on Russia, President Putin has announced a $20 billion oil trade agreement with Iran effectively circumnavigating and nullifying the impact of the sanctions. This is a double blow for the EU and U.S as Russia is now helping Iran increase its oil output.

If sanctions are the agreement of states to impose restrictions on another state to change a behaviour or course of action, how effective are they when countries like Russia and Iran can still continue to trade? It is theoretically possible for a number of sanctioned countries to join together and trade exclusively with each other especially where petroleum and energy distribution is involved as it is a vital part of economic and social growth. The problem with sanctions is that if too many are placed against the wrong country, then you have the risk of conflict. Furthermore petroleum producing countries often work with international companies which are usually allowed to continue drilling operations while sanctions are in place. Why would there be a sanction placed on a specific country to prohibit oil and gas drilling and distribution and not impose it on the major E&P organisations? Simply if Exxon or BP started to lose money or the overall distribution of oil was vastly reduced then the cost to the consumer would increase. Look at it this way, a democratic government is elected by its citizens and if that government has decided to impose sanctions upon another and as a result the price of oil rises and then the cost of living, those elected individuals would find themselves on very shaky ground come election time.

We also have to face the reality that until the world finds a new cheap form of energy, petroleum will always be in hot demand and as a result there will always be buyers and sellers coming to the market place. I see sanctions as an effective tool for certain situations as a means to restrict trade when combined with other measures towards companies that are trading illegally, or against countries that use the profits to fund acts of terrorism. However to apply an oil sanction towards a country that is a mature heavyweight and has political, economic and military might to back up what they are doing, then sanctions have little impact and can in fact start a war. The problem is the need for oil is so great that whoever controls a region of oil production wields great influence within that region. Therefore due to instability with conflicting governments in the East, the West now tries to influence African leaders and gain control of rich production sites. Even China is trying to carve a stake within the African market. I would suggest clarity of thought and a maturity of action when applying sanctions, in the same way a subsidy can have both positive and negative impact, so can a sanction. Therefore let the flow of oil continue so that it can benefit the lives of local people allowing them to prosper, and to increase wealth within the global community for many years ahead.

Subsidising the oil industry

A recent report showed Egyptian LNG (Liquefied Natural Gas) supplies have suffered due to the government’s program of subsidisation. Before examining why this is happening lets explore the term subsidisation within the petroleum industry. When a government implements a fossil fuel subsidy it will generally produce a lowering of production and consumer costs in the form of tax breaks, price controls and reduced loan agreements. On the face of it, subsidies seem like a good idea especially in new or stagnant markets. However they are not without risk or consequence. In Egypt the result of lowering the cost of gas has resulted in a huge increase in consumer demand. Wonderful I hear you say, customers get a cheap supply of gas, companies make more money on sales and the government acquires a positive image, but when local demand outstrips contractual export requirements then we have a problem.

A government will generally make more money from exporting oil and gas than selling to the local market and as a result may win a number of contracts to supply an amount of petroleum at a certain price for a fixed period, when they fail to deliver it will have an impact on both governmental credibility and potential future investments. Earlier this year the situation became so bad for Eqypt that international arbitration was launched by the Spanish energy company Fenosa because the government suspended exports of its part owned LNG plant. So are the lessons for Uganda as production starts? If the crude oil is efficiently drilled, refined and a competitive contract has been put into place then the requirement for a subsidy should be minimal. If this is not the case then Ugandan oil will not be a competitive product to challenge other more mature competitors.

If Ugandan oil costs more to produce than expected, what remedial measures could the government use to correct the balance? One way is to increase import duty on foreign suppliers. By raising the level of tax the government benefits from having a balanced national market and even a more competitive national product if the tax is high enough. Also the increase revenue could be diverted to aid domestic needs. However the downside to this is that neighbouring countries who directly supply oil or indirectly as part of a distribution network may increase their levies on Ugandan imports to offset the increased costs. This tit-for-tat is annoyingly prevalent with governments who jostle to outdo one another.

Another option is to subsidise the cost of oil and gas at the pumps, giving the customer a cheaper local option. Again this can have many benefits but as we have seen with Egypt if local demand becomes too high then exports suffer as supply runs low. Another alternative is to subsidise at source with the operator. This can be done in the form of interest free loans or tax breaks allowing the operator to ideally pass on the cost savings when delivering to the market. But reducing tax within such a prevalent market can have its drawbacks. The U.S, alone spends a minimum of $10 billion each year to subsidise the local fossil fuel market and internationally governments could be spending up to $1 trillion annually, which I am sure you will agree is an astonishingly large amount of money.

If subsidies were removed how would this impact the national and global markets? A subsidy is born out of a need to deliver petroleum and petrochemical products at a cost effect price that consumers and market forces find attractive, allowing for a continual growth in the national product. Furthermore a subsidy will aid and complement market balancing for International distribution requirements. The problem is that subsidisation is very expensive and will generally add to National debt. Oil Change International a research organisation, say that $21 billion is annually spent in the U.S on production subsidies and that this amount does not include military, health or industry costs. They believe this money is effectively wasted and could be better spent on providing health care for the poor and needy. Therefore to remove subsidies would increase the flow of tax payer money back into the economy.

Also if subsidisation was not in place the true cost of fuel would hit the high street. The cost of production and refining would have to be past onto the consumer resulting in a sharp rise of petrol, diesel and heating oil. Presently oil is wasted on a large scale due to the public perception of a plentiful supply and a sharp rise in prices would curb this especially if pump prices increased in the States. Currently in the UK petrol is the equivalent of $2.20 a litre, while in the U.S it can often be found for around $0.97 a litre meaning many U.S car manufacturers produce vehicles with large powerful engines which are totally unsuitable for day to day commuting. If petrol was so expensive car manufacturers would have to make small highly economical cars as the general public could not afford to run anything else and as a side effect global warming would reduce either because car ownership diminished or because cars became environmentally friendly. Furthermore a poll conducted by Stanford University found that nearly 85% of the pollsters would favour tax breaks for companies that produced hydroelectric power instead of using fossil fuels.

I see there must be a middle road that would allow for growth without over expansion. Oil is a National and International commodity and to pretend otherwise is to be somewhat short sighted. The need for petroleum and petrochemicals is not going to dissipated overnight therefore it would be more than prudent to fully understand how we can apply subsidies in a mature and responsible way to create growth in new markets until such a market has reached maturity would be a logical option. However to use them to prop up a stagnant or artificially high market would be dangerous and could lead to an implosion as the markets destabilise. For the U.S, subsidies should be gradually tapered off but for Uganda I see them as a positive short term option for growth in the future. 

End of a Titan

The transportation of crude oil is a very sticky topic. A company may have a rig in Uganda but the crude oil needs to be transported to a refinery in Kenya. The refined product is then distributed to customers globally. The problem arises when the distribution chain becomes interrupted and I do not mean by social economic factors but rather spillages of pre and post refined crude oil. The economic impact can be great and companies will certainly lose money, but the environmental impact is far greater financially, environmentally and socially for the producer, distributer, ecologies and communities.  

The reason I say this is due to the substances involved. If you have been following my articles then you will know that petroleum is formed over millions of years and is a combination of various hydrocarbons which are broken down during the refining process. These compounds include sulphur, hydrogen, carbon, oxygen and nitrogen all of which form naturally. The problem is that crude oil is very toxic to most organisms and highly combustible. Have you seen an oil rig fire on TV? They burn extremely fiercely and can take days, even weeks to fully extinguish. The petroleum lifecycle is one of pollution, from excavation of the unrefined material, refining and its waste products to consumption and burning of oil within combustion engines. However much has been done to try and reduce soil erosion, disruption toward communities and eco systems. Even cars and oil burning generators are becoming more efficient reducing carbon waste products.

I see one of the main problems surrounding the oil industry is the transportation of crude oil, simply because if there is an oil spillage then the destruction can be devastating. A tanker can carry nearly 30 million gallons of oil and can be 460 metres long compared to a standard aircraft carrier of 340 metres. These tankers are so huge and hold such a vast amount of oil, that when they are breached the oil slick can cause immense damage to the local ecosystem. Such a system is finely balanced and each organism is a food source for another. If any of these creatures are killed by an oil spill then it affects others higher up the food chain. For example single cell organisms called plankton may not seem relevant to you and me, but for a whale it is their food source and if the environmentalists are not crying over billions of dead plankton then they certainly will for even a single dead whale!

There are a number of factors to determine the effects of an oil spill, including the type of oil and the quantities involved. But all spills impact the ecosystem in the same way, firstly physical effects upon wildlife caused by the oil coating or smothering organisms and wildlife. Most of us have seen pictures of seabirds choking on oil drench beaches almost unrecognisable to the beautiful birds seen soaring through the sky and the toxic effects from crude oil as it is absorbed into the cells should not be underestimated. Also when a certain type of organism is destroyed or reduced it is usually replaced by another that is not fitting with the already established ecosystem. For example in the UK the red squirrel was a much loved sight but has become a rare sight these days since the release of the more aggressive American grey squirrel which has increased in numbers as the red diminishes.

Other indirect effects are the changes to the local environment and habitat. If these changes become too great, the ecosystem stops supporting the immediate ecology, thus killing not only the environmental habitat but the species of animals that need it to survive. The problem is that once a habitat is destroyed it may take decays to return if ever. Therefore if the dangers of oil spillages are so great then maybe we should look at the oil tankers and if there are alternatives that would better protect our precious environment.

So what are the alternatives and can we make the current tankers safer? Modern tankers are double and even triple hulled, but a number of private companies are still using single hulled tankers and as you can imagine they are much easier to rupture and a lot cheaper to buy. But with so many oil spills happening over the last decade we cannot afford to cut costs as the environmental damage is far greater. To be honest I see the oil tankers of old out dated as a means of distribution. The investment for deep sea pipes are very high but once in place take little maintenance, can be monitored electronically and greatly reduces the possibility of oil contamination. They are relatively clean and efficient compared to a diesel powered tanker. There could still be breaches to the pipeline but this should not be on the same scale as a tanker spillage and the flow controls of modern oil pipelines allow the values to be remotely closed at pipe intersections reducing the quantity of the spillage.

Ultimately the answer is to remove the risks of sea based transportation and produce oil as locally as possible to the consumer demand. The problem with this approach is that consumer demand maybe unsustainable for the levels of available production for a particular region. For African and Asian markets this levels of oil production could support the infrastructure and petroleum needs of their respective continents. The only way to keep petroleum supply close to demand is to maintain equilibrium between the two and for Western countries especially America, may mean controlling consumer demand by restricting the flow of oil and using alternative energy supplies. This has already started with States like California heavily promoting LPG as an alternative to petrol, not because it reduces the use of tankers but because certain American States suffer from smog which is a mixture of smoke and fog. This was extremely dangerous in Victorian England during the industrial revolution but the motor car is now seen as the modern day culprit. Therefore let’s seriously assess how we use oil, where it is produced and how it is delivered? Let this generation make a positive change that will allow the next generation to live in a cleaner, healthier and safer world.    

From Russia with love

Some time back I had the idea of supplying oil from the Kenyan refinery to Uganda via well established trade routes and distribution channels with the aim to reduce the holding time and cut costs resulting in healthier profit margins. I am happy to say this venture is going very well, but within I few days of starting I would get emails requesting a meeting with other suppliers. Intrigued I met with a few and they were mostly businessmen from Tanzania who were trying to break into the Ugandan market. Now Tanzania produces some natural gas for the country and has potential for crude oil especially from Lake Malawi, but they are certainly not in a position for production. So the question is why would they need a refinery and where is the large amount of crude coming from in the first place to attempt to disrupt the Kenyan market? 

A modern trend has started where countries like Kenya and Tanzania, who either do not produce oil or indeed very little of it, are taking a slice of the petroleum pie buy offering refining processes close to potential markets. This can be beneficial for the producing country who may only be drilling for crude and not processing it and for the refining country who can then distribute the refined product back to the original producer, so the investment needed to build a refinery of around $6billion for Tanzania, should over the next few years produce a healthy return on the investment. Now as Africa is a growing economy who would benefit from using this type of refinery, other African players?

Most of the big petroleum players in Africa have their sights set on the American market and often forget the potential to sell closer to home. It is therefore more external forces who are trying to capitalise in Africa, namely India, China and Russia. Interestingly a few years ago Russia appeared to be distancing itself from the African market but Mr Putin the Russian President has decided that Russia needs to exert more influence within the region and the quickest way to achieve this is to control the trade of oil. I have previously said that oil is power and whoever controls that oil has a big say about the politics and economic structure of the trading country. When Russia pulled away from African investments, China stepped in with a number of trade deals moving into the construction of infrastructure, for example they seem to have built most of the major roads in Ethiopia. Now Cnooc (China Offshore Oil Corporation) is pushing hard to control the drilling rights in a number of countries, this has forced Russia to play a more aggressive hand to try and reclaim some of the ground they lost. Nigeria has really accepted a lot of Russian trade and is probably their biggest trade partner in Africa. When a Nigerian-American oil deal was on the table, the Russian government made it very clear that any such deal would have a serious impact on Nigerian-Russian trade. Russia was clearly seen to exert influence over the African nation. 

Now going back my original question of who was supplying the oil to Tanzanian businessmen? They openly said it came from Russia who wanted to heavily penetrate the refined petrol and diesel markets. The problem was these guys were charging too much for their product and could not hope to sell any major quantities. The businessman looked at me, made a call speaking in Russian and immediately undercut our other prices. I said “how could you make a profit doing it so cheap?” The reply was “We take the market from Mombasa then increase prices later”. So clearly these guys were happy to make a huge loss, just to claim the market share, so what does this mean for the new players in the oil market? When Kenya and Uganda start production will they survive in such a cutthroat market place? The answer is yes if they can combine resources. The big players effectively have money to waste, to sell at a loss over an extended period of time is not good business sense and ultimately unsustainable unless of course you have very deep pockets. 

The Uganda-Kenya Crude Oil Pipeline (UKCOP) will help to merge potential exports especially if South Sudan constructs their pipeline to join UKCOP. Uganda probably does not need the additional expense of building a refinery at the moment, but considering petroleum was found in 2006 they have been a little slow to capitalise on their natural resources. Kenya is in a stronger position with its established refinery and trade links, in fact setting up good distribution channels is half the battle and must be planned well in advance of the first barrel of oil being produced, after all no point producing oil if it is prohibitively expensive to deliver to the customer making your product unattractive to the consumer and unprofitable for the producer. I found the Russian suppliers wanted to keep their product pure and not mixed with other crude oil suppliers. Now we can see that they either genuinely believed their product is of a superior quality and other local crude would contaminate their oil or alternatively they wanted to block other suppliers dealing with the local distributor again taking control over the distribution rights for that region.

Whatever the reasons now is the time to set firm those supply contracts ready for when production starts. Kenya has a head start and Uganda is close behind but unity could allow both countries to survive a Western power play for the region, the last thing either of these countries need is for another state run oil supplier dictating policy because they managed to get carte blanche over oil supply and distribution, thus influencing foreign and domestic policy. Let’s not forget American and Russian policy is not necessarily the policy of Africa and its Nations. Often these superpowers are butting heads trying to get one up on the other and having economic control over a region that is desired by a rival can be seen as a political coup de grace.      

Training - Malaysia or Africa?

Over the past few years the petroleum industry has become extremely favourable for the Malaysian economy and there has been much discussion about oil and gas production for that region. However I find it fascinating to see the increase in training programs originating from Malaysia, in particularly from the federal capital of Kuala Lumpur. If you do a quick internet search you will find pages of courses on oil and gas studies in Kuala Lumpur. Now I have to admit they do host a number of important conferences for the region, but are they the real driving force for Malaysian training as the distances needed to travel there seems excessive, can African institutes offer the same courses for local and international customers? There has been a lot of invested money and facilities to make training in this region attractive, but I believe Africa could be the new hub for oil and gas training.

I have two friends, one in the UK the other in Nigeria. The UK guy went to Kuala Lumpur for training and the Nigerian friend travelled to London. Interestingly both felt training courses outside of their respective countries were of more value and the additional expense incurred was worth it for the quality of the course and instructors. What they did not know was the two training companies providing the training were owned by an umbrella company where the CEO is a personal friend of mine and showed me the training material which was used by both trainees and the courses were almost identical. Now could the training have been conducted in Nigeria, Uganda, Kenya or any other country other than Malaysia or the UK? Certainly it could have been but do the training providers offer the same quality of service and value for money? Petroleum extraction and petrochemical refining are specialised areas that need educators with a strong background within the industry and not just theoretical knowledge acquired from PhD research.

Therefore what do African training providers need to offer to pull customers away from the Asian market? Firstly all institutions need to offer the very highest quality of educational standards and quality control. The ISO (International Organisation for Standardisation) is globally recognised along with the BSI (British Standards Institute) for quality control systems. Why is this important? I am a professional educator and have been a Headmaster and Principal and have seen too often institutes suffer from having no quality standards in place, which results in a lack of good quality teaching. If you had a choice of two institutes, one was cheap but did not follow any recognisable standards and another that was more expensive but had taken the time to implement internationally recognised standards, I believe most people would go for the later especially if they are willing to pay top dollar for the training.

Next institutions need to employ petroleum experts. I have seen academics take over a program and halt academic progress because of certain ideals and snobbery. Yes it is very nice being taught by a Professor; however I personally prefer educators with practical skills within the industry they are teaching. If you want to learn about business then seek a business mentor who has a proven track record, you will only learn so much from a book or from a lecturer who has never applied his or her knowledge in the real world. Professional work experience means so much more than a PhD, an oil worker will know the theory but also how to apply it and what not to apply because it either does not work or is dangerous. Once solid professionals are in place then practical experience needs to be offered to attract customers. The problem with oil rigs, they are extremely dangerous environments that need careful and constant monitoring. The last thing you want to do is to take students to an active oil field only to encounter a blowout which could result in serious injury or death. Therefore an investment must be made into modern technology and for petroleum studies this could involve a practice rig which is not producing oil but can show students how the mechanics of the system works, this would be safely controlled environment enabling students to have hands-on experience. Alternatively virtual reality is becoming very popular as a training aid. Virtual oil rigs come in a variety of formats from drilling simulators that run on an iPad, rig software for the PC and the most expensive a virtual console environment with HD screens. 

The expensive option will usually have a control deck where the student will sit, having a number of controls and joysticks to operate. In front of them there will be either one large cinema style screen or a number of LCD displays using fly-by-wire technology. This really is the future of training, so many oil companies are now investing millions of dollars to create virtual oil rigs that can be maintained from their HQ, which is often thousands of miles away. The problem with virtual rigs is they are very expensive unless you opt for a PC based solution. Therefore many universities and colleges have to partner with oil companies or other training providers to assist with the purchasing of such products.

The future is a virtual one and if your university or college does not provide such a system then I would seriously consider going elsewhere because without the hands-on experience these systems provide then your qualification is only theoretical. Heavy investment needs to be applied in these technological areas for African institutions to compete against their Malaysian counterparts. I would love to see people travelling to Africa for oil and gas courses. This continent has so much potential for the future of educational development and new technology must be placed into revenue mix. Furthermore governments should also play their part either to offer subsidised loans and equipment or to give tax breaks for educational institutes that wish to purchase new technology. This will allow Africa a chance to reach its full potential as a major player in the petroleum educational sector.