The political developments in the Middle East and North Africa once again show the importance of watching out for the supply side, even though recent discussion about energy security has focused on the demand side, particularly the runaway growth in demand in emerging economies. The current political unrest in the Middle East and Africa has placed significant pressure on the oil market. Lost production in Libya exceeds one million barrels per day, leaving almost none for export. In the European oil market to which most Libyan oil is exported, its benchmark price, the Brent Blend, has remained above US$120/bbl since early April. Fuelled by fears of a potential spill-over of the Bahraini conflicts to the Eastern Province of Saudi Arabia, the Asian benchmark price, Dubai, also increased to over US$110/bbl in early April. This higher oil price poses a serious threat to the still-fragile Western economies, and also to inflation in emerging economies.
An increase in the oil price due to a supply-side shock tends to cause more serious impacts on the macro economy than a demand-side shock. In the latter case, the oil price often rises during an economic boom and can coexist with robust economic growth. A supply-side shock happens regardless of macroeconomic conditions and may cause serious harm if economic conditions are already weak. The current political uncertainty in the Middle East and North Africa heightens this risk given the weakness of economies in the developed world.
In addition to short-term supply disruption, the wave of political unrest in the Middle East and North Africa may serve to keep oil prices high in the mid to long term. Additional investment to boost production capacity will slow down if political uncertainty in the region grows. Lack of investment will restrict future production capacity, even though demand continues to grow, causing tighter markets. The risk of uprising has become evident not only in the Middle East and North Africa but also in other countries with authoritarian regimes. This means that the governments of these countries will find it increasingly difficult to remove energy subsidies and to control the growth of domestic oil demand. Most of the growth in oil demand in the future will occur in developing countries — that is, the countries which tend to have authoritarian regimes — and the continuous provision of subsidies will discourage efforts to conserve energy. And, in some Gulf producing countries, public expenditure is being increased to soothe public discontent, and these additional fiscal expenditures will need to be funded by greater oil revenues among those oil producers, thus leading to a higher oil price.
What can oil consumers do to minimise the negative impacts of the supply risk?
A conventional, and oft-cited, but still very effective solution is diversification. This has several dimensions. On one level, geographical diversification of oil supply sources gives oil consumers greater flexibility to respond to supply disruptions, and may increase bargaining power with oil producers even in regular transactions. The recently-started export of Russian crude oil through the Eastern Siberia–Pacific Ocean pipeline, for instance, is expected to boost diversification in the Asian oil market. Some countries such as China may want to diversify their oil transportation routes to by-pass ‘choke-points’ such as the Malacca-Singapore Strait. This diversification is often motivated by military security concerns.
Diversification into other energy sources is also very effective. Developed countries have significantly reduced their dependence on oil since the oil crises in the 1970s, but developing countries still have much room for reducing such dependence. Natural gas will play a key role in diversification, as it is the cleanest fossil fuel and has abundant resources, including those from recently developed unconventional sources. Although the public acceptability of nuclear energy has slumped due to the Fukushima disaster, nuclear power cannot be ruled out as a bridging technology since wind and solar power are still prohibitively expensive for widespread deployment.
But measures taken by oil consuming countries are only a partial solution. Attention needs also to be given to what can be done in oil producing countries. In order for oil producers to secure stable demand to justify their investments to expand capacity, they need security of demand. Allowing oil producers to invest in consumer countries’ downstream assets will effectively secure an ‘outlet’ for their crude oil. Supporting economic reform in oil producing countries is also vital. Joint investment in the manufacturing sector, which employs many people and diversifies a country’s economic structure, will ease public discontent with the government and reduce dependence on oil export revenues.
Recent political volatility in the Middle East and North Africa has certainly raised the importance of oil supply security for oil importers. They now need to take bolder steps to manage the heightened supply security risk.
Yoshikazu Kobayashi is the leader of oil group at the Institute of Energy Economics, Japan, Tokyo.