Thursday, 26 July 2012

The Shift to a New Global Currency Alters International Relations

The present economic depression has been going five years, with no sign of abating. We now that in times of worldwide economic depression, one thing to suffer is worldwide free trade—and without being able to freely trade for energy and resources, some nation states will be worse off than others.
Which is why they’re making a grab for resources now…

imageGUEST POST by Marin Katusa of the Casey Daily Dispatch 

Last week I wrote about how Israel's newfound natural gas wealth is catalyzing a shift in Middle-Eastern relations. It was a topic that generated much discussion in our office - we knew that the Mediterranean Sea resource is highly significant for the Jewish state, which has long struggled with energy insecurity, but the deeper we delved into the issue the more we realized that Israel's new resource is already having wide global implications. In particular, we were very intrigued to realize just how cozy Russia and Israel are becoming - this being the same Russia that usually supports Iran and Syria, Israel's sworn enemies.

The article generated a fair bit of feedback from our readers as well, including several good questions. In answering the questions and in continuing to discuss the issues among ourselves, we placed Russia's advances on Israel as but one part of a shifting global web, wherein old allegiances are being dropped in favor of new friends with benefits. Those benefits are energy resources, and the race to control them is changing the way the world turns.

Dozens of countries are slowly altering their international allegiances because of energy considerations. Here I will shine a light on a few of the more significant transitions and how they might impact US and EU energy security.

Russia's Strategic Steps Toward Israel

I discussed this at some length last week, so rather than repeat myself I will just summarize the situation in order to address some questions that arose following that Dispatch. The gist of it is this: The Middle East has long been informally divided into two camps, with US allies such as Saudi Arabia, Egypt, and Qatar making up the camp that can get along with Israel, while Iran and Syria lead the group that cannot befriend the Jewish state. In a holdover from the Cold War, Russia has long backed the anti-Israel group, providing arms to Syria and support to the increasingly isolated Islamic Republic.

Now Israel, long the oil- and gas-poor brother in the squabbling Middle-Eastern family, has delineated trillions of cubic feet of offshore natural gas. It is hard to overstate the significance of this discovery. Instead of having to rely on a strained peace with Egypt for its natural gas, Israel now has far more natural gas than it can use - the country will be self-sufficient in terms of gas to generate electricity and will be able to fill its coffers with export revenues.

Israel's transition from a nation constantly in need of resources to one that could well play a major role in the global gas trade is earning it new respect. Greece and Cyprus are discussing paths for potential pipelines to Europe. Turkish leaders are likely kicking themselves for having destroyed what was a close friendship with Israel in recent years; now Turkey will have to sit on the sidelines and watch as Israel, Greece, and Cyprus work together to develop these gas riches. Egypt's Islamists, finally in power after decades of having to abide their nation's peace accord with Israel, have been stripped of the opportunity to cut off Israel's gas supplies - the Jewish state doesn't need Egyptian gas anymore. Syria and Lebanon, among others, are considering how to stake their claims on the gas bounty, which sits in waters laced with international boundaries.

And then there's Russia. Vladimir Putin's third official international trip after retaking the Russian presidency in May was to Israel. The two nations now share $3 billion in annual trade and considerable immigration. Arching over all those ties is the fact that, in the wake of the Arab Spring, Russia and Israel share an interest in preventing the rising tide of radical Islam.

The Russia just described sure doesn't sound like a very good friend to Iran, does it? But why the shift - is Russia that concerned about radical Islam? No, Putin has never cared much about religion; his decisions are always far more strategic than that. The reason is simple: Israeli gas.

That brings us to the most common question we were asked following last week's energy Dispatch: Why does Russia, a natural gas giant in its own right, want Israeli gas? To our questioners, you are absolutely right: Russia does not need any more gas for itself. Russia is home to one-quarter of the world's known natural gas resources, roughly 1,600 trillion cubic feet (TCF) according to the EIA. And that doesn't count potential reserves of unconventional gas. We think that all told, Russia may control as much as one-third of the world's natural gas.

Russia has gas. What Putin desperately wants is to maintain his country's stranglehold over European natural gas supplies.

Putin loves using control over resources to enhance Russia's power, and natural gas is a key part of his scheme - we dedicated an entire issue of the Casey Energy Report to this topic recently. It was only a few years ago that Russia cut off gas supplies to Europe for a few days in the middle of winter in order to punish Ukraine for siphoning fuel from Russian lines. Europe relies on Russia for 34% of its natural gas; Putin wants to increase that reliance. To that end, he has spent years building new pipelines to Europe that avoid transiting troublesome countries (i.e., Ukraine). As if controlling Europe weren't enough, Putin is also developing Russia's ability to sell gas to Asia by jumping into the liquefied natural gas (LNG) scene with new facilities in the Far East. And he's several steps ahead of the United States in this LNG game.

How does Israel factor in? Israeli gas could join the world market in two ways: through a pipeline to Europe running under the Mediterranean Sea (with a stopover in Cyprus); and/or as LNG, which would be sold to Europe and beyond. Both would turn the Jewish state into an unexpected competitor in Putin's plan to continue controlling European natural gas supplies. Since he can't prevent Israeli gas from flowing, Putin is trying to control where it flows and siphon off some of the profits.

That control is so important, it seems that Putin is considering coming out as a full-fledged friend of Israel. Such a move would almost certainly sever those long-time ties between Russia and Iran, but when the currency in question is energy then alliances formed over decades can change overnight. If Russia does take that strategic step away from Iran and toward Israel, it will rock the ever-delicate Sunni-Shiite balance in the Middle East... to what end is anyone's guess. As for whether Israel will reciprocate Russia's advances: never forget that Israel is a pragmatist nation, its very survival dependent on making strategic decisions. We would not be surprised to see the Jewish state playing both sides of the ex-Cold War game, if that's what makes sense for them.

Africa's New Best Friend: China

Late last week the news broke that China will lend $20 billion to African governments over the next three years. The funds will be directed at infrastructure and agriculture projects, but to anyone who views the world with an eye out for strategic resource relationships, the growing friendship between China and Africa is all about energy and minerals.

Specifically, China is cultivating the relationship very carefully in order to cement its role as Africa's best friend and top ally. Caring for Africa's needs puts China in a perfect place to negotiate resource deals with countries across the African continent - after all, aren't sharing and caring the first rules of friendship?

This isn't a new tactic - Chinese involvement in Africa has increased dramatically over the past decade. Today annual trade between the African continent and the People's Republic is worth more than $166 billion, a threefold increase since 2006. What is new in the relationship is China's new breadth and depth of caring. Until recently, most Chinese aid to Africa went to projects that were clearly designed to primarily benefit China's extractive industries on the continent, not Africa's people. To boot, Chinese laborers were brought to work on the projects, reducing the number of jobs available for Africans. The result: China was accused - by Africans and by international observers alike - of being dastardly self-serving in its African endeavors.

This has become particularly problematic in Angola, which has received more Chinese money than any other African nation. Angola is rich in oil, diamonds, gold, and copper, but a devastating 27-year civil war destroyed most of the country's infrastructure. China has been helping Angola rebuild by providing infrastructure-related loans in exchange for oil; bilateral trade between the countries topped $25 billion in 2010. But the projects, such as rebuilding the 840-mile Benguela Railway, are all designed to make it faster and easier for China to access Angola's resource wealth, and Chinese laborers are now a common sight in Angola. With jobs and resources ending up in Chinese hands, Angolans in recent years have started questioning whether China has their interests in mind at all.

Lopsided relationships like this are nothing new for Africa. From colonialism to aid dependency, Africa has been in a lopsided relationship with Europe for decades. However, it seems the continent has learned from the past and now wants to try to craft a deeper relationship with China... one that would hopefully result in a more sustainable partnership.

"Africa's past economic experience with Europe dictates a need to be cautious when entering into partnerships with other economies," said South African President Jacob Zuma at the recent Forum on China-Africa Cooperation in Beijing. He continued to say that China has demonstrated its commitment to Africa with investment and development aid and that Africans are generally pleased that they are treated as "equals" in the relationship. However, he cautioned that the trade balance "... is unsustainable in the long term."

It was seemingly in response to that worry that Chinese President Hu Jintao promised $20 billion in loans aimed at projects specifically not related to mining or oil. Instead, the money is earmarked for agriculture, manufacturing, education, safe drinking water, protected lands, and the development of small businesses.

Has the Chinese leadership suddenly taken to caring for the health, welfare, and economic prospects for the people of Africa? It might be nice to think so, but the truth is much more strategic: China realized that it needs to improve its standing in the hearts and minds of Africans if it wants to continue securing access to African oil, gas, and minerals. And it did so with a bang - the $20 billion pledged for the next three years is twice what China pledged for the last three-year period.

With a show of renewed friendship and caring, China will now go about seeking new resource deals to add to the plethora of extractive deals it has signed with African countries in recent years. In Nigeria, China is spending $23 billion to build three oil refineries and a fuel complex; the two countries are also building one of Africa's largest free-trade zones near Lagos, a $5-billion, 16,000-hectare project. In Sudan, where Darfur-related sanctions bar American companies from investing, China has invested billions in oil ventures and buys 90% of the country's oil exports. A billion dollars in bilateral trade between China and Mauritania revolve around oil; the magnitude of China's investment in the country has carried Sino-Mauritanian relations through two military coups in the last decade. In Botswana the expansion of the Morupule coal-fired power station is being funded through an $825-million Chinese loan, but that is only one of 28 infrastructure projects that China is b acking in the country.

China has money, Africa has resources, and both have tainted views of many other global powers. It's a match made in heaven.

Asia Stakes a Claim on Canada

They came only a month apart: two multibillion-dollar offers from Asian energy giants to buy up Canadian oil and gas companies. The first was in late June, when Malaysian state energy company Petronas offered $5.5 billion in cash for Canadian natural gas producer Progress Energy Resources. The offer represented a 77% premium over Progress' closing price the day before the deal was announced and is the biggest deal to date for Petronas. Why did the Malaysian firm play such a huge hand? Because Progress has 1.9 trillion cubic feet of proved and probable gas reserves in British Columbia's Montney shale region, a massive resource that Petronas hopes to export to Asia asLNG.

News of the second deal broke just yesterday; the dollar size of the deal sent it reeling across business headlines around the world. China National Offshore Oil Company (CNOOC) is buying Canadian oil and gas producer Nexen (T.NXY) for $15 billion in cash. It is the largest investment China has ever made into Canada - its previous Canadian investments total $23 billion - and the offer represents a 66% premium to Nexen's 20-day volume-weighted average share price.

CNOOC wants Nexen for its diverse project portfolio - the company has operations in Colombia, Yemen, the North Sea, and the United States - but it is the company's Canadian projects that hold the vast reserves that China seeks. Nexen is only a mid-sized player in the Canadian oil sands, but it has 900 million barrels in proven oil reserves plus another 5.6 billion barrels of less-certain contingent resources. In addition, Nexen is on the cusp of producing from its significant shale gas reserves in BC. Between those two forays - oil sands and shale gas - Nexen has major exposure to two of the world's most rapidly growing, major energy sources.

New, fast-growing supplies are exactly what Asian energy giants need. In the race to secure oil and gas resources for the future, importers have to look beyond historic suppliers to new frontiers. Big oil reserves in historic producing countries are generally either state-owned and therefore closed to investment - examples include Saudi Arabia, Iran, Mexico, and Venezuela - or have already been staked out and carved up among domestic and international partners who aren't likely to give up an inch of their claim.

That means nations looking to buy up international oil and gas reserves have to look at newer regions - the oil sands, the Arctic, the shale fields of North America, the sub-salt oil riches off Brazil's coast, and the like. The risks and costs may be higher, but at least these regions still offer the opportunity to stake a claim on a massive resource. When it comes to the oil sands and the shale fields of British Columbia and Alberta, the fact that these massive resources are in western Canada - pretty darn close to the Pacific Ocean - makes the opportunity almost picture-perfect.

That is precisely why Asian energy giants are moving on Canadian oil and gas companies... though to be fair, they were invited to do so. Led by Prime Minister Stephen Harper, the Canadian government has been actively courting Asian investment for its energy riches; these two multibillion-dollar deals are the first fruits of that labor.

The growing, energy-based relationship between Asia and Canada represents a seismic shift for Canada, which until now relied on the United States market to buy almost all of its oil and gas. Today, southbound oil pipelines are almost at capacity and political theater is slowing the approval process for new lines to a snail's pace, just as production in the oil sands is set to ramp up. Similarly, shale gas discoveries across western Canada have delineated vast new reserves that are begging for new buyers.

Canada needs to diversify its export list if it wants to capitalize on its unconventional energy resource wealth. Asian nations, led by China, are racing to put down payments on the oil and gas deposits that will fuel their futures. Sure, Canada and Asia are in the honeymoon stage of a new relationship, with multibillion-dollar deals keeping things new and exciting. When CNOOC, Petronas, PetroChina, Mitsubishi, Korea Gas, and the other Asian energy firms pressing Canada to permit oil and gas pipelines to the west coast come up against regulatory roadblocks and popular opposition, the new relationship will get a real test.

For now, however, it looks like the United States is losing a race that it has always led - the competition for Canadian energy resources (it's especially losing out to China, whose purchases of North-American energy resources include a stake in a Texas oil shale project). Interestingly, this is happening a few short years after the army of oil refineries along the Gulf Coast spent billions upgrading their facilities to process heavy oil in preparation for an onslaught of Canadian oil sands bitumen. If Asia beats out the US for access to Canadian oil, US refiners will be left paying a premium for heavy oil from other suppliers - not an ideal situation.

It's also interesting that this is happening just as the US seems to be at risk of finding itself distanced from two of its strongest Middle Eastern energy allies - Egypt under its new Islamist government and Israel, which might move gently away from the US in order to secure strategic ties to Russia. Is a hegemonic outlook still clouding US views on the security of its relationships and energy supplies, leaving the nation complacent while its competitors race to lock up new resources and secure new friends?

It's a very interesting thought, but the details of that discussion are best saved for another day. The point for today is that increasing desperation from resource-needy nations to secure oil and gas for their futures is putting the world's complex web of relations under incredible pressure. Longstanding allegiances are being tested, and any nation that assumes its historic friends and suppliers will simply stay by its side risks losing precious supply streams. Lubricated with money and the potential for future profits, new friendships are being forged that could alter the global balance of power.

Energy security underlies every country's abilities for today and prospects for tomorrow. Without secure access to the resources that power buildings, move vehicles, connect people, and enable growth, a country's economy will stagnate and its global influence dwindle. From that perspective it is easier to understand why Russia is considering a 180-degree shift in its Middle-Eastern relations, why China is willing to spend tens of billions of dollars on schools, wells, and hospitals in Africa, and why Asia is offering fat premiums to take over Canadian energy producers in a down market.

Energy is the new global currency, and its influence is starting to change the rules of the global diplomatic game. China is playing, Russia is working its hand, and countries with resources from the Black Sea to the Horn of Africa are placing their bets. As for the United States, it seems to be a couple of steps behind and had better figure out a game plan before new allegiances solidify and the US finds itself alone.

Marin Katusa is the chief investment strategist, Energy Division, of Casey Research, publishers of the Casey Energy Speculator and Casey Energy Confidential Alert Service.


  1. I guess we'll see the end result of two big trends in the next 10 years.

    1. State sponsored capitalism.

    2. Mutually assured distribution of resources. (MADOR)

    The west is likely to become increasingly starved for basic resources as governments around the world tie up resources either by direct ownership or right of first refusal agreements. The challenge for us is not to sell out for short term gain.

  2. The first challenge is to avert the lurch towards protectionism. If worldwide free trade can be preserved, the worst consequences can at least be avoided.


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