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Economics: The GeoPolitics of Oil
New York: January 10, 2005
By John R. Stephenson

Modern society is dependent on the abundant access to oil at a reasonable price. From automobiles to plastics, from chemicals to jet aircraft, we are totally dependent on oil to keep our lives and economies functioning smoothly. While many alternatives to petroleum energy have been proposed, none have been successful in displacing petroleum as the fuel of choice for the modern world.

From 1948 to 1972, seven out of every ten barrels of oil added to the world's free reserves were found in the Middle East. With so much oil being discovered in the Middle East, is it any surprise that we are dependent on this region for our energy needs? The discovery of such vast oil reserves in the Middle East during the 1950's and 1960's led to the formation in the 1970's of OPEC (Organization of Petroleum Exporting Countries) to try and control the production and hence price of oil.

Although today the Middle East is synonymous with oil, this wasn't always the case. The world has witnessed many great petroleum states. Whether it was in Pennsylvania where oil was first discovered or in Russia, the story is largely the same. Oil is power. In the aftermath of the First World War, Great Britain, the United States and the Netherlands were home to the world's largest oil companies, and their postwar oil concessions were a form of colonialism. It was precisely this colonial presence that led to the creation of OPEC. Wherever oil is found, there is sure to be not only the promise of great wealth but also the possibility of great hardship as the economic superpowers vie for influence and control over this liquid gold. Quite simply, no other commodity is as important as oil.

Today, the great game is very much alive and well and countries are actively engaged in trying to gain influence over this most precious of commodities. While nations still fight over access to the most prolific producing region of the world - the Middle East, a new frontier in the great game for global dominance has opened up - the Caspian. After the fall of the Soviet Union in 1991, this area of Central Asia which is comprised of five principal nations: Russia, Kazakhstan, Turkmenistan, Iran and Azerbaijan has been the center for intense political and commercial competition for the control of the vast energy resources of these newly independent states. With some 15 to 30 billion barrels of proven reserves (equivalent in scale to the North Sea reserves) up for grabs, the stakes are high and, as always, the prize for control revolves around power, influence, security and wealth. The oil deposits of the Caspian Sea are not of the same caliber as those found in the Persian Gulf region, however, recent geological reports indicate that the entire Caspian Sea is a basin full of oil and natural gas, starting from Azerbaijan and continuing into Kazakhstan and Turkmenistan. These deposits will take on increasing importance as it is expected that the oil and gas deposits of Alaska and the North Sea will be exhausted by the year 2015.

Figure 1: Caspian Sea Region

Although the area has long been known for its oil reserves, it has suffered from decades of under-development and neglect. All this is starting to change as oil companies, desperate to replace the declining reserves from their traditional fields, rush headlong into the region bidding up assets and providing much needed infrastructure and technology. The Caspian Sea region's natural gas potential is, by some measures, more significant than its oil potential. Regional proven natural gas reserves are estimated at 232 trillion cubic feet (Tcf) which is comparable to the production in Saudi Arabia.

Corruption, poverty, blood and tears have been the unintended consequence of the vast new oil wealth that has been inadequately distributed within these newly-independent states. In Azerbaijan and Kazakhstan (the region's two biggest oil producers) 49% and 26% respectively of the population were estimated to be living below the poverty line in 2001. Adding to the instability of the region, has been a spate of ethnic and religious differences as well as succession movements. Because most states in the Caspian region are land locked, a centuries-old debate about access and control of the resource has been ignited. The debate concerns the likely path of pipeline infrastructure which will carry the oil and gas to various ports for world consumption. Iran, which represents the logical path for a pipeline, is meeting with stiff opposition from the United States (as well as Russia) who believe that Iran is a sponsor of global terror and may be preparing to enter the nuclear arms race. Russia is active in promoting a pipeline through its territory but centuries of oppression and frequent military incursions into the former caucuses have left the states in the Caspian region wary of Russian involvement. The other alternative for a pipeline route would be to the east, but would involve a difficult land crossing of Afghanistan, a country that is known to be very unstable.

Although the world may be increasingly digital, it is still reliant on oil for the smooth functioning of its industrial economy. Control of this resource has been and will remain crucial in the decades to come. OPEC, a consortium of largely Middle Eastern producing countries, is extremely influential in setting the price of crude on the world's oil markets because, while they produce 40% of the world's oil, they hold 80% of the proven global reserves. Fully 22% of the world's oil is in the hands of countries that are state sponsors of terrorism and operating under sanctions and only 9% of the world's oil is in the hands of countries ranked free by Freedom House. Judith Miller in her book God has Ninety-Nine Names: Reporting from a Militant Middle East offers this pessimistic view of the Middle East. "The Arab Middle East lags behind most developing nations, and far behind East Asia in every World Bank component of productivity growth - spending on education, worker training, and the number of women in the work force. Arms purchases, by contrast, remain staggeringly high. The Middle East now buys almost 50 percent of all arms sold to the Third World." To bring order to chaos and to ensure the orderly flow of oil, the U.S. Navy's Fifth Fleet patrols the Strait of Hormuz (the world economy's current Achilles heel) on a permanent basis. The cost for this permanent military presence? Fifty billion dollars a year.

While the hotbed for control over oil will remain in the Middle East for the foreseeable future, the Great Game has started to shift to Central Asia and the region around the Caspian Sea. The essence of this new geopolitical game in Central Asia is twofold: first, control the production of the oil and gas, and second, control the pipelines which transfer the oil to Western markets. Russia wants to exert its centuries-old influence over the region whereas the United States would like to see the countries of Central Asia develop their oil and natural gas industries and move away from the Russian sphere of influence. Iran, by virtue of its geography, stands to benefit and is already starting to flaunt its independence at the West. Whether it is the war in Iraq or the attempted nationalization of Yukos and other corporate entities in Russia, the game is the same - control over critical and strategic resources. Look for increasing geopolitical tensions including armed conflict in the decades to come in Central Asia. As the world becomes more reliant on oil and gas from this region, the competing economic powers will jostle for position to ensure that their economies are first in line.

Investors looking for companies active in oil and gas in Central Asia need to look no further than PetroKazakhstan (PKZ - Target Price $54) a Toronto Stock Exchange listed company.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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