With all of these developments, to what degree has there been a change in the fault lines that define the geopolitics of energy? Is it really plausible to point to discontinuities from the past that could redefine global oil supply lines? This brief essay outlines some of the major considerations that must be taken into account in evaluating these possibilities.

The Conventional Wisdom about Demand and Supply: Right or Wrong?

The issue of security of supply is often tied to the analysis of the size and distribution of the global petroleum resource base as well as of the rate of growth and distribution of future demand. While there is continuing controversy over the long-term sustainability of the global hydrocarbon base, the current debate is concerned with the rate of growth of global demand and the capital requirements to build oil production capacity to match a continuation of the forecast growth rate.

The base, or reference case, for global demand is generated regularly both by the International Energy Agency in Paris and by the Energy Information Administration in the US Department of Energy. These efforts are fairly similar to one another. The latest projections in the reference case foresee global oil demand increasing from 74.9-million barrels per day in 1999 to 118.6-million b/d in 2020. Most of this 44.5-mmb/d increase comes from a doubling of demand in the developing countries from 25.5- to 50.7-mmb/d, with a concentration of the growth in Asia. China, India, South Korea and other Asian developing economies are foreseen growing at an average 3.7% per annum (versus global growth of 2.2%), with total volumes increasing from 13.3 to 28.8-mmb/d.

The only way that such demand growth can be satisfied is from a radical increase in investments and oil production capacity in Opec's Middle East producers. Thus, taking into account forecast growth in production outside of Opec, the reference case projects that to satisfying this radical increase in demand, Opec will need to increase its production capacity from 31.4-mmb/d in 2000 to 60.2-mmb/d in 2002. Saudi Arabia alone is projected to increase its capacity from 9.4-mmb/d to 22.1-mmb/d, a level similar to total Opec production for most of the past decade.

Will Opec countries be able to make the necessary investments? Will Opec countries be willing to make the investments? Is such a radical increase of dependence on Opec, Middle Eastern and, in particular, Saudi supplies dangerous in terms of economic and political vulnerability to a disruption? Will the implied dependence of China and other Asian importers on the Middle East mean that these Asia-Pacific area governments will gravitate politically toward the Middle East?

These questions have been placed in an even more acute microscope in the aftermath of September 11th. China and India, Asia's two largest emerging markets, have begun to target the building of strategic stockpiles to be used to insulate their economies from the impact of supply disruptions. China has gone beyond this, and has also questioned the political wisdom of relying of long-haul supplies of seaborne oil from the Middle East. It has accelerated the search for ways to substitute natural gas and other fuels for oil, to improve the efficiency of energy use in the country, and to find closer future oil and gas supplies. It is also turning toward Russia and the Central Asian countries rather than rely more exclusively on Middle East crude.

But there are other ways to look at these standard projections. For it may be that demand will fail to materialize at the forecast pace. The reference case, for example, foresees global demand increasing at 2.2% per annum, 3.3% in the developing countries, 3.2% in Eastern Europe and the former Soviet Union, and 1.1% in the industrial world (0.6% in Europe and 0.7% in Japan). What if demand fails to grow at this anticipated rate? There is, in fact, significant evidence that demand will not reach the level in this widely-accepted reference case. There is even evidence that demand is unlikely to reach the level forecast in the low case (106-million b/d). This evidence comes from recent history--for the past seven years global oil demand has grown by less than 1%. Evidence is also found in selected cases. In China and Russia, for example, oil demand either failed to grow at the anticipated rate or has actually fallen over the past few years, even though in both cases economic growth has been sustained at between 7 and 12% per annum. The reason appears to be that as these countries eliminate price subsidies and offer petroleum products to consumers at world market levels (ex-taxes), there are responses that lead to much more efficient energy use. These responses are found both in consumers and the choices they make and in investors who put capital into energy savings investments.

It therefore now is plausible to ask what the consequences might be in geopolitical terms if energy demand grows at a much slower rate, for example 1.1% per annum rather than 2.2% per annum in the reference case. One of the most important consequences of this would be a very different geopolitical scenario. Markets would be far softer. The fear of undue dependence by importing countries on the Middle East would be replaced by uncertainty about market share and fear of reduced revenue and loss of markets and, therefore, loss of influence from the perspective of Middle East and other Opec oil producing countries. That's because oil producers outside of Opec, and in particular those in Russia and the other states of the former Soviet Union as well as the oil producers of West Africa would almost certainly be able in this scenario to satisfy the lion's share of global demand increases.

Saudi Arabia: Lynchpin of the Global Oil System

There is little doubt that Saudi Arabia has been the lynchpin of the global oil system for the last quarter-century and is likely to remain in that position for some time to come. What provides international influence to Saudi Arabia is not simply the size of its oil resources, but the way these resources are used to boost Saudi Arabia as a global power. With 261.8-billion barrels, Saudi Arabia possesses 24.9% of the world's known petroleum resources. It also has 30% of Opec's production capacity and has the largest capacity by far of any country--about 10-million b/d as compared to 7.4-mmb/d in the number two producer, Russia.

Beyond its sheer size, what gives Saudi Arabia its dominant position in the global oil arena is it's spare production capacity. As a matter of government policy, Saudi Arabia has for more than a decade made its spare production capacity the cornerstone of its oil policy. Its investment in spare capacity is designed to enable it to achieve some critical policy objectives. The kingdom strives to have enough capacity to be able to replace, on its own, all of the oil exports of virtually any other large producer in case that producer's capacity is lost to world markets. This could take place by accident, because of internal political strife, or by design (as for example, in the case of Baghdad withholding oil supplies in order to put pressure on the international market).

Since Saudi Arabia is alone among oil producers in maintaining large spare capacity, it is able to command enormous influence over oil markets. It can, alone, in the short-run, prevent prices from rising too high or too fast so as to jeopardize global economic growth. This serves to protect the kingdom's main markets as well as its income. This power places the kingdom in a key position in terms of the overall health of the world economy. It's power to prevent a price surge means that other governments concerned with the world economy, with the level of inflation as well as the potential for economic growth, depend on Saudi Arabia to carry out this role judiciously.

Spare capacity serves other purposes as well, since the power to prevent prices from rising is also the power to reduce prices at will. This provides the kingdom with a vital and powerful policy instrument. Recognition by others that if they challenge Saudi Arabia's market share the kingdom might open its oil taps and reduce both prices and the income of challengers, is the key to Saudi Arabia's ability to maintain market discipline. This power exists both within and outside of Opec, where the kingdom is well positioned to challenge independent producers that might seek higher market share at the kingdom's expense. The history of use of the Saudi oil weapon provides tangible evidence to all others that the kingdom won't hesitate to keep prices low ñ very low at times--in order to protect its position in the oil market. It opted for market share strategies in 1985, 1989 and 1997, the first and last time with devastating impact on other producers as oil prices fell toward or below $10 a barrel.

Overlaying this key element of Saudi oil policy are several policy drivers, some of which are not consistent with others: (1) Maintain oil's competitiveness internationally by keeping prices below $30 a barrel; (2) Maintain the kingdom's income by keeping prices above $22 a barrel and aiming for output of at least 8-million barrels a day; (3) Protect the kingdom's role as the #1 global supplier; (4) guard Washington's commitment to Saudi Arabia's sovereign integrity by being the #1 supplier to the US market, supplying US military fuel needs and assuring that gasoline prices are moderate; (5) Foster global economic growth through price stability and moderation; (6) Use oil to foster Islamic and foreign policy goals by earmarking subsidized oil or tied income for Islamic institutions and specific governments, such as Bahrain, Pakistan, Afghanistan.

How has this Saudi position been challenged in the post-September 11th world? One key factor has been a re-assessment of Saudi Arabia's ties to the United States, a process that started even before September 11th and coincided with disagreements over the US on curbing violence between Israeli and the Palestinian Authority. The re-assessment reflects the multiple ways that identification with Washington has weakened the position of the Saudi government at home and within the Arab world. US belligerence toward Baghdad works in a similar manner.

Equally important, Saudi Arabia's multiple ties--however informal they might be--both to the Taliban regime in Afghanistan and to the al-Quaeda terrorists has triggered a re-assessment of US-Saudi relations in Washington and within US intellectual circles.

But the durability of the ties between Saudi Arabia and the US has thus far outweighed any fundamental re-assessment that could lead to essential changes. The kingdom has reaffirmed the importance of Washington to its security, but it has also distanced itself significantly from the US on key issues. This is evident in the way it has continued to commit itself to be the # 1 supplier to the US market and to affirm its interest in maintaining moderate prices and not to use the "oil weapon" by embargoing any countries or withholding oil from markets. At the same time, Riyadh has carved out a foreign policy role separate from that of the US. It has refused to allow its bases to be used in any operations against Iraq and it has adopted a strong, assertive foreign policy with respect to the Middle East peace process.

At the same time Riyadh has adopted a wary and nearly obsessive attitude toward Russia. While publicly saying that ties between Russia and Saudi Arabia are good and that they two countries are cooperating on oil markets, Riyadh also appears to be adjusting its production in step with Russian increases, to make sure that the kingdom remains the world's biggest producer. It is also prepared to challenge any Russian market share gains that are against its own interests.

Thus the post-September 11th reassessment both within Saudi Arabia and in capitals elsewhere remains an intellectual exercise ñ so far. It remains to be seen whether new patterns emerge that could challenge Saudi Arabia's position and the geopolitics of petroleum.

Russia and the Caspian: The Challenge

The one country to have taken political advantage of changing geopolitical circumstances after September 11th is Russia, where both the government and companies have taken advantage of the country's mushrooming oil production capacity. Timing has been especially beneficial for Moscow, for the September 11th attack came at a time when Russian production had increased some 500,000 b/d in two successive years and when the prospect for at least one more year of a similar increase was in the cards.

For the government, the offer of additional energy security to Europe and the United States fit well with a campaign to become more fully integrated into the Western security and economic networks. By providing a clear alternative to Middle East and other Opec supplies, Russia has also been able to overcome what had earlier been seen as a win/lose relationship with Washington over the two countries' interests in the Caspian. With both governments on the same side, politically, Moscow has gained a freer hand in controlling the access of the Caspian oil and gas basins to external markets. Russia has been able to forge new ties to NATO and gained Washington's support for Russia's entrance into the WTO in 2004, prospects that were not on the table before September 11th. It is also no accident that Moscow has become a full member of the G-8 group of industrial countries, nor that the G-8 now has an energy working group, nor that an upcoming meeting of the group will take place in the Russian capital. The G-8 symbolizes the center of the energy security system that binds the major Western countries together in the International Energy Agency, with their oil sharing mechanisms and strategic oil stockpiles.

For the companies, the new circumstances presented several critical opportunities. Their incremental supplies could gain new market shares in Europe and the Western Hemisphere, if governments in these oil-importing areas choose to favor them. The tilt toward Russian supplies could also gain these companies access to favorable financing of new projects as well as access to new joint ventures abroad with Western companies.

For Saudi Arabia and Opec, the turnaround in the Russian oil industry is of major concern. There are remaining skeptics who doubt that the Russian oil sector can continue to increase capacity at 500,000 b/d per year. Yet, as time goes on it has become clearer that Russian oil resources are far more abundant than previously recognized and that Russian companies have the wherewithal to turn cash flow into fresh investments on a fairly aggressive basis. The concern over Russia is linked directly to the issue of future demand growth. What does the future have in store for Saudi Arabia if demand continues to increase globally at 600,000 b/d as it has since 1995, if Russia and the Caspian producers increase their production capacity at this same rate, and if other producers in Opec (such as Algeria and Nigeria) are also increasing their capacity?

But Russia could be a potential challenge to Opec even if the above hypothetical questions are answered in a different way. For Russian companies and the Russian government have the ability to transform what has been essentially a European supplier into a truly global petroleum powerhouse. Indeed, this is already beginning to happen.

Until recently Russia has been a supplier of oil and natural gas to Europe alone (where it is the largest supplier of both). Yet by volume, Russia has become the second largest marketer of oil in the world, selling some 3.6-million b/d of crude oil during the first half of this year, versus Saudi Arabia'ís 6-million b/d of exports. The reasons that Russian sales have been limited to Europe are that it has no oil production outlets elsewhere and that it has no deepwater ports. Hence, Russian exports have been limited to what are short-haul locations; economically, small vessels cannot profitably move oil from Europe to other areas, such as the Western Hemisphere.

But Russian companies have begun to export larger quantities of oil to the United States ever since late spring 2002. Yukos, for example, moves oil into the Mediterranean Sea and then re-loads the crude oil onto VLCCs that can transport 2-million barrels of oil at much lower cost into the Atlantic Basin. Others are doing the same, so that Russian exports to the US have now increased from practically nothing to 250,000 b/d. Before long the level could well reach 1-million b/d, 1/10th the US import market. Russian companies are eager to do this because their burgeoning output has gone to the world's most highly competitive market ñ Europe ñ where demand growth has been stagnant for a decade. If they would continue to increase sales into the European market, they could jeopardize prices in that market and their own profits. Thus, by removing some oil from the European market and shipping West they protect their market position in their main sales area and develop incremental sales elsewhere.

Clearly the time has come for Russian companies to explore ways to ship oil from deep-water facilities. Hence, there are talks under way to build several pipelines into the Mediterranean basin, one of which would extend through Bulgaria to the Greek port of Alexandroupolis. Once deepwater facilities are available, the economics of selling larger amounts of oil into the Western Hemisphere will be more favorable and Russian will be on its way to becoming a global seller.

What's missing, of course, are Asian outlets for Russian oil. But this gap should soon be filled. For starters are the two major Sakhalin projects, led by ExxonMobil and Royal Dutch Shell. These natural gas-driven developments will have significant oil and condensate production by mid-decade, perhaps amounting to 400,000-500,000 b/d. But the more tangible jump should come from tapping into Russian reserves as yet to be developed in Central and Eastern Siberia. In this regards, Yukos has proposed a 600,000 b/d pipeline into China, while the state pipeline company, Transneft, eager to preserve its logistics monopoly, has proposed a 1-million b/d line from Angarsk in East Siberia to terminals near Nakhodka on the Far East coast. At this juncture the question is not whether a pipeline to Asia will be built, but rather which will be built first. At present it would appear that the Transneft line is the more likely and that would provide Russian firms with an all-weather deepwater port to Asian as well as Western Hemisphere markets sometime before 2006-07.

Thus, Russia will emerge during this decade as a global supplier on the same scale as Saudi Arabia and larger, as a supplier, than any other Middle East producer that also has potential global reach --Iran, Iraq, Abu Dhabi and Kuwait. Russian producers could well benefit in multiple ways by such an achievement, including garnering positions as the natural marker for the sour crude markets in Europe and Asia, where Russian oil could be base load.

But no matter how rapidly and how large Russian oil production develops, it will not fully rival Saudi oil in one critical respect. Saudi Arabia alone will likely continue to have a policy of maintaining spare production capacity, with all of the power implied by that. Yet a Russia that, together with the Caspian countries, is also producing 10-million barrels a day and exporting two-thirds of that could become a geopolitical force that must be reckoned with.

Other Hot Spots and Wild Cards

The potential rivalry between Russia and Saudi Arabia is not the only key or even new element in the geopolitics of petroleum post-September 11th. There are several other hot spots around the world, but perhaps none rivals that of the situation of Iraq in terms of global implications.

At the time of this writing, it appeared that after September 11th the US government had become determined to change the regime in Baghdad, which it has identified as dangerous to world stability because it allegedly harbors weapons of mass production and threatens to use them. But Iraq is no ordinary country, let alone an ordinary oil producing country. It has oil resources that could well rival those of Saudi Arabia. With a recent production capacity of 3.6-mmb/d on the eve of the Gulf War in 1991, Iraq has the potential rapidly to increase its capacity to double that level. The major constraints are capital investment in the Iraqi upstream and in transportation systems to deliver crude oil from this partially landlocked country to global markets.

Thus, in key respects, Iraq is far more of a wildcard and potential threat to the Saudi position than is Russia. That's based on the judgment that a post-Saddam Iraq will, whatever its government, have an incentive to marshal as much capital as it can to produce as much oil as it can, whatever the price of oil might be. Thus the geopolitics of oil involve the twin questions of (1) what are the consequences to markets of a war inflicted on Iraq that is designed to change the country's political regime? And (2) what are the consequences of an all-out effort by a new political regime in Baghdad to maximize exploitation of the country's resources.

Elements of the New Geopolitics

If there is a new geopolitics of petroleum, it is unfolding and remains potential. It would be based on a number of emerging elements, which can be summarized as follows:

A new concern in the US, Europe and emerging Asian markets, especially China and India, about oil dependence on Islamic countries in the Middle East, and a question of what can be done to reduce that dependence. The renaissance of the Russian oil industry, which could well be sustained as Russian firms marshal capital for domestic investment and as Russian companies mature and learn how to forge joint ventures with international firms at home and abroad. Russia and the Caspian countries could be the most significant incremental supplier to global markets for a decade or even longer.

A political desire of Russia, China, and the US to redefine energy alignments and forge new market arrangements.

But it would take more than this to fundamentally change the current geopolitical system. For, unless other players find a way to "re-invent" Saudi Arabia, they will find it very difficult to marginalize the world's largest producer and holder of the largest asset base. Saudi Arabia will never likely give up market share willingly. It would almost certainly use its own oil weapon if it began to find itself being marginalized. Thus, it will take a larger sea change in the petroleum sector than what is likely to result from the Russian challenge we are seeing unfolding. Such a sea change could occur if the Saudi regime were overthrown and if a significant amount of Saudi oil were removed from the world's market for a long period of time. However unlikely such a change might be, the fact is that every revolution that has taken place in an oil-producing country has resulted in the country's loss of production capacity. The most recent instance is Iran, which produced 6.5-mmb/d before the Iranian Revolution and has not been able to produce even 4-million barrels a day ever since. But a revolution is not the only potential triggering event. Another would be for the kingdom to decide to accelerate the development of its oil resources, which it could do on its own or by having international companies invest in its resources. A Saudi Arabia producing 20-million barrels a day with or without foreign investors would make a huge difference to the geopolitics of energy.

Yet another way would involve a conscious decision by the US and other oil importing countries to forge their own community of interests and restrict access to that community by foreign producers that, like Saudi Arabia, do not permit reciprocal investment in their petroleum sectors. Such a situation might appear highly unlikely from today's vantage point. But there are elements in the geopolitics of energy that come out of the September 11th situation that point in this direction.

(Note: Edward L. Morse is Executive Adviser at Hess Energy Trading Company, LLC. This essay is based on a recent presentation for the Aspen Institute Italia Conference on Emerging Challenges in the Field of Energy Policy for Europe, the US and Russia, in Florence, Italy.)