Seminar: Oil Politics

and Currency
Speaker: Prof. Albert Kwong
Date: 4, October 2014

Student: RIZVI, Syed Hassan Tallal

ID: 53915778
Programme: MSF
Course: EF5063 Professional Seminars
Report: Semester A

Table of Contents
Part 1: Oil Politics and Currency.............................................................2
Effect of Oil on Different Currencies.....................................................3
Part 2.............................................................................................. 5
Current Landscape and Politics in International Oil Market..........................5
Will Saudi Arabia Cut Production to Stabilize Prices?................................6
China and Oil Politics.......................................................................7
Conclusions...................................................................................... 9
References...................................................................................... 11

Part 1: Oil Politics and Currency

The modern world has an almost insatiable appetite for energy. From the smallest of mobile
phones in our hands to jumbo jets roaring through skies, in every product or service, energy
plays an integral role. No wonder then that energy plays a key role in economic growth of
nations in the modern world. In the energy spectrum, fossil fuels remains the dominant force and
expected to remain the most important fuel type for the world economy, despite the rise of
alternative fuel. This is because the changing the fuel type would require technology and
structural changes in the economic infrastructure of the world.
Within fossil fuels, oil is one of the most important, given its integral role in the modern
economy. Nations devise prudent policies which to serve to bring about energy security, and
since oil plays such an expansive role in world economy, politics and oil are often mixed
together. For this reason, I found the seminar by Prof. Albert Kwong titled Oil Politics and
Currency very pertinent. The speaker shed light on a very relevant issues these days and I
agreed with most of his ideas. Following from this, countries around the global have prioritized
energy security. Energy security has many dimensions, but may be loosely defined as
construction of policy incentives to acquire access to appropriate energy sources and reasonable
prices (International Energy Agency, 2014). The policy has both long term and short term
objectives. Short term objectives relate to normalizing demand and supply while long term
objectives seek energy independence and sustainability. Therefore, the absence of energy
security will adversely impact a countrys economic outlook and may have long-lasting social
impact.

Oil is spread around the world unequally, with some regions having a disproportionate share of
oil reserves. Saudi Arabia, for example, alone having 16 per cent of the worlds proven oil
reserves (U.S. Energy Information Administration, 2014). A list of the top 5 oil producers is in
the table below. US is the not far behind Saudi Arabia in terms of production, but is the worlds
largest consumer of oil in the world, consuming 18.6 million barrels per day in 2012 (Zhou,
2014).
Table 1:
Country
Production (000s barrel per day)
Saudi Arabia
11,726
US
11,119
Russia
10,397
China
4,372
Canada
3,856
Source: U.S. Energy Information Administration
Moreover, Prof. Albert Kwong explained how currencies of major oil producers are highly
correlated to fluctuations in the oil. As a student of finance, I found the linkages fascinating.
Furthermore, the speaker elaborated the important of energy security for China, one of the largest
consumers of oil.
Effect of Oil on Different Currencies
There is abundant research, analyzing the effect of crude oil prices movements on currencies
around the world. At a micro level, a long position in a commodity such as WTI crude oil, has an
effective counter short position in the US dollar (because the WTI crude oil is quoted in US
dollars) (Active Trader, 2014). Hence, most of the time we witness inverse relationship between
US dollar and WTI crude oil prices. Apart from US, impact of changes in crude oil prices on
currencies depend on how big of a role oil plays in the economy. For example, Canada is one of
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the largest oil producers and net exports of oil in the world (U.S. Energy Information
Administration, 2014). Consequently, upward movements in the price of oil would be beneficial
for the Canadian economy, which in turn would be eventually reflected in the appreciation of the
Canadian dollar (see figure 1 below). In Figure 1 we see that the CAD/USD exchange rate has
closely followed the oil prices. Same is the case with Norwegian Kroner in figure 2. In fact, one
of the most compelling reasons for Norway not to join the common currency bloc of Euro, was
to continue to reap benefits of a strong economy supported by oil, as pointed out by the speaker
during the seminar.
Figure 1:

CAD/USD vs WTI Crude Oil

Oil

CAD/USD

Source: (OANDA, 2014)

Figure 2:

NOK/USD vs Oil

Oil
NOK/USD

Source: (OANDA, 2014)

Part 2
Current Landscape and Politics in International Oil Market

While the importance of oil in the global economy has not been significantly dented, the current
landscape of the global oil industry has undergone dramatic shift since the innovation of shale
oil. The industry of this technology fundamentally changed the way the industry now operates.
Shale oil, also known as tight oil, is extracted from rock formations which do not allow the oil to
flow freely (Financial Times, 2014). Hence, until recent advances in extraction methods such as
horizontal drilling and hydraulic fracturing, shale oil was very difficult and costly to extract.
While it is still more difficult to extract than conventional oil, the innovative technology has
made the production of shale a commercially viable undertaking.
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In the US, shale oil production skyrocketed from a mere 111,000 barrels a day in year 2004 to
553,000 barrels a day by 2011. The success of shale oil has immense implications for the energy
security of US, a country which has relied on the Middle East for a major chunk of the oil
imports. Constant political and social unrest in the volatile region of Middle East exposed US to
energy security risks. While shale oil production in the US has not completed substituted Middle
Eastern oil, the production is constantly rising. The production has already resulted in fall in US
crude oil imports to 16 year lows (Zhou, 2014). Furthermore, as of current estimates, US oil
import levels from OPEC (organization of petroleum exporting countries) are now at 30-year
lows.
Several factors can be cited to explain the current situation of the oil market. Firstly, the boom in
shale oil extraction has flooded markets worldwide. Secondly, OPEC, which produces about
33% of the worlds oil has maintained its production levels. Lastly, demand for fuel in Europe
and some parts of Asia is forecasted to be low. The net result of these factors has been a dramatic
fall in oil prices (Anjli Raval, 2014). Brent prices, for example, have fallen by 30% to date since
June 2014. I intend to explain each factor is a fair bit of detail
Will Saudi Arabia Cut Production to Stabilize Prices?
Before I address the question, I believe it is important to shed some light on OPEC. OPEC is a
cartel of one the worlds largest oil producers and include the following countries: Algeria,
Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, UAE, and Venezuela.
All together, these countries produce roughly above 40% of total world supply. Hence, changes
in production levels of OPEC have significant effect on the world oil prices. A complicating
factor in the equation is that most of the countries in OPEC have been hotbeds of instability,
especially Iraq, Libya, and Iran. Its significance in the oil markets may be evaluated from the fact
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that in 1970s, the then Organization of Arab Petroleum Exporting Countries (OAPEC), the
precursor of OPEC, imposed an oil embargo which shot up price by almost 300% in a matter of
three months (History Channel, 2014).
Currently, OPEC still retains immense clout in the oil market but would be reluctant to resort to
measures such as oil embargos. However, it plays an active role in managing the supply levels in
the market and maintain profitable price levels for its member countries. For example, during the
recent financial crisis of 2008, when oil prices fell to $40 per barrel from highs of $140, OPEC
cut its production levels drastically to prop up prices to $80 (Mouawad, 2008).
As mentioned before, the fact that OPEC includes several politically unstable countries, regional
politics regularly impacts decisions of OPEC. Even in the 1970s oil embargo, conflict with Israel
was the reason behind the cut back in production. Currently, low oil prices should have ideally
prompted a production cut from OPEC. However, the organization, led by Saudi Arabia, has
failed to reach a consensus on the most feasible way to react to the scenario. Saudi Arabia, in
particular, has remained adamant that it would not cut production. Analysts are of the view that
Saudi Arabia wants to put pressure on Iran by keeping the price lowers. Saudi Arabia and Iran
are regional and ideological rivals: Saudi Arabia adheres to the Sunni school of thought whereas
Iran belongs to the Shia school of thought. Another view is that Saudi Arabia wants to maintain
its large market share by not increasing the price levels. Yet another opinion is the country wants
to fight off competition from the shale oil producers, primarily in US, by keeping prices low and
hurting the profitability of companies there. I believe there is confluence of all the
aforementioned factors that explain the current situation in the oil market.
China and Oil Politics

According to reports by the US Energy Information Administration (EIA), China is now the
worlds largest net importer of petroleum and other liquid fuels (U.S. Energy Information
Administration, 2014). Chinas oil demand growth has far outpaced the growth in its domestic oil
output, leading to the current situation. Consequently, EIA expects China to import 66% of its oil
in 2020 and 72% by 2040. This was a natural outcome of a rapidly growing economy that at
times averaged in the double figures. This fact however also has implications for Chinas energy
security policy.
The Middle East has historically been and continues to be the largest source of oil for China.
While China has made efforts in diversifying its sources, the region retains its importance. This
means that the Indian Ocean, for example, has an important place in Chinas energy security
policy. Roughly 70% of the world petroleum products are channeled through this ocean
(Rasgotra, 2014). Since oil plays such a major role in Chinas economic growth, oil supply
security is top priority for the Chinese government. The importance of the Strait of Malacca can
be highlighted here. It is narrow and congested waterway in South-East Asia that provides the
shortest route between the Indian Ocean and the Pacific Ocean, channeling approximately 25%
of world trade each year (The Jamestown Foundation, n.d.). In order to promote a more reliable
and safer route for ships carrying oil for China, it has strengthen it naval force and increased its
presence in the sea. China often has disputes with the US, who in turn has often increased its
presence in the seas under the pretext of providing security in the region.
In response to the volatile nature of sea routes in Asia, China has embarked upon strategies to
secure stable oil supplies through land routes. One of the most feasible land routes for China is
through Pakistan, a country with which China maintains cordial relations. This particular trade
route involved the port city of Gwadar in Pakistan. Over the years, the Chinese government has
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made substantial investments in the city (Subohi, 2013) . The entire process would involve the
off-loading tankers at Gwadar, transferring it to the capital Islamabad up north some 900 miles
and then would be passed into the Xinjiang province into China. While this would provide a
more efficient route of Chinas energy supplies, Pakistans internal security issues complicate the
matter. Gwadar is located in Pakistans volatile province of Balochistan, which is home to
several separatists movements. Furthermore, Chinas Xinjiang province has its own problems of
its Uyghurs.
Conclusions
In conclusion, I agree with most of Prof. Albert Kwongs views in his seminar. Oil has and
continues to play an important role in the modern world economy. Despite the adverse impact on
the environment through its use, it is impossible to immediately turn away from this fossil fuel.
The entire oil industry, from upstream to downstream, has made substantial investments in the oil
infrastructure, making rapid shift to another fuel infeasible. Since oil is so important, nations
have made the stable and secure access to the fuel a top priority. This is all the more true for fast
developing nations such as China, which are growing rapidly and demand for oil is increasing.
Developed countries too have immense vested interests in securing oil. This prominence of oil
has earned it a special place in global politics as well. China for example has propped up
financial support for countries such as Pakistan, to gain short and secure route for oil imports
from the Middle East.
However, Prof. Albert Kwong did not mention some critical features of the shale oil production.
Definitely shale oil has revolutionized the oil industry and U.S. one of the largest importer of oil,
has seen its imports shrinking. Nevertheless, according to my research, the shale oil wells have a

more rapid depletion rate than conventional oil wells such as those in Saudi Arabia (Wile, 2013).
So while oil importers such as U.S. has exuberant that their dependence of imported oil is falling
with increasing production of shale oil, they must also consider factor in the life of the wells. If
the wells do deplete fast, how long can the independence from oil imports last?
Furthermore, although alternative energy forms such as solar, biomass, and wind are fast being
implemented to replace our dependence on oil, we are still technologically far away from fully
replacing oil. This miracle fuel will continue to play an important role in our lives. The seminar
was most pertinent for aspiring financial analysts who may eventually work for institutions
which specialize in the trading and research of the commodity oil and the industry as well. The
seminar has thus helped me identify some of the core issues currently facing the oil industry and
pushed me to further investigate the matter. This will not only help broaden my current
understanding of the oil industry, but enhance my understanding of the financial markets in
general.

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References
Active Trader. (2014). Crude Oil and Currencies. Active Trader.
Anjli Raval, N. H. (2014, November 23). Oil markets: A new chapter for Opec? Retrieved from
Financial Times: http://www.ft.com/intl/cms/s/0/64c2485e-70a4-11e4-811300144feabdc0.html#slide0
Financial Times. (2014, November 21). Lexicon. Retrieved from Financial Times:
http://lexicon.ft.com/term?term=shale-oil
History Channel. (2014, November 23). Energy Crisis (1970s). Retrieved from History:
http://www.history.com/topics/energy-crisis
International Energy Agency. (2014, November 21). What is energy security. Retrieved from
IEA: http://www.iea.org/topics/energysecurity/subtopics/whatisenergysecurity/
Mouawad, J. (2008, December 17). OPEC Agrees to Another Cut in Production. Retrieved from
The New York Times:
http://www.nytimes.com/2008/12/18/business/worldbusiness/18opec.html?_r=0
OANDA. (2014, November 21). Historical Exchange Rate. Retrieved from OANDA:
http://www.oanda.com/currency/historical-rates/
Rasgotra, D. (2014, March 32). India-China competition in the Indian Ocean. Retrieved from
IISS Voice: http://www.iiss.org/en/iiss%20voices/blogsections/iiss-voices-2014b4d9/march-2014-cd5b/china-india-ocean-c0d6

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Subohi, A. (2013, February 25). Gwadar deal: business optimism, Baloch reservations.
Retrieved from Dawn: http://www.dawn.com/news/788568/gwadar-deal-businessoptimism-baloch-reservations
The Jamestown Foundation. (n.d.). China's Malacca Dilemma. Retrieved from The Jamestown
Foundation: http://www.jamestown.org/single/?no_cache=1&tx_ttnews%5Btt_news
%5D=3943#.VHaVmjGUdfM
U.S. Energy Information Administration. (2014, September 30). Canada. Retrieved from EIA:
http://www.eia.gov/countries/cab.cfm?fips=ca
U.S. Energy Information Administration. (2014, November 21). Saudi Arabia. Retrieved from
EIA: http://www.eia.gov/countries/country-data.cfm?fips=SA&trk=m
U.S. Energy Information Administration. (2014, March 24). Today in Energy. Retrieved from
EIA: http://www.eia.gov/todayinenergy/detail.cfm?id=15531
Wile, R. (2013, May 19). Why America's Shale Boom Will Last For Years. Retrieved from
Business Insider: http://www.businessinsider.com/fracking-shale-extraction-anddepletion-2013-3?op=1
Zhou, M. (2014, January 4). U.S. Crude Imports Fall to Lowest Level Since 1998. Retrieved
from Bloomberg: http://www.bloomberg.com/news/2014-01-03/u-s-crude-imports-fallto-lowest-level-since-1998.html

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