The oil price slide since mid-2014 has severely constrained economic growth and investment in the Economic Cooperation Organization (ECO) Caspian region. Despite this, regional governments nevertheless expect an improved market climate are continuing to draw down their significant currency reserves in order to keep their economies and projects afloat.
The Republics of Azerbaijan, Kazakhstan and Turkmenistan have suffered significantly, according to energy economics analysts. Petroleum producers and exporters all seem to be on the same boat around the world as they face revenue shortfalls and economic crisis.
International Oil Companies (IOCs) National Oil Companies (NOCs) have had no option other than to cut billions of dollars in spending and investment programs. This has caused thousands in the industry to lose their jobs and forced many contractors to declare bankruptcy.
In the meantime, the Saudi Arabian government’s brutal message for high-cost petroleum producers exporters such as ECO-Caspian region is: “…Get out of Markets…”
No one can predict with any certainty when and how this long-standing market volatility will come to an end and some observers believe that instability is actually in the interests of market participants such as traders and exchanges.
Whether or not the markets enter a period of stability, this fall in prices not only leads to reduced income for regional producers but also to competition for a limited pool of available capital funding.
In addition to the market situation, another item on the agenda for the 4th ECO Energy Petroleum Ministerial Meeting planned for the second half of 2016 will probably be a new and neutral “Market Model” or legal and financial framework for ECO-Caspian countries.
As a former Director for Energy, Minerals Environment of the ECO Secretariat during the last recent decade I am on record as saying that energy-related economic cooperation in the region may take place without ECO Caspian Sea member nations being bound to the U.S. dollar.
A proposal for a new “market model” was introduced by Wimpole International – a UK-based consortium headed by a former director of London-based International Petroleum Exchange Mr. Chris Cook.
The key elements of Mr. Cook’s proposal are firstly that energy trades may be priced in dollars without being settled in dollars and secondly that it is even possible to maintain pricing in energy itself as a unit of account or standard unit of measure for value. As Mr. Cook points out, it is possible to keep score of, or account for, transactions in energy rather than dollars and that to price in energy leads to very different economic outcomes.
Such a model of an Energy Clearing Union may resolve present difficulties faced by the Islamic Republic of Iran – as a founder member of ECO and a member of Caspian littoral states – through sanctions restricting access to dollars notwithstanding an outstanding agreement with 5+1 nations.
In my view the ECO-Caspian region is well placed to be a proof of concept for a collaborative energy market model which is complementary to previous agreements and transcends negative impact of current ideological conflicts through energy diplomacy.
ECO region combines a vast eight million square kilometres area and a population of 450+ million people who share cultural heritage and borders. To bring the nations together collaboratively as a United States of Energy Producers and Consumers may point the way to a resolution of the current global energy crisis. A first step might be an ECO-Caspian Energy Accord with neighbors such as the European Union which would build upon initiatives dating back to 2002.
Caspian Sea “Nondominium”
As a Senior Research Fellow at University College London, Mr. Cook has developed a proposal for the Caspian Sea littoral states to resolve existing territorial water delineation issues through what he has termed a Nondominium framework agreement. This name’s origins in the ancient Latin language reflect the crucial attribute of the agreement that no nation or stakeholder will have dominant rights over others, but that all will rather have rights of veto on issues that concern them.
Nondominium has two elements
Caspian Partnership – a framework agreement within which production flows would be allocated between nations and service providers individually.
Caspian Clearing Union – an agreement within which production rights (energy credit instruments) would be created, exchanged, and settled with a mutual guarantee.
This proposed “Nondominium” will not function as an organization but rather as an agreement for self organization to an agreed common purpose. The neutrality of governance ensures that the sovereignty of participating states is not compromised.
Back to the future
To those who doubt that such structures and instruments can work, Mr. Cook points out that these concepts and instruments actually pre-date existing financial structures and instruments by millennia. For instance, he points out that the concept of prepayment at a discount – prepay credits – is an ancient one which remains embedded (but forgotten) in the English language.
“For more than 500 years UK sovereigns financed their expenditure through issuing at a discount undated prepay credits – known as ‘stock’ – which were returnable in payment of taxes. The truth is that such ‘stock’ had nothing whatever to do with the ownership ‘shares’ in joint stock companies with which we are all familiar today.”
And he further added: “Not only is such stock no longer traded on stock exchanges, but also I find it completely fascinating that the phrase ‘rate of return’ in fact had nothing whatever to do with a fixed rate of return on debt, but actually refers to the potentially variable rate over time at which these prepay credit units – issued at a discount to give an absolute return – can be returned to the issuer. It follows that the issue of stock or prepay credits based upon the value of energy will essentially create a form of new currency returnable either in payment for natural gas, or for the equivalent energy value in electricity or other carbon fuel.”
What value in exchange would such energy credits have?
Mr. Cook says: “Energy has a value in use over time, and this value depends upon the type of energy (e.g. heat, electricity, power) and its location. Credit instruments based upon these types of useful energy would be generally acceptable in exchange – which is the definition of a currency. However, the value in exchange of such different energy currencies would vary by reference to conventional deficit-based ‘fiat’ currencies issued by banks, and particularly the global reserve currency, i.e. the U.S. dollar. But the question is whether energy currencies would come to be priced in dollars or dollars would come to be priced in energy!”
Is Mr. Cook proposing pricing in OIL?
He answered: “I’m not proposing pricing in oil. I’m proposing denominating exchanges in energy as a unit of measure. Whether it is called an energy dollar or a petro or an electro does not matter. Electricity, and any form of fuel e.g. gasoline, natural gas, heating oil, fuel oil will all have a fixed price denominated in it, but a variable price against everything else.”
The idea of establishing ECO-Caspian Clearing Union – where such energy credit instruments can be created, issued, traded against a new ECO-Caspian benchmark spot gas price, and returned in payment for energy supply – would therefore provide a collective guarantee to ensure performance by both energy producers and consumers.
This is consistent with President Rouhani’s proposal in his speech at Davos 2014 in which he suggested that energy/petroleum producers exporters must join with consumers to create multilateral institutions for defining global energy prices.
In doing so, it is necessary to evolve from a market of energy as a commodity traded for transaction profit to a new approach for energy as a service provided directly by producers to consumers on a new market platform.
As Mr. Cook points out, “We are seeing a transition from sale of energy as a commodity to supply of energy as a service and from conflicting absolute asset ownership rights of use and the fruits of use to collaborative rights of risk and production sharing.”
Towards a global reserve currency
As Mr. Olexander Hryb – a London-based analyst pointed there are proposals for a new supra-national complementary currency anchored on prices of a basket of commodities. Bernard Lietaer’s Terra (Trade Reference Currency) is one such proposal.
Mr. Cook’s concept is to introduce an energy value standard unit – a conceptual standard unit of measure. In the same way that a meter is a standard unit of measure for length and a kilogram for weight, an energy standard unit would be an absolute unit of energy which is independent of energy currencies which may be priced against it.
As Mr. Cook points out, “While it will be possible to run out of energy currency, it is no more possible to run out of an energy standard unit of account than it is possible to run out of metres or kilograms. It means that we will come to keep economic score in energy, rather than dollars, and to make economic decisions by reference to ‘least energy cost’ rather than ‘least dollar cost’ as now.”
Any ECO-Caspian nations could choose to adopt such an energy standard simply by opting to fix its currency unit to an absolute unit of energy in the same way that the European currencies all fixed their currencies to the abstract Euro unit at its launch date.
Mr. Cook explains: “At this point everything would change and nothing would change. Since banks do not produce energy, they would not be able to produce energy credits. However, the banking function of risk management and supervision of credit issuance, exchange and return would continue, so that energy producers could not issue more energy credit instruments than they could satisfy.”
Mr. M. Moslehi, an energy expert in the UK who was also involved with the feasibility study for the Petroleum Bourse later established on Kish Island, says according to his understanding of Mr. Cook’s idea: “Energy customers would pay a spot price for energy supply within local or regional energy pools either in local currency, or alternatively could pay for supply by returning prepay energy credits previously acquired on what would be a global market platform.”
Mr. Moslehi explains: “A global reserve currency to be known as the “Bancor” was strongly advocated by John Maynard Kenyes at Bretton Woods in 1944 to be issued by an ‘International Clearing Union’. Mr. Cook’s view is that a new “Petro Credit” based on the energy value of natural gas and carbon fuels will be accepted regionally within an ECO-Caspian Energy Clearing Union, which would in due course become the founder member of a networked and decentralised Global Energy Clearing Union.”
How might ECO-Caspian energy grid potentially work?
Mr. Cook says: “Perhaps the most interesting potential lies in the global market in natural gas, where Iran and its immediate neighbors in the ECO- Caspian region own largest gas fields of global reserves. Iran played a major role in instituting Gas Exporting Countries Forum in Doha that its current secretary general is also an Iranian energy diplomat.
I believe that this monetisation and clearing of natural gas offers the potential basis for an International Energy Clearing Union. By way of example, the massive dollar loans which financed global LNG infrastructure may be refinanced interest-free simply by producers issuing and selling prepay gas credits redeemable in natural gas to major consumers such as China, who thereby both lock in a price, and create the basis of a new global energy-based reserve currency.”
Mr. Cook’s suggestion highlights the fact that at the moment oil is priced in U.S. dollars and then natural gas is typically priced or indexed against oil. During the recent periods of high oil prices the historic pricing relationship between natural gas and crude oil broke down, which Mr. Cook points out was itself strong evidence that the high oil price was in fact a bubble. He observes contractual pricing difficulties between Gazprom and EU customers, and the inability of Russia and China to agree on a long term gas price mechanism, as evidence of this fact.
Mr. Cook has been known for a number of years as an advocate of a ‘Transition through Gas’ whereby for a transitional period the use of a reserve currency based upon natural gas will enable a high carbon price to be set based upon the energy value of natural gas, rather than upon a carbon price based upon worthless CO2 and arrived at purely administratively.
The resulting surplus would be shared equitably – in a new global settlement between producers, consumers and service providers – with at least part of the surplus being used for massive investment in renewable energy and energy savings.
Natural gas as an energy benchmark
While Director of the International Petroleum Exchange, Mr. Cook, was responsible for the introduction of the UK ‘Balancing Point’ natural gas Futures Contract he proposes that a similar gas ECO-Caspian Balancing Point system wide price should be used for physical supply, but that the financial gas market should be through gas prepay credits, rather than complex and illiquid derivatives.
Mr. Cook points out: “If Iran’s policy makers can convince ECO-Caspian states to participate in such an ECO-Caspian Energy Clearing Union then rather than oil being priced in U.S. dollars and gas priced in oil as now, then we may perhaps come to see U.S. dollars, regional electricity and crude oil all priced against natural gas.”
Mr. Cook concluded by saying: “It is only a dream now, but as markets became comfortable with the use of natural gas and other energy currencies, and the transition proceeds, then existing national currencies – and eventually the U.S. dollar itself – would eventually come to be fixed against a standard unit of energy within what will have become a networked International Energy Clearing Union.”
Peak demand
OPEC has cut its demand forecast for 2016 and has said global consumption will grow by 1.2 million barrels per day, about 50,000 barrels per day less than it previously forecast. The IEA said it expects growth in global oil demand will ease to around 1.2 million barrels per day in 2016, below the 1.8 million barrels per day expansion of last year, with demand growth expected to cool in China, the United States and much of Europe. This takes no account of how much of current demand is for energy security reasons (strategic stocks) or for financial reasons (oil reserves becoming preferable to dollar reserves).
The current oil market situation sees oil producers and exporters (OPEC non-OPEC) in disarray, and several analysts, including Mr. Cook, believe that the oil price will yet test new lows before current oversupply finally clears.
Many analysts agree that the dollar-based financial system and commodity markets are not only unsustainable but are in fact broken beyond repair. However, there has to date been no practical proposal for a viable alternative system, still less a proposal of a mechanism for transition between them.
Mr. Cook’s proposes to bring together and incorporate into a prototype energy clearing union the existing Energy Swap agreements initiated by Iran such as gas exchanged for electricity with Armenia, gas for gas exchange with Azerbaijan and Turkmenistan as well as Iran’s Caspian Oil Swap for Persian Gulf oil.
ECO–Caspian energy accord
A prototype aimed at initiating a new ECO- Caspian gas framework and market instrument in the course of the 4th ECO Energy/Petroleum Ministerial Meeting during 2016 may be included on the agenda and has the potential if accepted, to open up new avenues for resolving many of the most intractable current economic and investment issues.
*The article is written by Mahmood Khaghani, former director of energy, minerals and environment-ECO secretariat
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