Meet the oil world's marginal producers.

A cheat sheet for the news.
May 10 2006 11:56 AM

The Little Guys of the Oil Business

Meet the "marginal producers."

With the stream of alarming news coming from Iran, Iraq, and Nigeria, media reports of turmoil in places like Chad and Ecuador often go unnoticed. But in an exceptionally tight energy market, political uncertainty in some of the world's largest energy-exporting states gives new importance to the so-called marginal producers: countries that produce between 100,000 and 1 million barrels of crude oil per day. That's why markets took note when Chad's president, Idriss Deby, threatened in April to shut down his country's 180,000 bpd of oil production, and when Ecuador's parliament passed a law in March that substantially increases the government's share of oil profits at the expense of the foreign firms operating there.

The world's oil suppliers are still able to provide the 85 million bpd that the world now consumes—but just barely. Spare capacity is limited to about 1.5 million bpd from Saudi Arabia. So, an output disruption in even a marginal producer affects global markets, and some of these states are prepared to leverage their new market power to political advantage.

Consider Chad, one of the world's poorest countries. The World Bank had conditioned financial support for Chad's oil industry on a government pledge to allow the bank to direct 85 percent of energy income into badly needed poverty-reduction, health, and education programs in the country. In January, when Chad's parliament voted to funnel more of the proceeds directly into the country's treasury, the bank froze the funds. Armed with new market influence provided by global price increases, in April Deby threatened to shut down all Chad's production unless a consortium of foreign firms led by ExxonMobil paid his government about $100 million in taxes.

Deby needs the money. On April 13, Chad's military repelled a surprise rebel attack on N'Djamena, the capital, that was intended to oust him from power. Hundreds of rebel fighters were killed. But unless Chad's military receives an infusion of cash, its government cannot quell the unrest produced by those who don't share in the country's natural wealth or support Deby's approach to the violence in neighboring Sudan.

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The president's threat produced results. Chad and the World Bank reached an interim agreement on April 26 that increases the percentage of oil income that will flow directly into Chad's treasury from 15 percent to 30 percent. Whatever his promises to international lenders, Deby will probably spend the extra cash on guns. Chad's oil is more valuable than ever, but the country's underlying instability remains.

Ecuador's government has also recognized its new leverage. The hydrocarbon law its parliament approved in March sharply increases the percentage of oil profits the government will claim and violates the country's production contracts with more than a dozen foreign firms. Ecuador produces about 530,000 bpd, but the true measure of its market power comes from the 190,000 bpd it exports directly to the U.S. West Coast, making it the third-largest foreign crude supplier to the Western United States after Saudi Arabia and Iraq. Even small cuts in these supplies would be hard for the Western states to replace.

Ecuador is unlikely to follow Chad's lead and threaten a production shutdown, but the country's frequent strikes and production stoppages—including one in 2005 that interrupted crude supplies for two weeks and helped drive up the price of New York-traded oil futures by about $2 per barrel—pose substantial risks for U.S. markets.

Many more of these marginal producers pose risks for consumers. Africa provides nearly 20 percent of U.S. oil imports, mostly from the Gulf of Guinea region. Widespread piracy off Africa's west coast could affect U.S.-bound oil supplies from countries like Angola and Equatorial Guinea, the second- and third-largest African exporters of oil to the United States after Nigeria.

In the Arabian Peninsula and Persian Gulf region, two marginal producers in particular face domestic challenges that could undermine their ability to maintain production levels. Yemen now produces more than 400,000 bpd, but the country's weak central government will struggle to ease domestic social tensions and manage threats from Islamic militants in the lead-up to September's presidential elections. Bahrain, which produces nearly 200,000 barrels of crude per day, is a majority Shiite state ruled by a Sunni royal family. Sunni-Shiite violence in Iraq could fuel sectarian tensions there. Another reason that political strife in Yemen or Bahrain could add to global price fluctuations: Both states border major oil production and transit points.

In the Caspian region, political conflict in Azerbaijan could disrupt supplies. Despite his re-election last November, President Ilham Aliyev's ability to implement policy is limited by an emerging group of oligarchs. In addition, tensions have re-emerged with Armenia over the disputed enclave of Nagorno-Karabakh, the site of a war between the two countries in the early 1990s.

Some 400,000 bpd will flow through Azerbaijan toward the Mediterranean by the end of this year via the newly opened Baku-Ceyhan pipeline; as many as 1 million bpd are expected by 2009. While another war over the enclave is unlikely, even low-level fighting there could threaten the pipeline, which passes within 10 miles of Nagorno-Karabakh's northern border.

What's more, the market power these states now enjoy may well breed new political turmoil, as increased investment and inflows of cash give competing domestic factions more lucrative spoils to fight over. In the Republic of Congo, a country that produces a little over 240,000 bpd and is already plagued by ethnic unrest and threats of civil war, high energy revenues have fueled rampant corruption. In recent years, an estimated $500 million have changed hands there in black-market oil trading. The state-owned oil company SNPC has sold hundreds of millions of dollars' worth of cut-price oil to private businesses with ties to the government. The country faces threats from southern-based rebel groups who hope to oust President Denis Sassou-Nguesso and win a greater share of the new wealth. Rich offshore reserves have fueled maritime disputes with some of the country's neighbors.

Conflicts in some of these states also increase tensions between the most powerful consumer nations. The United States is currently leading efforts to impose international sanctions on Sudan in response to government-supported violence in the country's Darfur region. Sudan is expected to produce about 500,000 barrels of crude per day by the end of this year. More than half its oil exports flow directly to China, which has blocked sanctions on Khartoum in the past and threatens to do so again.

The tight oil market has given energy companies, particularly smaller independents, new incentives to scramble for contracts in less familiar states. To protect their market shares and to profit from rising prices, these firms have little choice but to accept the risks that marginal producers pose for their investments—and for the industrialized economies that are increasingly dependent on their product.

Oil production data from International Energy Agency annual figures for 2005.

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