USIP hosts an online roundtable among three experts on the crisis with oil in Sudan and South Sudan and how it might unfold. 

Oil, the Two Sudans and a USIP Roundtable: Whither South Sudan's Oil?
Photo courtesy of NY Times

Sudan and the newly independent South Sudan continue to be at loggerheads over whether South Sudanese oil can be sent through Sudan to get to market – and how much South Sudan should pay to use Sudanese pipelines and refineries. Numerous rounds of negotiations between the parties have yielded little progress, and in January South Sudan shut down all its oil production, accusing Sudan of stealing significant quantities of its oil. South Sudanese oil wells remain closed as its leaders speculate about building alternative pipelines through Kenya or Ethiopia and Djibouti. With tensions between these former foes rising, USIP is hosting an online roundtable discussion between three experts in oil politics – Dr. Raymond Gilpin, director of USIP’s Center on Sustainable Economies, Dr. Paul Sullivan of Georgetown University and Dr. Jill Shankleman, a former Jennings Randolph fellow at USIP and an oil consultant based in the U.K.

Some believe that shutting down oil production in South Sudan will ultimately have an impact on American oil prices. Do you agree?

Jill Shankleman: Shutting down oil production in South Sudan is one of the factors affecting American oil prices. But it is only a minor factor. The fundamentals of crude oil are that for several years, global consumption has been increasing faster than global production. This underlies the upward trend in oil prices that will not go away until large new resources come on stream - such as the Brazilian reserves that are now starting to be developed. But it will take years before this affects supply.

On top of the underlying trend, and because supplies are tight, prices respond sharply to disruptions to supply and demand. At the moment, global crude oil supplies are down about one million barrels a day (bpd) from interruptions to the supply from South Sudan, Syria and Yemen. Of that, the loss of approximately 350,000 bpd is from South Sudan. Technical problems (now resolved) have reduced output from the North Sea. Meanwhile Japan has increased oil imports for power generation by 350% due to the more or less complete shutdown of nuclear generation from the earthquake, reportedly now drawing in 730,000 bpd for power generation alone. Other countries are increasing imports to build up their stocks - Thailand for sure, possibly India and China too. This demand, of course, falls outside the overall trend of increased consumption particularly in Asia.

Overhanging these actual disruptions to supply and demand are actual and anticipated falls in production from Iran related to the nuclear crisis. Iran's output is already dropping. But by summer demand is expected to fall by 800,000 bpd when European Union sanctions kick in fully. This itself will keep prices high. Should there be an escalation in Iran, an attack on the nuclear facilities or disruptions to Gulf oil shipping as Iran has threatened, then oil supplies and prices will go through the roof.

The role of trading and speculation in oil markets is complex and contentious. But it is clear that in the current situation, prices are highly volatile to news and events, whether or not these actually mean a change in the actual supply of oil. Hence the headlines on March 15, “Crude tumbles as leaders discuss supplies,” on reports that President Barack Obama and U.K. Prime Minister David Cameron have discussed releasing supplies from strategic oil reserves.

American oil prices are unusually sensitive to volatility because, compared to other developed countries, gasoline is so lightly taxed in the United States. In the U.K., where I am writing this, only 40% of the pump price is due to the cost of fuel. Sixty percent is taxes.

So if South Sudan starts producing oil again, this will get headlines, and may generate a downward blip in oil prices, especially if the Iran crisis was over. But because South Sudan is only a small producer, the impact on America’s oil prices will be small too, and may well be overwhelmed by other factors. But the impact of South Sudan turning the oil spigot on again will have the greatest impact on the people of South Sudan, and that would be much greater and positive.

What are the potential consequences of maintaining the shutdown in South Sudanese oil production?

Paul Sullivan: The potential consequences for both Sudan and South Sudan are complex and could prompt more instability and strife within and between the countries. South Sudan relies on its oil revenues for 98 percent of its government revenues outside of aid. Oil is the major export of South Sudan. It is the major source of hard currency. The South Sudanese economy is one of the most oil-reliant states on earth. It is a very poor country in need of much human and infrastructure development. Its government is sorely lacking in the capacity to deal with many of the problems it may face. The government needs to pay the Army, police forces, other security institutions, as well as civilian government workers and more. The country is in great need of road building, clinics, schools and more. South Sudan faces a steep and long road to economic and human development. Closing off its main source of income seems to make little sense from the perspective of the needs of the people of the country.

Many places in South Sudan are either already unstable or heading in that direction. Having less money to go around for security, development, employment, maintenance of infrastructure and more could make these situations more unstable and violent. The longer the oil is shut off, the longer South Sudan will be shutting off its major source of income.

In addition, the longer the pipeline is shut the longer the pumping stations and other important machinery related to the pipeline will remain idle and prone to rust and other problems. The longer the pipeline is idle, the longer the oil fields will not be kept up to speed and maintained properly. There could be damage not only to the field equipment, but also to the fields themselves. South Sudan may also lose more and more of its skilled labor and managers the longer this goes on.

For Sudan, closing off the oil flows means a huge drop in their government and export revenues, and more, depriving Sudan of needed resources to pay its Army and other security forces. Naturally, that will create tremendous stress within the security forces at a critical time. The north is also facing increasing instability, especially from the youth. Unemployment and underemployment amongst the youth are vast. Not having enough money to help spur further government and other employment will not help the situation.

There also seem to be fissures in the elite of the country as the economic situation becomes clearer. Much of the loyalty to Sudan’s Gen. Omar al-Bashir has come from patronage schemes, crony capitalism, and just plain corruption. This is far more difficult to do with less money flowing into the treasury. The Salafists are becoming more powerful. The Sufis are losing political power. The situation for Sudan could become far more unstable, and soon, due to the vast decline in revenues.

Tensions between the two countries are also rising as each accuses the other of trying to threaten the stability of the others. The longer the pipeline is shut off the greater the chances are of conflict within – and between - each of the Sudans.

What issues does South Sudan face in exporting its crude? 

Raymond Gilpin: Negotiations between the two Sudans have stalled because of a seemingly intractable disagreement over pipeline charges. Khartoum expects to receive roughly $36 per barrel from South Sudan, while Juba considers something in the region of $6 per barrel as a fair price. Citing international precedents, both sides appeared to have painted themselves into a corner and a compromise has proved elusive.

Meanwhile, the pipeline that transports crude oil from oilfields in South Sudan to Port Sudan for export has been shut and trade has been halted. In addition to having an immediate fiscal impact in both countries, this development also has broader operational implications. Most of the oil produced in South Sudan is the heavy Dar blend and shutting the pipeline for a protracted period could create problems when the spigot is turned back on. There is also the possibility that significant reputational damage resulting from this spat could deter potential investors. Prospecting for new oil deposits could require specialized technology and expertise. Companies in such niche markets could be risk averse if significant doubts are raised about the regulatory environment and contractual compliance in both countries.

South Sudan views the pipeline as a key vulnerability that perpetuates a de facto dependency on its northern neighbor. The country is actively seeking alternatives. These include the construction of other pipelines (proposals have been tabled to construct pipelines to Lamu in Kenya, Djiboiti and Kinshasa in the DR Congo). The South Sudanese government believes that they could survive what it hopes would be an 18-month wait for a new pipeline (this would be an incredible fiscal feat, since South Sudan depends on oil exports for over 90 percent of its revenues). A new pipeline would be costly. Most estimates put the cost of a new pipeline to the East African coastline at $1.5 billion.

Any potential investor would be concerned about two broad issues: rewards and risks. Rewards are uncertain, primarily because very little is known about existing reserves in South Sudan. Also, output from existing wells is declining. A commercially viable pipeline would require consistent and assured through-flow above a threshold for an extended period. As things currently stand, South Sudan alone cannot guarantee this. This is why many observers believe that such an initiative could only be viable if it is part of a regional grid connecting new oil fields in Uganda and DR Congo, for example. While this is financially attractive, regional collaboration on this scale would be fraught with tremendous difficulties. In addition to negotiating complex cost-, burden- and profit-sharing agreements, the collaborating partners would also have to contend with anticipated downstream activity (i.e. refining) in the exporting country. In addition to financial risks, a new pipeline would also face significant security risks --- whether the pipeline goes east or west. Mitigating security risk could affect premiums, add costs or constrain potentially-interested parties.

Rail transit has been put forward as another alternative to transport crude to the ports. Proponents argue that construction could be easier and possibly cheaper. They also contend that the railroads are multifunctional and could boost regional trade. Railroads could be cheaper, but acquiring and maintaining the insulated and heated rail cars would increase both capital and recurrent costs. The single railcar carries 600 to 800 barrels. Roughly 500 railcars would be required to transport the 400,000 barrels/day South Sudan is likely to produce in the short- to medium-term. The loading facilities would be handling an average of 20 railcars each hour (assuming they work 24 hours a day). This is a logistical and operational challenge for participating countries. Besides, the sheer volume of crude-related rail traffic would seriously limit the multifunctional capacity of the rail system. Railroads offer flexibility when there are multiple destinations for refining/export (as in the U.S.). A single destination is seldom cost-effective, as Kazahkstan is finding out with its TengizChevroil rail transport system.

No matter which infrastructure alternative is adopted, South Sudan will still be faced with tremendous challenges. Everything from tariff negotiations, cost-sharing, capacity building and sector governance would need to be addressed fairly expeditiously. It is also worth noting that the net fiscal impact might not be as favorable when all costs and new responsibilities are factored in. There are also additional problems associated with effectively severing crude oil ties between both Sudans. Oil is not the only thing that connects Sudan and South Sudan. Brinksmanship in oil negotiations could muddy the waters in other areas (like non-oil trade, movement of people, human rights, etc). Reaching a practical compromise requires some recognition that having both parties painted into their respective corners is unhelpful and untenable.

A compromise should be reached via muscular diplomacy involving both parties and all external stakeholders. While infrastructure is not the biggest problem facing both countries, a helpful compromise in this area could unlock fruitful collaboration and peaceful coexistence between Sudan and South Sudan.

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