The renewables driven revolution in electricity pricing

Away from the public eyes, one of the most radical transformations of wholesale electricity markets in the last 100 years is occurring. Since the time of Thomas Edison, almost all the electricity that we use has come from the combustion of fuels. By releasing the latent energy in coal, gas, wood or oil, we convert latent energy into heat, and use that heat to create steam. The steam forces a magnet to spin around a set of wire coils, thus creating a current. It is this innovation in science that created the modern world, but today a growing proportion of the developed (and developing) world’s electricity no longer comes from fuels. I am of course talking about wind and solar.

When power is created from the combustion of fuels it is dispatchable. This means that it can be turned on and off whenever the owner of the power station wishes. While a Nuclear plant will often generate electricity around 92% of the time, making it effectively a constant (hence “base”) generation source, most fuel based generation sources run for much less time. In the USA, coal and gas plants often run less than 60% of the time. By contrast wind and solar are not dispatchable. Rather, their production output is variable. Wind and Solar do not require a fuel to create energy, but they cannot control when they will produce electricity. It is this contrast that is at the crux of the challenge.

To ensure a power grid has sufficient electricity for all consumers, a grid operator such as National Grid, must estimate demand and source that demand on an annual, monthly, daily, hourly and sub-hourly basis. In complex power markets like the UK, the sourcing of electricity supply comes from an auction system. This is why wholesale power prices are in upheaval.

To match supply with demand, national grid asks companies that produce electricity to make offers to supply electricity. Each company states how much electricity it can supply and the price it will accept to supply that level. These prices are then sorted from lowest to highest and national grid will accept all bids necessary until it reaches the supply level it requested. This is called “Merit Order Dispatch”.

To explain this is shown in the table below:

Electricity needed 100MW   
Clearing auction price £30/MWh  
       
Bidder name Bidding price Quantity of power offered Quantity of Power Accepted
Wind 1 £10/MWh 20MW 20MW
Solar 1 £20/MWh 20MW 20MW
Nuclear 1 £25/MWh 30MW 30MW
Gas 1 £30/MWh 30MW 30MW
Coal 1 £40/MWh 30MW 0MW

As wind and solar have no fuel, their cost to run is essentially zero. As such they can bid any price they like. For Nuclear, the cost of fuel is considerably less than building the site, so it also bids a low price. By contrast gas and coal have to buy their fuels to combust them. As shown in the table above, coal can’t compete against wind and solar on cost and so it losses the auction. Everyone else is paid the marginal cost of production, which is the amount that gas receives (£30/MWh) and they supply the grid.

So what does this mean? Essentially as we build more wind and more solar, we will increase the number of electricity supply bids into the market which are below the viable level for any fuel based generation. This is why the USA’s Department of Energy wants to pay a subsidy to coal and nuclear. As wind and solar are not dispatchable, there is a concern that all dispatchable fuel sources will be unable to compete in the price auctions for the majority of the year, except for periods when electricity demand is extremely high. That would make most plants economically unviable, as they would be required to cover all of their capital costs, maintenance and staffing, based on generating electricity for less than 50% of the year. If these plants go, then what will provide the electricity when the sun goes down and the wind doesn’t blow? That is the question that energy market regulators are asking in the UK, USA, Europe and across the developed world.

To many the concept that renewables are cheaper than fuel based sources doesn’t seem correct. Indeed, most renewables remain more expensive than coal (though not in all areas and not by much), when considering the total cost of the system. But it is important to understand that wind and solar are fundamentally different in how they are financially structured and that explains the pricing disruption. Operations and maintenance of renewable power plants are minimal. Building the assets is the expensive part. As a result, Renewables always want to sell their power at any price in order to re-coup the cost of construction. By contrast a coal plant or gas plant will lose money if they try to sell electricity for below the cost of their fuel source. This gives renewables an incentive to bid almost zero, thus guaranteeing that they will be able to sell almost all their electricity they generate at any time.

This is actually worse in countries that have adopted a renewable government subsidy called a Feed-In-Tarriff (FIT). Under a FIT, the government guarantees the owner of a renewable company that they will receive a fixed price for the production of their electricity. However, the electricity has to be generated and supplied to the market in order to claim the subsidy. As a result, renewables have no incentive to put in competitive prices for auctions because they already have a fixed price.

What does all of this mean though for businesses, consumers and investors? Well for now it means that the annual average wholesale cost of electricity has fallen in countries like the UK on a constant basis. That also means that most households and industries have paid less in energy bills than would otherwise have been the case.Wholesale market

But while the costs of electricity have fallen, other costs are occurring across the system. As coal and gas plants cannot compete in the market they are forced to close the plants early and suspend new constructions. A great win for climate change, but an outcome that has cost European utilities half a trillion euros according to the economist. In California, where solar PV deployment is high, prices in the wholesale market now go negative for periods of the day. Yes that is correct. Producers effectively pay other people to take the power that is being produced. In the same is happening in Germany.

The move towards greater renewables in the electricity mix is vital. But like any great transformation there will be unintended and unanticipated consequences. The greater the growth of renewable energy, the more inevitable it will become that wholesale power markets will change. If consumers are focused that could potentially lead to longer term price stability and cost savings. But only if they know where to look.

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The Case for BREXIT

The starting gun has been fired and now begins the race. By the end of June 2016, the UK will have made the most important decision it has faced in 25 years. Do we stay or do we go?

The BREXIT debate is one of identity, and it is on this issue that the referendum must deliver a clear answer. The question of Britain’s role and place in Europe has always been defined by this question: are we Europeans or are we something different?

Many misunderstand this notion. To say you are different makes people uncomfortable. In this context, it inspires claims either that British people are exhibiting national chauvinism or that they are being willfully ignorant of the realities of today’s world. These claims, however natural they may be given the appalling narrative on immigration in Britain today, are wrong. Britain is different not because we do not share with other Europeans the common bonds of humanity, shared love and respect for liberty and human decency, respect and tolerance of others and a commitment to helping those in need. We are different because we do not believe, nor do we accept, that Europe’s methods of how to build a society are the right ones.

Most would like this vote to be about a simpler issue. The “vote leave” seeks a migration narrative, the “vote stay” wants an economic narrative. But for the future of Britain, they must both fail in their endeavours. Instead, voters should understand the clear meaning of their actions. To “vote stay” means that British people must finally accept that they have a shared responsibility to working with Europeans to help solve their problems as well as our own. To “vote leave” requires British people to acknowledge that if we do not feel a responsibility to help Europeans outside of our national interest, then we must acknowledge simultaneously that Europe has no responsibilities to support our national interest.

In the narrative of history, we must all hope that the story of Europe continues. The European Union has made life better for the continent and its people. It is a symbol of hope and idealism to many across the world, despite all its failings. But it is not our story. I believe in BREXIT because in viewing my home and those from it, I see the world differently from those on the continent. Our nation is not afraid of no longer being a titan on the world stage, nor are we afraid of a world where we do not control the global agenda. Britain has always thrived on its ability to innovate, to be pragmatic and to take risks in order to survive. Such has always been the necessity of island nations.

Europeans see the EU as a mechanism to sit at the world table in the rising new world order. As an equal to China, the US and to India. Today’s modern Britain does not see that necessity. The reality of the modern world is that no nation, or body of nations, can unilaterally determine their economic environment or their security environment. The age of autarky and isolationism is dead. The challenge of our time is not do we choose to work with others, but how we choose to do so. In this context, one must always remember that national interests reflect national character.

The UK does not believe that protectionist trade tariffs, strict labour laws, state controlled economies or heavy state regulation leads to a greater quality of life for our people. The history of our nation shows that our prosperity has been driven by the periods where we innovate, where we seek out new ideas and where we search the world for new markets. The wealth of our nation similarly should never be dependant on one single trading block. It is often forgotten that before the European Union the UK’s biggest trading market was India. Why it is that such a pattern could not re-emerge is one of many unanswered questions that the “Vote stay” movement has yet to address.

The security of our nation has been achieved through the strength of our national endeavours. No foreign-armed force has landed on the British islands in over 300 years and when left alone to defend our citizens rights abroad, we have shown our ability to act unilaterally to protect them. Many mistakenly associate peace in Europe with the European Union. This is wrong. Peace in Europe has been achieved by NATO and de-facto by America. The “Special relationship”, for all its failings, has always been the recognition by Britain that Europe lacks the motivation internally to unite collectively in its own self-defence. If evidence of that were ever needed, the use of NATO in the Balkans and the European reliance on new US armoured brigades in Eastern Europe, provide two immediate examples (there are of course others). The Freedom of our nation therefore will always rely, first and foremost, on our own efforts and our relationship with the US. As to threats of terrorism and transnational crime, it is often forgotten that the UK’s worst period of terrorism came during the “Troubles” in Northern Ireland. If at the height of the cold war our allies were unwilling to help us when it conflicted with their national interest, it seems disingenuous (to say the least) that this will change in the future.

The challenge facing those who campaign to leave has been to explain “what comes next”. Setting aside the unchallenged assumption that staying in Europe will ensure that the UK follows a clear and predictable path for 20 years, it is not unreasonable to say that a vote to leave also requires a plan on how to leave and what should happen after we leave. As with all well laid plans, few survive contact with reality. Assumptions of behaviour and of processes are notoriously challenging even where precedents exist, let alone where they do not. But setting these aspects aside, a strategy for the UK would go as follows.

Following a vote to leave the UK will not immediately leave the EU. This is the reality and yet it appears often ignored. The UK will enter into a period of negotiation on the terms of our exit, while remaining in the Union. The negotiations are likely to require 4-5 years and, in essence, they will require the UK to accept EU governance for its companies who wish to trade in Europe. Conversely, European firms who wish to trade in the UK will have to follow English laws and governance. As most global regulation is increasingly being harmonised, over time there will remain few significant differences in regulation between the two. On immigration, the UK will move to a points based system. In so doing, it will significantly ease work and residency related visa requirements for Australian, New Zealand, US and Canadian nationals. Over time, these restrictions are likely to be expanded to other commonwealth states as their levels of development increasingly reach parity with our own.

From a trade perspective, we will work with the WTO to expand its effort for a new set of global standards and a reduction in global trade restrictions. We will also explore deals with ASEAN and other regional markets across the world. Such action was how we once thrived. We will re-discover this talent, as many of our young entrepreneurs already are doing.

At the International level, the UK will continue to sit and act in partnership with European nations. We will join with Canada, Australia, Norway, Switzerland, Turkey, New Zealand (and occasional the USA and Japan) as part of the EU+ grouping which exists within the major multilateral banks and other international organisations. On security matters, we will remain committed to the defence of Europe and particularly Eastern Europe, where we have already increased our presence and where we played an instrumental role in bringing these nations into both the EU and NATO. For issues of transnational crime, a bilateral extradition agreement will be made with the EU as part of our terms of exit. On this last matter, there is little disagreement between the EU and the UK and little incentive from either party to prevent such an outcome.

This is the case for BREXIT. A UK that remains a friend and partner of Europe, whilst remaining an independent nation state that pursues the best interests of its people on its own terms. To “Vote leave” is not a rejection of liberal values and a statement of disregard for the well-being of Europeans. Instead, it is a re-assertion of the well known principle that the best form of governance is self-governance. It is time British people remembered this principle.

To my countrymen and women, whatever your opinion, please make sure that you vote on 23rd June. This is our future and I hope you vote to leave with me.

The Good, the Bad and the Unknown – Predictions for 2016

To kick off the 2016 period, I thought I’d share some thoughts on the world as things stand and offer some predictions for the year.

Missing Billionaires, a lost election in Taiwan, abducted Hong Kong Journalists, a public rebuke to George Soros and suggestions that China’s economy may be growing at nearer 2.4% than 6%….2016 is certainly an interesting time to watch the Middle Kingdom. For my two cents the Chinese seem spooked, but their actions appear to be precautionary measures rather than those driven from a general fear that all hell will break loose. Expect more bad news and panics in the market, but that is unlikely to reflect a true collapse in the Chinese economy and a “hard landing” is still far from predictable.

From the Iran side, it remains “too early to tell”. What seems clear is that the oil oversupply argument is over-hyped. Iran already exports circa 1m barrels per day and likely smuggles 300-500k a day. At most it can add another 1m, but even that is uncertain. At the same time global oil production is at maximum, so the system has no spare capacity should a shock hit a major supplier (look to Venezuela for a possible negative oil shock by the end of the 2nd quarter 2016).

The Refugee crisis seems destined to dominate the EU discourse. There remains no easy solution, short of following the advice of an article from The Times and letting migrants drown in the Aegean (with mercy killings for those who survive their ship sinking). The mood however is clearly ugly and this looks unlikely to change. With Europeans feeling poorer and more afraid than ever, expect the ugly monsters of racism, extreme nationalism and xenophobia to provoke ever harsher measures. Still, these will deter none. The alternative remains worse for the refugees. Watch the Greek-Macedonian border for the first signs of trouble.

Brexit will still loom large in the UK, but investors and politicians will be forgiven for their lack of patience. At the end of the day, this is nothing to do with economics or politics and everything to do with Britain’s identity and place in the world. The UK will likely become more insular in its affairs leading up to June and no meaningful concessions will be made to Cameron. Still the Out campaign have their work cut-out. The lobby of big-businesses and institutional vested interests, coupled with British inertia to radical change, gives the edge to a “yes” vote to stay in Europe. Still, Labour is not as pro-Europe as it has been, with many Corbynistas seeing the possibility of Brexit as a chance to allow state-aid and interventions into the private sector. However don’t rule out Cameron bottling the whole thing and waiting till 2017. After-all Brown made the same mistake when he failed to call a General Election in 2008, despite holding the upper hand.

Lastly the US election. My increasing feeling is that Trump will actually get the nomination. The other “moderates” have run out of time and increasingly the view is that any establishment branded candidate is doomed in the current political atmosphere. Given the evils of Trump or Cruz, most commentators overwhelmingly back Trump to make the deals necessary to secure the establishment support at the final hurdle and knock out Cruz. This then creates two challenges – do the Democrats react with their own radical (Sanders) or play it safe with Hillary? Hillary is dull and a known entity, rightly many are asking whether she could energise a campaign in the same way that Trump has energised his parties base. It is still highly unlikely, but I reckon there is a 25% chance of a Sanders v.s. Trump campaign and of Americans being offered the most divisive split of candidates in a generation. Of course, at that injunction maybe we will see that famous “3rd party” entrant, with Michael Bloomberg looking very dangerous in such a role. If, and its a big if, that becomes the 3 way split in 2016, the outcome will be huge for America and the world writ large.

The Myth of “The United Petrostates of America”

Firstly my apologises for the delay in writing another article. It has been a busy few days, but now back to the title!

On Monday the well-known US publication, Foreign Policy, published an article on how the US would be transformed by the advent of Shale gas and become The United Petrostates of America (for the link click here). Of course this assertion is absolutely laughable.

Firstly the advent of US Shale will not lead to massive exports of Oil and Gas from the US because other domestic US energy sources (Coal, traditional oil + gas wells) are declining and also because other developing nations like China, India and Brazil have a plethora of other less politically sensitive sources of Petroleum products they can access.

Secondly, the US Petroleum industry primarily exists to service the production of US goods for US consumers and whether that is for transport needs (in a vast territory with poor public transport) or heavy industry like Chemical manufacturing, Ship building, Car building, etc. In short the US does not export what it needs at home and so does not get the boost in its trade figures with other states.

The Last error however is the assertion that the export of Shale oil & gas will boost the strength of the dollar. Now assuming the author of Foreign Policy by some miracle is correct, this is not the reason why the US dollar is strong against other currencies, it is because the Dollar is the world’s currency reserve. The value of the US dollar is high because in times of insecurity people put their money in Dollars because of the long held belief that the US will not default on its debts. Excluding those who write about the decline of the US from a position of desire not knowledge, and the mythical “Credit-ratings agencies” (if they even still deserve that name) people trust the US to pay and are almost blind to any other considerations, see the decline in US 10yr bond yields when the US had its Triple A rating cut for the first time.

In addition the US debt (now in excess of USD$14 Trillion) is, contrary to popular belief, largely held by Americans. The citizens of the US and global investors now the US will pay its debts because over $9 Trillion of that debt is owed to fellow Americans. Thus the incentive to default on citizens and institutions of the state itself is, in essence, non-existent.

All of these things combine to a very simple point that seems to be missed in the US discussions of Shale gas, what is the US net increase in Energy supplies? If we look at the historic growth in US natural gas over a 20 year period, we see that consumption of gas in the US rose from 19.17 TcF in 1990 (from all Sources) to 24.09 TcF in 2010. To put it more simply, between 1990 and 2010 US gas demand grew by 25%, yet over the same period the US production of natural gas only grew at 21% (17.81 TcF to 21.58 TcF). To add to this even further, the growth in US gas supply between 2012 and 2032 is predicted to increase at an even slower level of 15% over the whole period.

Thus the key point is that US Shale Gas is not a “Bonus” to US energy supplies, rather it is the critical lifeline preventing them from a huge collapse. According to the EIA the US is expected to increase its supply of gas (as mentioned above) from 23.65 TcF of gas (from all sources) in 2012, to 27.27TcF from all sources by 2032 but if the growth in gas demand increases by the same factor as it did between 1990 and 2010 then there will be a net deficit.

Last thoughts to add here: if the US population grows by 15% between 2015 and 2035 (prediction from US Census) and Obama and Republicans want to see the US boost domestic manufacturing to boost their exports (despite the growth in gas demand occurring during a decline in US industry), will the US still have to import gas even with Shale?

Militarised Multinationals?

Why the decline in State Security forces is leaving the private sector to provide its own security.

Since the 1990’s Immanuel Kant’s perpetual peace thesis, nowadays better known as the Democratic Peace Theory, has returned with a vengeance. The theory, for those who were spared having to actually read Kant (a good save there) is that Democracies do not fight democracies and so as the world has become more democratic it has become less violent.

Now admittedly this topic has primarily stayed as a bitter debate in the academic world of International Relations, but what is important for those without MA’s and PhD’s in Political theory is that the nature of warfare and violence has been changing.

Since the 1990’s (and well before too) there has unquestionably been a dramatic rise in violence conducted by non-state actors, with the most famous contemporary group being probably Al Qaeda (with the IRA, FARC, MEND and ETA all being close contenders too). But the problem with saying the world is less violent because less states fight each other is that this argument becomes a political cover for politicians to cut defence spending, and contrary to popular belief this is a problem.

Taking aside the ridiculously expensive F-35 programme (at over $200 million a jet on current estimates) and the Trident nuclear submarine project (at £100 Billion for 4 submarines over 25 years), the British armed forces has never been smaller. By 2015 the Air force and Navy will number under 70,000 on current estimates with only 120 fighter jets (the same number as Belgium) and 80,000 members of the army across all disciplines (engineers, artillery, infantry, armour). And Britain is not alone.

Only 5 members in NATO managed to keep to the charters 2% of GDP on defence spending in 2012 and this may fall even lower in 2013.

So why is this relevant and how does it fit into this articles premise? Quite simply, I want to argue that as governments reduce their ability to provide physical security against the threats of violence by non-state actors, businesses will take their personal security into their own hands. And in fact this is already happening.

Marine Piracy and the Private Sector:

Piracy since 2007 has largely been internationally associated with one word, “Somalia”. In a country where the state has not technically had an Armed Forces since 1991 and where the UN and USA have been forced to pledge commitments of around $390 Million to the AMISOM mission it is perhaps not surprising that piracy has been able to flourish. What had been so surprising was its success.

With certain vessels like the Samho Dream being released after the payment of $9.5 million (2011) and an estimated $135 million being netted in ransom payments in 2011, it is hardly surprising that piracy groups proliferated and became so well equipped at such a fast level. Combine that with an area of over 3.4 Million km2 at risk (IISS) and the fact that round 22,000 vessels pass through the Gulf of Aden each year and it’s not hard to see why 802 people had been taken hostage by pirates in 2011 on the East and West coasts of Africa.

In fact between 2008 and 2010, NATO claim that 131 vessels were hijacked and 315 vessels were physically attacked by pirates. As a direct consequence of this an estimated $7.5 billion is now being spent by navies from across the world under 3 separate multinational missions, which would seem to emphasise that the issue is being taken pretty seriously.

Sadly though it is not the response of governments that seem to have led to the much lauded reductions since 2012. According to data from Lloyd’s List there was nearly a 65% reduction in piracy attacks in 2012 and what people are saying behind the scenes (and seeing in the budget sheets) is that this change all comes down to one main reason, Armed Guards.

Since the advent of Armed Guards there has been a significant drop in successful piracy attacks and then you have Typhoon. Typhoon is a private security firm that provides close quarter support for convoys of vessels traveling through the Gulf of Aden and is being rolled out in collaboration with Glencore. The firm aims to replicate the tactics of pirates by using smaller fast response, armed patrol boats, launched from mother ships to counter the pirates using their own tactics. By using this method Typhoon believe they can deliver a more robust and effective deterrent to would-be attackers in a far cheaper and more advantageous way than the Royal Navy can.

In effect, the private sector has the flexibility to adapt rapidly to demand where there is a personal financial gain. Armed forces and certainly naval forces cannot.

Whilst Typhoon is just limited to the Gulf of Aden it is important to note that the highest region in the world for piracy historically and in 2012 is actually Indonesia. In addition West Africa and many of the Littoral South-East Asian states experience significant piracy threats, in particular in the Malacca straits. With an increasing amount of global trade going through more politically insecure areas and the value of vessels increasing (think of the ransom on an 18,000 TEU Maersk C-Class vessel) the relative success of Typhoon will be watched closely and almost certainly emulated in some form.

Most significantly in this rise of privatised security arrangements are the terms of engagement these new actors adhere to. Yet again the lead in this respect has been left to a variety of non-governmental bodies like the International Maritime Bureau to listen to the concerns of their members (shipping companies largely) and then recommend best practises. The reality however is very complicated.

As the demand for armed guards has soared, the cost and quality for these PMSC’s[1] has continued to diverge and the lack of reporting when arms have been discharged is a growing concern for those maritime forces operating in the region. In essence the issue is becoming one of which the PMSC’s are able to decide what is a legitimate target and what is an appropriate level of response and may hide behind flags of convenience and the legal ambiguity of combat in the high seas. The lesson being taken is clearly that if security is left to private actors then private actors will also take the lead on establishing how they provide their own security. 

Oil and Gas – Africa and the Middle East

As the recent situation in Algeria has demonstrated, Oil and Gas workers are always a high value target regardless of their location. The very fact that this particular BP facility was so far from the Mali border, where AQIM[2] are said to operate, is merely a further reminder that private sector actors in even relatively secure developing nations cannot rely exclusively on state protection for their security.

 Image Courtesy of Statoil

Figure 1 – Courtesy of Statoil

But the recent flurry around Algeria is just the tip of the global issue of kidnapping the employees of oil and gas businesses. Whether it is Shell employees and their families in Nigeria or BP, Shell, Exxon staff facing threats to security in places like Iraq or the high kidnapping rate in Venezuela and Colombia, there has been a long growing trend for multinational firms to seek their own security arrangements.

On the face of it again this pattern is inherently logical. A states armed forces and police cannot anticipate and protect every employee of a foreign national effectively and often the state may not have the resources to do this anyway. By contrast, Multinational companies like Shell may use their provision of private security staff to re-assure their employees and contractors to work for them in high risk areas instead of their rivals. How staff are treated in high risk areas is increasingly becoming a very significant factor within the Oil and Gas industry, with the various different levels of response to Oil and Gas firms in Libya, where Russian and Chinese nationals were effectively abandoned by their respective national industries, being a case in point. That sort of care towards staff matters.

The problem again though of relegating the security of these employees to the firms themselves is perhaps best explained by the controversy of private military contractors in Iraq. If a PMSC kills or injures a foreign national (assuming they can carry some form of weaponry, or is particularly adept with his/her hands), then how does the host state respond? If they prosecute the individuals due to public pressure then multinational firms whose investment is so desperately sought and required may not feel able to ensure it employee’s security and so may restrict their operations in that region or pull them entirely. On the other side, if individuals are not subject to local laws though this can lead to a back-lash against the government for being seen as under “foreign influences”.

General Issues:

Further highlighting these issues is the basic fact that across all industries operating in developing nations, establishing which individuals are threats and which are not is incredibly difficult. With regards to piracy, the vessels used by pirates are often identical to local fishing vessels and in certain cultures the carrying of weapons in public is not an uncommon occurrence, thus how do you distinguish between those who are carrying weapons for personal security and those carrying weapons to threaten others?

Even more worryingly many people are realising that the local state security forces may even be part of the risk themselves. The “Green-on-Blue” incidences in Afghanistan are the most high profile of these, but actual involvement by local state police with would-be-kidnappers is certainly not unheard of. Is it not perhaps un-surprising then that multinational companies are beginning to turn to the private sector for their security?

The private sector itself now provides comprehensive risk mitigation methods to enhance the security of Multinational firm’s people and assets. Whether this is in the form of better knowledge of market risks by using ControlRisks or bespoke products like the WorldRiskReview, the purchasing of Political risk insurance and Kidnap and Ransom policies or at the first (or last) stage, directly hiring PMSC’s.

Concluding remarks:

In 2004 the BBC suggested the global private security industry was globally worth $100 Billion, would anyone even be able to truly guess its value today? I doubt it. Companies like G4S and Blackwater now employee 100’s of thousands of employees each and even in combat location like Iraq the number of PMSC’s has risen from 1 in every 100 soldiers in 1991 to around 1 in 4 soldiers in 2011. The increasing use of the private sector is here to stay, and the private sector is responding to this. 

As States have gradually allowed the private sector to take responsibility for their own security, the private sector has gradually started to shape the rules and behaviour that govern their use of Private Security Providers. Furthermore, as attacks against firm continue (with a 300% increase in kidnapping’s in Mexico between 2005-2011 being just one example), the speed of these changes and the move away from the traditional reliance on the State for their security will decline.

If States do not begin to respond much quicker and more robustly to the changing threats faced by companies then there will inevitably be either a move away from the state as the sole legal source of security to a system were the private sector begins to define what is necessary for its security not the state.

 This is not just un-democratic and lacking transparency. This is a genuine concern for all states and their claim to the “Monopoly on the legitimate use of Violence” which has underpinned the modern state we live in. Governments need to start being creative or risk being outflanked on this issue.


[1] Private Military Security Providers

[2] Al Qaeda in the Islamic Maghreb

Russia 2020 – Game over Putin?

Since 1990 Russia has experienced something of an escalator ride in the nation’s fortunes. From near bankruptcy the Russian economy has bounced back since the beginning of the Putin years, largely on the back of a vast overhaul of its oil and gas industry which has fuelled the increasing spending demands of Putin’s various administrations. Yet are we about to see the Russian state experiencing another rollercoaster drop in the next decade? Here are a few humble suggestions why Russia is facing a perfect storm in 2020:

“It’s the Economy Stupid” – or more accurately it’s the Oil Price.

For most of Russia’s history its economy has been primarily driven by its primary industries which have exported the vast resources at the states disposal. But in recent years the dependency of the current Russian economy on oil and gas exports has become truly staggering. Not only does Russia’s oil and gas industry now account for 49% of the state’s revenues, but Russia also requires over 2/3rds of its gas production simply to service its own economies internal requirements.

The situation when we start to examine Russia’s much discussed export of oil and gas products gets far worse (if you are Russian). Of Russia’s 600BcM of gas produced every year, around 140BcM is exported to Europe but of that 140 BcM exported to Europe, Germany and Ukraine account for 70BcM of exports combined (at 30BcM and 40BcM respectively. To re-phrase this, Russia relies on Germany and Ukraine for around 34% of its gas sales, whilst Ukraine accounts for nearly 19% of all Russia’s gas exports. Compounding even this terrifying over-reliance, the pipelines that provide Russia’s gas to the rest of its EU markets all currently use Ukraine as a transit nation. Thus for anyone who remembers the 2009 gas crisis in Europe, this is why Russian planners are so concerned about their gas position.

Even if Russia is able to construct its South Stream project to reduce its reliance on Ukraine as a transit hub it is not only competing against the EU machine, which has aggressively tried to challenge Russian gas hegemony, but also the alternative gas pipeline, Nabucco West.

Taking aside the above issues however the baseline concern for the Russian economy is to do with the price of oil. With the US explosion of Shale gas, estimated to increases the US gas production by 25% by 2020, there will be an inevitable decline in demand for oil related products on the international market, especially as other BRIC nations seek their own domestic means of energy production. In addition, the climate change agenda and the effects of air pollution in major cities is leading developing nations like China to increasingly seek gas as an alternative to oil. The problem for Russia however is that, simply put, it gets such a good price from Europe that it won’t accept the terms China and others are offering.

The implication of this fall in the oil price is an inevitable decline in the Russian state revenues. If the price of oil and gas declines then Russia will face a choice: to reduce its current output of oil and gas to maintain the price level (assuming the rest of OPEC will do likewise) or to maintain its output but at a reduced profit (and in some cases certain projects will become close to loss making). All of which is disastrous for the Russian government’s spending pledges, including its $800 billion armed forces modernisation programme….

The energy crisis however is not just linked to the state revenues from oil and gas however. The World Bank’s latest report on the ECA and FSU states has indicated that they will need to invest $1.5 trillion into maintain and modernising its energy infrastructure within the next 20 years, yet to do this will require a large increase in the price of electricity. This then leads to the next problem of the Russian economy: a large proportion of high energy intensity industries whose main advantage is price competitiveness, in no small part due to low energy prices. So the question here is: if faced with a decline in global oil and gas prices will Russia reduce its supply of oil and gas and sell its products purely on the basis of the highest bidder in Europe and at home, or will it maintain its output levels and use its oil and gas industry to subsidize its domestic manufacturing industries?

The net result of any of these variables above will mean less revenue for the Russian state and hence the problems below:

Increasing domestic instability and declining state security resources:

The re-election of Vladimir Putin was considered by many competitors to be an academic exercise. He was too strong, too popular or too well connected to lose so commentators said. And sure enough they were right, except this time Russia’s voters didn’t lie down and play dead. The scale of protests was unprecedented under Putin’s rule and provides a glimmer of the hostility ordinary people feel towards the current government.

It is true that for many Putin is still deeply popular but the same is certainly not true of his lieutenants and it is their increasingly public misdemeanours that are starting to significantly chip-away at the regimes support base. The sense of insecurity felt by Putin was perhaps best displayed by the obscene levels of attention and media coverage that was generated by the Russian punk rock band “Pussy Riot” whose 30 seconds of fame generated world-wide news coverage.

Now whilst Russia has often suppressed riots and domestic violence, it is the impact of declining state revenues that will suddenly start to lead to difficult strategic decisions on where Russia spends its resources. If the state continues to focus its funding on internal suppression then it will inevitably have to reduce its spending on its planned military modernisation programme, something which will surely reduce the global reach of the Russian military and certainly the extent it can intimidate its neighbours.

Furthermore, if Russia does retrench domestically, will this lead to more aggressive actions by those states that have territorial disputes with Russia currently? Any increased belligerence by states like Georgia and Azerbaijan would be increasingly embarrassing for Moscow, whose people would demand a response. Will the Russian state be able to in the future? Even the latest Russian fighter jet project, a symbol of its super-power aspirations, could be threatened if it fails to find suitable export partners and its numbers drop below its already low order number, (expected to be initially 100 or less).

Demographic issues:

Inherently linked in Russia with domestic security concerns is population issues and immigration. The Russian state has always incorporated a large number of ethnic minorities and different faiths, but notice the word minorities. The modern Russia today is facing a marked decline in the birth rate of European, orthodox Russians, whilst its minority populations, notably those who follow Islam, continue to grow, as does the number of immigrants from central Asian states.

This again will start to stir domestic tensions where the state has historically under invested in the East and often concentrated its investments into a few key cities like Moscow. Furthermore, regional hot-spots like Chechnya may become emboldened to push for further regional autonomy if the region’s population continues to grow whilst the typically more Slavic and European population of western Russia declines.

Linking this all back in again. Under-investment in regions with high birth rates which will require greater state resources for health care and education as well as state and/or private investment to create job opportunities for a rapidly increasing young workforce will create a policy headache for a state with limited alternatives than state spending or careers in the oil and gas sector. Both of which seem certain to decline.

Squaring the Circle – concluding remarks:

So what does all this mean? In effect Russia is facing a perfect storm by the end of this decade and the only possible solutions to its problems still look as distant as ever.

The Russian state cannot generate internal investment without an end to the rampant corruption that eats away at public confidence in the state bureaucracy and decimates the ability of financial institutions to invest sensibly into growth prospects. But more fundamentally what Russia really lacks is a functioning rule of law.

No company today can invest in Russia without the concern of expropriation or state interference and those that have tried have often been burnt badly in the process, whether BNP-TNK or Shell and its development of Sakhalin island. This hampers any serious private sector investment and again places the onus of investment squarely on the Russian state.

With declining state revenues and increasing demands on its budget, does Russia have many options left open? Can it cut spending and if so what? Can it increase its level of government debt and if so for how long and at what cost? All of these questions leave Russian policy planners feeling uneasy and with Putin’s grand ambitions so publically stated what would be the political damage if the policies failed or perhaps even worse, they were cancelled?

So while for now Russia may be having its moment in the spotlight as a super-power in Syria, it’s worth waiting to see what happens next. My suspicion? Russia may just start getting that bit quieter and quieter as this decade progresses.

So keep an eye on Russia and 2020. The Russian roller coaster may just be about to drop.