Dazed and confused – world energy markets

When Islamic State (IS) fighters took over Iraq's second largest city Mosul in June this year, everybody was caught unaware. In just three days, Sunni militants swept through northern Iraq, forcing thousands of poorly organised US-trained Iraqi troops to flee.

Whether it was ignorance of the group's foundation, or the difficulties of reporting the civil war in Syria, it's hard to work out why people were taken so much by surprise. But, from that moment onwards, everybody knew something terrifying was happening. The lines between Iraq and Syria had dissolved and an area bigger than the UK had fallen to a group so extreme, not even al-Qaeda could accept it.

"The birth of the new state is the most radical change to the political geography of the Middle East since the Sykes-Picot agreement was implemented," said The Independent's Middle East correspondent, Patrick Cockburn.

As this group grows and the area it controls expands, the threat it makes to oil and gas supplies in Iraq and Syria grows. After Saudi Arabia, Iraq is the second-largest oil and gas exporter in OPEC, producing around 3.3 million barrels every day. This interests IS because, unlike other Islamist groups, it is funded almost entirely by its own activities. Extortion rackets from areas it has occupied and oil smuggled out from fields it controls have made the organisation almost entirely self-sufficient.

For all its successes, however, IS remains a long way from the major oil-producing regions in the north-east and the south, where the vast majority of the country's oil and gas is produced.

Reaching that would be a major achievement, given the geographical distances involved and the large Shia population that lives there. But markets have still been spooked. In June, shortly after the attack on Mosul, light crude oil futures spiked to the highest level in nine months. However limited the immediate threat to oil prices might be, IS is a sophisticated military group with an expansionist ideology. As Keith Johnson, an energy writer at foreign policy argues, such a major geopolitical event should not be understated.

"The real problem posed by the offensive unleashed by IS is not what happens to Iraqi oil production this week, but whether OPEC's second-biggest producer can meet outsized production-growth expectations for the rest of the decade," he says.

If it can't, energy analysts predict that the world's inexorable thirst for oil could soon collide with limited growth in supply, leading to higher prices and lower economic growth in the US and around the world.

Taken by surprise

Nobody in the West was looking when IS took over Mosul, partly because of a civil war unfolding much closer to home. Twelve months have now passed since the EuroMaidan protests first erupted in Kiev's Independence Square and a lot has changed. The country's corrupt pro-Russian President, Viktor Yanukovich, has been replaced by a new government of broadly pro-European parties; Crimea, a region long divided between Russian, Ukrainian and Tatar communities has been annexed by Russia; and Ukraine's Eastern regions of Luhansk and Donetsk have become the front line of a war between a desperate state and a Russian-backed separatist insurgency.

That this happened in a European country perfectly peaceful just 12 months earlier remains as remarkable as it is tragic. Since the conflict began, a million citizens have been displaced, and nearly 5,000 combatants and non-combatants have lost their lives. Understanding how this happened so quickly and so violently is difficult; there are countless internal and external geopolitical factors that have played a role.

As they are in so many conflicts, natural resources were one of these factors. Ukraine's dependence on cheap gas from Russia - it imports around 50% from its neighbour - influenced the way events unfolded right from the start. Yanukovych's original decision to reject a neoliberal EU trade pact on which so many hopes had perhaps naively rested was based at least in part on a rival deal from Moscow that offered much lower gas prices for Ukrainian citizens.

In the months that followed, Russia was able to use its position as a net exporter of gas within Europe as a strong diplomatic lever. While the West imposed heavy sanctions on Moscow for its support of Ukrainian separatists, Russia hit back by turning off the taps to Ukraine for the third time in a decade.

To Ukraine, that decision was purely political - an attempt to starve the country and threaten its European allies. To Moscow it was purely economic. Supplies were halted, they claimed, because of a $5 billion debt owed to Gazprom, the state- controlled energy provider.

Thankfully, the stand-off ended. In October, the debt was settled and a deal negotiated to turn the gas back on just as overnight temperatures hit freezing. And, yet, the problems seem to linger. The present conflict may not have seen the kind of showdown that took place during the gas wars of 2006 and 2009 but the existence of such a fundamental trade imbalance between Western Europe and Russia has diplomatic consequences that will persist as long as there is a cleavage between the East and the West.

How this will affect the future of Europe's gas supplies remains to be seen. Earlier in the year, John Boehner, speaker of the US House of Representatives, urged the US to step up its gas supplies to Europe through an increase in hydraulic fracturing. Others countries - particularly Germany - have encouraged the continent to use the Ukraine-Russia crisis as an opportunity to move away from dependence on hydrocarbons and diversify its energy mix. Both seem likely to happen.

Held together

If Russia's invasion of Crimea provided a blueprint for how secession should not take place, Scotland's referendum on independence was the opposite entirely. Although the union eventually stayed together, this was a vote cast in democratic conditions that were peaceful from beginning to end.

The referendum might not have looked quite as significant with the re-emergence of old tensions between the east and west, but it was important for a number of reasons. There was the damage a 'Yes' vote would have done to the confidence of Westminster; the constitutional muddle that would have ensued; the challenge to the orthodoxy of austerity that the Scottish National Party (SNP) would have probably brought; and, of course, the potential loss of oil and gas revenue.

The latter point barely featured at all in the case put forward by the Westminster establishment when it finally come round to the idea that Scotland might actually vote to separate. But it was at the centre of the independence campaign and has been for the last 50 years. Back in the 1970s, the SNP campaigned widely for control of the vast fields of North Sea oil and gas found off the north and east of the Scottish mainland. Those same fields became the foundation on which former SNP leader Alex Salmond promised to maintain the kind of generous public spending that English nationals can only dream off.

Not everyone bought his argument though. Only two months before the referendum was due, the Office for Budget Responsibility significantly downgraded its forecast for future oil and gas revenues. Plenty of experts agreed with that. Described by Sir Ian Wood as "the North Sea's most eminent oil and gas tycoon," Salmond's ambitions for a big North Sea oil fund were wildly exaggerated.

"Young voters right now should be aware that, by the time they are middle-aged, they'll begin to see a real rundown, not just in the level of oil and gas being produced, but the ongoing implications of that: the jobs, economic prosperity and public services," he said. "And that rundown will begin in 2030, which is only 15 years away. So it's really not right to focus the debate on the short term."

Whether those figures are accurate or not, it's hard to deny the short-term benefits of North Sea production. If Scotland had gained independence in September, the separation would have almost certainly triggered years of legal wrangling over the control of resources and revenues.

It would also have meant a change to the entire fiscal regime in which North Sea oil operates. According to the campaign group Platform, the UK receives only a fraction of the revenue from oil and gas that Norway does.

If it were taxed at the same rate as the Scandinavian country, income per resident could rise from $1,020 to $27,497.

"In the six years from 2002 until 2008, Britain missed out on £74 billion in revenues," the report said. "£74 billion spent in Scotland could have provided Scotland with ten new mega-hospitals like the South Glasgow Hospital and 1,000 new GP clinics, with 10,000 new doctors and 20,000 new nurses to staff them."

Questions over who should control North Sea oil and gas and where the money should go are unlikely to disappear, even with the union intact. The possibility of greater fiscal devolution and full stewardship over North Sea resources will form a central plank of the SNPs post-referendum strategy. The push towards 'Devolution Max' will raise all kinds of questions for the energy companies that operate off the Scottish coast, so far used to a favourable tax regime and minimal regulation.

Iraq, Scotland and Ukraine may have little in common, but the effects of events in these far-flung regions are typical of dramatic global changes to energy markets. The development of new drilling technologies in the US has pushed the superpower into a position of strength it hasn't been in for decades. In Mexico, a series of long-awaited reforms in the oil and gas sector leave it poised for an energy boom, while in nearby Venezuela the sliding price of crude oil has left an already unstable country in tatters.

If 2014 was an unstable year for global energy, 2015 is shaping up to be even more volatile as the geopolitics of energy production and consumption continue to morph.