139432_Monthly Forecast-Oct. 2011

GEOPOLITICAL ISSUES AHEAD:A Monthly Assessment

IntroductionThe European crisis has intensified and remains at the heart of the international system. We have always thought that the European Union is unsustainable, and others are now coming to that conclusion. However, their underlying assumption is that everything will work itself out, while we find it difficult to see how that will happen. The fundamental problem remains that Europe created a free trade zone that benefits Germany, the world's second-largest exporter, more than any other nation by leaving the less-developed countries unprotected against German exports, regardless of how they are priced in practice. This creates domestic problems in the rest of Europe that emerge in times of recession. Subsequently, this contraction creates first a sovereign debt crisis and then a banking crisis among those holding the debt. Germany's solution to this problem is a bailout designed to stabilize the financial system, the price of which will primarily be held by Germans and other Europeans. However, for this to work, debtor countries must bring their budgets into balance, which means substantial economic contractions ranging from wage cuts to unemployment. Unlike the financial bailout portion, the austerity portion will never be recovered, almost surely crushing the futures of a generation of workers. The southern European governments cannot survive under these circumstances. Elections will be held in many countries in 2012 and 2013, and if austerity is applied, the ruling parties will lose. It is not clear that existing opposition parties will win. We expect new parties akin to the American Tea Party to emerge and currently marginal parties to rise in significance. They will challenge the two foundations of the European Union: open borders and an integrated currency. The European elite still do not fully understand that this is a political crisis and that their position is at risk. The European leadership believes that the various bailout measures will solve the banking problem and therefore solve the financial problem. They do not understand that the level of austerity being imposed on Greece, extended potentially to other countries, will breed a massive backlash that will buckle the European Union. For the Greeks, it is not obvious that austerity is a better solution than bankruptcy. That might be the case for the banks, but for the masses, cut off from banking services by the banks' conditions and by their own financial situations, holding onto their jobs and homes is by far the dominant issue. Their governments want to protect their access to the financial markets, but the average citizen has already lost that access. Their perception is that they will be saving the bankers by losing their own jobs. It is important for U.S. firms to begin re-examining the portfolio of relationships they have in EU countries. Many of the political and financial relationships that have been in place for the past 20 years may stop being valid in the coming year, in part because they will depart and in part because they simply will lose authority. The upheaval that we have seen with the Tea Party will be mild compared to what we think is coming in Europe unless the situation changes dramatically. We would also draw attention to the massive U.S. assault against al Qaeda personnel throughout the Middle East and South Asia, including Pakistan. This is against the backdrop of serious negotiations under way between the United States and the Taliban, and Pakistan's desire to be the only conduit for the talks. The United States is demonstrating that it is effective without the help of Pakistani intelligence and that it is prepared to bypass the Pakistanis in terms of both negotiation and the war. The recent killing of a senior Afghan official who was negotiating with the Taliban was Pakistan's answer to this.

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While the situation seems to be getting out of hand, the fact is that this is part of an attempt to end the war and create a coalition government with the Taliban; the issue is the degree to which Pakistan will play a role. At the same time, the actions in Yemen could spread elsewhere in the region on an uncertain basis and should be kept in mind.

East AsiaEast Asia-wideThe South China Sea likely will be the subject of much regional diplomatic discourse in October. With just a month before a series of high-level regional meetings, such as the Asia-Pacific Economic Cooperation summit, the Association of Southeast Asian Nations summit and the East Asia Summit – the latter of which the United States will participate in for the first time as a full member – claimant countries and interested players likely will increase their rhetoric in an attempt to garner international attention. Vietnamese President Truong Tan Sang will make a state visit to India in early October to secure joint oil exploration projects on the margins of the South China Sea (which China still claims) as well as closer defense ties. The Philippines is likely to attempt to forge a regional alliance and seek the aid of third parties, particularly Japan and the United States. Meanwhile, the first trilateral talks between India, the United States and Japan – none of which have territorial claims in the sea – will be held Oct. 7 in Tokyo and will focus on China’s increasing assertiveness, both in the sea and in the Asia-Pacific region in general. This meeting will be largely symbolic, but the countries’ alignment of interests will force Beijing to put more diplomatic resources toward containing the issue.

With Japan planning to deploy a large patrol ship Oct. 8 and an ongoing Chinese patrol ship deployment in the area, a similar struggle over the East China Sea also may take place in October. However, a pair of planned meetings may lessen tensions over the issue: New Japanese Prime Minister Yoshihiko Noda plans to visit China in early October, followed by a visit by Chinese Prime Minister-designate Li Keqiang to Japan later in the month or in November, during which both sides will emphasize cooperation over disputes. Nevertheless, China will continue to gauge the new Japanese government’s stance on the East China Sea issue.

ChinaThe worsening U.S. and European economic situations have led a number of Asian policymakers to slow down monetary tightening. A further economic slowdown would particularly affect China both because of its heavy interaction with the global economy and because of an ongoing inflation problem that leaves it little room to focus on growth. With Beijing’s top priorities being curbing inflation and speculation, the Chinese government likely will continue tightening but will allow some adjustments to alleviate immediate problems, such as the risks to small- to medium-sized enterprises.

Beijing also is likely to face renewed international pressure over currency and trade issues during October. U.S. lawmakers, faced with internal political concerns and pressure from other countries, are again pressing for the passage of bills asking China to appreciate the yuan, and officials from the United States, European Union and Japan are set to discuss China’s policy on rare earth elements. The bills on the yuan are unlikely to be successful – the yuan’s rapid appreciation is sapping their political leverage – and trade tensions remain low, but these moves show the United States’ willingness to build up gradual pressure on China.

An October EU-China summit is expected to set the stage for China to increase its investment in European countries. China’s position toward the eurozone crisis, which involved buying Greek sovereign debt and making investments in eurozone countries, remains more of a verbal commitment than any real movement. Beijing sees the opportunity in the eurozone crisis to increase its influence, but it does not see assisting bailout efforts as worth the cost yet. China may take steps toward helping the European Union, but these will merely be symbolic unless there are large political gains to be made.

ThailandThai Prime Minister Yingluck Shinawatra will visit China and Myanmar in early October to discuss Thai and Chinese investment in Myanmar. Domestically, the Thai government is displaying aggressiveness in addressing some of the country’s more difficult issues, such as the appointment of Cabinet seats and

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© 2011 STRATFOR Austin, TX 78701 Tel: 1-512-744-4300 www.stratfor.com


relations with Cambodia, with the ultimate goal of facilitating the return from exile of Yingluck’s brother, former Prime Minister Thaksin Shinawatra. The Thai military and political old guard are losing the capability of, and interest in, challenging the government, giving Yingluck a much freer hand even as her administration threatens the former establishment. This could be demonstrated through a bureaucracy reshuffle, during which some Thaksin loyalists were appointed, as well as through a late September military reshuffle. The real challenge for Yingluck’s government comes from factions within her own Pheu Thai party, specifically from members of the United Front for Democracy Against Dictatorship, aka the Red Shirts, who are demanding greater influence in the government. As long as Pheu Thai remains unified, there is less likelihood for large-scale political turmoil – though the opposition continues to bide its time, waiting for an opportunity to increase its influence.

In keeping with a promise to farmers, the Thai government will introduce a new policy this month wherein it will buy rice directly from farmers at a price 50 percent higher than current market value. Thailand is responsible for 30 percent of the world’s rice exports, leading to fears that spiking prices will destabilize the global supply chain. The move, more of a populist political consideration (albeit a controversial one) than a logical economic decision, risks reduced export revenues, which could hurt farmers in the long term. The government thus knows it must carefully employ this policy, as well as other aggressive policies, lest they fail and generate influence for the opposition.

Indonesia and MalaysiaIndonesia is expected to resume sending domestic workers to Malaysia in October following the end of the former’s ban, in place since 2009, on deploying domestic workers to Malaysia. An August decision by Malaysia to legitimize the country’s large illegal workforce highlights its need for low-skilled labor and has driven the government to allow the direct hiring of Indonesians. For Indonesia, limited domestic employment opportunities continue to make the country one of Asia’s major exporters of immigrant labor.

EurasiaEurasia-wideVarious partners are expected to strike deals in October on the proposed South Stream natural gas pipeline, with South-Central European countries, such as Bulgaria and Hungary, signaling increased openness to negotiate on the controversial energy line. Previously, these states had only expressed rhetorical willingness to discuss South Stream while at the same time actively pursuing the Western-sponsored proposal for the Nabucco line, which would run from Azerbaijan to Europe.

Notably, these shifts are coming amid backchannel talks with Russia on the European financial crisis. According to STRATFOR sources, these discussions are linked, with Russia using financial negotiations to effect subtle shifts in other sectors, such as energy and security. Moscow will continue these talks in October and will begin discussing South Stream with Turkey, specifically water rights. This is an issue Ankara is loath to make a decision on; it is in ongoing discussions with Azerbaijan over future natural gas sales via both current lines and proposed ones such as Nabucco.

RussiaRussian Prime Minister Vladimir Putin’s publicly announced return to the presidency in March 2012 will have significant consequences to observe in the coming months, foremost with regard to plans to shift current President Dmitri Medvedev to the premiership. The prime minister oversees Cabinet ministers, and many of those ministers would rather see Medvedev moved to a different post, such as Duma speaker, than report to him. Internal feuding already has begun; Finance Minister Alexei Kudrin stepped down in protest Sept. 26. There are rumors of others being considered for the premiership, such as Moscow Mayor Sergei Sobyanin, but this decision will not be made until after the December elections.

Also of importance will be the international reaction to the announcement of Putin’s return to the Russian presidency. Putin prefers to direct the affairs of the country from behind the scenes, so his return only comes because Moscow sees a need for a shift in the international community’s perception of the Kremlin to one of strength and power. With this move, the world will once again deal with Moscow as an assertive force.

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Russian energy consortium Alfa-Access-Renova’s (AAR) lawsuit against BP will be heard in court Oct. 7-15. The dispute between BP and AAR, which runs the TNK part of TNK-BP, took an unexpected turn in September when AAR chief Mikhail Fridman, who has connections to the secret and interior services in Moscow, organized a raid on BP’s Russian offices without the Kremlin’s consent, according to STRATFOR sources. While Fridman reportedly was reprimanded for the raid, this does not mean the Kremlin will be stepping into the legal proceedings between BP and TNK. Moscow has become indifferent to the case; a deal between its own energy firm, Rosneft, and ExxonMobil has allowed it to step back from championing either BP or TNK (though it disapproved of the raid on BP’s offices). Now the case will be heard in the Tyumen court system, which AAR has used many times previously – with all cases ending in its favor. STRATFOR sources in both London and Moscow say that BP chief Robert Dudley has vowed not to give in, which, if true, more than likely means a loss in court for BP. TNK-BP chief Tony Hayward already has resigned from the company because of this, and sources say several others will follow him.

UkraineOne country to watch for a shift in perception since Putin’s announcement is Ukraine. Ukrainian President Viktor Yanukovich met with both Medvedev and Putin over several tense energy issues Sept. 24 in Russia, just after the announcement on Putin’s return to the presidency. Notably, Yanukovich was not originally set to meet with Putin; a late schedule change occurred the morning of the meeting. Ukraine is asking for a lower price on natural gas supplied by Russia and a set amount of such supply. Just days after the meeting, Ukrainian Prime Minister Mykola Azarov said Russia agreed to review its contract with Ukraine. Azarov said an agreement was reached for a tripartite consortium to be created between Ukraine, Russia and the European Union to manage Ukraine’s natural gas system. He also said Ukraine agreed to reduce its transit fees in exchange for a reduction of the price charged by Russia for natural gas. No specific details were given on these prices, and it was announced that this agreement would be prepared in October and formalized in November. Moreover, Gazprom denied Azarov’s statements, raising the question of whether these deals actually had been reached. It will be key to watch what other concessions, if any, Ukraine will give to Russia for such a deal, as the lowering of the transit rate is far less than the concessions Moscow has demanded from Kiev, such as customs union membership and a merger between Gazprom and Naftogaz. Given that this agreement will be formalized in November – the same month Nord Stream comes online – the leverage is still very much on the side of Russia.

PolandPoland will hold elections the first week of October, and polling suggests the main parties are running close. The ruling Civic Platform party currently holds the edge, but the elections could switch up the makeup of its coalition. The outcome of the elections will influence how confidently the government can make decisions, particularly in energy and relations with Russia. The Polish parliament rushed through a bill on energy liberalization just before the elections, knowing that the government would be preoccupied with the run-up to the elections for much of October. The bill liberalizes the ability of domestic energy firms to tap into the Polish natural gas market, which is monopolized by PGNiG. The European Union had been pressuring Warsaw to pass this bill, threatening to take Poland to international arbitration should it not pass. The bill will go into effect in October and will allow firms to start gaining more access, particularly in trade and storage, in the Polish market. Also in October, PGNiG will hold another round of negotiations with Gazprom over the price of natural gas imports. PGNiG, like many other European firms, is looking for a 10 percent price break. Gazprom is not entirely against such a price break; it is negotiating similar deals with other foreign firms now that new natural gas transit routes are open to Europe. However, Gazprom is looking for the negotiations to fit into a larger set of terms that include level of supplies and length of contract. PGNiG has threatened Gazprom with arbitration should an agreement not be reached by November.

AzerbaijanAzerbaijani President Ilham Aliyev is expected to travel to Turkey in October in order to sign a large-scale energy deal that is currently being negotiated. The terms of the deal are still vague, but Turkey is looking at securing supplies from the Shah Deniz II natural gas project, which is set to be operational in 2017-2018. During the negotiations, the two countries disagreed over which would legally own the pipelines and the price for the natural gas, and it is not clear that these issues have been resolved. The

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main issue is that Turkey wants control over the supplies coming from Shah Deniz II, but Azerbaijan wants to retain the right to shift its contracts and pricing depending on developments in the energy situations of Europe and the rest of the region. Thus, any deal signed in October between Turkey and Azerbaijan will start to resolve the issue of future supplies, though Baku will retain sufficient loopholes to shift the deal when needed.

Middle East and South AsiaSyriaThe impact of U.S. and EU sanctions on Syria’s energy sector, placed in response to the Bashar al Assad regime’s heavy-handed crackdown on the country’s opposition, will be seen in October. Sanctions by the European Union, the main importer of Syria’s roughly 160,000 barrels per day (bpd) of heavy crude, may begin affecting the financial stability of the regime in the coming weeks, and Turkey also is rumored to join the sanctions soon. Syria’s total crude exports could easily be shipped to Indian or Chinese refineries, but there is no indication that this has been happening, other than an unconfirmed report that India’s Oil and Natural Gas Corp. is considering importing 15,000 bpd. Meanwhile, media reports claim that some energy companies were told to cut back production due to high inventory. This may continue in October if the Syrian regime faces difficulties in finding alternative clients.

IraqAlthough there has been much rhetoric and planning as well as heated negotiations in recent months regarding the U.S. efforts to leave behind a significant residual military force in Iraq beyond the end of the year, October likely will be a decisive month. It has been a little more than a year since the United States reduced troop numbers to their current level of 47,000, and these forces will begin moving out of the country to meet the deadline. Whether U.S. forces remain in Iraq after Dec. 31 depends on whether the United States reaches an understanding with Iran – and thus far, there are no signs that backchannel talks are making any progress. While U.S. military authorities will be working on pulling troops out of the country, the political leadership in Washington will be working with its Iraqi partners to try to get around Tehran’s relative position of strength. Should Iran feel it is not getting its way in the matter, violence by its militant proxies is likely as part of its effort to enhance its position. Concessions of sorts to Iran also cannot be ruled out.

YemenYemeni President Ali Abdullah Saleh returned to Yemen on Sept. 23 after three months in Saudi Arabia, where he was receiving treatment for wounds he sustained in a June assassination attempt. His return has increased political tensions and related protests, and October will indicate whether the stalemate between Saleh’s allies and opponents will be broken. Currently, neither side has been able to gain a decisive advantage, but there will be opportunities for both in the coming month. Well aware that his return has the potential to re-energize his opponents – as evident from the armed clashes between rival military forces and the reinvigorated protests on the streets immediately after his return – Saleh will spend October trying to capitalize on the fact that his opponents remain divided and that the United States and Saudi Arabia are not pushing for his immediate ouster, fearing that anarchy would result from a power vacuum in Sanaa. His opponents also can be expected to take the opportunity to exploit reignited anti-Saleh sentiments by continuing protests. Therefore, October likely will see more violence both between rival security forces and between Saleh’s forces trying to contain protests.

EgyptThe ruling Supreme Council of the Armed Forces (SCAF) issued a constitutional declaration Sept. 27 establishing exact dates for the country’s upcoming parliamentary elections. The opening stage for elections in the lower house will occur Nov. 28, meaning the month of October will see a flurry of activity all revolving around preparations for the vote. The filing period for candidacy for both houses will begin Oct. 12. Though the setting of dates for the elections is slight relief for the opposition, a large portion of which had begun to express concerns that the SCAF would break its pledge to hold the vote by November, the structure of the elections has failed to curb growing anti-SCAF sentiment in the country. At issue is the SCAF’s decision to allot a certain percentage – expected to be about 30 percent – of parliamentary

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seats to an individual candidate system, barring members of political parties from seeking positions in these seats. What the vast majority of the Egyptian opposition wants is a vote entirely run according to a list-based system, which is akin to straight-ticket voting. The SCAF has refused to concede on this point out of a desire to ensure that a sufficient number of individuals aligned with the military’s interests enter office. This issue will lead to continued demonstrations in October but will not be enough to derail the election process itself.

LibyaTwo themes will dominate Libya in October: ongoing political disputes among rebel forces over the transition into the post-Gadhafi era and rising oil production in a country that has had next to none since February. French state-owned firm Total SA and Italian state-owned firm ENI, both with ownership stakes in Libyan oil fields, restarted oil production in late September. As Total resumed work in an offshore facility removed from the insecurity on the ground in Libya, its return did not offer much insight into the ability of other international oil companies to follow suit. ENI’s return, however, occurred on land in the main oil-producing region of the country, located southeast of Marsa el Brega. Though security threats do persist in the area, evidenced by the Sept. 12 attack by Gadhafi’s soldiers on the Ras Lanuf refinery, ENI’s presence harbors good signs for the ability of the Libyan oil industry to begin returning to normalcy. No oil has actually been exported yet, but that will begin to change in October. Total output, however, will remain far below the pre-war levels of roughly 1.6 million bpd, even as other oil companies – most notably Spanish state-owned firm Repsol YPF – are expected to resume work as well.

Meanwhile, Gadhafi loyalists have held firm over the past months in the central Libyan strongholds of Sirte and Bani Walid, and though their supply lines have been greatly disrupted, there still remains a strong possibility that rebel fighters will be unable to clear these areas by the end of the month. Meanwhile, it is not a guarantee that the repeated pledges by the National Transitional Council to form an interim government will yield an actual agreement by the end of October.

TurkeyThe United States’ Noble Energy started its natural gas and oil exploration operations off southern Cyprus, despite Turkey’s warnings, as part of the deal it made with the Greek Cypriot government in 2007. Block 12, where its platforms operate, is part of the exclusive economic zone claimed by the Greek Cypriot government and recognized by Egypt, Lebanon and Israel. In response to the exploration, Turkey sent its seismic vessel Piri Reis, which started its work off northern Cyprus (near the part that is de facto governed by the Turkish Cypriot government and recognized only by Turkey) on Sept. 26. Even though the tension seems to be on the rise, STRATFOR does not expect a military confrontation between Turkish and Greek Cypriot warships in October. According to STRATFOR sources in the Turkish energy sector, the Turkish government’s official policy is to take decisive action – including, if necessary, a military response – to prevent Greek Cypriot operations from reaching the production phase, provided feasible reserves can be found. Turkey, on the other hand, would need a foreign partner to be able to begin production, and it is unclear whether foreign countries would be eager to invest in these contested regions. For now, this is less an issue of energy production than a dispute over the divided island’s sovereignty. Thus, though minor skirmishes cannot be ruled out, the issue likely will subside in the coming weeks as each actor assesses the impact of its recent moves.

Latin AmericaBoliviaBolivian state-owned natural gas company Yacimientos Petroliferos Fiscales Bolivianos began construction on a natural gas liquids separation plant Sept. 5 in Rio Grande, Santa Cruz department. The plant is part of the company’s $443.8 million investment plan for Santa Cruz, which also includes the upgrading of the Guillermo Elder Bell Refinery in Santa Cruz. This focus on Santa Cruz represents 42 percent of the company’s total planned investment in 2011 and a 26 percent rise over 2010. Santa Cruz is Bolivia’s economic center of gravity, although most natural gas is currently produced in Tarija department. On the political front, Bolivian President Evo Morales continues to see a drop in his popularity – from 44 percent to 37 percent in just one month – as his administration continues to confront indigenous protesters opposed to a road set to be built through the Isiboro Secure National Park and Indigenous Territory natural reserve. A police action against the protesters Sept. 25 has

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exacerbated tensions. This will cost Morales even more support among his political backers. Sympathy protests can be expected throughout the country during October.

VenezuelaThough it is difficult at this point to distinguish fact from rumor, STRATFOR believes Venezuelan President Hugo Chavez’s health to be bad and worsening. Outside doctors have advised that Chavez may have no more than two years to live. The uncertainty surrounding Chavez’s health makes the lead-up to the election and the ongoing power struggle among Venezuela’s elite particularly important. Electricity Minister Ali Rodriguez appears to have been sidelined during the past month, removed from his position at the head of state-run electricity company CORPOELEC and set to take on the role of secretary general of the Union of South American Nations. Rodriguez is a key member of Chavez’s administration, a close ally to Chavez himself with ties to the Cuban government, and his movement may herald larger shifts within the elite. Meanwhile, the country continues to suffer from goods shortages and consistent power outages. The government is working to implement the Law of Costs and Prices, which establishes a new regulatory regime for consumer goods price control, in November. In the meantime, the government is collecting price information throughout the economy.

ColombiaColombian police have secured control of the oil production facilities managed by Canadian company Pacific Rubiales Energy Corp., where workers on strike were able to halt the production of 225,000 bpd, or about 25 percent of Colombia’s total oil production. The company is still in the process of evaluating the damage done to the facility as a result of the stoppage and has not announced when operations will resume. The protests, which were led by oil worker unions demanding improvements in working conditions and wage hikes, were significant in scope. Notably, the Colombian government was relatively responsive in helping to control the impact, something that is consistent with the government’s strong relationship with those companies investing in the country. While worker protests are becoming more common, the government’s commitment to ensuring the safety of investments in Colombia remains strong, and international investors can count on government support in dispute mediation.

EcuadorThe U.S. Second Circuit Court of Appeals issued a decision in September that will legally require Chevron to pay an $18.2 billion fine levied by an Ecuadorian court against the company for environmental damages. The ruling overturned a New York District Court injunction that blocked Ecuador’s ability to collect the fines based on Chevron’s allegations that plaintiff lawyers fabricated evidence. The decision does not end the legal debacle quite yet. The plaintiffs are waiting for Ecuadorian courts to finish considering related legal questions before attempting to collect on the ruling.

PeruIn his first two months in office, Peruvian President Ollanta Humala has had several successes as he seeks to redefine the relationship of the state to foreign investors. A law requiring consultation between foreign investors and local communities passed the Peruvian legislature in September. It is not immediately clear how the law will be implemented, and it is thus difficult to judge whether it will have a significant negative impact on the implementation of new resource extraction projects. Peruvian indigenous organizations are working through the next several months to train local indigenous leaders to understand and take advantage of the law, which means we may not see the law acted on for the duration of that process. Nevertheless, the government appears committed to attracting foreign investment. In September, newspaper Gestion reported that Peru would seek to award more than 50 licenses, worth $9.9 billion, in the next year for infrastructure projects ranging from natural gas pipelines to hydroelectric plants. The challenge for Humala, as always, will be to balance the need for international investment with the societal needs of a country experiencing an extreme gap in income distribution and significant demographic divisions.

MexicoMexico is scheduled to begin the second round of bidding on private oil extraction contracts in October. The round will include licensing options for six blocks – two offshore and four on land. Meanwhile, tensions are rising between Mexican state-owned oil company Petroleos Mexicanos (Pemex) and

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Spanish firm Repsol. Pemex is in the process of increasing its stake in Repsol to a 10 percent holding and has signed a partnership agreement with Spanish conglomerate Sacyr Vallehermoso to combine their stakes to form a 28.9 percent unified voting bloc. This would be the largest bloc of Repsol shareholders, and the two will use that influence to restructure the company. Pemex plans to utilize its investment in Repsol to gain access to deep-water drilling technologies. The plan effectively bypasses the restrictions that have limited investments in new oil production incorporating Repsol into the national energy structure. Such a scheme, if successful, could have a significant and positive impact on Mexico’s oil future. Repsol, on the other hand, is concerned about the rise in Pemex’s influence and a reduction of the company’s “Spanishness.” The company is pushing back against Pemex’s efforts to control the board, alleging conflicts of interest.

The Mexican military continues to focus its efforts on combating Los Zetas and the Gulf cartel in Mexico’s northeast. This, in addition to the growing factionalization of the Gulf cartel, will spur continued fighting and street crime in Tamaulipas and Nuevo Leon states. Recent interdictions of weapons shipments destined for Los Zetas forces in Coahuila and Tamaulipas states indicate that the cartel is increasing its weapons acquisitions for the fight against the Gulf and Sinaloa cartels as well as against the military. Violent clashes between cartels and the military are expected to continue. Also, Jalisco, Guerrero, Chihuahua and Zacatecas states continue to demonstrate high levels of violence.

Events in Veracruz from Sept. 19 to Sept. 23 may indicate a significant destabilization in that city. At least 32 Zetas escaped from three different jails early Sept. 19, though authorities re-apprehended 14 that day. The next day, the bodies of 35 people identified as Los Zetas members, seven of whom reportedly were part of the prison escape, were dumped from trucks onto a major thoroughfare on the south side of the Veracruz metro area by what STRATFOR believes to be the Sinaloa cartel’s enforcement arm, Gente Nueva. Then on Sept. 22, the bodies of 14 more Zetas were discovered in various locations in Veracruz. Los Zetas may mount a retaliatory strike in October.

Jalisco state will host the Pan American Games from Oct. 14 to Oct. 30. The games will be held in venues in the northern Guadalajara metropolitan area, with a few events in Ciudad Guzman, Puerto Vallarta, Tapalpa and Lagos de Moreno. We do not anticipate direct targeting of the venues by cartel elements, though we expect significant security issues due to ongoing conflict between Sinaloa, Los Zetas, the Cartel de Jalisco Nueva Gente, and the Milenio and La Resistencia cartel groups. The cartels have not displayed a tendency to target tourists or bystanders, but neither will they go out of their way to prevent collateral casualties. Spectators and athletes may therefore find themselves in the crossfire.

BrazilA weak sugarcane harvest has sent ethanol prices soaring in Brazil. Concerns about the availability of sufficient ethanol supplies have led the government to lower the percentage of ethanol required to be blended with gasoline from 25 to 20 percent starting Oct. 1. Brazil will increase imports of gasoline to compensate for the shortfall in ethanol. An appreciation of the real (currently hovering around 1.8 reals to the dollar) is increasing operating costs for Brazilian importers and borrowers. This has affected Brazilian state-controlled energy producer Petroleos Brasileiro (Petrobras), which recently predicted a financial loss in the coming quarter as the cost of servicing dollar-denominated debt increases. Petrobras made clear in July that it intends to sell less-profitable assets around the world to fund its 2011-2015 investment plan. Most recently, Petrobras backed out of the WA-360-P oil block off the coast of Australia. This is a trend that is expected to continue in the next months.

Sub-Saharan AfricaAngolaThe ruling Popular Movement for the Liberation of Angola (MPLA) will likely convene a leadership convention in December, and it is possible, though not yet certain, that Angolan President Jose Eduardo dos Santos will publicly identify his successor. There is talk that Sonangol CEO Miguel Vicente has been selected to succeed dos Santos, but this is not a guarantee, and it is unclear when dos Santos will hand over power. Meanwhile, the Angolan government is working to rehabilitate and modernize the extremely congested port of Luanda with an estimated $155 million in financing, though deadlines for the project are not clear. Luanda is the country’s capital and main business hub, but most oil and natural gas activity occurs farther north near Soyo city and Cabinda province. An alleviation of

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congestion at Luanda will be a slow process, but it will at least help reduce the backlog of the import and export of supplies and equipment.

NigeriaRoyal Dutch/Shell in the Niger Delta will aim to finish repairing pipelines from August’s oil spills and illegal pipeline bunkering during October. The company has filed force majeure for about 25,000 bpd, releasing liability for scheduled deliveries of some Bonny Light crude this month. Meanwhile, the Nigerian government will be mostly focused on the threat from the Islamist sect Boko Haram. While working to improve intelligence-collection activities, Abuja simultaneously will hold backchannel negotiations with northern politicians who have links with the sect’s members – who likely will extract patronage concessions from the government in exchange for curbing violence.

SudanNegotiations between the governments of Sudan and South Sudan over tariffs levied by Sudan on South Sudanese crude oil using Sudanese crude oil pipelines will continue through October. Negotiations on this matter have occurred since South Sudan achieved its independence in July, with a $32-per-barrel transit fee still being the amount Khartoum wants to levy on Juba. Oil production and export will continue throughout these negotiations. Border spats between Sudan and South Sudan also will continue, with Khartoum aiming to insist that South Sudan withdraw its proxy politicians and militias from Sudanese territory. International mediators will be present to reduce hostilities. No significant fighting is expected, but there may be sporadic contacts between the different forces in the border region.

North America and CanadaKeystone XL pipelineOil sands opponents will hold a rally Oct. 7 outside the final U.S. State Department hearing in Washington on the Keystone XL oil sands pipeline. The event will build on the rallies that were held outside the local hearings on the pipeline in various Midwestern and southern towns at the end of September as well as the two-weeklong sit-in at the White House at the end of August. The Oct. 7 rally also will kick off a monthlong series of actions at President Barack Obama’s re-election campaign offices to show opposition to the pipeline. Opponents want to persuade the Obama administration that the pipeline is not in the United States’ interests because of the potential for spills in important areas of the country; because it would result in higher production of oil sands in Canada, resulting in the release of more greenhouse gas emissions; and because it would distract policymakers from making changes to the nation’s energy system that are necessary to avoid the worst effects of climate change.

Air Pollution for Oil and Natural Gas DrillingEnvironmentalists and other oil and natural gas activists will submit public comments to the U.S. Environmental Protection Agency (EPA) through October in support of the agency’s air regulations for oil and natural gas drilling, including hydraulic fracturing. The rules would apply more stringent sulfur dioxide and volatile organic compound regulations to hydraulically fractured wells, among other steps in natural gas production. The rules also update air emissions standards (“Maximum Achievable Control Technology”) to apply to oil and natural gas production and natural gas transmission and storage. Groups likely will claim that the Obama administration has become weak on environmental regulations and that it must act on the oil and natural gas standards to protect public health amid a perceived boom in natural gas drilling. The public comment period ends Oct. 24. The EPA is expected to finalize the rules by the end of February 2012.

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139432_Monthly Forecast-Oct. 2011