March 31, 2020
Oil Price Rises After Trump Phones Putin
by Gary Littlejohn
The recent rapid decline in oil prices may now be coming to a halt as Trump and Putin agreed in a recent phone call that their oil industry ministers should talk to each other about the oil standoff that began when Russia refused to agree to participate in a cut in oil output proposed by OPEC. This proposed cut was then effectively reversed by Saudi Arabia ‘opening the taps’ to increase its oil output. Russia continued to refuse to cut back, even though the COVID-19 pandemic drastically reduced global demand for hydrocarbon products.
Various oil-producing countries have suffered from this as global storage capacity for oil has rapidly been filled up. For example, Oman may be compelled to sell off its energy companies because it cannot afford to run them at a loss, and Nigeria may have to cease production as it is one of the countries with a very low storage capacity. Yet contrary to long-running media coverage (recently reversed as the present oil price standoff developed) the US shale oil industry is very vulnerable to the refusal of both Russia and Saudi Arabia to cut production in the face of collapsing demand.
There has for about the last three years been a minority voice among US analysts of shale oil production claiming that the ‘sweet spots’(most readily accessible and high production oil fields) in the US Permian Basin had all been played out, such that the debts incurred by the extracting companies were becoming unsustainable. This view was increasingly recognised as being supported by the reluctance of lenders to continue financing such shale oil production on the grounds that the underlying geology indicated that the remaining oil (in proposed new fields) could not be recovered profitably.
In this context many commentators have seen the oil price standoff between Russia and Saudi Arabia as an attempt by one or both to eliminate a vulnerable competitor (shale oil) from the market.
Recent doubling down by Saudi Arabia after Russia claimed that it could withstand a long price-reducing output competition seemed to confirm this:
This seems to be the reason for the phone call from Trump to Putin:
Certainly some analysts have argued that the price competition could lead to a rebound to as much as $60 per barrel if the US shale oil sector were eliminated from the market. This growing chorus included a recent very direct claim from Igor Sechin, the head of oil major Rosneft:
It certainly looks as if there is very little room left for US shale oil to reduce its production costs further, especially when lenders have been increasingly shunning the industry for about the last three years. This has considerable implications for the USA in sustaining its dominant position in the global economy.
Whereas in the past the US had been self-sufficient in oil, by 2005 it was looking to rely more on oil and gas from the Gulf of Guinea in Africa, a policy that led to the US Department of Defense engaging in a diplomatic initiative to reduce maritime insecurity in that region, thereby minimising the risk of disruption to the envisaged new oil supply routes. This initiative resulted in the establishment of the Gulf of Guinea Commission in November 2006, but then the sudden technical and financial changes that led to the surge in US shale oil production meant that this reliance on West African oil was no longer necessary. Regrettably, since then maritime security in the Gulf of Guinea has become a great deal worse.
The fact that the US had become less reliant on oil imports was very important for sustaining the position of the US dollar as the global reserve currency, because it is the fact of the global trade in oil being priced in dollars that is the main foundation for that reserve currency position, thereby enabling the US economy to keep growing in a way that is fuelled by debt. That growth strategy is now under serious threat unless the USA can control oil supply and prices in other parts of the world. This ‘necessity’ places the current US refusal to leave Iraq and its theft of oil from Syrian oil wells in context, and makes it easier to understand the intense pressure being placed on Iran and Venezuela in particular. The aggression is actually sign of strategic weakness, verging on desperation. In other words, this is a major geopolitical turning point. It is for this reason that the US is pushing for an end to the oil price war:
From the viewpoint of Russia, this is certainly a good time to eliminate US shale oil competition, because Russia has recently grown into a much stronger position in the global energy market, after being underestimated until about 2015. In 2014, at about the time of the Maidan square coup in Ukraine, Saudi Arabia and the US increased oil production in an apparent attempt to bankrupt Russia by pushing down the global oil price. At that time, Western commentators assumed that Russian oil fields were old, with future production likely to be flat, and that Russia would not be able to innovate to increase production on existing fields. It was also felt that there would be few new oil or gas fields that would enable Russia to increase its production substantially. Finally it was generally assumed that the devaluation of the Ruble would cripple the Russian economy, leading possibly to social unrest and an over throw of the Russian government. All of these assumptions proved to be false, and were seen to be false at the time by a small minority of well-informed Western commentators.
In fact the devaluation of the Ruble was far less damaging than most had assumed, partly because economic sanctions meant that Russia became even less reliant on imports, including of food, while pushing on with a revolution in Russian wheat production that led to a rapid growth in exports and lowered domestic food prices. In addition, ongoing oil and gas export revenues continued to be in foreign exchange, while the devalued Ruble meant the Russian oil became cheaper internationally.
In 2014/5 Russia immediately began to turn its oil production around with four innovations, one of which greatly extended the productive life of its older oilfields. Then it opened a major new natural gas field in the Arctic (Yamal, soon to be followed by Arctic 2) and continued with the construction of various pipelines that meant it could supply the EU, China and Turkey with gas more cheaply than would have been possible by ocean shipping or rail. Furthermore, the implications of the fact that the Power of Siberia pipeline to China, which started on 2nd December 2019, is a fixed price contract seem to have been missed by many commentators: at a time of steep oil price decline, there is no reason to believe that the price of Russian oil exports to China has declined at all, let alone by the same amount as the global market price. At a time when China is now gearing up to restart its economy following the worst of the COVID-19 pandemic there, it will presumably soon start to consume oil and (via LNG tanker shipping) natural gas at almost the same level as before.
This level of resilience is further boosted by the Turkstream and Nordstream pipelines, and the Nordstream 2 pipeline is due to start up later this year in spite of all the obstacles placed in its way:
Russia also seems to be moving into energy markets in Africa, with one company now having a stake in the Algerian gas pipeline that crosses the Mediterranean to feed into the EU gas market and with an apparent attempt to recover ownership of oil fields that it lost when Gadaffi was ousted in Libya:
Yet what is most important in the longer term is that the earlier assumption that there were no new oilfields to be developed in Russia has also proved to be mistaken:
No wonder Russia has claimed that it could withstand a low oil price for a decade:
Nor should Russia’s position be considered in isolation from developments elsewhere. For example, Iran has discovered a large oil field next to one of its gas fields, but has little chance of developing it in the present circumstances. The long-term implication in terms of shifting global energy sources is evident, however. More important in the shorter run are the vast oil resources in Venezuela, one of whose fields borders neighbouring Guyana. US oil companies are already eyeing up these enormous opportunities. The sudden re-emergence of overt political pressure by the US on Venezuela is an indication that there are strong reasons for the US not to give up on ‘regime change’ in Venezuela:
The last link above provides important detailed information as to why the charges of Venezuelan government involvement in the Columbian narcotic trade are untrue. Part of Russia’s response to this US campaign has been for Rosneft to sell its Venezuelan subsidiaries to a company wholly owned by the Russian government, in order to avoid US sanctions:
In general Russia has undertaken a whole suit of measures to insulate its economy against the sanctions imposed since 2014, with the result that it now has a highly resilient, diversified and increasingly innovative economy with two sovereign wealth funds, with gold and foreign exchange funds sufficient to pay off all government and corporate debt, and with a highly trained and well-equipped military that implies that some forms of intervention and destabilisation are much less likely to succeed. In the global energy power game, the fact that US President Trump phoned Putin amid speculation of offers to ease various kinds of sanctions in return for a renewed agreement on oil output with OPEC is certainly a very important development. For an economy not much larger than that of Germany on the Purchasing Power Parity measure, an economy that defaulted on its debts in 1998, this is quite a turnaround.
River to Sea
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