Friday, December 12, 2014

The USA's new Nuke - Shale oil

Interesting things happened in March of 2014. Russia invaded Crimea and the world waited with held breath to see how the world would respond. The response would come rather quickly in the form of sanctions. Sanctions that on the surface looked rather mild. Echoes of Georgia 2008 were feared. As was the case then it appeared now that the West was too preoccupied elsewhere to deal properly with Russian aggression.

The sanctions quietly struck at Russian energy expansion aspirations. One of the results of which is the recent halting of the South Stream Pipeline. Behind the scenes something else was happening in the United States. Shale oil production began pumping at an unprecedented rate. Global production had dropped significantly, but U.S. shale production picked up the slack.

On March 24th the leaders of the G8 decided to suspend Russia's membership effectively becoming the G7. 4 days later Barrack Obama would meet with King Abdullah in Saudi Arabia. The public reason for the meeting was that Obama wanted to "reassure" the King on U.S./Saudi relations. He wanted to make it clear that the United States wold not pursue a "bad" nuclear deal with Iran. Whatever else said or discussed was off the record. My guess is that Obama warned his ally of the impending "Shale Boom". They must have discussed their mutual benefit from it.

Some say that the Shale Boom is anything but a benefit to the Saudi Kingdom. In fact the recent OPEC decision not to cut production was seen as a direct attack on shale production. The theory is that the cost to extract shale oil is too expensive to maintain at a low Price Per Barrel (PPB). With both U.S. Shale and OPEC production high the PPB would be so low that Shale producers couldn't keep up.

So who are the losers and who are the winners in this situation? The Saudis have the only reserves in the area large enough to maintain production at such a reduced PPB. The Iranians simply don't. King Abdullah must have smiled at the thought of prolonged and extended nuclear talks with the west. As long as the talks are extended and sanctions are in place the low PPB can effectively hemorrhage the Iranian economy. It's no coincidence that the clear advantage this gives the Saudis over Iran is similar to the advantage this gives the West over Russia.

Think about it. The only people that can play this game and win from it are the Americans and the Saudis. The economies of both Russia and Iran are nearly solely based off of hydrocarbon sales. In time their currency and economies will buckle.

Eventually the low PPB would have an effect on Shale production...but it would take awhile. But let's say that happens. The shale producers will pull back on production, the PPB would rise and that would reopen the profitability to start production again. This model has effectively turned the United State's Shale production into the modern day economic nuclear weapon. Rather than NORAD the frackers now have their thumbs on the "red button". Ready and willing to press it should they have to. Should a country such as Russia or Iran step out of line the U.S. and Saudi Arabia could tank the global PPB again.

We all noticed when Regional powers such as China, Russia, India, Pakistan, Iran, etc began building up and modernizing their armed forces. The development of new weapons of war has been reported on every front page for the past decade. As tanks roll into Eastern Ukraine, S300 missiles ship to Syria, and satellites enter orbit the most potent weapon of them all was being developed in Southern Texas. The United State's new weapon of war has been developed, tested and as of March 2014 has been deployed on the battlefield. Companies such as Exxon, Marathon and Conocophillips have joined the likes of Lockheed, Boeing and Northrop.

With the Saudi ability to maintain high production regardless of cost and the U.S. ability to manipulate production based off of high or low PPB a new oil production model has been created. That model effectively weaponized Shale oil. But maybe the bigger story here is the diminishing role OPEC will play going forward. You could make the argument that OPEC has been broken by this. Oil is entering a market where those that can manipulate it have changed. Nations that haven't diversified their economies enough will find themselves on uneasy ground.