Since my last post on geopolitics and oil price my theory about what's going on here has evolved a little bit. One of my Twitter followers which I believe has ties to the Russian and Arab oil markets claims that Saudi Arabia is working with Russia, and the Chinese, to artificially lower the price of oil beyond the margins of profitability for the majority of North American oil production. With the way things are shaping up I'm inclined to believe her.
The most common cover story being played by the media is that this really is just a simple matter of demand and supply, that demand is low and America's "fracking boom" has contributed greatly to oversupply. This analysis refuses to take into account a number of factors namely that the perception of future oversupply is being driven by the words and promises of Saudi Arabia and ignores the dropping rig counts across North America. As I described in my last post there isn't going to be an oversupply for long, but there is very likely going to be an undersupply and resulting oil price shock.
Oddly as a culture North Americans would be much better off if we were just told the truth about our situation but instead those in power are opting to lie likely in some hope of keeping this corrupt house of cards together. These lies are in the way the situation is framed particularly in the sense that the economic impacts of these oil prices in the east, and the west, are on par or in some cases worse in the east than what the west is likely to experience.
Something I've noticed reading the dozens of articles on "breakeven" costs and whatnot is that western media when comparing these breakeven costs are comparing the cost to produce a rig (like the literal breakeven cost of the rig and company) Vs. the breakeven cost to operate an entire country. We are comparing the breakeven cost of western oil production itself against the breakeven cost of using oil to finance roads, healthcare, the entire system! These countries are producing oil much cheaper than we are, they maybe can't afford their social services, but we can't even afford our rigs! (Or oil sands here in Canada). That's a big discrepancy when you consider that in this condition these high risk or insolvent companies will barely be contributing to the operation of the state, or jobs to provide taxes. Alberta and the U.S. are comparing themselves to Saudi Arabia now but Alberta has been running a deficit from oil revenue for awhile. Alberta has been borrowing from the future to pay for it's "capital expenditure" and it's "operational budget" while technically "balanced" is woefully inadequate to cover the overhead and "growth" the oilsands booms created.
As we delve deeper into the situation it's useful to keep this fact in mind that not only are the energy companies leveraged on the promise of returns that will never materialize, so too are the provincial and state governments that have taken out loans to provide the massive infrastructure expansions these projects require; again on the promise of returns that will never materialize. This is how the peak oil story will play out.
Once I realized the Saudi's, Russia, and China were working together on this a bunch of other dots fell into place for me. I no longer believe this oil price war is about oil at all. As I mentioned in my last post the market share story just doesn't make sense (I then theorized that perhaps the Saudi's felt their oil trade with the U.S. was in danger, this is incorrect). I now believe that this move is directed not at oil production, but rather using oil production to weaken and destabilize the western banking system ahead of the launch of the BRIC international currency and development bank expected this year (whatever form that takes shape in) and their replacement to the SWIFT transaction system that they've also claimed will be ready this year. 2015 is also the year it is projected that the amount of GDP generated by $1 of new debt in the U.S. falls below $1. The "fiscal cliff" hasn't gone anywhere.
Bankers See $1 Trillion of Zombie Investments Stranded in the Oil Fields
There are zombies in the oil fields.While Russia's production will be clearly affected I believe they are well prepared to weather the storm and that the Kremlin sees this as a necessary step in their war with the U.S. dollar and will take the losses on oil as I believe they fully expect a larger gain. The state of the Ruble I don't think is very relevant except in the short term in regards to the unexpected actions that can take place. I fully expect if this continues that there is going to be an implosion in the credit and derivative markets this year and it will likely be timed to coincide with the rising of BRIC international finance.
After crude prices dropped 49 percent in six months, oil projects planned for next year are the undead -- still standing upright, but with little hope of a productive future. These zombie projects proliferate in expensive Arctic oil, deepwater-drilling regions and tar sands from Canada to Venezuela.
In a stunning analysis this week, Goldman Sachs found almost $1 trillion in investments in future oil projects at risk. They looked at 400 of the world’s largest new oil and gas fields -- excluding U.S. shale -- and found projects representing $930 billion of future investment that are no longer profitable with Brent crude at $70. In the U.S., the shale-oil party isn’t over yet, but zombies are beginning to crash it.
The chart below shows the break-even points for the top 400 new fields and how much future oil production they represent. Less than a third of projects are still profitable with oil at $70. If the unprofitable projects were scuttled, it would mean a loss of 7.5 million barrels per day of production in 2025, equivalent to 8 percent of current global demand.
How Profitable Is $70 Oil?
Making matters worse, Brent prices this week dipped further, below $60 a barrel for the first time in more than five years. Why? The U.S. shale-oil boom has flooded the market with new supply, global demand led by China has softened, and the Saudis have so far refused to curb production to prop up prices.
It’s not clear yet how far OPEC is willing to let prices slide. The U.A.E.’s energy minister said on Dec. 14 that OPEC wouldn’t trim production even if prices fall to $40 a barrel. An all-out price war could take up to 18 months to play out, said Kevin Book, managing director at ClearView Energy Partners LLC, a financial research group in Washington.
If cheap oil continues, it could be a major setback for the U.S. oil boom. In the chart below, ClearView shows projected oil production at four major U.S. shale formations: Bakken, Eagle Ford, Permian and Niobrara. The dark blue line shows where oil production levels were headed before the price drop. The light blue line shows a new reality, with production growth dropping 40 percent.
Even $75 Oil Crashes the Shale-Oil Party
The Goldman tally takes the long view of project finance as it plays out over the next decade or more. But the initial impact of low prices may be swift. Next year alone, oil and gas companies will make final investment decisions on 800 projects worth $500 billion, said Lars Eirik Nicolaisen, a partner at Oslo-based Rystad Energy. If the price of oil averages $70 in 2015, he wrote in an email, $150 billion will be pulled from oil and gas exploration around the world.
An oil price of $65 dollars a barrel next year would trigger the biggest drop in project finance in decades, according to a Sanford C. Bernstein analysis last week.
A pause in exploration and development may sound like good news for investors concerned about climate change. A vocal minority have been warning for years that potentially trillions of dollars of untapped assets may become stranded due to climate policies and improved energy efficiency. The challenges faced by oil developers today may provide a small sense of what's to come.
However, these glut-driven prices can’t stay low forever. Oil production hasn’t slowed yet, but as zombie projects go unfunded, it will. This is how the boom-bust-boom of the oil market goes: prices fall, then production follows, pushing prices higher again. The longer this standoff goes, the more zombies will languish and the sharper the rebounding price spike may be.
Perhaps what's most aggravating in this situation for me is that the North American people should have seen a situation like this coming from a mile away. The very idea that extreme energy production can remain viable and profitable in a highly volatile post peak oil world is simply crazy. The morale boosting bullshit of "energy independence" and other media fables combined with ultra low interest rates designed to encourage you to spend spend spend! Rather than prepare prepare prepare! I can't believe we fell for it, hook line and sinker.
Nevermind, I guess Alberta's "operational surplus" doesn't exist anymore now either.
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Richard Fantin is a self-taught software developer who has mostly throughout his career focused on financial applications and high frequency trading. He currently works for eQube gaming systems.
Nazayh Zanidean is a Project Coordinator for a mid-sized construction contractor in Calgary, Alberta. He enjoys writing as a hobby on topics that include foreign policy, international human rights, security and systemic media bias.