ENERGY WATCH #3 - October 30, 2018
It’s not easy being an oil producer (why Europe should not envy the U.S.)
by Karel Beckman
The importance of building a successful domestic European battery industry cannot be underestimated.
It will be key to Europe’s economic and political position in the global economy of the future.
As the European Commission writes in its recent press release on the European Battery Alliance: “Batteries will be as essential to the automotive industry of the 21st century as the combustion engine was in the 20th century.”
As financial energy analyst Gerard Reid wrote on Energy Post in March 2017, in his article The Great Battery Race: “The coming of cheap and effective lithium-based batteries will cause the greatest changes in the energy and automobile sector since Henry Ford built the model T…. . As battery technology improves they will become critical components for powering our automobiles as well as become vital assets for our power system.”
Reid warned that whereas China had a clear strategy and battery roadmap, the same was lacking in Europe. That was of course before the European Commission launched its European Battery Alliance.
The crucial importance of a domestic EV and battery production capability was brought home in the past few weeks with the Khashoggi affair, which showed how risky – and morally unacceptable – relying on Saudi Arabia has become.
Saudi Arabia is of course the world’s most important player in the global oil market. Direct crude oil supplies from Saudi Arabia to Europe are actually rather limited: 37million tons in 2017 on total imports of 516 million tons, according to the BP Statistical Review of Energy. (Europe imported 170 million tons from Russia, 66 million tons from CIS countries like Kazakhstan and Azerbaijan, 53 million tons from East Africa, 52.8 million tons from West Africa, 51 million tons from Iraq.) Nevertheless, a major political crisis in Saudi Arabia would have a great impact on all oil markets.
Such a crisis is not impossible.
As political analyst Daniel Lazare writes on Consortium News, an independent investigative website, in an excellent analysis:
“The kingdom may be less stable than it appears. It was already in trouble when MbS [crown prince Mohammed bin Salman] began his rise in early 2015. The second generation of Al-Saud rulers appeared played out along with their economic model.
Adjusted for inflation, oil prices had fallen two-thirds since the 2008 financial crisis while the kingdom was as dependent on oil as ever despite forty years of lip service to the virtues of diversification. Corruption was out of control while unemployment continued to climb because young Saudis prefer to wait years for a no-show government sinecure instead of taking a private-sector job in which they might actually have to work. (Studies show that Saudi government employees put in only an hour’s worth of real labor per day.)
Internationally, the country found itself facing growing headwinds as Barack Obama firmed up his historic nuclear accord with Iran. Obama’s statement in April 2016 that Saudis needed to “share” the Middle East with its arch-rival to the north would come as a blow to a family that thought it could always count on unqualified U.S. support.
Oil was supposed to keep Saudi Arabia rich and powerful, but instead total reliance on it was threatening to eventually weaken it. Something had to be done, and King Salman, although only intermittently lucid, figured his 29-year-old son was the man. Shoving rivals aside – most notably cousin Muhammad bin Nayef, the prince in charge of combatting Al Qaeda – Muhammad bin Salman began grabbing the reins and issuing orders.
The results have been disastrous. Within weeks of being named minister of defense — his appointment as crown prince would take a few months longer — MbS launched an air war on Yemen that would soon turn into a classic quagmire, one that would cause as many as fifty thousand combat deaths, propel much of the country to the brink of starvation, and generate annual costs back home of $50 billion or more that the kingdom could no longer afford.
In June 2017, bin Salman imposed a quarantine of Qatar on the grounds of excessive cordiality with Iran and too close relations with the Muslim Brotherhood, but he was taken aback when the emirate showed that it could carry on despite the blockade. A few months later, MbS’ henchmen kidnapped Lebanese Prime Minister Saad Hariri and forced him to read a resignation speech on Saudi TV. But Hariri repudiated the speech as soon as he was back in Lebanon.
Every attempt to assert Saudi strength only underscored its growing weakness. Bin Salman rounded up two hundred of the kingdom’s richest princes and businessmen last November, herded them into the Riyadh Ritz-Carlton, and then, following beatings and torture, forced them to hand over $100 billion or more.
Capital flight accelerated as a consequence while foreign direct investment is now off eighty percent from 2016 levels. The crown prince unveiled a series of grandiose vanity projects – an entertainment park twice the size of Disneyworld, a $500-billion robot city known as Neom, and a tourist park the size of Belgium – but then had to put them on hold when his father blocked plans to privatize five percent of Saudi Aramco, which he had been counting on as a revenue source. He hiked gas prices by eighty percent and slapped on a five-percent sales tax, but then went on a Marie Antoinette-style spending spree, shelling out $550 million for a yacht, $450 million for a painting, and $300 million for a French chateau. Whatever the benefits of austerity, they were promptly undercut.
Now the torture, murder, and dismemberment of a dissident journalist in Istanbul has made matters many times worse. With MbS persona non grata across the globe, the kingdom’s political and economic isolation is as great as it has probably ever been. According to a report in the Paris daily Le Figaro, moves have begun to replace MbS as crown prince, second in line to the throne.”
In short, there is every reason, from an economic and political viewpoint – in addition to important moral and environmental reasons – for Europe to reduce its reliance on Saudi Arabian oil and oil in general. The future for Europe clearly lies in electrified transport.
One could think that the U.S. is in a better position than Europe, being a major – and growing – oil producer in its right. Yet, the U.S. position (which cannot be imitated in any case, as Europe does not have the same resources), may not be so enviable as it seems.
First of all, for the U.S. Saudi Arabia is a key partner for much more than its oil. Saudi Arabia forms the foundation of the U.S.’s geopolitical position in the Middle East.
“If the Saudi power structure were ever to crumble in the wake of the Khashoggi scandal, there would likely be chaos because there is no alternative to replace it”, writes Lazare. “The impact on the region would be significant. With its 55-percent Shi‘ite majority, Iraq is already in the Iranian orbit after the U.S. overthrow of Saddam; Qatar and Oman are on businesslike terms with Tehran, while Kuwait and the UAE could possibly reach an accommodation with Teheran as well.”
“The upshot would be an immense power shift in which the Persian Gulf could revert to being an Iranian lake. That’s probably why the United States and Israel will do everything in its power to prevent the House of Saud from falling.”
Lazare notes that “the consequences in terms of U.S. imperial interests would be nearly incalculable. For decades, America has used the Gulf to shape and direct its interests in the larger Eurasian economy. Thanks to trillions of dollars in military investment, the Saudis control the spigot through which roughly 24 percent of the world’s daily oil supply flows, much of it bound for such economic powerhouses as India, China, South Korea, and Japan. Should control pass to someone else, America would find its monopoly severely impaired. The effects would also be felt in Syria, where Israel is incensed by the Iranian presence. It would be even more so should the Saudi counterweight be removed.”
Thus, as Lazare makes clear, it is a mistake to think of Saudi Arabia as an essential oil supplier to the U.S. The country is an essential oil supplier to Asia – and that is why controlling Saudi Arabia is crucial to the U.S.’s geopolitical influence.
Perhaps Donald Trump should have been in less of a hurry to tear up the nuclear agreement with Iran.
Nor is the American shale oil miracle the simple success story that its supporters often make it out to be.
As the Institute for Energy Economics and Financial Analysis (IEEFA) points out in a recent analysis (“Energy Market Update: Red Flags on Fracking”), the U.S. shale oil and gas sector has been loss-making from the start and not even the recent oil price rise has changed this.
“Even after two and a half years of rising oil prices and growing expectations for improved financial results, a review of 33 publicly traded oil and gas fracking companies shows the companies posting negative free cash flows through June”, notes IEEFA.
Some of its key findings:
- In the first half of 2018, U.S. fracking-focused oil and gas companies continued their eight-year losing streak.
- The 33 small and mid-size exploration and production companies (E&Ps) we examined reported $3.9 billion in negative cash flows through June.
- E&Ps dipped into cash reserves in the first half of the year to fund capital expenditures and shareholder payouts.
“These disappointing results come on the heels of a decade of bleak financial performance by the fracking sector, which has consistently failed to produce enough cash to satisfy its thirst for capital”, writes IEEFA.
“The industry instead has been forced time and again to raise new money from capital markets—racking up enormous long-term debts and creating growing frustration among investors. The sector has consistently spent more on drilling than it has generated from selling oil and gas.”
A similar story can be told for Canadian tar sands.
“At current prices, Canadian tar sands oil producers are losing money on every barrel of oil they dig out”, writes Justin Mikulka on DeSmog blog website in an interesting analysis. “Despite signs earlier this year the industry would turn profitable in 2018, a much more likely scenario at this point is a fourth straight year of losses.”
Producers are forced to keep cranking out product and selling it at a loss to cover the massive costs required to start one of these sprawling unconventional oil operations, notes Mikulka.
In fact, in June 2018 Canada “set a new record for exporting oil to the U.S., hitting well over three million barrels per day.”
If this sounds great, think again. Since the U.S. is currently the only major market for Canadian crude, and domestic U.S. supply is large, the Canadians are forced to sell at extremely low prices.
How low? In mid-October, Western Canadian Select (WCS) was $19 a barrel — approximately $50 a barrel cheaper than a barrel of the American oil standard known as Western Texas Intermediate (WTI)!
Yes, you are reading this correctly. Whereas oil prices exceed $70 a barrel on global markets, U.S. refiners are buying oil from Canada at $19 a barrel!
Yet even under these economic conditions, one company, Teck Resources, is proposing to build a new tar sands mining operation, notes Mikulka. “Projections estimate the cost to produce a barrel of oil at this operation will be around $85 a barrel.”
Another complicating factor, he notes, “is that even at such low prices, American refineries only want and need so much tar sands oil, which is a heavy, lower-quality oil. America is experiencing a boom in production of the light fracked crude oil from shale basins, which is not only more valuable to refineries but requires much lower transportation costs than importing crude from Alberta, the tar sands capital of North America.”
“To help extract itself from this difficult situation, Canada is looking to build pipelines, such as the still-uncertain Trans Mountain pipeline expansion, to transport its landlocked oil to tidewaters, where companies theoretically can sell the oil to Asia’s rapidly growing market.”
However, “Canada’s tar sands pipeline plans have several fatal flaws”, Mikulka points out. “The first is that tar sands oil is heavy and not the most desirable oil on the market. The second is that Canada is late to the game, with some rather formidable competition from the U.S., which is exporting oil to Asia at ever increasing rates, and also from the Middle East.”
“While Canada’s tar sands proven oil reserves are the third largest for any country in the world, Saudi Arabia holds the number two spot (Venezuela is number one). Unlike the stiff production costs Canadian tar sands operators face, Saudi Arabia has production costs in the range of $10 per barrel. Plus, Saudi Arabia is producing more desirable grades of oil and has easy access to ports, giving the country a strong competitive edge.”
So, the life of an oil producer can be hard. And it could get harder still.
The International Energy Agency concludes, in a new report, that “major oil and gas exporters face unprecedented challenges in the years ahead”.
Major oil and gas exporters “have weathered many upheavals in recent decades but a renewed commitment to reform and economic diversification will be vital to cope with the changing dynamics of global energy. These include rising production from new sources such as shale, uncertainties over the pace of oil demand growth and deployment of new energy technologies.”
The IEA examined six “resource-dependent economies that are pillars of global energy supply: Iraq, Nigeria, Russia, Saudi Arabia, United Arab Emirates and Venezuela. It assessed how they might fare to 2040 under a variety of price and policy scenarios.”
“The rollercoaster in oil prices over the last decade has brought into sharp relief the structural weaknesses in many of the major exporters”, notes the IEA. “Since 2014, the net income available from oil and gas has fallen by between 40% (in the case of Iraq) and 70% (in the case of Venezuela), with wide-ranging consequences for economic performance.”
“More than at any other point in recent history, fundamental changes to the development model of resource-rich countries look unavoidable,” said Fatih Birol, the IEA’s executive director. “Following through with the announced reform initiatives is essential, as failure to take adequate action would compound future risks for producer economies as well as for global markets.”
The IEA recommends six “key responses” that oil exporting countries should adopt:
- capturing more domestic value from hydrocarbons, for example via petrochemicals
- using natural gas as a means to support diversified growth
- harnessing the large but under-utilised potential for renewable energy, especially solar
- phasing out subsidies that encourage wasteful consumption
- ensuring sufficient investment in the upstream (the ability to maintain oil and gas revenues at reasonable levels is vital for economic stability)
- and playing a role in deploying new energy technologies, such as carbon capture, utilisation and storage
For Europe, not being a major oil and gas producer, the geopolitical shift resulting from the transformation to a low-carbon economy could in the end work out quite well.
Yet, the new global energy system, increasingly electrified, also represents “new threats”, as three researchers – Andreas Goldthau, Martin Keim andKirsten Westphal – from the German Institute for International and Security Affairs (SWP) in Berlin point out in a recent paper, the Geopolitics of Energy Transformation.
The energy transformation essentially implies a systemic shift, the effects of which must not be underestimated, they write.
Three factors are key in this context:
- The energy transformation recalibrates value chains. In a low-hydrocarbon – i.e. decarbonised – energy system, the economic value is no longer generated primarily from the (fossil) resource. Rather, it is accrued at the stage of conversion into end-use energy and energy services. This, in turn, means that the ability to generate profits will hinge on the availability and use of low-carbon technologies.
- The energy transformation will yield new energy spaces, defined by infrastructure, production chains, and industrial clusters. This spatial effect results from (geo-)technological change, for example in the shape of local micro grids or region-spanning super grids, such as those promoted by China’s Belt and Road Initiative.
- Today’s focus still rests on individual sectors (i.e. electricity, buildings, transport, industry), each characterised by a dominant mix of (fossil) fuels. The future focus, by contrast, will be in sector coupling. Integrating electricity, heat, and mobility will reinforce the relocation and reconfiguration of energy spaces.
Decarbonisation promises a “security dividend”, notes the report. “If more energy is produced locally, this has an impact on the relations between producer, transit, and consumer countries, arguably rendering the latter less dependent on the former. This goes hand in hand with an increase in sovereignty over energy supply.”
“The electrification of the system also levels out the role of states in the international arena, as they all become “prosumers”, i.e. producers and consumers alike. In addition, states may well become part of an encompassing “grid community”. This obviously requires conscious political decisions, both with regard to the domestic expansion or importing of renewables and to common control and cooperation mechanisms for the exchange of electricity in the grid. A single grid implies that vulnerabilities and sensitivities are distributed among all participating parties.”
However, “securing these transformation dividends also comes with new risks and challenges. For instance, the electrification of the energy system is associated with considerable risks in the area of grid stability and cyber security.”
“Stranded assets” are also a growing risk. “Assets linked to fossil fuels represent up to 30 per cent of the capitalisation of international financial centres, such as the London Stock Exchange. Depending on the depreciation rate, this clearly will represent a systemic risk”, write the SWP researchers.