OPEC (Organization of the Petroleum Exporting Countries)

  • Oil and Petroleum Products
    OPEC in a Changing World
    Western leaders have long criticized OPEC’s power to raise oil prices, and the bloc continues to influence the global market even as U.S. oil production has soared and alternative energies have come to the fore.  
  • Energy and Environment
    Corporate Virtual Roundtable: Petrostates in Peril
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    Panelists discuss the geopolitical and economic ramifications of the current state of oil markets.   KRAUSS: Good morning. Welcome to today's Council on Foreign Relations meeting. I'm Clifford Krauss, national business correspondent for energy at the New York Times. We're in a historic moment. And a sidebar to this moment has been the oil story and energy at large. And it strikes me that we are facing a paradox. For decades since the Nixon administration, we as a country have been striving for energy independence and expanding our domestic fuel production. We reached this point, and now we have a collapse in demand, and so, in the face of coronavirus and the global economic downturn. So what does this mean for our country and the world and especially producers like Russia and Saudi Arabia? We know that Middle East producers cannot balance their books. What does this mean? We're fortunate today to have two fine experts to discuss, neither of whom needs a long introduction. Helima Croft of RBC Capital is one of the world's leading commodity experts. She knows energy and geopolitics and her commentary is closely watched by government officials and investors. And Arjun Murti is a senior advisor at Warburg Pincus and a director at ConocoPhillips. He is an advisory board member at Columbia University's Center for Global Energy Policy. So let's get on with it. So, let's start with looking at this from thirty thousand feet. Saudi Arabia and Russia face a dilemma that has produced tensions within OPEC+. They would like to force down American oil production, but at the same time they want to lift oil prices that support, uh, at the same time they are lifting oil prices or wish to and that only supports shale production in the United States. How do they get out of that box? Arjun, you want to start? MURTI: Well, so I think a lot of attention is placed on how Saudi and Russia are viewing U.S. shale. I think the interesting point to me is, U.S. investors, the public capital markets, had significantly soured on the shale E&Ps unrelated to what OPEC is doing or not doing. The shale E&Ps have been very successful in massively growing production. What they didn't grow was profits. Returns on capital were mid-single digit or worse, balance sheets for many companies are stretched. And so you had this issue where concerns about energy transition, what is the long term outlook for oil and gas demand, concerns about profitability, concerns about balance sheet help, all of these things are going to weigh on the shale E&Ps, actually irrespective of COVID-19. And irrespective what OPEC does or does not do, there's going to be a critical need, in my opinion for shale going forward. But investors funding these companies is a huge question mark. And I think the outlook for that is quite uncertain right now. KRAUSS: And Helima, how about the geopolitical piece to this? CROFT: Well, I think what's really interesting if we go back to what happened on March 6th, in Vienna, when we couldn't get an agreement between Russia and Saudi Arabia, I think part of the reason why Russia was reluctant to cut an additional three hundred thousand barrels of production and prop up the price then was because there was a view amongst some energy leaders in Russia that shale companies were weak and that they should not be giving a constant lifeline to these companies. And I think their view was, why should Russia continue to cut production, allow U.S. shale to grow, and allow a Russian energy company to be sanctioned? And so I think that part of the reason why they were willing to risk low prices, the view from Moscow was, could we potentially, you know, put some of these companies out of business and not have to deal with the foreign policy implications of having the U.S. believe that because of this resource endowment, that they could sanction companies and not pay a price in terms of U.S. consumers. I think for Saudi, it's a little bit different. I don't think that Saudi was primarily focused on U.S. energy companies, I think the Saudis were very focused on everybody having to basically pull their weight within OPEC and OPEC+, including Russia. I think Saudi is more willing, was more willing, to tolerate U.S. companies and their market share because Saudi I think, was more focused on getting a price that made their math work in terms of their budget. KRAUSS: And Saudi Arabia had attempted that same strategy in 2014 and 2015, and it didn't work out. I'm just, I'm wondering, going forward, is there a tension between Russia and Saudi Arabia that seems to be alleviated for the moment? Are we going to see that bubble up again? Arjun, do you want to take that? MURTI: Well, let me start with that 2014, 2015 didn't work out because why didn't it work out? The perception was the shale guys needed $80 or $100 a barrel, the price fell to $50. So that wasn't gonna work. There was, we were coming off a ten year, commodity boom in that period. There was a lot of fat to cut. It was early days in shale, so there was a lot of cost cutting, technology, drilling longer laterals, all the things that lowered the cost. The big kind of thing that didn't work out is the shale guys said, our wells work at $40 or $50 a barrel and they drilled accordingly and production ramped up massively. That was not accurate. Certain wells work at 40 to 50 (dollars). The vast bulk need $60 plus, you can see it in the full-cycle returns on capital. Again, companies were promising 30, 50, 100 percent, internal rates of returns on individual shale wells, they actually delivered 3, 4, 5 percent full-cycle returns. And so in 2015, capital markets flooded in to fund these programs that they thought were going to be very profitable. That did not work out at all. And so this cycle, you have capital markets, in some respects aligned with OPEC. We don't want shale to drill as much. We want more disciplined companies. And so I think I get why people look at 2015 and say, that didn't work out. But there was massive equity offerings, we're not having that this time. Companies are going to spend within cash flow before they would overspend cash flow, and I think everyone gets that the well IRR math just simply failed for the shale E&Ps, and that a different type of business model is going to be needed going forward. So in that respect, I actually think capital markets are more in line with Saudi and Russia, I think Helima will be more insightful and that dynamic between those two companies, but I'd say it's a strategy. I do think the capital markets will be aligned with OPEC in terms of limiting CapEx into shale. KRAUSS: So Helima, it feels to me like we have a different flavor here. And that is this morning, we have the reports of Chevron trying to take over Noble and, which is a relatively small deal, but maybe the beginning of a wave of consolidation, which would lower costs, eventually, if you have economies of scale. Is it possible that once again, the oil patch in the United States will accommodate this change from the international you know, oil patch? CROFT: Well, you know, Arjun is actually the expert on the U.S. story as well. I might actually take a little bit back when you go to Russia question and can that marriage stay together. I mean, I think one of the you know, the key things in 2014 as Arjun talked about is I think Saudi Arabia was really surprised and the OPEC planners who decided to not cut production in 2014 that capital markets remained open to those companies. They were not aiming to have $30 oil in 2014 and 2015. When they made that decision, they were surprised that the companies were able to survive that downturn. And so remember, when Ali Al-Naimi the Saudi oil minister said, I don't care if it's $30, I don't care if it's $20. We're not cutting. I don't think the Saudi leadership ever believed that you'd be looking at a $30 or $20 scenario. They thought you'd be looking maybe at a $70 or $60 scenario, it can be shorts day and the companies would fold. And I think what they learned from that, what they would say they learned from that, is OPEC was not sufficient to deal with U.S. shale, at least that's why you needed Russia. So I think that what 2014 taught them was you needed to bring somebody else into the arrangement to have market share power in terms of being able to manage the market. So I always talk about OPEC+ Saudi and Russia as that sort of shotgun marriage driven by shale. And I think that we had a test of it this year, clearly in March, in April, but when prices collapse and storage started to fill up, all the sudden people decided they needed to get their vows back together. And President Trump played a really important role in actually getting OPEC and Russia back together because when U.S. companies were threatened by the price collapse, and all of a sudden the American energy abundance and American energy dominance was threatened. President Trump had to drag that deal across the finish line and get everyone back together. So I think that is sort of where we are with Russia and Saudi, I think they're back because price dictated that they needed to get back. But again, the future in terms of a couple years from now will be determined. We don't know if this arrangement will last but right now I think they're in it. I will hand it back to Arjun to talk specifically about that Chevron-Noble. KRAUSS: Well, yeah. Arjun? Yeah. I'm glad you put, good. I want to move on to other things but before I do, Arjun, to the point of consolidation, which is widely expected, is that going to save shale? Is that going to improve the economics of shale as we move from the independence to the super majors getting into this driving down costs yet again, is that is that going to happen? MURTI: Not for the reasons typically articulated by the majority of folks. I think that and companies going out of business are the things most misunderstood. So there's always been throughout my thirty-year career, hundreds if not thousands of E&Ps and you merge a couple together, some of the management teams split off and start their own private equity or small cap E&P companies and that cycle just goes on and on and on. You're never, I mean, never is a long time but for, you're not going to have some super consolidated U.S. energy industry, there's just simply too many companies to do that. Consolidation in and of itself is only logical if you end up with a better company. If there are good assets to harvest that are at the low point of the cost curve that can be perpetuated, then it makes sense, but simply slamming two companies together in and of itself is not particularly relevant. As far as putting companies out of business, which is the other angle you always hear. I think that can be a fundamental misunderstanding of chapter eleven bankruptcy in this country, you go bankrupt, you wipe out your debt, you wipe out the equity holders, you simply have new equity holders, the company doesn't really go away. So what is needed here is either disciplined by capital markets for any number of reasons, discipline on the part of boards and managements to simply pursue their lowest cost assets that can generate good returns and good full cycle returns and free cash flow. And there are just too few companies today that do that, we need more companies that do that. And perhaps we'll see that going forward. KRAUSS: I want to go globally again, to Helima. This is something that you've written a lot about. And that is the kind of fiscal pressures that are being faced by Russia, Saudi Arabia, Algeria and these producers. What are the potential political impacts? And are we going to see or may we see more instability in the Middle East? CROFT: Well, you know, I love the question about, you know, people talk about bankruptcies for companies and can you put companies out of business? I think if Ali Al-Naimi was unsuccessful in putting a major U.S. shale company out of business, he put a country out of business. I mean that – KRAUSS: (Laughs.) CROFT: – price war essentially put Venezuela out of business. MURTI: (Laughs.) CROFT: We saw, I mean, really huge pain across the OPEC producers in 2014. And we think about where we stand now and it was extraordinary. If you look at 2012, the Middle East North African producers brought in $1 trillion in oil revenue in 2012. You go to 2019. That was $575 billion. In 2020, according to the IMF, the Middle East North African producers are expected to bring in only $300 billion. So in a span of eight years, we've gone from, you know, $1 trillion to $300 billion. And so that has really huge implications as you know Clif. I mean, the demographics of the Middle East, you know, where you have in certain countries, two thirds of the population under the age of thirty, very high youth unemployment, very high expectations of a social welfare safety net and employment opportunities provided by the state. And so when they don't have the revenue to provide those opportunities, you know, you really do risk social unrest. And if we look at what happened just last year, we saw multiple governments fall on the face of popular demonstrations over the failure to provide economic opportunity and poor governance, I mean Bouteflika and Algeria. He left the scene. You know, you had the government of Sudan fall, you had regime change in Iraq, and other places where the regime did not fall you have mass social demonstrations. You think about Iran, and Iran has been hit so hard by the combination of collapsing prices, but also sanctions. I mean, they've gone from being able to export, you know, over two million barrels a day to basically down to a couple hundred thousand because of U.S. sanctions. So it's not only their hit because of price, it's been hit by volume. And in that period, 2012 to you know, 2019 they've lost $80 billion in oil revenue. And so you know, countries like that really $40 Brent, the recovery of the $40s is not sufficient. I mean, RBC we estimate that the collective fiscal breakeven for OPEC+ is $90. And so this is recovery still means a lot of pain. It means going to the IMF for emergency funding. It means borrowing. It means cutting key social programs, tripling your VAT in the case of Saudi Arabia. So this is going to be an enormous challenge to get through this period of low prices. And then you think about a looming energy transition. And so the outlook is not great for these hydrocarbon states. KRAUSS: I'm glad you brought up the sanctions, because if it weren't for all of this expansion of U.S. oil production in recent years, you wouldn't have had the same sanctions regime on Iran and Venezuela, the United States would not have been able to do that, at least not to this extent. And of course, in the end, any instability in the Middle East while we may be cushioned, China's not cushioned. They're very dependent on Middle East, on Middle East oil, Japan, Korea, the world is interdependent and so this economic, this economic or this energy independence is a chimera. It's not real. If you're reducing dependence, but we remain interdependent in this global economic system. Arjun, this is, I think your wheelhouse. MURTI: I mean, you said it best. It's certainly better that we have some better balance between our production and our demand that that buffers extreme volatility, but certainly doesn't make us immune from it. You know, I think you noted earlier for the first time ever, a U.S. president as Helima mentioned actually helped support an OPEC deal that raised oil prices. I mean I'm fifty years old, that has not happened in my lifetime. And, you know, my former colleagues at Goldman Sachs, I think put out an analysis where these days, higher oil prices are a marginal net positive. Clearly the consumer loses on gasoline but the producing states benefit, it's, it's a marginal net positive from what years ago would have been a major net negative and it does allow us freedom to do things we didn't do before. But we're certainly not un-dependent on international markets. And if the price goes up some other part of the world, certainly consumers in this country will still, will still feel it. So. KRAUSS: Right, in the past oil shocks were spikes in price. Now we have, I live in, I live in Houston. Now the oil shock is a decline in oil prices. Oh, Helima you're, you're nodding and smiling. CROFT: I mean, absolutely. I think what's extraordinary is if you think about 2019, I remember flying into Abu Dhabi, and we had a report that you'd had tankers hit off the coast of Fujairah, that really important port, and oil didn't really move when you had, you know, potential disruption in the Strait of Hormuz, and then you went through a summer of 2019. We'll get pipelines attack, drone strike, tankers seized. And then on 20, September 14, we had a cruise missile and drone strike, knocking out more than half of Saudi's production temporarily, hitting the all-important Abqaiq facility, the world's largest oil processing facility, a facility that was seen as the nerve center of the global energy system. And you know, prices rallied, you know, one or two days, you know, ten bucks, but fell off. If you had said Cliff, ten years ago, Abqaiq is hit in an attack tied to the Iranians, where would you think oil would be? You'd think oil will be over $100. And you also would have thought the Carter Doctrine would have been invoked the doctrine that it was a core national security interest of the United States to protect Middle Eastern oil facilities. That doctrine has been in place since 1980. You would have thought an attack on Abqaiq tied to a sovereign state would have been enough to invoke the Carter Doctrine and President Trump was like, it's not an attack on the world, it's an attack on Saudi Arabia! Following up — KRAUSS: (Laughs.) The Trump Doctrine! CROFT: Right! Following up in January, I was actually in Abu Dhabi it was right after the killing of Soleimani and you had reprisal attacks on the Americans, you know, in Iraq. And you know, he said, we don't need Middle Eastern oil. I think that is what is really to me, which changes all the disruption and the attacks on facilities in 2019. Just didn't move the needle in terms of price and it meant the U.S. didn't feel compelled to have to intervene in a way it might have done so a decade ago. KRAUSS: And now we have these mysterious explosions in Iran, and all of the turmoil in Iran. At the same time, China and Iran are talking about oil deals and other kinds of relations, and I'm wondering what you both think of that. MURTI: Helima, why don't you start? CROFT: Well, I think what's interesting is that, you know, when this, when the U.S. pulled out of Iran nuclear deal, there had been this view in the market, it was not going to be effective, the U.S. was going alone, and that China would essentially back up the truck and essentially take all of those discounted Iranian barrels. What has been interesting, despite the deals that we've seen China sign recently with countries like Iran, these big investment energy deals, is they still abided largely by the U.S. sanctions, because of the ability of the United States now to essentially say, dollar transactions will be targeted. And if you want to do business in the United States, you have to make a choice. And so we have seen the sanctions be more effective, even China to a large extent had to go along with them, because of the power of the U.S. to basically lever the dollar and basically penalize these other companies and countries for doing business with states like Iran. We saw with Venezuela as well, the Chinese largely abided by the sanctions on Venezuela. And so I think we like to focus on the idea that you know China will go in there and take this. They're all to sign these deals. But the Chinese still for now, watch what Treasury is doing with extraterritorial sanctions. For now, they still have fight. Some people are starting to speculate, are we going to see more non-dollar transactions to get around sanctions, but I think that is something just to bear in mind as well. Like even China had to largely abide by the U.S. sanctions on Iran and Venezuela. KRAUSS: Arjun? MURTI: Clifford, the only thing I'd add is really these large oil importing countries of which China is the most meaningful one today, India is growing up in this world as well, is they're gonna have to figure out ways to ensure there is sufficient capital investment outside of the OPEC country. So if you go back over fifty years, OPEC production has gone up and down. But I would defy anyone to point to any individual country within OPEC that has had sustained production growth. Russia, part of OPEC+, has demonstrated that, Saudi has raised and lowered their production between eight and ten and a half million barrels a day numerous times, but never sustainably grown beyond that we know about Iran, Venezuela and so forth. And so whether it's shale, whether it's deep water, or whether it's other areas we're at a time of significantly diminished CapEx. It doesn't matter today, because demand is weak, and we've got COVID. But whether it's three years, five years, ten years down the road, I think people better hope there's an energy transition, because right now, investors significantly dislike the energy sector and there's very little capital investment going in and there will be a supply price to pay at some point, again it may not matter for the next couple years, but that deficit is coming. And so you look at China, they've generally been pretty smart about filling up their SPR when oil prices have been weak. So I think they certainly have an impetus to continue to expand that to try and provide their own buffer. But we are going to need more CapEx in the sector at some point by someone. KRAUSS: Well, well, when prices go up as presumably they would, wouldn't capital flow follow? MURTI: It should follow. I will say right now, when you look at how out of favor the sector is, I think companies are going to have to demonstrate again, I've said this a few times, they're gonna have to be more profitable going forward. But I think there's uncertainty even in shale development. We don't know what future administrations are going to do in terms of allowing fracking, in terms of allowing leasing and all these kind of things. There's always been challenges in many other areas, but I don't think you could just take it as a given, which is what I think people do. I think people presume prices going up and supply will be there. And undoubtedly, it probably will. But, but it can be a challenge. It just doesn't bubble out of the ground for free. It takes real companies with real effort and real capital markets backing and we have almost none of that today. KRAUSS: So, Arjun let's presume that production is in decline, well it is in decline and it remains lower in the U.S. And exports which are lower, remain lower. What does that mean, not just for the industry, but for energy independence in the U.S.? And then Helima, maybe you would also chime in on that. MURTI: You know, we probably have seen our peak minimum dependence, if that's the right word? KRAUSS: (Laughs.) MURTI: Or we've been sort of energy independent. And it does seem like it's going to be a little bit more challenging achieving that going forward. You know, we still are looking at, on my numbers at least, in the worst case of flattish U.S. demand outlook, once we recover from COVID. You can build in a slight growth or maybe even a modest decline, but something that does call for sort of continued healthy levels of demand going forward. And that may be hard to fill with domestic supply. I think you said it again earlier, Clifford. We're still part of the global energy world and so we might be a little less energy independent, going forward, but all these geopolitical risks, all this sort of dearth of CapEx, all these questions about timing of energy transition, the efficacy of the energy transition is going to be a big issue that we face. KRAUSS: Helima, this is a big idea. Please, speak up. CROFT: I always thought that there was a weakness, the whole American energy dominance argument that the Trump administration was making, because every time they had to call Saudi Arabia and ask them to put more barrels on the market. Like we saw that in the summer of 2018, when the U.S. pulled out of the Iranian nuclear deal, you had that rise in prices over the summer as they had talked about ending exemptions for importers of Iranian oil. We had Libyan supplies off the market temporarily. And we had President Trump putting a lot of pressure on Saudi Arabia that summer OPEC meeting to put a million extra barrels on the market. And so I always feel like if you have to still call Riyadh, it means that you are not independent. And then of course, the price collapsed when you had seven or eight exemptions offered in the fall. And I think that was the sort of back and forth between OPEC and Trump in terms of, we'll help you but we don't want to tank the old price. And again, we saw this year the fact that President Trump who'd been a critic of OPEC was having to basically at the eleventh hour, when the big deal to cut 9.7 million barrels was on the line and the Mexicans were stalling. The fact that President Trump was calling Lopez Obrador and Mexico and doing a workaround arrangement to get this thing across the finish line, again, shows that American energy dominance or that shale was always supported by an OPEC lifeline. There was always this interdependence between shale on this OPEC floor. So I think interesting enough going forward, I think the question is, are, is the U.S. going to be as willing to use the unilateral sanctions, you know, apparatus. I mean, are we going to be looking to do again what we did to Iran, on another country? I think those will be interesting questions. I do think a Biden administration, if we do get an incoming Biden administration, will look at sanctions in a different way. I think we could be thinking about next year, you know, not more sanctions on Iran, but potentially Iranian barrels coming back on the market if they react to the Iranian nuclear deal. So I do think we may have reached the kind of peak American energy dominance narrative, but again, I think that was undercut by the price collapse and the fact that shale needed that almost very explicit bailout from OPEC. KRAUSS: We'll open up for questions from our participants in just a moment. But let me ask one last question before we do that, and that is on Saudi Arabia. There's the other news this morning. The king, maybe ill, maybe having an operation. Why do, why should we care? Helima? CROFT: Well, I think we care because we still care about stability in the Middle East, irrespective, you know, we're not independent in terms of oil price of what happens in the Middle East. But we still care more broadly about stability in the Middle East. We still have troops in the Middle East, we still find moments where there is unrest in the Middle East and the U.S. is drawn back into the region. And I do think that it's a really important inflection point for the kingdom right now. I mean, one of the things about, you know, Prince Mohammed bin Salman, the Saudi Crown Prince is you know why there was initially so much enthusiasm about him? Would he really correctly assess the challenges facing Saudi Arabia and that they had to find a way to make this transition away from sole dependence on oil because it wasn't going to be able to fund future generations and so Vision 2030 was an accurate diagnosis of the problems that ailed Saudi Arabia. And so I do think that, you know, right now, it's a real inflection point in terms of will they be able to generate the millions of new jobs to accommodate, you know, university leaders in that country? So I think people will be watching if a potential sensation story comes. And of course, you know, a lot of these leaders are very old in the Middle East anyway. So we are looking at, you know, next generation leaders and Saudi Arabia is just so critical to the overall stability of the region. KRAUSS: Right, and will MBS have the support of the royal family going forward? This is, this is his moment, potentially. CROFT: Again, he has I mean, he has built his base of support on young Saudis. I mean, he's offered, explicitly offered, young Saudis a different at least social contract in terms of, you know, offering them more social freedom. And so it's a question of will he be able to generate the jobs to meet their economic ambitions as well? KRAUSS: At this time, I would like to invite participants to join in our conversation. A reminder, this conference call is on the record. Operator, may we have the first question. STAFF: (Gives queuing instructions.) Our first question comes from Mark Schaltuper. Q: Hi, Mark Schaltuper with AIG. I'm very interested in what you said earlier about, I guess kind of to rephrase it the cost benefit of CapEx versus transition that somebody mentioned, that you kind of better hope that transition accelerates. Would you mind commenting a little bit more about that? I'm just very curious in terms of the next couple of years, if more of the burden of maintaining access to reliable supply falls on China or other countries away from the U.S.? Is it going to be easier for them to accelerate that transition? Or are they going to have to kind of flex their own muscles to make sure that they have access to these strategic reserves? Thank you. MURTI: I mean, maybe I can start on that. So you know, I think energy transition is a huge topic. Clearly there is a need for the world and all countries to take positive steps to addressing climate change. But it's easier said than done. And so where you look at where energy transition, I think is most logical, and maybe has a clearest path and I still think it's going to take a long time is on power generation. We've always had many different ways to generate power. Coal, nuclear, in the old days diesel and residual fuel oil, today solar, wind, and you can like or dislike any of those, but you have choice. And you have opportunity. And clearly solar, wind, and some of these newer renewable forms, they're going to need battery storage going forward. But you can see a trend there where that makes sense. Where I am still very uncertain on how quickly this will happen is in transportation fuels. And so I am the proud owner of a Tesla Model 3, I will never go back to personally buying a gasoline car. But I also know I'm very lucky in my life. I did work at Goldman Sachs and I'm able to afford this Model 3. I think outside of Tesla, I defy anyone to point to car companies that are currently making cars that people want to drive. It's not that they won't, BMW, Mercedes, VW, all these folks will figure it out over time. That takes a while. And if you're someone in China, if you're someone in India, if you're someone in other parts of the developing world, the fossil fuel gasoline car is going to be overwhelmingly cost effective for you and you're gonna want the same benefits that we enjoy here in the United States and Europe. And so the transition when it comes to crude oil, I think it's actually much longer term, unless you have a much weaker economic environment, which is possible. Maybe global trade is peaked. At the same time, in crude oil, if you don't invest, supply declines. Not really true on a lot of those power generation alternatives. Some it's true, a lot it's not. In crude oil, if you don't invest, you're gonna have somewhere between a 5 to 10 percent annual decline in supply. It doesn't matter when we're in the heart of a pandemic. But I think there's a presumption, energy transitions here, we care about ESG. We care about all these things for sure. But you're still going to need a massive amount of CapEx to ensure especially the developing parts of the world have a chance to enjoy the same types of economic benefits we enjoy in the United States and Europe. And I think there are big question marks on that. Energy, traditional energy, traditional gases, very out of favor. Some of it's self-inflicted. A lot of it's self-inflicted, you don't generate good returns, but oil is $100. Why should they trust you when oil is 40 or 50 (dollars)? But you're going to need it, you're going to need CapEx. And I think there's so much emphasis on energy transition ESG I think we're at the risk of having a significant CapEx shortfall that again, may not matter for a couple years, but I think will bite at some point in the future. KRAUSS: Helima, you want to chime in? CROFT: I just want to follow up on Arjun's like terrific point about energy access, because we both go to these conferences all over the world. And I keep hearing from you know certain parts of the developing world, particularly in sub-Saharan Africa, the whole idea that we still need access to energy. I mean, if you have millions of people using biomass to heat their home, they're not talking about going out and getting a Tesla. And so there is some pushback in some of these capitals in the developing world, where they say this is essentially Europe and the United States basically, putting a ceiling on our ability to basically grow our middle class. Like they still are deeply, deeply concerned about getting access to affordable energy. And so I do think there is this sort of tension in this debate that isn't accurately captured, because we're still missing the fact that there are really important parts of the world that still want sort of cheapest forms of energy and believe it's their right to have a stable, cost effective, you know, supply of energy to lift people out of poverty. KRAUSS: Let me, let me bring the conversation back to the pandemic for the moment, its implications for the future. I think we can expect some rather large stimulus packages around the world to get us out of this and it's probably going to take several years. Will that stimulus go make a difference for the development of alternative energy and conservation and the kind of things that we need to do to stem climate change? Arjun or Helima? MURTI: I mean, you know, the foundation for good clean energy programs is always going to be a strong economy first. So if people are in an economically secure position, I think you're more likely to have these things. Now Europe's enacting a very strong green stimulus program. Those kind of things probably are helpful. Under the current administration, that seems far less likely here. You can argue these kind of things do make sense in terms of going forward, but they're still very long term in nature. They end up being, with apologies, a drop in the bucket, if you will. I think what is most important is that you continue to spend money on the R&D and trying to push these technologies that enable people to have the choice. So if there are ways to incentivize auto companies as an example, to continue to pursue electric vehicles, ensuring you have much tougher fuel economy standards. Keep in mind, we've had almost no fuel economy gains in this country because people have subsidized, substituted SUVs for cars. And so yeah, the current SUVs are more fuel efficient than ones twenty years ago. But that SUV is still far less fuel efficient than a car, so we make lots of choices every day. And there's no evidence of that changing. People still generally buy the most luxurious car they can buy. And fuel economy tends to be probably the last reason people buy a car. KRAUSS: Consumers are not on board. MURTI: They, not, they, people don't actually spend their money that way. That's unproven. So can you force it through government action? Perhaps? I think it's hard to force seven billion people in a certain direction. Without the technic- again, Tesla's proven that those cars are not less expensive. They're more expensive. KRAUSS: So that's a fascinating contradiction. MURTI: Can you make something people want to buy? Then they'll buy it. They're not buying, no one buys a Tesla for green reasons, not even clear how green it is. But that's a different argument. You got to make things people want, or it has to be significantly cheaper and we've not seen that combination yet with clean energy. KRAUSS: Helima, you're smiling. CROFT: No, I have nothing to add to that, you know, great analysis. KRAUSS: I think there's a, I think there's an interesting dilemma and paradox here and that is the investors see one thing, and the consumers seem to see another. They still want a gas guzzling, gas guzzler. They may not see it that way. And the investors are not putting the money into the oil companies because there's a disconnect between the gas guzzlers and making a profit. I'm wondering, um, these tensions between the United States and China, what impact does that have on the world trying to push forward with the Paris Climate Agreement and coming to some kind of collective effort. Is that a problem? MURTI: I would say the thing I worry most about in terms of the energy outlook, all forms of energy, would be have we had globalism? And are we moving towards more nationalistic instincts? And you mentioned China - U.S. that's clearly one example. But global trade has been very good, or at least positively correlated with energy demand is probably the right way to say it. I think there is risk that for any number of reasons, those trends are changing, and the more you have protection, you know, the less you have free trade, you know, that could cast a pall on global economic growth and hence energy demand growth. CROFT: Yeah, the only thing I would add, which is interesting on this topic of protectionism, is I feel like the one place that we saw is countries are moving more inward thinking about securing supply chains because of COVID-19, you know, health care, food. We actually saw this in the case of energy, you know, when prices collapsed, we actually saw, you know, the G20 become this forum for addressing, how do we have an oil price that works for consumers and producers? Like I felt like energy in this one instance, was this one place when everyone was on the same page. Negative prices was not in anybody's interest. So you know, whether this holds or not remains to be seen. I actually think energy was the outlier as more countries become more inward looking. What we saw at least this post COVID-19 world at the beginning was an effort to sort of work together to stabilize prices for everybody. KRAUSS: Without embarrassing either one of you with an endorsement of a presidential campaign. We're not going to go there. But what difference could a Biden administration make for the energy transition or relations with oil producing countries? We've touched on Iran just a little bit, but there's also Venezuela and there's Russia. Let's think about that scenario, because it's coming up in a few months, possibly. CROFT: I mean, I'm not totally taken on the sanctions issue. And I certainly think when we think about physical bounces in the oil market, like what could potentially change in terms of a new administration, I do think, you know, there'll be a lot of stipulations on how do you resurrect the JCPOA nuclear deal, but I think that the door would be open to potentially resurrecting that deal if the Iranians would make, you know, significant concessions on enrichment levels and becoming once again compliant with the terms of that agreement. So I do think the path of you know, getting that deal resurrected would be there with the Biden administration. And that's, again, significant quantities of oil. I mean, we're talking about a loss of close to two million barrels of Iranian exports because of unilateral U.S. sanctions. And so I think that is something we would watch very carefully in terms of what could change physical market balances, but also, would we be as willing to sort of unilaterally sanction again, countries like Venezuela to really target their ability to sell their oil to essentially get you know, lending by basically foreign banks and debt restructuring all those things we've gone after in terms of punishing these countries would a Biden administration work more in concert without, I mean would they use the sanctions tool in the same way? I think that could really change under a new administration. It may even be there wouldn't be that the same type of focus though on OPEC, I don't think necessarily that would maybe be as front and center as President Trump was very focused on sort of managing the market. I actually think you could make a case if President Trump became the de facto secretary general of OPEC, I'm just not sure that will be as much of a Biden administration focus. MURTI: The only thing I'd add Clifford and that is a great point by Helima is, if I look at it from the perspective of U.S. oil producers, since you asked about the U.S. election. I think there's a perception that Republicans are good for oil and Democrats are bad for oil. And I don't think you can actually show that that was true in history. I mean, your two biggest oil crashes. This is probably coincidence. We're in 1986, President Reagan, and then the most recent crash to negative $37. And maybe with a crash in 2014 under President Obama, but the point being, you've seen oil companies do well and poorly under both Republicans and Democrats. The shale boom started as a gas boom under President Bush. It clearly expanded and turned into an oil boom under President Obama and then it sort of continued, but now petered out under Trump. And so yes, there'll be different areas of regulation that you'd expect from Biden versus a Trump probably a different emphasis positively on clean energy versus traditional fossil fuels. But whether that is actually good or bad for the U.S. oil industry specifically, I would push back that there's some automatic one side to the other side in fact. I don't think it's proven historically, I think you'll have different areas of emphasis. And maybe there is a competence in running government that one might look forward to under future governments, whoever that is that we've lacked here. Look at the examples of the DAPL pipeline and some of the pipeline blockages. You know, you've had steps taken that I think haven't been super helpful to the oil industry, even though that might have been the original intention. The point being, I don't think we can judge these automatically as good or bad. We'll see what the policies are. KRAUSS: Certainly enough to talk about, but I just want to remind participants that they can ask a question by clicking the raise hand icon. One point, when I got on this beat fourteen years ago, we were wondering where we were going to get the next barrel of oil. And now suddenly, there's the possibility that there's not only more oil out there in the ground, but if there was if there was a change in Iran, or a change in Venezuela, or a change in in Libya, that you would have millions of more barrels of oil coming on the market, which might be nice for consumers at the pump, but could be a disaster for American oil companies. Arjun, do you see that as a possibility? MURTI: I mean so I'd say, even during my most bullish days at Goldman Sachs during the height of the supercycle, our view was never that we were going to, quote run out of oil. I've never bought into the peak supply argument. I suppose it's true in some ultimate multiple thousands of years sensitives? KRAUSS: (Laughs.) MURTI: But there are clearly numerous places to continue to develop oil. It's always been a question to me of, is the investment climate favorable or unfavorable? So where I've been less favorable in OPEC in terms of their ability to sustainably grow supplies, I don't think the countries have had the types of investment climates, either for their own companies, or for foreign investors, whichever you prefer is fine to become a countries choice, but neither opportunities had the chance to develop the oil reserves. Venezuela had a favorable investment climate in the 1990s under Luis Giusti head of PDVSA was the oil minister and they went from some small amount of production to three and a half million barrels a day and then under Chavez and the current regime, three and a half down to effectively zero investment climate. But we've generally had a favorable investment climate in the United States through both Republican and Democratic administrations. North Sea has been a little more volatile, some of the West African countries very positive. But that's where you are, I think in all this. We are not running out of oil, we are very unlikely to run out of oil in anyone's multiple generational lifetime. It is a question of whether the investment climate is favorable or unfavorable. Today, it's unfavorable. Today, investors are out of, out of favor, while these countries are facing challenges. And again, I think that does create supply risks going forward. KRAUSS: Well, I wasn't referring to the geology, Helima I'm gonna set you up here. Not referring to the geology, I'm talking about the political situations in those producing countries. CROFT: Well, I say, I should say Arjun was a total legend at Goldman Sachs. I can tell you when I started my career in the U.S. government in 2001, you know, right after 9/11 with permanent energy security group at you know, U.S. government and you know, there was this sense. Matt Simmons was, you know, people were still reading his work and there was a sense of being dependent on foreign supplies and what does that mean in terms of U.S. policy? And I certainly, I was covering Nigeria, I mean part of the reason I can have a career in the U.S. government covering Nigeria was there was this hope that, you know, Nigeria, all these other Gulf of Guinea producers would grow their production, and we would be less, we wouldn't have concentration risk, wouldn't have to be as dependent on regions like the Middle East. And so I remember there was this expectation, Nigeria in 2001, was producing over two million. There was a view that by 2010, Nigeria will be producing 4 million barrels a day, and that was seen as good for the United States because 10 percent of our imports came from Nigeria in 2001. We wanted to grow that share. It was talked about in terms of political terms. Nigeria was a transitioning democracy. It was seen as favorable to the United States. We liked the new leadership there.  You know, what I think has been really interesting is is that the shale revolution has meant that we don't really need those barrels in Nigeria anymore. Are we as invested in the stability of that country as we were when we thought of ourselves as sort of needing that oil? And I was on actually a CFR task force. I was a visiting fellow at CFR, I was on the task force on energy and national security. I remember, the opening of that report was, you know, we'll never be able to draw our way out of dependence on foreign oil, we have to manage our dependence on these producer states, and that was pre-shale revolution, that report came out, but I certainly feel like we felt the U.S. government, you know, after 9/11 that we needed, not that we were running out of oil, but we needed every barrel because we wanted to make sure we weren't dependent on certain regions alone. There was a huge emphasis on energy security through multiple producers bringing that supply on, I think that's what has shifted. KRAUSS: So we have instead of peak oil, peak demand, potentially. But what I was, what I wanted to get at is we have, you know, large producers out there with political problems that may resolve themselves, at least to a point like Libya, like Iran, like Venezuela, if any one of those countries suddenly resolve the issues that they have, maybe not overnight, what would that mean, for the world? CROFT: Well, I think Cliff, a concentration in Libya, you know, we've missed... the trend line in Libya seems to be, you know, in many ways getting worse as more and more countries become involved in this sort of great game for Libya's natural resources. I mean, there was a fantastic piece in the Financial Times over the weekend, looking at Turkey's geopolitics of energy and their entry into the Libyan conflict as part of an ability to try to secure, you know, gas supplies out of the region. And so I, I guess I'm not as excited or optimistic that Libya can off-ramp as easily but certainly now in a situation where you have two million off of Iran, it could maybe come back with sanctions being removed. If you could have a settlement to Libya to get a million back. I think Venezuela is still a long way back, even if you have sanctions removed. I mean, that country has been in structural decline since Chavez, you can't flip a switch and bring those barrels back. But certainly, you know, as we're working off of the COVID-19 effects in terms of demand, if we start to get a million back from you know, Iran or half a million back from Libya, that certainly puts the burden back on OPEC to try to balance this market and not have it, the market soften further. KRAUSS: Operator, I think we have a question. STAFF: We do. We'll take our next question from Tracy Roou. Q: Hi. Good morning, everybody. I had a question on the title of the series today, petrostates in peril. But talking about or thinking about Russia in the OPEC+ agreements or disagreements in there. Would, do you put Russia in that category of a petrostate in peril right now? Thank you. KRAUSS: Helima? CROFT: Oh I'll...and then I'll hand it over to Arjun, I mean I think — MURTI: Helima has to start. CROFT: I think in March, when they made that decision, I was in Vienna, when the Russians basically said, we're not going to do it. We're not going to cut an extra three hundred thousand. Let's put the burden of adjustment on to shale. I think part of their calculation was that they had a lower fiscal breakeven than the rest of OPEC, they basically said, we're more diversified. We can balance our budget in the fifties. But what we're willing to risk a collapse to the fifties. I think even the Russians though, there were prices that fell through $50, and you started having storage fill up, that is not what they had anticipated, and the Saudis could borrow. I mean, that's one of the differences is that Saudi Arabia is not under sanction. And so while they have a higher fiscal breakeven they can access capital markets. It was harder for the Russians to borrow because of international sanctions. And so I do think that, you know, the Russians quickly had to understand that, you know, sustained low oil prices was putting their regime in political peril as well. I think that is why they were quick to get back to the negotiating table to take a cut that was three times larger than the one they had initially balked at, and why they are for the most part, much more compliant with OPEC than they had been since 2016. I think they saw what the future looked like in terms of price. And that was not going to work for the regime. KRAUSS: Just one point before Arjun, you get to add in. I just want to point out that one of the reasons why the Soviet Union collapsed, was a decline in oil prices. So Arjun? MURTI: I would just add to Helima's comments that I've always thought of the petrostates, they have a somewhat better business model in that they have these handful of sort of government owned, sort of private, but at least independently financed oil companies that ensures relative health to the oil industry, that you don't quite see in some of these other countries where there's one state and one state owned oil company, and they might be very dependent on allocations of dollars either from a monarch or some congress, or some other avenue that often isn't there because they have to do all the social programs and so forth. So there has always been this buffer in Russia that has allowed them a rate of oil production increase that you don't see elsewhere. I mean, only the U.S. frankly has achieved it on any sort of sustainable basis. Clearly, the government is still very dependent on the oil price and oil export revenues. But as Helima mentioned, they have lowered their fiscal breakevens to a much better degree, than you've seen in other parts of the world as far as the oil companies go, they've got a very inverse correlation where oil prices are high, more of the profits go to the government, but when oil prices are low, the taxation is much less so it's created a healthier oil industry, again, relatively speaking, than what you've seen in any of these other petrostates. And it's  to the credit of how Russia has run things, again, at least relative to some of the peer countries. KRAUSS: So Helima, do you want to respond to that, add to that? CROFT: Well there are a couple other things I would add to Arjun’s great points is they have exchange rate flexibility. And so their ability to adjust to lower prices initially was better if you look at 2014, I think they weathered that price collapse better. I think that again, what they didn't expect when they made that fateful decision in March. I think that they believed that the Saudis would blink first. I think they held stoically. I think they thought the Saudis would blink, they look at the Saudi fiscal breakeven being much higher. And they thought either shale collapses, or Saudi will have to just bear the burden themselves. And we're going to be off the hook on this one. And I think they just didn't anticipate that the Saudis would basically be prepared to borrow to basically door low prices to force the Russians back to the table. And again, I think it's been remarkable that even though they have a lower fiscal breakeven, even though they have these companies, that they still, for the most part are now compliant with this agreement. KRAUSS: So I think they may have also underestimated the power of the coronavirus and the impact — CROFT: Oh yeah. KRAUSS: —that it would have. And they're not the only ones that it would have on demand. CROFT: No absolutely, Cliff. I was inside. I was actually in the kingdom in Saudi Arabia for a big international energy conference that major stakeholders were at and there was a view in mid-February that coronavirus was basically contained. That it was contained to China, that we were seeing recovering numbers, and it had yet to spread to Italy. And I think that also influenced the calculus of the Russians, not wanting to cut they did not anticipate what was happening was going to happen in Europe with lockdown conditions. KRAUSS: Good, staying on Russia for a moment, if we have a prolonged period of moderate to lower oil prices, and then oil prices could go down from here, for sure. What impact could that have on Russia, its stability, and its outreach in foreign policy, which has been so aggressive in recent years? Including on elections. MURTI: Helima you want to start? CROFT: Well, I think it's, it's an interesting question again, I mean, they have lower fiscal breakevens. And, you know, we just had an OPEC meeting Cliff, and the Russians, were basically I think, happy that OPEC is going to start putting some more barrels on the market. And so I think that they believe that we're kind of in a sweet spot that sort of works for them, where you can keep shale depressed, and you've had a recovery from negative numbers. And so obviously, if we were to get a major reversal of fortune, I mean, I think it's really important to watch do we get re-position of shelter in place policies that are mandated that have a second wave effect on demand. And I think the Russians, again, they are in better shape than a lot of the OPEC producers, but they're not going to be in a good position if we head back into the twenties. Certainly. KRAUSS: We could go on and on, but it is unfortunately time for us to conclude. I want to thank you all for joining today's virtual meeting. And thank you to our speakers. (END)
  • Russia
    Russia's Complex Oil Reality
    This is a guest post by Hunter Kornfeind, intern for Energy and Climate Policy at the Council on Foreign Relations and current student at Temple University. Russia is coping with a new reality from the lasting effects from the brief crude oil price war with Saudi Arabia this past spring and the ongoing COVID-19 pandemic that has left Russia’s domestic energy industry in its most difficult position since the breakup of the Soviet Union. Delivering an unprecedented production cut – around 2.5 million barrels per day (b/d) in May and June according to the terms of the recent agreement between the Organization of the Petroleum Exporting Countries (OPEC) and other major oil producers – in an accelerated manner left Russian oil companies with the difficult decision to select what wells to keep going and what wells to idle. Depending on how long oil production reductions are needed, cutbacks in specific Russian regions could potentially lead to some permanent shut-ins due to operational challenges across an industry with little storage capacity and natural geological constraints in a large number of maturing fields. Production curtailments could also affect the quality of Russia’s main crude oil Urals export blend, which is a mix of oils coming from different production streams. Variability of quality can alter the desirability of a crude oil in the export market, thereby influencing its value to refiners. These challenges are exacerbated by the fact that Russia’s oil trade faces strong competition from Middle East exporters in its key markets in Asia and Europe amid flagging demand caused by economic slowdowns. A deterioration in domestic consumption also poses headwinds, so much so the Kremlin recently banned certain oil product imports to protect the Russian market from a wave of cheap fuel.  Russia is fully committed to the historic 9.7 million b/d production cut agreed by the OPEC+ producer coalition of which it is a member. The Kremlin reaffirmed that commitment in announcing publicly today that there was “close coordination” between Saudi Arabia and Russia on oil output restrictions. The Kremlin is hoping its constructive role in fostering the final agreement to stabilize global oil markets could create a diplomatic opening to improve relations with the United States, which took an unprecedented public diplomatic role in pressuring the parties for the oil agreement, ultimately fostering cooperation between top Russian and Saudi leaders. Russian Energy Minister Alexander Novak recently met with major Russian oil companies to discuss a possible extension of the current level of production cuts past June. Much will depend on market conditions in Europe, where demand is beginning to recover. A longer period of curtailments could pose operational or geological difficulties for some Russian producers, including Russian flagship oil and gas firm Rosneft PJSC. Russia has been angling to get some U.S. sanctions eased, especially those applied to Rosneft PJSC, which is no longer trading Venezuelan oil. The technical challenges in Russia’s oil sector could give impetus to Moscow to want to gain access to capital markets for its oil sector as well as U.S. technology and industry assistance. It is unclear where diplomatic progress can be made in the complex U.S.-Russia bilateral relationship that ranges from concerns about future nuclear proliferation agreements to the difficulty of reaching a diplomatic solution to the humanitarian crisis in Venezuela as well as Russia’s continued military presence in the Ukraine, among other active hotspots. This week, the United States chided Russia for its alleged role in escalating conflict in Libya, in an indication that tensions remain on a wide range of issues.   Still, other geopolitical conflicts aside, Russia has a point in noting the significance of its contribution to global oil market stability. The 10 percent year-over-year decline in Russia crude oil production, described in April by Russian Energy Minister Novak, would make 2020 the first year of a double-digit decline in crude oil production since the early years of the Boris Yeltsin presidency. Following the collapse of the Soviet Union in 1991, Russian crude oil production reached a low of about 6.0 million b/d in 1996 according to the BP Statistical Review of World Energy, declining from about a record 11.4 million b/d in 1987. The state suffered from sharp declines in oil production from 1991 to 1994 when the Russian oil sector was under reorganization and little to no capital investment was made in new wells. Only after more than two decades of strong oil company investment, equating to hundreds of billions of dollars, has Russia able to restore its crude oil production capacity to return to its Soviet-era highs.  Russia currently has about 200,000 active wells, more than most other crude oil-producing states. Compared to Saudi Arabia’s lower per barrel cost of production, Russia’s hydrodynamic methods – including horizontal drilling, sidetracking, and hydraulic fracturing – are capital and labor intensive, especially with the country’s older wells. Reactivating a well that is throttled back can be challenging. For some wells, the longer a reservoir remains idled, the higher the chance pressure, water content, and clogging could affect future production. Experts say curtailment decisions will ultimately hinge on the characteristics and geological constraints within production regions. Companies have to assess where it makes the most technical and economic sense to make the cuts, either in brownfields – fields that have matured to a production plateau or even progressed to a stage of declining production – or in greenfields – a new oil and gas field development – throughout Russia. Increases in COVID-19 cases at Russian crude oil assets could also lead to production difficulties in select regions due to quarantines.  West Siberia, an oil producing region in central Russia that extends from the northern border of Kazakhstan to the Arctic Ocean, continues to be Russia’s dominant producing region and contributes more than half of Russia’s total crude oil production. Most fields operating in the region are older, conventional reserves. They are facing permafrost melting and rising associated water levels, which reached 86 percent on average in 2018. According to a study from the SKOLKOVO Energy Centre, Russia’s largest active Siberian brownfields reported a 22 percent increase in drilling rate penetration from 2012 to 2016 but recorded a 5 percent decrease in total crude oil production, demonstrating how Russia’s older fields require more intensive methods to keep production growing. Yuganskneftegaz, Rosneft PJSC’s largest unit with operations in West Siberia, cut crude oil production by about 289,000 b/d between May 1 and 11 from February levels, according to Bloomberg News. Lukoil PJSC, the second-biggest Russian operator, decreased output by about 312,000 b/d compared to February with almost half of the production cuts originating from fields in West Siberia.   Before the OPEC+ cuts, Russian companies were actively exploring greenfield development in remote onshore regions like East Siberia and the Russian Far East, attempting to offset declining production elsewhere in Russia. The shift had been successful – greenfields continue to yield higher production growth compared to legacy brownfields. According to analysis from the SKOLKOVO Energy Centre, Russian greenfield crude oil production grew 77 percent from 2012 to 2016, reaching 21 percent (roughly 2.3 million b/d) of total crude oil production.It remains unclear whether the current oil price environment will hamper continued greenfield investment and production in Russia. So far, Russian oil companies have not abandoned their large-scale investments, instead deferring them in hope of a rebound in global oil prices and eventual relief from the OPEC+ production limitations. State-owned giant Rosneft PJSC announced plans to continue the development of new fields but is "postponing short-term less economically viable projects" and “…high risk long-term projects, including joint ventures.” Russia could have difficulties staying the course, however, given the departure of some Western majors, who continue to slash capital expenditures. Royal Dutch Shell recently withdrew from its proposed onshore joint venture with Gazprom Neft in the Arctic, citing a “challenging external environment.” The current low oil price environment may discourage future Western investment in Russia’s upstream, which also continues to face complications from Western sanctions.   In addition to cash flow consequences and possible damage to oil fields or equipment, Russia’s continued oil production cutbacks could create a marketing headache for Russian firms. Russia’s most popular crude oil blend for export, Urals, is a mix of different grades of crude oil from different regions in West Siberia. As production cuts occur, the mix of crude streams going into Russia’s export pipelines can change, shifting the quality of the export blend and thereby its value to refiners.   Already, amid slumping petroleum demand due to COVID-19 pandemic lockdowns, Russia faces lower demand for its crude oil exports. Rystad Energy estimates crude oil demand in Europe declined 38 percent year-over-year in April and expects demand to slump 13 percent year-over-year for 2020. Chinese demand is slowly recovering following the easing of stringent lockdown measures, helping Russian export sales.   Russia sells roughly three-quarters of its total crude oil exports to just two markets Europe and Northeast Asia, much of it by pipeline delivery. In China, Russia has gained market share since the COVID-19 crisis began, replacing curtailed oil from Iran and Venezuela which recently reached all-time lows. China imported about 1.7 million b/d of crude oil from Russia in April, about a 14 percent year-over-year increase. That compares to about 1.2 million b/d in Chinese imports from Saudi Arabia. Shipments along the East Siberia-Pacific Ocean (ESPO) oil pipeline to the Kozmino export hub near the port city of Nakhodka in the Russian Far East point to a 24,000 b/d month-over-month gain to about 757,000 b/d in May to customers including Japan, South Korea, and Singapore, according to Energy Intelligence Group. In addition to linking to the Kozmino export hub, the ESPO pipeline connects directly to China via the Skovorodino-Daqing spur, an about 660 mile long pipeline transporting oil from Russia’s Far East to China’s Northeast province of Shandong, home to half of China’s teapot refineries and nearly 70 percent of teapot refining capacity.   !function(){"use strict";window.addEventListener("message",function(a){if(void 0!==a.data["datawrapper-height"])for(var e in a.data["datawrapper-height"]){var t=document.getElementById("datawrapper-chart-"+e)||document.querySelector("iframe[src*='"+e+"']");t&&(t.style.height=a.data["datawrapper-height"][e]+"px")}})}(); The recent success in oil sales to China contrasts to struggles in Europe and domestically. Seaborne crude oil shipments from the Baltic Sea ports of Primorsk and Ust-Luga are set to see a 620,000 b/d month-over-month decline in May due to reduced refinery runs and lackluster demand across Europe. March crude oil shipments via the Druzhba pipeline, the longest pipeline in the world, fell about 125,000 b/d month-over-month in April and may experience more headwinds in the coming months. Domestic demand for crude oil has also cratered amid the COVID-19 pandemic. Deputy Energy Minister Pavel Sorokin explained in April that domestic gasoline, diesel, and jet fuel consumption has fallen by 40 percent, 30 to 35 percent, and more than 50 percent, respectively, due to the shutdown of the Russian economy in light of the pandemic. Data shows gasoline production for the first six days of May declined to about 572,000 b/d, down about 40 percent from March levels as about a third of Russian products output is consumed domestically.   Although the OPEC+ agreement is finding very successful implementation, Russian and Saudi Arabian exports are still competing for similar customers going forward. Now, the United States could be added to the mix as the Trump administration is calling upon China to honor its bilateral trade pact, which included increased purchases of U.S. crude oil by China’s refiners. The negotiated increase in U.S. energy purchases, however, has been hampered by China’s economic contraction in the first quarter of 2020. Rebounding oil demand may help paper over such differences when the OPEC+ coalition meets again in less than two weeks, but there will be a lot to navigate beyond June as oil producers try to build on momentum created by the historic deal made in April.  
  • COVID-19
    The Elements Unfold: A Possible Bottom to Oil Prices
    The process of going into lockdown due to the coronavirus pandemic has been revealing, especially in regards to oil. There are many elements to the smooth operation of global oil logistics that are now facing potential problems due to the unprecedented lockdowns. Here are a few of these elements and the complications the lockdown process is exposing.
  • Iraq
    Between a Rock and a Hard Place: Iraq’s Pledge to Cut Oil Production
    Iraq faces an uphill battle in meeting its obligations to the historic production cut agreement reached by the Organization of Petroleum Exporting Countries (OPEC) and other major producers such as Russia. The production cuts are due to begin today. Not only is Baghdad mired in deep economic and political crises that show little signs of abating but Iraq’s complex service agreements with international oil companies (IOCs) operating its southern fields means that the Gulf producer would actually have to pay more money to the foreign firms working in its oil sector in excess of existing service fees if it demands the IOCs rein in output to help Iraq meet its targeted quotas. The supplemental fees, which could be millions of dollars, are stipulated in the oil field service contracts that Iraq holds with foreign oil companies that have been assisting with its oil production capacity expansion program over the last several years. The payments structure for Iraq’s service contracts means that output cuts put an added financial strain on the ability of OPEC’s second largest oil producer to comply fully with its pledged one million b/d plus output reductions in the coming months.  
  • Financial Markets
    OPEC Plus’ Zero-Sum Oil Game
    Prior to the U.S. invasion of Iraq in 2003, international sanctions had severely curtailed Iraq’s oil industry. Oil production sat at 1.4 million barrels a day (b/d). Iraq’s beleaguered refining industry was forced to inject surplus heavy fuel oil into oil reservoirs because there was nowhere else to put it. Iraq’s oil industry was debilitated from years of war and sanctions. It took the country billions of dollars of foreign direct investment and over twelve years to restore production to its pre-revolution 1979 capacity of above 4 million b/d. The breakup of the former Soviet Union tells a similar story. Russian oil production declined slowly from 11.3 million b/d in 1989 to a low of 6 million b/d in 1996. It only reached its pre-collapse level of 11.3 million b/d again in 2018. These lessons from history are important because they demonstrate the severe and long-reaching consequences that can result from mismanagement of oil sectors amidst turmoil created by endogenous or exogenous forces. The COVID-19 pandemic has already shown it could produce unprecedented shocks both from the health crises within petrostates and from external forces such as the sudden loss of demand for oil and the accompanying logistical and operational problems arising from oil pricing volatility.     The news that the Organization of Petroleum Exporting Countries (OPEC) plus other key oil producers like Russia had reached a historic agreement on April 12, 2020, to jointly cut production by 9.7 million b/d and that other output reductions would follow from other countries such as Brazil, Norway, and Canada was hailed as a good first step to stemming the tide of a massive surplus of oil that is accumulating across the world. The intervention was welcomed by the G-20 and in particular, the United States, which put its diplomatic weight into the effort to broker the arrangement, hoping to stave off a sovereign credit crisis in fragile petrostates and ease the pressure of mounting global oil inventory surpluses. But just a week later, the difficulties of the arrangement, which does not officially start until May 1, 2020, are starting to emerge. OPEC’s own internal calculations anticipate 300 million barrels accumulated in global inventory in March, with even more to come in April. Energy Intelligence Group reported that surplus floating crude oil storage, which is surplus too, and does not include crude oil in transit at sea to meet anticipated demand, had already increased to 117 million barrels by the end of February, up from 99 million barrels at the end of 2019.   The Wall Street Journal reported late last week that twenty large oil tankers holding a combined 40 million barrels of Saudi crude oil is heading towards oil ports in Texas and Louisiana and are due to arrive in May. Some of the oil was diverted from China, whose shutdown in February left it unable to absorb Saudi oil. But Saudi Arabia also emptied oil from its oil storage facilities in Egypt, Europe, and elsewhere as it was ramping up its declared price war in early March 2020. Now, Saudi Arabia will have to consider if it should slow steam its tankers, that is, have them sail at a slower than normal rate, or even reverse course, to ease the pressure of the arrival of so much oil amidst a continued collapse in U.S. oil demand in the wake of longer than expected economic slowdowns from COVID-19 related directives to shelter in place.   Saudi Arabia owns a 600,000 b/d refinery in Port Arthur, Texas but overall U.S. refining utilization has fallen below 70 percent of capacity nationwide this month in the wake of collapsing demand for gasoline and jet fuel. It is technically difficult for refineries to operate below 60 percent of capacity without turning off some processing units.   The time lag between when oil demand began to crater in February and the point at which the May OPEC Plus oil deal will kick in has created a rush to find storage where it might be available. Over 19 million barrels of crude oil was added to U.S. inventories last week alone. American pipeline companies are requiring companies seeking space on their lines to provide proof of destination certificates verifying there is a refiner at the other end of the pipeline willing to take the oil. U.S. crude oil exports are still moving into ships at the same rates as earlier this year with expectations that firm buyers are still there at the other end. Already, as storage tanks and distribution systems fill, logistical problems and related oil price volatility is worsening. Today, for example, May futures prices for West Texas Intermediate (WTI) crude oil on the New York mercantile exchange (NYMEX) have fallen precipitously to $1.75 as the contract comes towards its expiration date. If the economic demand rebound in May and June in Asia and beyond does not materialize fast enough and at the large scale needed to absorb the world’s oil, continued oil price volatility could be harsh. Recent Chinese traffic data, for example, shows a strong resumption in driving of personal automobiles on the road during work related commuting hours but a still subdued amount of traffic at other times of the day when cars could have been expected to return to the road for shopping and recreational activities.   If global oil demand does not pick up sufficiently in the coming weeks, then lack of access to physical oil storage facilities is bound to cause some oil production to shut-in. Analysts believe that oil production in Africa, Latin America, and Russia could be the most at risk to storage shortage-related curtailments, with potential damaging results for the long run performance of some older oil fields. The prospects that some oil exporters could be forced to close oil fields sooner than others means that all producers have some incentive to take a wait-and-see approach to their promised cuts. In recent years, the collapse of Venezuela’s industry has made room for better prices for the rest of OPEC. Loss of exports from war-torn Libya has also helped.   Despite all the uncertainty or maybe because of it, Russia and Saudi Arabia released a joint statement last week saying that they will “continue to monitor the oil market and are prepared to take further measures jointly with OPEC Plus and other producers if these are deemed necessary.” At the same time, analysts are struggling to anticipate which will come first, a gradual recovery of oil demand as various countries or regions reopen their economies, or damage to oil fields whose operations can no longer continue normally due to financial bankruptcies, severe economic losses, lack of access to storage, or worse still, a severe outbreak of coronavirus among critical offshore workers in a particular location or platform. The uncertainty is bound to create a volatile mix for oil prices in the next few weeks and complicate any future international diplomacy to bring longer range stability to oil markets.  
  • Oil and Petroleum Products
    FAQ: A Shale New Deal
    This is a guest post by Hunter Kornfeind, intern for Energy and Climate Policy at the Council on Foreign Relations and current student at Temple University. A breakthrough agreement between major oil producers and the G-20 has ended the oil price war that began with a conflict between Saudi Arabia and Russia on how to respond to a sharp collapse in global oil demand following the wide spread of the coronavirus global pandemic. The deliberations, highly influenced by diplomatic intervention from the Donald J. Trump administration, brought to the fore questions about how the United States can contribute to a global oil deal to stabilize markets by curtailing U.S. oil production or exports. There is virtually no oil production under the direct control of the U.S. federal government.  The U.S. Naval Petroleum Reserve, which was established in 1912 to provide the U.S. Navy with an assured source of oil, was disbanded starting in the mid-1990s amid changing markets.  To support the broader global oil stabilization program, the Trump administration has said it will lease the 77 million barrels of storage space left in the U.S. strategic petroleum reserve as a means to reduce the rising surplus of U.S. oil production, in effect taking some U.S. oil production off the market and putting it into storage to supplement market-related cutbacks that have already been announced by private U.S. companies.   This backgrounder of frequently asked questions explains how much oil is produced in the United States, what percentage comes from fracking activities in the U.S. shale, and the outlook for U.S. oil production going forward in light of the latest global oil producer deal, and volatile oil prices. This brief also includes some discussion on how the U.S. Presidential election might influence U.S. oil drilling and production going forward.   How much oil does the U.S. produce?  The United States produced 12.2 million barrels a day (b/d) in 2019, an 11 percent increase from 2018, according to official statistics of the Energy Information Administration (EIA). Texas is by far the largest oil producing state at 5.1 million b/d, followed by North Dakota at 1.4 million b/d. Alaskan production was 466,000 b/d in 2019, down slightly from 2018. Production on federal offshore waters offshore Gulf of Mexico stood at 1.88 million b/d, up from 1.76 million b/d in 2018. Close to 65 percent of U.S. crude oil production in 2019 came from tight oil production, of which roughly 4 million b/d came from just three Permian Basin areas – Spraberry, Wolfcamp, and Bonespring – in Texas and New Mexico.  In January 2020, U.S. tight oil production reached an estimated 9.1 million b/d, including 4.77 million b/d from the Permian region and 1.47 million b/d from North Dakota.  Tight oil represented 72 percent of total U.S. production of 12.74 million b/d in January 2020. EIA is projecting February and March data will show U.S. shale production is flattening. Alaska production was 482,000 b/d in January 2020 and U.S. Gulf of Mexico federal offshore was 1.98 million b/d.  The stunning increase in U.S. oil production over recent years results from new, innovative methods of oil and gas recovery, which combines hydraulic fracturing or fracking and horizontal drilling to produce unconventional reserves found in tight oil formations such as shale. Shales hold millions of tiny pockets of resource that have been described by analogy to bubbles in champagne. Fracking involves pumping a water and chemical gel mixed fluid down a well at high pressure to create cracks in shale source rock. Tiny particles of sand in the mix is used to keep the cracks from closing, allowing the production of oil and gas as long as the well remains pressurized. This contrasts with conventional drilling that focuses on a large continuous reservoir of oil or gas from a trap, that is like an underground lake or pocket that can be produced by designing a production system that taps the field’s natural geologic pressure.   Due to the combined effects from the COVID-19 pandemic and low oil prices, analysts are estimating a drop in U.S. crude oil production later this year for the first time since 2016. The latest EIA report currently projects U.S. production to decline by about 473,000 b/d in 2020 and 729,000 b/d in 2021. However, other estimates paint a grimmer picture: consultancy IHS Markit estimates U.S. crude oil production will fall 2.9 million b/d by the end of 2020, cratering below 10 million b/d. Citi estimates that stripper wells that produce less than five barrels a day represent about 450,000 b/d of U.S. total production and will be highly susceptible to closure if U.S. oil prices remain below $30 a barrel.   Low oil prices have led to cuts in capital expenditures across the U.S. industry. The largest U.S. oil majors ExxonMobil and Chevron have slashed their spending by an average 25 percent for 2020, focusing the largest portion of spending cuts on operations in the Permian Basin.  U.S.-based exploration and production companies EOG Resources, Pioneer Natural Resources, and Concho Resources are also reducing their full-year capital spending by about an average 34 percent, also succumbing to the lower crude oil price environment. According to IHS Markit, North American exploration and production companies, to date, trimmed 2020 capital expenditures by a combined $24.6 billion compared to 2019.   The United States has become a major exporter of oil. How much crude oil does the U.S. export? Will cuts in drilling affect the amount of oil to be exported by United States?   In 2019, the U.S. exported about 3.0 million b/d of crude oil, a 45 percent over the previous year. The top destination for U.S. crude oil was Canada, which imported 459,000 b/d, followed by South Korea (426,000 b/d) and the Netherlands (280,000 b/d). The rise of crude oil production over the past decade allowed the U.S. to become a net exporter of crude oil towards the end of 2019, the first time in history the U.S. was exporting more than it was importing.  The United States maintained high exports of crude oil in January 2020, exporting a total of 3.2 million b/d.   However, expected reductions in U.S. crude oil production as a result of low oil prices and the coronavirus crisis could adversely affect exports. The EIA’s forecasts in its most recent Short-Term Energy Outlook that the U.S. will again become a net importer of crude oil and petroleum products in the third quarter of 2020, remaining a net importer throughout the majority of 2021. But, the longevity of this not only depends on trends in U.S. crude oil production, but also U.S. oil demand trends. Government stay at home orders have lowered many Americans’ rates of daily driving, leading to a collapse of demand for gasoline. EIA is reporting U.S. gasoline demand plummeted over 30 percent to a twenty-six year low. Jet fuel use has declined by over 50 percent from usual levels.   Refiners across the United States are reducing refinery runs as refined products begin to buildup in storage tanks around the United States. Shutdowns of refineries in other international locations has allowed U.S. exports of some refined products such as diesel fuel to continue. Depending on configurations of processing units, it can be difficult for refineries to operate at below 60 percent of capacity without shutting down at least partially. To minimize the excess of jet fuel production, U.S. refiners are trying to reduce the percentage of jet fuel that gets produced during the refining process as well as trying to blend some jet fuel back into other product streams, repurposing some tankage to hold more jet fuel or hiring ships to store jet fuel. At some point, it might be necessary to waive the Jones Act which requires the use of U.S. flag ships for journeys in U.S. waters.   Is it possible for an oil price war or low oil prices to “destroy” the U.S. shale industry?  The U.S. Federal Reserve Bank of Dallas reported its most recent Energy Survey that exploration and production firms need an average West Texas Intermediate (WTI) price of $30 a barrel to cover operating expenses for existing wells and $49 a barrel to profitably drill a new well. Whiting Petroleum filed for bankruptcy protection on April 1, becoming the first notable exploration and production company to crumble under lower crude oil prices. Permian producer Callon Petroleum and Chesapeake Energy recently hired restructuring advisors and Moody’s downgraded Occidental Petroleum’s credit rating to junk. The industry already faced numerous headwinds, plagued by leveraged balance sheets and lackluster shareholder returns over the past decade. While the current economic crisis may be the final “nail in the coffin” for some individual firms, the shale resource itself will remain intact for more efficient operators to produce down the road.   When oil prices fell in 2015, several shale exploration and production companies stayed afloat by working out a new debt repayment schedule with bankers. Well productivity gains through technology improvements, hedging, and an eventual recovery in prices by 2017 helped keep many shale players afloat and supported new injections of capital. This time around, some of the largest banks are preparing to take over operations of the oil and gas assets and manage them directly instead of dumping the assets through a bankruptcy process at pennies on the dollar. The hope is that the banks could create vehicles to manage the assets until more favorable conditions would emerge at a later date either through rising oil prices or via a federally-assisted, credit workaround.    For the largest public traded U.S. exploration and production companies, only a small number have large non-revolving debt payments coming due this year. Production declines in the U.S. shale patch are more likely to come from pipeline and storage limitations, rather than outright bankruptcies, in the coming months. Spending cuts and capital constraints could, however, severely limit shale growth into 2021 and beyond if oil prices remain below $30 a barrel. However, chances are if oil prices recover at some point, shale development could accelerate again and growth could be restored, even if the actual companies who controlled the resource changed through industry consolidation or asset sales. The level of future investment will be highly sensitive to perceptions of future market developments.   Among the options considered by the White House during the price war was whether production should be shut down for a time on federal lands in the Gulf of Mexico in light of the COVID-19 pandemic.  However, such an option was not viable because it could potentially have resulted in some permanent loss of producibility of curtailed offshore production. By contrast, shale operators have more flexibility since well completion can be throttled back without fewer, if any, large scale, negative ramifications for future production from the resource. The Texas Railroad Commission, which last regulated state oil production levels in the 1960s and early 1970s, held a hearing this week on whether the state should institute mandated pro-rata reductions in production to prevent the waste of oil resources. Wide differences of opinion were presented at the hearing, reducing the chances of such a policy change, which faces legal, administrative, and political barriers to implementation.    Current Trump administration policy affirms that U.S. oil and gas investment and production is based on market forces and that a market-oriented approach in the United States is likely to produce reductions in oil production in 2020. President Trump’s intervention in the diplomatic process surrounding the G-20 oil stabilization effort was intended to preserve stability of international credit markets, to protect against geopolitical destabilization, in fragile oil producing regions like West Africa and Latin America, and to stave off major logistical problems that could stem from mounting global oil and refined product inventories. The coordinated approach within the G-20 on oil is seen as a continuing process that will require monitoring and refinement over time.   What percentage of U.S. oil demand is met by foreign imports? How much foreign oil does the U.S. import and where does it come from?   U.S. imports of foreign crude oil have been steadily dropping since January 2017 and stood at 6.4 million b/d as of January 2020, or about 30 percent of total U.S. oil demand. Imports from Saudi Arabia have taken a major hit, falling from 1.3 million b/d in January 2017 to 355,000 b/d in November 2019. They recovered slightly in December 2019 to 401,000 b/d. At the same time, crude oil imports from Canada have increased from 3.5 million b/d in January 2017 to 3.9 million b/d in January 2020. Crude oil imports from Mexico to the United States have declined from 730,000 b/d in January 2017 to 614,000 b/d in December 2019 but recovered to 854,000 b/ d in January 2020. U.S. refiners also import other petroleum blending stock materials other than crude oil to supplement the refining process to get the right quality standard of refined products to meet demand. These imports including unfinished oils like residuum, which are imported from a variety of countries including Russia.   Several democratic presidential candidates had proposed a ban on hydraulic fracturing on federal lands during the primaries. Democratic Party presumptive presidential nominee former Vice President Joe Biden has said he supports an end to new permitting for oil and gas drilling on federal lands. How much oil is produced by fracking on federal land? What would be the outcome of a fracking ban on federal land?  The Democratic Party’s presumptive 2020 presidential nominee,  former Vice President Joe Biden promised in a June 2019 climate change plan “… to stop issuing permits for new oil and gas drilling on federal lands and waters.” However, Biden stopped short of supporting a full ban on fracking in the United States, telling a September 2019 town hall that he did not believe a nationwide ban on fracking could get passed in the U.S. Congress. Democratic legislators Senator Bernie Sanders and Representative Alexandria Ocasio-Cortez have each sponsored legislation titled the “Ban Fracking Act” earlier this year and the position is popular with progressive voters. Opponents of fracking highlight problems that some communities have suffered as a result of nearby fracking activities, including contamination of groundwater, air pollution and negative health consequences, and increase in the number of earthquakes in drilling areas. Climate concerns about methane leakage from well sites, pipelines, and processing facilities, as well as from burning fossil fuels in general also play a big role in calls for a fracking ban. The Trump administration is against a ban and has promoted drilling on federal lands, emphasized fracking’s important role in promoting U.S. energy security and enhancing American’s international power and influence.     The Office of Natural Resources Revenue (ONRR), an agency within the Department of Interior (DOI), reported crude oil production from federal lands reached about 2.9 million b/d in 2019 (including Native America and Mixed Exploratory lands). About 64 percent of total federal production in 2019 came from offshore locations, with only about 36 percent derived from onshore fields including those where fracking techniques are prevalent.   Since 2010, crude oil production on federal land has grown at a slower rate relative to production on state and private lands. Production from non-federal land made up about three-quarters of total U.S production in 2019, up about 12 percent since 2010.  According to the ONRR and EIA, New Mexico federal crude oil production reached about 444,500 b/d in 2019, up from just 8,300 b/d in 2010. Almost all of New Mexico’s crude oil production from federal lands originated from two Permian Basin counties – Lea County and Eddy County. Crude oil production in Wyoming on federal lands hit 125,900 b/d last year, up about 37,400 b/d above 2010 levels with more than half coming from Converse County and Campbell County, part of the mineral rich Powder River Basin. Roughly 131,000 b/d of North Dakota’s crude oil production is from federal lands.   While legal experts have questioned whether a federal ban on fracking will pass the courts, analysts also disagree on how much production would be shuttered as a result of a ban on fracking on federal lands. Wood Mackenzie Consultants forecast total U.S. crude oil production could fall by about 750,000 b/d in 2021, if a ban was put into place. This estimate assumes no new wells would be brought into production but that existing wells would continue to produce.   One key factor in determining how much of an impact a fracking ban could have would be how much drilling activity would be shifted to private lands. For example, Consultancy Rystad Energy suggests a fracking ban would likely have no immediate impact on U.S. total crude oil production as capital would shift to private lands as the companies now drilling on federal leases redirect their efforts to other locations to replace lost volumes. Other analysts say that this view is too optimistic and might ultimately depend on market conditions. Current constraints in the availability of capital for shale companies, combined with operational constraints in acquiring new land, permits, lease obligations, and equipment, may potentially provide headwinds for a barrel for barrel shift away from production on federal lands by any particular firm.   What would the national security implications be of a ban on fracking on federal lands?   Prior to the shale revolution, the United States was a major oil importer with imports representing about 60 percent of U.S. oil use or about 12.6 million b/d at its peak in 2005. Since then, dependence on imported oil from the Middle East and elsewhere has declined precipitously. A fracking ban on federal lands alone would not likely return the United States into a major oil importer because the volumes curtailed would be significantly smaller than current U.S. exports of crude oil. Ultimately, the level of future U.S. oil production and exports will likely be a function of oil prices and changes to U.S. oil use. Sustained low oil prices would hinder future investment levels in fracking. However, future trends in U.S. oil use will also influence how much oil would be available for export versus internal use.  
  • Oil and Petroleum Products
    Oil Ground Zero: Running Out of Storage
    In recent days, the Donald J. Trump administration appears to have been sending mixed messages about oil. Typically, low oil prices can be a stimulus to the U.S. economy, but that is in situations where American consumers can benefit from reducing the burden of the costs of their gasoline use. In what is increasingly moving towards a national lock down to stem the severity of COVID-19, falling gasoline prices pack little punch to the many Americans, who are sitting in their homes out of work and to the rest of working Americans whose pocketbook is focused not on car travel, but on necessary home goods: food, medicine, cleaning supplies, and home maintenance. To keep the logistics of vital goods moving, an army of brave Americans – truck drivers, postal workers, warehouse workers, cargo pilots, and others, are serving our nation. The U.S. oil industry needs to make sure that these valiant workers have the fuel they need. In the case of goods movement, that is diesel fuel for trucks and natural gas for local delivery vehicles.  Right now, there are roughly 140 million barrels of diesel fuel accumulating in storage tanks inside the United States. That is sufficient to support the vial goods industries of the United States for a few months. But storage for other petroleum products such as jet fuel and crude oil is filling rapidly and can become a larger logistics problem, even inside the United States, if it is not managed eventually. Total U.S. on-land inventories of jet fuel are at about 40 million barrels, with only about 10 million barrels left in tankage. As a result, companies are starting to investigate storing jet fuel on ships until demand picks up again. Globally, jet fuel tanks are also closing in on physical limitations, but air travel and refiner flexibility in some locations will be higher than in others. This burgeoning problem of oil storage is yet another reason why the Trump administration is correctly focused on diplomacy to end the oil price war. Time is of the essence since running out of oil storage globally is in no one’s national interest.  The Trump administration has tried to focus G-20 members like Saudi Arabia and Russia on the problem for sovereign credits markets if low oil prices persist. Now, policy makers have to concern themselves with a second order problem. Lack of access to oil storage is going to force shut-in a portion of oil operations around the globe, both refineries and wellhead crude oil production, in some cases potentially with dire consequences. Saudi Arabia has cleverly positioned itself to maximize its access to oil storage, as opposed to Russia which is more disadvantaged in the flexibility of storage in its oil operations. China still has 200 million barrels plus of strategic storage it can offer to desperate oil exporters. The United States has opted to reserve the remaining 77 million barrels of space in its strategic petroleum reserve for U.S. domestic oil producers.  Late last week, Citi analysts calculated an immediate 10 million b/d reduction in global oil production is needed to prevent global oil inventories from reaching maximum capacity. Over the weekend, Saudi Arabia and Russia let it be known that they are making progress towards a deal that would accomplish this. Early proposals included a 2 million b/d cut from both Moscow and Riyadh with another 4 million b/d from other producers. A group including the Organization of Petroleum Exporting Countries (OPEC) was seeking a 2 million b/d reduction from the United States. The Trump administration is pushing for at least a 10 million b/d reduction from the OPEC plus group, which includes Russia, and has suggested that Saudi Arabia contribute more than 2 million b/d to reduction efforts. The United States could need time to work out how it would participate in any Plaza Accord style oil stability program that would come under the auspices of the G-20. Canada has already stated it is open to participation. The Trump administration has already committed to taking U.S. oil off the market by leasing storage in the strategic petroleum reserve and possibly elsewhere. Legal, political, and other technical hurdles to a federal intervention in ongoing private oil company decision making means any additional cutbacks would take time to organize. There is virtually no federally-owned oil production in the United States since the U.S. Naval Petroleum Reserve was sold in the mid-1990s.  If OPEC does not act, lack of storage will force shut-in of crude oil production in any case, since oil demand will be unlikely to recover substantially in the coming weeks. The distribution of remaining storage for crude oil is not equally distributed around the world. According to Cornerstone Macro, most of the available large-scale storage capacity for crude oil is located in just five places: the United States, China, Europe, Japan, and South Korea. The United States and Canada still have a combined, 380 million barrels of tanks available for oil storage.  Some oil producers have already announced production shut-in based on low oil prices, including Brazil (200,000 b/d), Chad, and Canadian oil sands producer Suncor, which has already shuttered a portion of its oil sand mining operations at Fort Hills. Russia’s lower natural gas sales to a struggling European economy almost certainly means a drop in its high condensate production, which was the focus of concern at the December OPEC meeting. Limitation of storage along some of Russia’s export routes are also likely to curtail oil production soon if it cannot gain access to storage from other places. Certain Texas oil pipeline operators are already warning smaller U.S. fracking firms that they may have to turn away their oil by the end of May for companies that do not have existing long-range contracts.  All of the above developments mean that, soon, the determinant of whose production gets curtailed could become a function of access to storage, not oil prices or the cost of production, if a market stability deal fails to materialize. That raises some tricky questions because not all oil fields are geologically alike, and some are easier to close and restore later than others. The nature of how naturally-derived or manufactured pressure drives the oil out of the ground is key to whether turning off an oil field means permanent damage that could result in a loss of productive reserves or not. Saudi Arabia has decades of experience in mothballing and restoring oil field capacity, though occasionally with some difficulties. U.S. shale is uniquely resilient as the pressure for production comes from the artificial means of hydraulic fracturing which can be turned off and on easily. It is impossible to destroy U.S. shale reserves since there is no natural pressure that has to carefully be maintained.  Any time the capital, equipment, and workers are there to produce it, it can be restored quickly in a matter of days or months.  The ongoing crisis in Venezuela has already resulted in some of its smaller oil fields being damaged in ways that the remaining reserves are likely lost forever. This type of permanent damage and loss of reserves could also happen in other places. Several of Iran’s largest oil fields require natural gas injection to produce oil and would be at risk if it cannot maintain a certain minimum production level across the country. Even some deep-water offshore oil platforms could be tricky to restart if they had to be fully shuttered for a long period of time. The technical difficulties of halting offshore production means suggestions that the Trump administration use its authority to close offshore oil production on federal lands could essentially be proposing the U.S. government destroy some percentage of that resource for all time. Finding a legal way to mandate limited, prorated cutbacks from multiple producers, while extremely difficult, could be the best manner for the United States to participate in a G-20 oil stability effort with an eye to sustaining U.S. companies’ ability to restore production capacity at a later date.  The looming shortage of remaining storage means the stakes are high for a major agreement among the world’s largest oil producers to throttle back in order to prevent global storage from filling to excess. It also means that oil production reductions are inevitable, if only because some producers will be thwarted by lack of places to store their oil.  Some U.S. politicians are calling on the United States to impose tariffs on imported oil. Implementation of this suggestion would be ineffective since the shortage of storage means any foreign oil producer who has concerns that shutting-in production would damage their reservoirs, will sell their oil at a loss just to get rid of it. That means they would still dump oil into the U.S. market to get access to buyers and/or buyer’s storage even with tariffs that lowered the profitability of doing so. Some oil is already trading around the world at negative value, that is, at prices where it costs more to produce the oil and ship it, leaving no percentage of funds received for the oil netting back to its seller.  There is disagreement on how long it would take the global oil industry to work off a historic buildup of inventories, were the surplus to reach the 900 million to one billion barrels analysts are calculating in the worst-case scenario. In 2015, when oil prices were cratering, surplus inventories ended the year at 593 million barrels and took two years of concerted producer cutbacks, led by Saudi Arabia, to run down. But that was when the global economy was humming at a 3.5 percent increase per year in Gross Domestic Product (GDP).  Presumably, this time around, it could take longer.  Finally, just as some crude oil exporters will have an easier time adjusting to storage problems than others, localized constraints on jet fuel storage could produce varying degrees of operational flexibility for refiners. That could be a serious problem if the pandemic’s negative influence on air travel is long lasting, given the configuration of the refining industry where it is difficult to produce needed diesel fuel for goods movement and industrial use without also amassing a certain amount of unwanted jet fuel that could not be disposed of. That could be the refining sector’s next big headache, once it recovers from the shock of abrupt loss of demand for its products overall.   
  • Oil and Petroleum Products
    Oil Price War: Is U.S. Shale The First To Blink?
    As the oil price war continues, markets are hanging on every word coming from Washington, Moscow and Riyadh, amid signs that diplomacy could be afoot. A statement by the Kremlin’s presidential spokesperson, that Russia would like to see higher prices, signaled that Russia might be willing to blink in the Russia-Saudi oil price standoff. It appears that the fall in the ruble is larger than Moscow expected, prompting them to use up foreign currency reserves at a faster clip than anticipated. Russia could also be finding it more difficult to sell its oil in China and Europe.
  • Saudi Arabia
    Why Current Saudi-Russia Oil Price War Is Not Déjà Vu
    It’s happened several times before: geopolitical tensions between Saudi Arabia and Russia have led to a dramatic drop in oil prices in years past. But the breakdown in Saudi-Russian cooperation in oil markets over the weekend is strikingly different this time.
  • Iran
    Iran, the Strait of Hormuz, and the Ever-Complex Geopolitics of Oil
    In a sign that anxiety about oil security of supply isn’t what it used to be, the Group of Twenty (G20) meeting broke up this week with no big joint statements regarding how to protect the freedom of navigation in the Strait of Hormuz. From the sidelines, U.S. President Donald J. Trump said there was “no rush” and “no time pressure” to ease tensions with Iran. German Chancellor Angela Merkel said she advocated “very strongly” to get into a negotiating process on the Iranian situation. Chinese President Xi Jinping noted that China “always stands on the side of peace and opposes war.” The latter statement was a pretty mild one given that approximately one-fifth of the oil that passes through the Strait of Hormuz is destined for China. China has given no public indication that it plans to protect its own shipping. Roughly 60 percent of crude oil passing through the Strait goes to China, Japan, South Korea, and India. The biggest statement about oil that emerged from the G20 came from Russian President Vladimir Putin who announced at the sidelines that Russia had agreed with Saudi Arabia to extend by six to nine months a deal with the Organization of Petroleum Exporting Countries (OPEC) to restrain oil output to support oil prices. OPEC then announced at its July 2 meeting in Vienna it had agreed to extend the deal for nine months into the first quarter of 2020. In speaking about OPEC’s deliberations, Iran’s oil minister said OPEC was being used as a “tool against Iran” jeopardizing the cartel’s survival. Last year, Iran told other members it was considering quitting OPEC. These various events say a lot about how the geopolitics of oil has changed and the huge implications those changes have for Iran. A decade ago, countries from the Gulf Cooperation Council (GCC) were of the mindset that they would never let Russia become a member of OPEC. At the same time, Iran was also a major rival to the GCC countries in its overall influence on OPEC outcomes, and both Russia and Iran boasted of their relations with each other in bolstering their respective positions in Mideast regional conflicts. But the new reality is that countries like Saudi Arabia now feel that they can basically ignore Iranian sensitivities at OPEC gatherings and have increased incentive to align with Russia on oil, not only because of the pressing need for revenue but also because of the geopolitical benefits of driving a wedge between Russia and Iran. In turn, Iran may have less to offer Russia as Moscow’s relations with the Arab world continue to improve, except perhaps the possible threat Tehran can make trouble for Russia in Syria or along susceptible pipeline routes. U.S. sanctions against Iran have long been in Russia’s interests to prevent Iranian oil and gas arriving in Europe to compete for its market share. But, Russia has a difficult road to navigate in its relations with Iran and Saudi Arabia since it will want to keep itself an important power broker around many of the Mideast’s current conflicts. This keeps U.S.-Russian interactions on the topic of Iran a challenging one.  The results of the G20 and subsequent OPEC meetings highlight the bind Tehran is in. What will be its geopolitical lever if oil and gas, which might have provided in years past, is no longer working? The large market surplus of natural gas is working against Iran. Japan’s state firm Japan Oil, Gas and Metals National Corporation (JOGMEC), for example, just signed on to Russia’s Arctic liquefied natural gas (LNG) expansion, in a sign that many countries that might have bought natural gas from Iran are looking elsewhere. The expected rising supplies of U.S. LNG are another. Chinese firms have also slowed new rounds of investment in Iran’s oil and gas sector and are increasingly investing in China’s own clean tech industry instead. Iran has to concern itself with the fact that as the United States, Russia, and oil producers in the Persian Gulf region expand capacity, its own reserves may become more likely to become obsolete or devalued if oil demand peaks over time. All this raises the question about how a petro-state like Iran reacts to the possible weakening of oil as a strategic tool. Iran will want to show the world that it still has a bargaining chip beyond its own oil resources. Some analysts are suggesting that by boxing it into a corner, the Trump administration might actually incentivize Tehran to lash out to make clear it is too important to ignore in an effort to drive the United States and others to the negotiating table, much the way North Korean missile tests got President Trump’s attention. Most recently, Iran’s response has focused on restarting its nuclear program. Iranian President Hassan Rouhani announced Tehran would return to its previous activities at the Arak nuclear reactor if the remaining signatories to the nuclear deal do not fulfil their promises. Iran might decide to focus on fast tracking its nuclear program to assert itself and gain leverage at a future negotiation. Alternatively, if it gets no geopolitical traction from restarting its nuclear program, Iran could stick with its grey area attacks on energy facilities to make the point it still has hard power to bring to bear. To date, the rules of engagement on cyber warfare against such targets have been harder to establish. A cyber escalation would be a dangerous outcome that would leave the United States with hard decisions about what kind of precedents to set in an active cyber conflict since a large escalation could lead directly to attempted cyberattacks against the U.S. homeland. Oil markets are betting that Iran will not choose to continue to disrupt shipping through the Strait of Hormuz since doing so would clearly escalate into a military confrontation with the United States. A second possibility, which would require much more diplomacy, is that Iran’s oil woes could prompt its leaders to look at the world with colder realism and come directly to the diplomatic route. One reason that approach could be compelling is that perhaps the real lesson for Iran is not that of North Korea, but of Venezuela whose oil industry is now decimated from years of corruption, lack of financing for maintenance, and an exit of foreign investors. As Mideast oil expert Sara Vakhshouri wrote in a report for the Atlantic Council in 2015, “Most of Iran’s oil fields are old and mature, which means they require further investment and treatments like gas reinjection, in order to maintain current production levels. The country’s oil wells are mostly in the second half of their lives, and are facing continued natural depletion of production capacity at the rate of 8-11 percent per year. It is estimated that Iranian oil fields lose between 300,000 to 500,000 b/d of natural reduction every year due to maturity of fields.” With its oil exports further curtailed this year, Iran should worry about not only losing market share today (and for however long it takes to restore its position in the global economy), but also the possibility that output drops could cause it to lose productive capacity more permanently if oil fields are damaged from forced production curtailment or reduced spending on maintenance over time. As Iran can see from its current failure to incentivize relations with Europe, Russia, India, China, and Japan by offering future stakes in its oil sector—a strategy that worked in the past but is apparently no longer effective—time is not on its side when it comes to preserving its future oil and gas sector opportunities.
  • China
    Is OPEC China's Problem?
    The decision by the United States to wind down waivers on U.S. sanctions against Iranian oil exports has laid bare some new realities about oil geopolitics that were previously not well understood. Oil supply shortages --regardless of whether they are orchestrated by the Organization of Petroleum Exporting Countries (OPEC) or come about from sabotage of oil facilities or escalating military conflicts in the Middle East-- are more China’s problem than the United States’ worry. President Trump muddied the waters of that perception by simultaneously bragging about U.S. freedom molecules (e.g. U.S. oil and gas exports), but then constantly jawboning OPEC to keep oil supplies high. No doubt Americans care about gasoline prices and don’t stomach petro-blackmail well, but everyone from Iran’s Supreme Leader Ayatollah Ali Khamenei to Wall Street hedge fund strategists are focused on how President Trump cannot afford let U.S. gasoline prices rise in an election year, and they are missing the forest for the trees. It is the Chinese economy, not the U.S. economy, that stands to lose the most from oil supply cutoffs. China’s oil imports have been rising and hit over 10.6 million barrels a day in April as the country’s refiners built up stockpiles ahead of expected disruptions from Iran and Venezuela. That begs the geopolitical question: Who does Beijing consider a reliable energy supplier and can they afford to skip U.S. oil and gas exports? If you are President Trump, you are probably thinking the answer to the second part of that question is no, especially since you are cutting off supplies from Iran. To address the reliability issue, let’s take a tour of Chinese suppliers. Saudi Arabia has been quietly shifting oil from the United States, where imports from the desert kingdom are nearing low levels not seen since the mid-1980s, to China where it is now the largest supplier to the Asian giant. But China has to worry about Saudi production cuts as part of future OPEC agreements as well as attacks on Saudi oil infrastructure.   Igor Sechin, head of Rosneft, told the St. Petersburg International Economic Forum this week that China and Russia should increase their oil trade. The statement coincided with bilateral meetings between Russian President Vladimir Putin and Chinese leader Xi Jiping in Moscow.  But Chinese investments in Russian oil firms have run afoul in recent years and the massive contamination of oil supplies shipped via the Druzhba pipeline to Europe is raising questions about Russia’s reliability as an energy supplier. China’s $160 plus billion in investments in foreign oil fields to garner secure equity crude oil supply in rogue petro-states has not panned out well. Several oil states have defaulted on Chinese loans or failed to deliver the promised oil. Most recently, oil payments by Venezuela to cover its $60 billion in borrowing from Beijing has fallen by the wayside as the country’s oil production has collapsed. Prolonged civil wars in Sudan and South Sudan have severely restricted the amount of oil Chinese companies could extract. Now with U.S. sanctions, oil shipments from Iran are in question. Angola, another important Chinese supplier, could see its production plummet by a third in the next few years if it cannot shore up investment. All this puts more importance on other Middle East supplies, which could face increased geopolitical risk if the escalating conflict between Iran and Saudi Arabia leads to additional sabotage against Persian Gulf shipping and production. Iraq, Kuwait and the United Arab Emirates are major suppliers to China. When the trade war with the United States worsened last year, Chinese firms curtailed spot market purchases of U.S. crude oil. It remains to be seen what the long run ramifications of less transitory, more structural worsening of U.S.-China relations would mean for energy ties. Presumably, China would intuitively feel relying on U.S. oil supplies would be strategically risky. And then, there is just the worry that the Gulf of Mexico hurricane season or a rapid downward spiral in oil prices could mean U.S. oil exports levels suddenly sink. All this leads back to the main point. China, which has no real experience in jawboning OPEC for more supply because it was energy self-sufficient in 1973, and even in 1990 when Iraq invaded Kuwait, has not grappled yet with this new reality. To date, China’s complaints have focused on complaining about U.S. policies towards Iran. That belies the fact that China is freeriding off the U.S. President making statements about the need for adequate supplies from OPEC to keep the global economy from slowing down. Moreover, the United States is accommodating China by making those statements, even as Washington cuts off access to Iranian oil. That raises an important question: when (and in the future, if) Saudi Arabia and Russia fail to respond to U.S. appeals to put more oil in the global market, are they secretly, or at least inadvertently, attacking China? It is a question that bears asking in Beijing. Even if Russia and Saudi Arabia have offered China extra oil in recent weeks, if that oil is just coming from elsewhere in the market (e.g. commodity shuffling) and doesn’t reflect added barrels, as is currently the case, the bill could someday be sent to Chinese consumers in the form of higher oil prices and a shrinking trade surplus.