US shale oil dream shattering

I am a student of geopolitics and also write a blog, ‘Geo Politics in South Asia and MENA’. Spending nearly 30 months in trying to understand the dynamics of the area of my interest I have reached a conclusion, the US has created more foes than friends.

Going a little further in history the other glaring examples are sponsoring proxy war in Syria, toppling regimes of its own ‘installed rulers’, attacking Iraq for alleged possession of weapons of mass destruction and Afghanistan for providing refuge to Osama bin Laden and its Ambassador supporting rebels in Libya.

The worst victim of its hegemony is Iran, the country facing the worst sanctions for more than three decades simply on the pretext (having no grounds whatsoever) that it is a threat for the kingdoms located in Arabian Peninsula and Israel. The Muslim Arabs have been so thoroughly brain washed that they now openly say ‘Iran is a bigger threat as compared to Israel’.

The supported Saudi Arabia in keeping crude oil prices high with two motives: 1) to sell more arms to Saudi Arabia and other Middle Eastern monarchies and 2) to attract investment in shale oil and gas for freeing itself from imported oil.

After having achieved the status of largest oil producing country in the world now the United States wants: 1) to teach a lesson to Iran and Russia already facing tough economic sanctions and 2) to test the lowest price level at which production of shale oil and gas remain economical.

It is no secret that the United States enjoy power to cause disruption in global oil supplies by asking its ‘operators’ in Iraq, Syria, Libya, Nigeria and Sudan to enhance level of their activities, imposing stringent sanctions on Iran and Russia. However, this is one side of coin and the other should also be looked at dispassionately,

To begin with, Saudi Arabia has supported the United States in keeping crude oil prices high to achieve its motives that include 1) buying more arms, 2) punishing Iran, 3) mobilizing funds for the rebels and 4) continue the legacy that it enjoys power to determine oil price. However, attaining the status of largest oil producer has shattered Saudi dream because Middle East has gone very low on priority list of largest oil consuming country, the United States.

When it comes to ‘business interest’ even the best friends turn the worst foe that is the inference on could draw from current Saudi-US rift. Saudis have a grudge against the United States which refused to attack Syria and helped in easing sanctions on Iran, is now capturing its share in oil market. Let one point be kept in mind that United States is curtailed import but has not started exporting oil as yet due to ban on oil export. This ban could be removed any minute.

The United States also suffers from an illusion that low crude prices will have adverse impact on Saudi Arabia, Russia and Iran. It is true that Saudi revenue will decline substantially in the short term but higher cost of production of shale oil may lead to many delinquencies and may deciding to stop production. Production of shale oil at US$60/barrel is not economically viable.

Russia will also face reduction in revenue from oil but it continues to enjoy control on gas being supplied to other European countries. An attempt to stop/curtail supply during winter can help in getting the sanctions removed and the added advantage is that lower oil prices can usher greater economic activities in the country, help in producing exportable surplus and improving competitiveness in the global markets.

A closer look at Iran highlights: 1) probability of easing economic sanctions due to the United States no longer being dependent on Middle East for supply of oil, 2) European countries having keen interest in investing in Iran’s energy projects offering very attractive returns, 3) Iran also making concerted efforts to boost non-oil exports and 4) supporting Saudi Arabia in maintaining current level of OPEC production to ease tension between the two countries.

Almost all the non-oil producing countries are more than happy with the decline in crude oil prices as they these are able to accelerate economic activities, airlines able to wipeout accumulated losses and benefit of lower cost of production to help in improving purchasing power of domestic consumers.

To conclude, I would like to refer to a news item released by Bloomberg. The United States is becoming victims of its own success. At prices hovering around US$70/barrel, drilling is close to becoming unprofitable for some explorers, said Leonid Fedun, Vice President and board member at OAO Lukoil (LKOD).

In Russia, where Lukoil is the second-largest producer behind state-run OAO Rosneft (ROSN), the industry is much less exposed to oil’s slump, Fedun said. Companies are protected by lower costs and the slide in the ruble that lessens the impact of falling prices in local currency terms, he said.

“In 2016, when OPEC completes this objective of cleaning up the American marginal market, the oil price will start growing again,” said Fedun, who’s made a fortune of more than US$4 billion in the oil business, according to data compiled by Bloomberg. “The shale boom is on a par with the dot-com boom. The strong players will remain, the weak ones will vanish.”

At the moment, some producers in the United States are surviving because they managed to hedge the prices they get for their oil at about U$90 a barrel, when those arrangements expire, life will become much more difficult, said Fedun.

  

Winners and losers of oil war

In less than one year time crude oil prices have come down by more than 30 percent and it is expected that the downward trend will continue for a while. The United States having emerged as the largest producer of oil does not seem in a mode to curtail its oil production. Smaller oil producing member countries of OPEC are proposing reduction in daily production. All eyes are set at forthcoming OPEC meeting. While non-oil producing countries are more than happy with the reduction in price, it seems both the United States and Saudi Arabia want to show the world that one of them controls oil prices, who is that?

I have stated in my last blog that many wondered why Saudi Arabia has been supporting the United States in keeping oil prices high. My perception is that since United Stated was working on shale oil and also wanted to keep Iran from oil market it lured Saudi Arabia to produce extra oil and mobilize more petro dollars. During this period Arabs were brain washed and made to believe that Iran was a bigger enemy as compared to Israel. This allowed the United States to sell over US$36 billion arms to Saudi Arabia in one year. Since United States refused to fight proxy Saudi war against Syria and Iran the King and his allies were upset. Signing of an interim agreement between the superpowers and Iran further annoyed the Arabs.

Historically, Saudi Arabia has been extending its support to the United States in keeping oil prices high, but this time it is reduction in production which the monarchs of Arabian Peninsula don’t like at all. Instead of carving any mutually acceptable strategy OPEC led by Saudi Arabia is trying to enhance production to maintain its revenue levels. This policy has led to the decline in oil prices which was certainly not liked by United States. The reason is obvious Shale oil production in not economically viable below US$80/barrel. Saudi Arabia still believes that shale oil production will not remain economically viable if prices decline below US$70.

After attaining the position of largest oil producing country after more than three decades the United States seems to suffer from the illusion that it has also attained control to fix price. To avoid any adverse price movement United States has not officially removed ban on oil export and its stockpiles are at record high. Instead of capping its own production the super power wants OPEC members to cut production of oil. There is high probability that OPEC may agree to this proposal to boost its petro dollar income. If this happens it will become too evident that oil producers other than United States and particularly Arabs have lost pricing control.

Oil is the most geopolitically important commodity. It drives economies around the world and is located in some usually very volatile places. Now U.S. crude production exceeds 9 million barrels a day, the most since at least January 1983. Over the last 10 years, the defining factor in the oil market was the growth of China and Chinese oil demand but at present the defining factor is the growth of U.S. oil production.

While making attempts to achieve this position, the United States has also been able to prove to the world that it remains the sole super power. Some experts say a new age of abundant and cheap energy supplies is redrawing the world’s geopolitical landscape, weakening and potentially threatening the legitimacy of some governments while enhancing the power of others. Surging U.S. oil production enabled United States and its allies to impose tough sanctions on Iran without having to worry much about the loss of imports from the Middle Eastern nation. Now Russia faces a catastrophic slump in prices for its oil as its economy is battered by U.S. and European sanctions over its role in Ukraine.

The first prey of this policy is Russia, which is the second largest producer of energy products outside OPEC. One can still recall that plunging oil prices in the latter half of the 1980s helped pave the way for the breakup of the Soviet Union by robbing it of revenue it needed to survive. Russia again looks likely to suffer from the fallout in oil markets, along with Iran and Venezuela.

The second prey is Saudi Arabia that is trying to prove it still enjoys pricing power. If it succeeds in plunging the price down to $60 or $70 a barrel, there could be a slowdown in the U.S. shale oil production but the world is not going to see it stop. The factors that can possible reverse the trend are: 1) terrorist attacks on a few oil fields in the volatile Middle East, 2) production cut by OPEC and 3) revival of global demand but neither is likely in the near term.

The third prey is Iran, like Russia its economy has been weakened by economic sanctions due to its nuclear program. The steps by the United States and its allies have almost closed Iran’s oil and gas fields to investment over the last decade, limiting the country’s access to technology to boost output. The nation needs to achieve enhance its oil revenue to keep its budget in balance. The decline in crude prices and a Nov 24 deadline for a nuclear accord are raising pressure on Iranian president elected last year on the promise to end Iran’s isolation and revive growth. If he succeeds in striking a deal and sanctions are lifted and the country is allowed to increase its oil exports, price may come under further pressure.

Oil producers, other than United States have to agree on the bottom prices if their governments want to survive. Social turmoil could paradoxically help prop up prices in the short term if output is disrupted, but that may not be the real solution.

The biggest winner in oil war will be the United States with Increasing energy independence, it will become less vulnerable to supply disruptions that will also provides added leverage in international negotiations, whether with Iran over its nuclear program or with Russia over its intentions in Ukraine.

China is also likely to emerge as a big winner, as it imports almost 60 percent of its crude. The world’s second-biggest economy probably will take advantage of the savings to build up its strategic reserves rather than dedicating the funds to increased spending on defense or any other program. The plunging oil prices will also gives the nation leverage in its dealings with Russia. The two countries signed a US$400 billion, 30-year gas-supply accord in May during a summit in China and then deepened their energy ties earlier this month by signing a preliminary agreement for a second Russia-China pipeline. China will always have an upper hand in dealing with Russia as long as crude prices stay low as Russia needs the energy income dearly.

Pakistan to produce extra 600,000 tons motor gasoline annually

According to a report published in Pakistan’s leading English newspaper Dawn dawn.com, motor gasoline production by local refineries will increase by 600,000 tons next year that will help the country save US$60 million per annum. Three of the local refineries would produce motor gasoline from naphtha, at present around 800,000 tons naphtha is being exported every year. This has become possible due to these refineries investing around US$200 to upgrade their facilities.

These three refineries namely, Attock Refinery, National Refinery and Pakistan Refinery are installing isomerisation units which are expected to be completed by the end of next year. Attock Refinery is installing isomerisation unit of 7,000 barrels per day to produce environmental-friendly gasoline that will enhance its production by 20,000 tons per month. Monthly motor gasoline production of Pakistan Refinery will be doubled to 24,000 tons from 12,000 tons. Monthly production of National Refinery will also increase to 16,000 tons.

Every year in winter motor gasoline consumption increases due to closure of CNG stations, which erodes paltry foreign exchange reserves of the country. During 2013-14, around 58 per cent of petrol demand was met through import. Total sales of motor gasoline in 2013-14 was 3.8 million tons in which local refinery produced 1.6 million tons while remaining quantity of 2.19 million tons has to be imported. During 2012-13 country has imported 1.89 million tons while refineries produced about 1.4 million tons and total sale was 3.3 million tons.

According to the report record 267,763 tons of motor gasoline was imported in April and this record was broken with import of 273,681 tons during September. Earlier, the highest monthly import record of was 233,348 tons registered in Nov 2013. The import of  was just 127,000 tons in 2007-08, rising to 249,177 tons in 2008-09; taking a quantum jump to 625,019 tons in 2009-10, rising to 1.06 m tons in 2010-11 and 1.55 million tons in 2011-12.

Pakistan: Is LNG the right solution?

The PML-N government is very actively perusing LNG import and also terming it the right solution to overcome Pakistan’s looming energy crisis. However, some of the quarters attribute this to be nothing more than ‘rental power scam’. They insist that it is ‘selecting a lesser evil’ and question the prudence of policy planners. They even go to the extent of saying that the power energy policies of ruling junta have always been dictated by those having vested interest. If rental power scam was a display of PPP’s corruption the same may be said about distribution of half a trillion rupees among the favorite IPPs by PML-N soon coming into power.

On the request of the Ministry of Petroleum and Natural Resources, the Economic Coordination Committee (ECC) has exempted the import of LNG from Gas Infrastructure Development Cess (GIDC). The decision looks like a joke because the purpose behind imposition of GIDC was to mobilize funds for the construction of Iran-Pakistan gas pipeline and LNG terminal. Therefore, collection of GIDC in imported LNG was irrational and to be blunt unconstitutional. Ideally, imposition of GIDC is unconstitutional because it is the sole responsibility of the government to mobilize funds for infrastructure development fund and it should refrain from penalizing the customers. The ECC, however, decided to levy five per cent GST on LNG import in any case, instead of prevailing general sales tax rate of 16 per cent.

Over the years experts have been saying that Pakistan’ energy crisis can be overcome by following a prioritized agenda that should include immediate actions like; 1) curbing theft of electricity and gas and 2) improving recovery of electricity and gas distribution companies. Let this point be kept in mind that the PML-N distributed half a trillion rupees to overcome circular debt issue. However, the government completely failed in taking the above stated two steps. The result is that the size of circular has bulged to around the same quantum in slightly more than one year.

The recommended medium term measure is changing the energy mix by minimizing dependence on imported fossil oil by switching over thermal power plants to coal, initially to imported one and then to indigenous. They also suggest construction of smaller ‘run of the river’ type hydel power plants, close to the places of power consumption

They also demand granting status of IPPs to sugar mills, which are capable of supplying 3000MW to the national grid to begin with and the output can be doubled by operating sugar mills at 100% capacity utilization. At present the mills are produced around 5 million tons sugar against an installed capacity of 9 million tons.

The added advantage will be double the production of molasses that is the basic raw material for the production of ethanol, being used to produce bio-fuel E-10 (motor gasoline containing 10% ethanol). This percentage can be enhanced to 35% by taking advantage of Brazilian experience. The move will: 1) improve capacity utilization of sugar mills and help in producing exportable sugar, 2) enhance production of molasses and ethanol, 3) contain motor gasoline import and above all save natural gas (CNG) currently being used in vehicles.

In the medium term work on coal fired and nuclear power plants should be completed on war footings but the core objective should remain increasing hydel power generation. The country is capable of producing 40,000MW hydel power and the added advantage of construction of mega dams are 1) generation of electricity around Rs2.50 per unit as against cost of Rs15 per unit produces at furnace oil based thermal power plants. The exact cost can be determined by examining cost of generation of HUBCO and KAPCO, Pakistan two largest IPPs.

While the fate of first LNG project is in doldrums the GoP has taken decision to construct another LNG terminal at Gwadar. Early October the ECC approved ‘fast track’ construction of 710km Gwadar to Nawabshah gas pipeline and LNG terminal at Gwadar port as an alternate plan to facilitate Iran-Pakistan pipeline and transport liquefied natural gas (LNG). The Gwadar to Nawabshah pipeline, with 42-inch diameter shall be laid along with two compressor stations. The terminal will have the capacity to handle up to 500 mmcfd of gas. Interstate Gas Systems (Pvt) Limited (ISGS) will be authorized to execute the implementation of the project. The committee also directed the Ministry of Petroleum and Natural Resources to finalize the funding plan preferably on government-to-government basis or build, operate and transfer or build, own, operate basis.

It is an incorrect perception that the country suffers from shortage of gas. To be precise if use of gas in power generation is stopped, thefts are contained the shortfall can be reduced substantially. If cement plants can switch over to burning coal why power plants can’t be run on coal? One has the reasons to suspect that ‘oil lobby’ is deadly against promoting use of coal in power generation. This point gets credence if one looks at the failure of the GoP to exploit Thar coal potential.

The time has come to put the things in right perspective and take the right steps to overcome the energy crisis. Keeping in view the high cost of LNG using it as a prime source of energy is highly imprudent. At the best it could be used as a make shift arrangement during winter and during the days supply from gas fields remain suspected due to annual turnaround. This consumers should not be forced to pay for high cost imported case as the country has ample supply if use prudently. Containing the leakages and theft of Sui twins would can add nearly 1,000 mmbtu or more than what the GoP intends to import as LNG.