Mar 11th 2020

Behind the Turmoil: Russia Provoked Oil Price Fall to Protect its Markets from US Frackers, which could now Collapse

by Juan Cole

Juan Cole is the Richard P. Mitchell Professor of History and the director of the Center for South Asian Studies at the University of Michigan. His latest book, Engaging the Muslim World, is just out in a revised paperback edition from Palgrave Macmillan. He runs the Informed Commentwebsite.

 

Ann Arbor (Informed Comment) – Last weekend, OPEC Plus, an expanded cartel of petroleum exporters, considered a plan for members to cut back on their oil production so as to support prices in the face of a slowing world economy owing to the novel coronavirus. The Russian Federation rejected the plan put forward by OPEC, insisting on continuing to export around 5 million barrels a day and on retaining its market share. The Saudi leaders, furious at Moscow’s intransigence, decided to flood the market by cutting prices for favored countries like China and announcing a production increase to over 10 million barrels a day beginning April 1. That is the date that the current OPEC agreement on production quotas runs out.

The Russian resistance appears to have derived from fears that if they cut back exports and OPEC managed to keep the price high, US petroleum firms using hydraulic fracturing (fracking) would simply rush in to grab Russian markets in Europe.

BBC Monitoring translated the statement of Mikhail Leontyev the press secretary of the Russian oil giant, Rosneft, to the RIA Novosti news agency. He said Sunday after the OPEC Plus talks failed,

  • “From the point of view of Russia’s interests this deal is simply senseless. We are relinquishing our own markets, removing cheap Arab and Russian oil from them, in order to clear a space for expensive American shale oil and ensure the effectiveness of its production. Of course, even in the current conditions it could have been possible to reach some sort of agreement with partners. But the proposal that was made was not partner-like. Our volumes are simply replaced by the volumes of competitors. This is masochism.”

So the theory that Russia provoked the price fall to harm US fracking companies is incorrect. They provoked it to avoid being harmed by the American producers, as they saw it.

Russia seems to have felt that the Saudi-OPEC proposal for production cutbacks was just too severe, and would only benefit the Americans. Fracking oil is relatively expensive, involving pumping water underground under high pressure. Infopedia explains that the average fracked well seems to have a production cost of $60 a barrel, although some fields can be exploited for as little as $40 a barrel. Fracking is an environmental disaster, leaving behind pools of polluted water and contributing to global heating by releasing masses of methane and by providing further petroleum to the world market. When burned, it releases heat-trapping carbon dioxide into the atmosphere. New York state has banned fracking.

In contrast, Saudi production costs are about $2.80 a barrel. So when Saudi Arabia sells a barrel of oil for $70 a barrel, it is making way more money than Occidental Petroleum, which has the upfront costs of $40 to $60 barrel. Still, if you sell a million barrels at a $10 a barrel profit, that is $10 million, which is better than a kick in the head.

But at Monday’s closing price of $36 a barrel, very few if any American fracked fields are making money, as Alexander C. Kaufman at HuffPost shows. Moreover, petroleum extraction has not been attracting much investment because a) it is embarrassing for investors to be known to be putting money into wrecking the planet’s climate and b) European and American car companies are selling loads of new lines of electric vehicles starting in September, which don’t use gasoline. As people buy and drive them they will throw petroleum prices off a cliff.

In part because of low investment funds coming in, some companies engaged in fracking, like Chesapeake Energy Corp. and Whiting Petroleum Corp., have had to take on a lot of debt. Their stock prices cratered on Monday, which will add to their woes.

Many fracking firms will go bankrupt if petroleum prices stay low for a year or more. Those that are highly leveraged and which have seen the value of their collateral much reduced may also have loans called in. Others will be more resilient because of deep pockets (ExxonMobil) or because they hedged for 2020. If $36 a barrel becomes the new normal the next couple of years and if this price point intersects with the EV onslaught, then fracking as an industry could be over with during the next decade.

Fracking allowed the United States to bounce back as a petroleum producer from 2006. Many ordinary oil fields had been depleted in the US, so that production was down to about 5 million barrels a day in 2009. The US uses about 21 million barrels a day of petroleum, mostly to fuel transportation. Now, with fracking, the US produced 12.1 million barrels a day in 2019. Although fossil fuel boosters keep saying that the US is now a net exporter of petroleum, that is ridiculous. It still imports about 9 million barrels a day more than it uses. And while it does export some oil, that is because it is cheaper to send Alaskan crude to, say, Japan, than to send it to New York. But then an equal amount is imported from places like Nigeria and Saudi Arabia. Also, there is a difference between petroleum and “petroleum products” such as distillate fuel and jet fuel. That is a minor part of the market, and in that small niche, the US did in December export slightly more than it imported. But the US is still very much dependent on imports for crude petroleum. If fracking ceases being profitable because of sustained oil prices of $36 a barrel, US production will shrink significantly.

In any case, the extra US production of some 7 million barrels a day over what was possible 15 years ago has contributed to keeping oil prices much lower than their 2014 high of $110 a barrel. Moreover, the US firms have horned in on the market share of other producers, creating resentments all around. And the US is increasing production by a million barrels a day, so that if that goes on it really will be reducing both price and market share for Russia and Saudi Arabia.

In countries like Russia and Saudi Arabia, petroleum underpins their economies. Oil and gas constitute 30 percent of the Russian gross domestic product; for Saudi Arabia they are 50 percent of GDP. They are thus in a 15-year race to make as much money off their petroleum as they can before its value declines precipitously with the electrification of transportation and the shift to wind and solar.

That is the reason for which market share is more important to Moscow and Riyadh than simple profits per barrel, which are in a long-term downward spiral any way. Say you had a million widgets that cost you a dollar each, which you had been selling at $10 a widget. Let’s say you know that widgets will be worthless in 15 years. And lets say someone came along who would sell the widgets for $8 apiece, but couldn’t go lower because they make them for $7 apiece. So what would be a logical move? Sell your widgets for $6 apiece, take the $5 profit on each, and drive out the competition so that you can sell all million widgets quickly before anyone realizes how worthless they are about to become.

Boom.

 

Link to Juan Cole's web site Informed Comment - click here.

Browse articles by author

More Current Affairs

Oct 17th 2021
EXTRACTS: "But property-sector woes are not the only economic danger China faces in 2021-22. The Chinese government’s mounting crackdown on the country’s burgeoning tech sector may pose an even greater threat." ---- "According to a recent study by McKinsey & Company, the share of Chinese urban employment supported by private enterprises more than quadrupled between 1995 and 2018, from just 18% to 87%. The share of exports generated by the private sector more than doubled over the same period, from 34% to 88%. And private-sector fixed-asset investment jumped from 42% to 65% of the total. The message in the data is clear: clamping down on the private sector and threatening innovators is not the way to ensure sustained rapid growth. Chinese entrepreneurs can read the writing on the wall. They understand that their political and regulatory room to maneuver is shrinking, and that the balance has shifted in favor of state-owned firms and public officials. And they understand that this uneasy atmosphere is likely to persist."
Oct 16th 2021
EXTRACT: "We designed a programme that incorporated data from over 300 million buildings and analysed 130 million km² of land – almost the entire land surface area of the planet. This estimated how much energy could be produced from the 0.2 million km² of rooftops present on that land, an area roughly the same size as the UK."
Oct 6th 2021
EXTRACT: "Britain in the 1950s was wedded to the US, acting as a partner rather than leading the charge. Now, while the UK continues to support the US, the influence it has seems negligible. While it may bring comfort to the UK to feel it is a partner to a superpower, being its stooge or subordinate is an unpleasant place to be, no matter how much you tell yourself it values your opinion."
Oct 6th 2021
EXTRACT: "That was then. Now, the Chinese government has doubled down, with President Xi Jinping throwing the full force of his power into a “common prosperity” campaign aimed at addressing inequalities of income and wealth. Moreover, the regulatory net has been broadened, not just to ban cryptocurrencies, but also to become an instrument of social engineering, with the government adding e-cigarettes, business drinking, and celebrity fan culture to its ever-lengthening list of bad social habits. All this only compounds the concerns I raised two months ago. The new dual thrust of Chinese policy – redistribution plus re-regulation – strikes at the heart of the market-based “reform and opening up” that have underpinned China’s growth miracle since the days of Deng Xiaoping in the 1980s. It will subdue the entrepreneurial activity that has been so important in powering China’s dynamic private sector, with lasting consequences for the next, innovations-driven, phase of Chinese economic development. Without animal spirits, the case for indigenous innovation is in tatters."
Oct 5th 2021
EXTRACT: "Wartime nostalgia plays an important part in Britain’s instinctive fondness for the special relationship. Like former Prime Minister Tony Blair in the run-up to the invasion of Iraq in 2003, some British politicians might believe that the United Kingdom is the only European country with serious armed forces and the political will to use them. Prime Minister Boris Johnson, like Blair before him, seems to fancy himself a modern-day Churchill. Unfortunately (or not), Britain’s military power is insignificant compared to what Churchill could command in 1944. Wartime nostalgia has drawn Britain into several foolish American wars, which other European countries were wise to avoid."
Sep 24th 2021
EXTRACTS: "We have found that 47 million American adults – nearly 1 in 5 – agree with the statement that “the 2020 election was stolen from Donald Trump and Joe Biden is an illegitimate president.” Of those, 21 million also agree that “use of force is justified to restore Donald J. Trump to the presidency.” Our survey found that many of these 21 million people with insurrectionist sentiments have the capacity for violent mobilization. At least 7 million of them already own a gun, and at least 3 million have served in the U.S. military and so have lethal skills. Of those 21 million, 6 million said they supported right-wing militias and extremist groups, and 1 million said they are themselves or personally know a member of such a group, including the Oath Keepers and Proud Boys." ----- "..... the Jan. 6 insurrection represents a far more mainstream movement than earlier instances of right-wing extremism across the country. Those events, mostly limited to white supremacist and militia groups, saw more than 100 individuals arrested from 2015 to 2020. But just 14% of those arrested for their actions on Jan. 6 are members of those groups. More than half are business owners or middle-aged white-collar professionals, and only 7% are unemployed."
Sep 11th 2021
EXTRACT: "That long path, though, has from the start had within it one fundamental flaw. If we are to make sense of wider global trends in insecurity, we have to recognise that in all the analysis around the 9/11 anniversary there lies the belief that the main security concern must be with an extreme version of Islam. It may seem a reasonable mistake, given the impact of the wars, but it still misses the point. The war on terror is better seen as one part of a global trend which goes well beyond a single religious tradition – a slow but steady move towards revolts from the margins."
Sep 11th 2021
EXTRACTS: "Is it not extraordinary that in a country that claims to be as enlightened and advanced as ours, the combined wealth of three individuals – Amazon founder Jeff Bezos, Microsoft founder Bill Gates, and investor Warren Buffett – exceeds the total wealth of the bottom half of Americans? One has to return to the days of the pharaohs of Egypt to find a parallel to the extreme wealth inequality that we see in in America today." ...... "The top tax rate remained above 90 percent through the 1950s and did not dip below 70 percent until 1981. At no point during the decades that saw America’s greatest economic growth did the tax on the wealthy drop below 70 percent. Today it is somewhere around 37 percent. President Biden’s American Families Plan would increase the top tax rate to 39.6 percent – a fairly modest alteration, albeit in the right direction. It is true that there was a time when the top marginal tax was even lower than it is today: in the years leading up to the Great Depression it hovered around 25 percent."
Sep 7th 2021
EXTRACT: "But Biden can’t be blamed for the rise of the Taliban, or the fragile state of a country that has seen far too many wars and invasions. The US should not have been there in the first place, but that is a lesson that great powers never seem to learn."
Sep 4th 2021
EXTRACT: "The world is only starting to grapple with how profound the artificial-intelligence revolution will be. AI technologies will create waves of progress in critical infrastructure, commerce, transportation, health, education, financial markets, food production, and environmental sustainability. Successful adoption of AI will drive economies, reshape societies, and determine which countries set the rules for the coming century." ----- "AI will reorganize the world and change the course of human history. The democratic world must lead that process."
Sep 1st 2021
EXTRACT: "Although the Fed is considering tapering its quantitative easing (QE), it will likely remain dovish and behind the curve overall. Like most central banks, it has been lured into a “debt trap” by the surge in private and public liabilities (as a share of GDP) in recent years. Even if inflation stays higher than targeted, exiting QE too soon could cause bond, credit, and stock markets to crash. That would subject the economy to a hard landing, potentially forcing the Fed to reverse itself and resume QE." ---- "After all, that is what happened between the fourth quarter of 2018 and the first quarter of 2019, following the Fed’s previous attempt to raise rates and roll back QE."
Sep 1st 2021
EXTRACT: "Today’s economic challenges are certainly solvable, and there is no reason why inflation should have to spike."
Aug 27th 2021
EXTRACT: "To be sure, they have focused on their agenda, which is totally misguided—not by our own account but by the account of the majority of the American population, who view the Republican party as one that has lost its moral footing to the detriment of America’s future generations, who must now inherit the ugly consequences of a party that ran asunder."
Aug 21st 2021
EXTRACTS: "Now that so many sad truths about Afghanistan are being spoken aloud, even in the major media – let me add one more: The war, from start to finish, was about politics, not in Afghanistan but in the United States. Afghanistan was always a sideshow."--- "....the 2001 invasion was fast and apparently decisive. And so it rescued George W. Bush’s tainted presidency,..." --- "Bush’s approval shot up to 90% and then steadily declined,..."
Aug 17th 2021
EXTRACT: "The Taliban’s virtually uncontested takeover over Afghanistan raises obvious questions about the wisdom of US President Joe Biden’s decision to withdraw US and coalition forces from the country. Paradoxically, however, the rapidity and ease of the Taliban’s advance only reaffirms that Biden made the right decision – and that he should not reverse course. ...... The ineffectiveness and collapse of Afghanistan’s military and governing institutions largely substantiates Biden’s skepticism that US-led efforts to prop up the government in Kabul would ever enable it to stand on its own feet. The international community has spent nearly 20 years, many thousands of lives, and trillions of dollars to do good by Afghanistan – taking down al-Qaeda; beating back the Taliban; supporting, advising, training, and equipping the Afghan military; bolstering governing institutions; and investing in the country’s civil society. .... Significant progress was made, but not enough." ....... "That is because the mission was fatally flawed from the outset. It was a fool’s errand to try to turn Afghanistan into a centralized, unitary state. "
Aug 6th 2021
EXTRACT: "But even in the US, which is more lenient than most countries, the principle cannot be absolute. Inciting imminent violence is not permitted. Donald Trump’s speech on January 6, urging the mob to storm the US Capitol, certainly came close to overstepping this boundary. It was a clear demonstration that language can be dangerous. What the internet media has done is raise the stakes; “fighting words” are spread around much faster and more widely than ever before. This will require a great deal of vigilance, to protect our freedom to express ourselves, while observing the social and legal bounds that stop words from turning into actual fighting. "
Jul 27th 2021
EXTRACT: "When it comes to the Chinese economy, I have been a congenital optimist for over 25 years. But now I have serious doubts. The Chinese government has taken dead aim at its dynamic technology sector, the engine of China’s New Economy. Its recent actions are symptomatic of a deeper problem: the state’s efforts to control the energy of animal spirits." ---- "... the Chinese economy, no less than others, still requires a foundation of trust – trust in the consistency of leadership priorities, in transparent governance, and in wise regulatory oversight – to flourish. --- Modern China lacks this foundation of trust ."
Jul 25th 2021
EXTRACT: "It seems that they are, as the last 18 months have seen a remarkable expansion of the central banks’ fields of activity, largely driven by their own ambitions. So they have moved into the climate change arena, arguing that financial stability may be put at risk by rising temperatures, and that central banks, as bond purchasers and as banking supervisors, can and should be proactive in raising the cost of credit for corporations without a credible transition plan. That is a promising new line of business, which is likely to grow. ---- Central banks are also trying to move into social engineering, specifically the policy response to rising income and wealth inequality, another hot button topic with high political salience."
Jul 25th 2021
EXTRACT: "The EU’s ambitious unilateral climate strategy will transform Europe into a trade fortress, encourage green protectionism worldwide, and give other regions the opportunity to develop using cheaper energy. And without China, India, and the United States on board, other countries will be careful not to follow the EU in its self-appointed role as the world’s green guinea pig. If Europe is not careful, it will risk finding itself in a climate club of one. "
Jul 9th 2021
EXTRACT: ".... ruminants belch and fart methane, an extremely potent greenhouse gas. As a result, rearing beef cattle brings about, on average, six times the contribution to global warming as non-ruminant animals (for example, pigs) producing the same quantity of protein. ..... if projected to 2050 [beef production], would use 87% of the total quantity of emissions that is compatible with the Paris climate agreement’s objective of staying below a 2° Celsius increase in temperature."