Remember Obama’s retort ‘we can’t drill our way out of this one‘ referring to the mythology of scarcity that underwrites the malthusian justification to demonize either the market or American ingenuity. The simple truth is difficult for any autocrat to handle, namely the nosedive in world oil prices. Entire nation states have rigged themselves to both fallacies, namely cheap U.S. money & un-diversified economies. As of this writing, the U.S dollar is appreciating due to massive capital inflows while deflation surges making technocrats all over the world nervous that their specialization cannot conjure growth.
Let’s examine why?
What underwrites the American achievement in fracking? Its federalism and property rights. American states are surging at horizontal drilling/fracking because they’re operating outside the myopic confines of massive bureaucracies that hinder growth! By pursuing self-interest, states are pouring massive amounts of oil on a flooded market making prices fall. Normally, this would occur due the strengthening of the dollar. That’s happening anyway with surging capital inflows. Where do the world’s wealthiest move when the world get’s into trouble? U.S. equities and T-bills! Let’s remember, the U.S. Federal Reserve has ended quantitative easing, the primary driver of equities over the last six years effectively splitting volatile markets from securities. Gone are the days of passive investing!
Why come to the U.S? Well, there’s no growth in Japan, ditto for Europe, China has collapsed and emerging markets don’t demonstrate any discipline by embracing contract rights or the rule of law. The U.S. has profoundly deep bond markets, institutional liquidity ‘on demand’ and the rule of law. Why go elsewhere?
The Saudi’s are now threatened on two fronts. Domestically, the threat of modernity continues socially while Iran moves toward a nuclear device. Team Obama now has the complete attention of the House of Saud. The Saudi’s know they’ve been playing for time. Instead of reforming their own domestic economy away from oil, they continue to export militancy in the hope of burnishing ‘street’ credentials. October and November were very threatening to the Saudi’s, officially they’ve decided to increase oil production so as not to loose market share! What their really trying to do is kill any U.S. company operating on the margins. They seek to annihilate the Americans. We have to wait and see how this unfolds. OPEC members aren’t operating in unison anymore with members no longer supplicant before Saud.
Since June, Brent crude has dropped 40%. All the growth in oil reserves has been among non-OPEC members. And remember, the American’s have the world’s largest refining capacity!!
So here’s how it looks: OPEC members along with the House of Saud aren’t cutting production, their tied to our reserve currency, they need to continue to dominate whatever market share they have WHILE sustaining a game of ‘chicken‘ with several other producers. Russia, Nigeria and numerous others need $100 a barrel to finance bloated domestic budgets. They also have massive cash reserves to outlast U.S. shale oil producers. The Saudi’s are running to energy starved India, Pakistan, China and Egypt in the hope of reducing their own massive energy subsidies. Remember the Saudi’s want to hurt Russia which is dependent on oil for 42% of its government outlays. With the ruble collapsing after an abortive float that cost Putin 75$ billion, Russia’s left with capital controls and massive import of inflation.
Wait it get’s better!
Venezuela (a shia outpost) is on its back, exhausted. Chavista needs 125$ a barrel to cover its domestic expenditures, 65% of which are directly dependent on oil exports. As of this writing, production is down nearly 40%. Nigeria’s naira (its dollar) is down nearly 12% while its oil productive capacity has shed nearly 80% since October.
The question is, how low can oil prices go?
I’ve often thought that the real question is more political? How long can government expenditures go with falling gas prices while domestic budgets surge throughout the world? Remember, the 50$-69$ barrel ‘break-even’ point for U.S. shale is less relevant as is the cost for exploration, drilling and transportation. Let me explain.
What the Saudi’s envision we MUST pay attention to: what matters are marginal costs, the expense of retrieving oil once holes have been drilled and pipes laid. That magic cost is around 10$-20$ a barrel throughout OPEC and about 50$ a barrel for the U.S.
So the Saudi’s think that the floor is about to be reached, while they know Obama isn’t favorable to U.S. shale revolution. Politically, the Saudi’s see a trend line that is sound. My guess is that’s a very myopic vision, true and empirical as it is, their remain unknown UNKNOWN’S that will shake this shell game in the coming months.
In the meantime, developing countries that depend on commodity exports for hard currencies to service foreign debt will produce and export even at prices far bellow marginal costs. The Saudi’s can win this ‘one’, but the political, geopolitical, monetary and social threats that the House of Saud has sought refuge from will continue. My monies on the U.S. & Israeli’s longterm, for the enormities that other political economies seek refuge from are embraced and challenged by political economies far stronger than Iran, OPEC, Saudi Arabia or Nigeria.