Yemen, shale, fracking and an unfolding new energy market

Published April 3rd, 2015 - 05:13 GMT

West texas and Brent crude have both risen five per cent after the unrest in Yemen unfolded.

Yemen’s significance lies in its strategic location near oil tanker shipping routes in the Gulf of Aden and the Red Sea.

The oil supply shock trade will not last since the real energy choke point in the Middle East is the Strait of Hormuz, where 17 million barrels of crude-laden tankers, mainly headed to Asia, sail every day. There is no supply risk in the Strait of Hormuz.

The macroeconomic fundamentals for crude oil are negative record inventories, a strong US dollar, weak Chinese demand and a European recession. A global light sweet glut all means that last week’s rise in Brent crude will be short lived.

The US shale oil revolution, thanks to the new technologies of hydraulic fracturing and horizontal drilling, has had an impact on the world oil market that is far greater than even the Alaskan oilfields or North Sea strikes. Not since crude oil exports from Saudi Arabia and Kuwait in the 1950s has the world faced at least five million extra barrels of light sweet crude, as happened with US and Canadian output rises since 2008.

Shale oil output, not Saudi Arabia or the Opec, sets the world’s price of crude oil. Saudi Arabia has refused to cut its own output or sacrifice its downstream market share in Asia at the last Opec meeting in Vienna. This is logical since Saudi Aramco exports 1.1 million barrels a day to China alone, where oil demand is slowing.

Between 2011 and 2014, the world oil market did not crash since Chinese demand was healthy, the US dollar was in a trading range against the euro and the Arab Spring created supply shock fears in Iraq, Libya, Sudan, Yemen, Syria and Iraq Kurdistan. However, in mid-2014, the global light sweet crude glut (created by the US/Canada shale oil revolution in the first place) led to an oil price crash.

Saudi Arabia did not respond to by playing its traditional role of swing producer in the Opec. The 20 per cent rise in the US Dollar Index since mid-2014 also coincided with the fall in Chinese crude demand and a bear market in emerging markets currencies, mainly the Russia rouble, the Brazilian real and the Turkish lira.

Since short-term price elasticities of both supply and demand are both high in the crude spot market, the result was a 50 per cent oil crash. The US shale oil revolution has also led to steep falls in deep water/offshore drilling and LNG and oil sands, since high-cast energy no longer makes economic sense.

The US shale oil revolution means that oil prices will trend lower as hundreds of private producer desperate to repay Wall Street bank loans will keep their wells active as long as oil prices, are above the marginal cost of production. Marginal costs in North Dakota’s Bakken and Texas’s Permian Basin shale acreages can fall as low as $20 a barrel dye to technological innovations in fracking/drilling.

The oil price crash has also raised credit risk for US and Canadian shale oil exploration and production companies. Hundreds of small, inefficient producers will be forced to merge or go out of business. Only the biggest, lowest-cost shale producers with economies of scale will be able to issue high-yield debt on Wall Street or float billion-dollar syndicated bank debt to finance takeover bids.

Super majors like Exxon, Chevron, Shell, BP, Total and ENI are underexposed to shale oil and will be tempted to buy the larger, independent shale oil producers. When oil prices crash, super majors drill black gold in Wall Street, not in Texas, Oklahoma and North Dakota. Expect mergers, hostile bids, proxy fights, consolidations, asset sales, restructurings and a desperate attempt to lower cost of capital. This means “bigger is better” will be the theme in the boardrooms of Shale Oil Inc in North America.

High-cost projects will be cancelled worldwide. The Russian Arctic, offshore West Africa and offshore Brazil are victims of the post-US shale global oil order. US shale oil output growth will slow in 2015-16, as the fall in the US rig count demonstrates. However, even if US shale oil growth is only 0.5 million barrels a day, world oil prices will remain under pressure. US shale output growth will be supplemented by spectacular output growth in Iraq and Iraqi Kurdistan, now at four million barrels a day. The global light sweet crude oil glut will define 2015, 2016 and 2017.

The writer is a Dubai-based research analyst in energy and GCC economics. Views expressed are his own and do not reflect the newspaper’s policy.

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