Energy players are in a painful place at the moment, with companies and governments ‘tightening their belts’ as the price of oil remains low. The winners in the current scenario, of course, are those who neither produce, nor sell energy. However, ‘things are coming to a head’ and we are all likely to be affected.
The possibility of another financial meltdown constitutes a global threat. Up to one-third of US junk bonds are linked to shale gas plays, where companies hedged their bets on a $100 barrel of oil. As the outlook looks likely to be nearer to $50 per barrel, many of these will default. After hundreds of billions of dollars were invested in shale, there are looming fears of boom turning to bust.
Shale players are ‘hanging in there’, hoping prices will go up before their debt is due. Nevertheless, there is a consensus that the world has an energy glut, with less of an appetite for fuel guzzling. That is true, particularly in the case of the Chinese economy, which currently resembles a super tanker struggling to change direction. As low prices hit shale production, previous talk of the US no longer being a net energy importer by 2019, is also being revised. The possible date for that landmark in US energy self-reliance has been put back to 2030, at the earliest. That means the next four US Presidents, just like their predecessors, will have to keep an eye on what other energy producers are doing. The US will continue to have an active international interest in global energy markets. It will have to stay focused on the Middle-East, as well as watching China and its Pacific neighbours.
The good news for the Japanese is that the nuclear power plants, mothballed after the Fukushima disaster, are gradually being turned back on. Consumers and the Japanese government should benefit from lower bills. Japan had been buying heavily on global energy markets, which in turn, pushed up prices, but its return to nuclear, will remove that pressure. Japan and its neighbours are becoming concerned though about China building up its maritime presence near the contested borders in the East China Sea, and about the airport China is constructing on the Spratly Islands in the South China Sea.
Admiral Katsutoshi Kawano, Japan’s top military man, has spoken of Japanese plans to patrol the South China Sea, following a new bill allowing the Japanese military to defend other regions. The issue feeding these tensions is energy. Staking a claim to rocky outposts makes a lot more sense, if there are large energy deposits under the sea. China’s so-called ‘string of pearls’ – deepwater ports stretching around the world to the energy-producing Middle-East – reflect the country’s desire to protect its energy supply routes. India is amongst the countries worried by China becoming more assertive on the seas.
Many energy producers are feeling under pressure. Russia is facing recession, with sanctions adding to the misery. Although Russia is talking of energy deals with China to replace falling demand from Europe, this will require infrastructure investment on a huge scale – and that, in turn, would allow China to ‘play the global market’ to obtain the best price. Already, Russia is anxious about losing influence in the energy-rich Central Asian countries, as China’s new Silk Road initiative means it is investing heavily in direct energy deals with Central Asian states. The worry is that the Russian bear may lash out – either by encouraging more military action in the Ukraine, or by stirring up trouble in the Baltic States.
The European Union is looking to reduce overall energy consumption, and also to diversify supply, given the uncertainty surrounding Russia, as a result of the Ukraine situation. However, moves to set up an Energy Union do not suit everyone. France remains heavily dependent on nuclear energy, whilst Germany is phasing it out. Some countries depend on Russian gas, and have no easy alternative; others still rely heavily on coal. If the EU wants to reduce coal as part of its efforts to meet carbon targets, this might well mean having to rely to a greater extent on Russia.
Iran is the ‘joker in the pack’. The nuclear deal holds out the hope of sanctions being lifted and the country once again becoming a global energy giant – but that will entail major investment. Doubling oil production to 5.7 million barrels a day, will cost an estimated $185 billion: and finding the money to overhaul your energy infrastructure is difficult at a time of low oil prices. Such investment in Iran could, therefore, drain some funds away from other OPEC members – a potential source of further tension, at a time when an unofficial Shia-Sunni civil war, with Iran and Saudi Arabia, respectively, leading the opposing sides, is getting fiercer in Yemen, Iraq and Syria. Ironically, the energy-rich eastern province of Saudi Arabia has a Shia majority, whilst some of the richest energy regions of Iran have a significant Arab population.
Saudi is one of the biggest losers in the current scenario. Initially, it was perceived in some quarters that the Saudis welcomed low oil prices, as a means of driving the US fracking industry out of business. The reality, however, is that they are now caught in a price trap, where every single increase in the oil price will bring more shale back on to the market, so pulling prices back down. Saudi’s reserves fell from $746 billion in September, 2014, to $672 billion by the end of June this year. If they keep on taking out $2 billion a week from their reserves, they can stay in the black for six more years. Another drain on revenues is the fighting in Syria and Yemen, which the Saudis are bankrolling. Domestic subsidies have risen by $130 billion, but civil unrest is likely if they are not maintained.
In Africa, Nigeria is amongst those worst hit by low oil prices. The country produces 1.8 million barrels a day of low-sulphur oil. However, US tight oil (or shale oil) is also low sulphur, a fact which is aggravating an already difficult market. The ratings agencies forecast that Nigeria will go ‘into the red’, at a time when the government already has a fight against the Islamist extremists of Boko Haram on its plate.
Norway, meanwhile, has built up a sovereign wealth fund of £560 billion, the world’s biggest, through investments on global markets, that amount to 1.3 per cent of global stocks. However, some 20,000 oil jobs are currently at risk. If Norway raids its fund – it is permitted to take out 4% of the value every year – then, global markets could also ‘feel the pinch’.
In Latin America, Brazil is better placed than other producers such as Venezuela and Mexico, as it has a diversified economy and has pioneered biofuel innovations. Venezuela, by way of contrast, relies on oil sales for 95% of its income – and revenues have plummeted at a time when the country is facing a $15 billion bill in bond repayments over the coming eighteen months. Unrest is growing, and the government is lashing out, making threatening noises towards Guyana, which has just discovered large energy reserves. So, December’s elections promise to be interesting.
The Paris climate summit in December is expected to see China and the US coming from the ‘back of the pack’, to ‘the front’, in setting more ambitious carbon targets. Sustainable green energies are likely to be among the beneficiaries. The biggest winners will be solar and wind power, alongside nuclear in Asia, even though countries such as the UK and Germany are cutting subsidies, because they are too expensive, and distort local energy supply. A growing interest in sustainable energies can be expected. Brazil, with its sugarcane ethanol programme, is already a leader in biofuels. After Paris, more countries will be looking to learn lessons, although some argue that Brazil’s biofuels experience is closely linked to its climate and sheer size, and will, therefore, prove difficult to replicate in other countries. Offshore oil from the Arctic, the Atlantic and the Gulf of Mexico requires prices above the present level, in order for producers to break even. It is likely that there will be underinvestment in upstream exploration, and that eventually demand will out-strip supply. No one knows when that might be, however – and history tells us that when everyone does agree about how the oil market will behave, something then happens to upset those predictions.
Shale will be a key factor as exploration technology becomes increasingly efficient, costs are reduced, and fracking takes off in more countries. One good tip, therefore, is to watch the price of guar gum in India, as this is an important thickening agent in the fracking fluids. Indian exports of guar shot up from $200m in 2009, to $2.4billion in 2013, thanks to US shale demand. The price of one tonne of guar powder dropped from$3,500 to $2,000 in the year to August – so if you see more Indian farmers with smiles on their faces, it’s a clear sign that the frackers are back.
Ian Walker, Managing Director, MEC International Ltd