The Geopolitical Consequences Of U.S. Oil Exports

Authored by Kent Moors via OilPrice.com,

Two crucial things happened last week.

The first you may have noticed – oil prices moved back up briefly.

As for the second, most so-called “experts” seemed to have missed.

See, the environment we’re seeing in energy markets is very different from what we saw only a week ago, when oil prices were also rising.

Because last week also saw – for the first time in world history – a reigning Saudi Arabian monarch in Moscow for talks with Russia’s head of state.

Historically, Russia has been much closer to Iran – Saudi Arabia’s main regional enemy.

Now, King Salman and President Putin are expected to endorse the plan to extend the OPEC-Russia deal to cut oil production and boost prices beyond the current end date of March 2018.

But that’s not all they’re going to talk about…

Other, more far-ranging matters will also be on the agenda, including the war in Syria.

And the catalyst for this huge shift in global geopolitics is surprisingly simple.

It’s all about America’s record-breaking oil exports…

Russia and Saudi Arabia Need Each Other… for Now

Now, there’s no indication that Russia and Saudi Arabia are on the road to an alliance on anything beyond oil prices.

Even then, that accord remains only as long as it is in the subjective interest of the parties.

Nonetheless, it is disquieting to Washington that any such prospects may be on the horizon… or that U.S. oil exports may be introducing a range of foreign policy concerns.

From an energy perspective, the main issue at hand is the OPEC-Russian deal to cap oil production, which is now almost certain to continue further than the agreed-on end date of March next year.

And after some concerns had been raised over individual OPEC members exceeding the quotas the deal assigned them, evidence is now emerging that the restraint is holding.

As I’ve several times before here in Oil & Energy Investor, there’s no genuine alternative.

The major global sources of oil need to allow the worldwide market to rebalance.

That’s the only genuine basis for stability and a slow increase in prices.

Now, with some of Libya’s oil production coming back on line, it may seem like there’s less flexibility for some producers to increase their crude output and still “hide” within the overall figures set by the cap accord.

But that’s ignoring four major factors that could cut into oil supply, and send prices higher…

Massive problems are accelerating in Venezuela, Nigerian extraction levels remain under threat from domestic instability, non-OPEC producer Mexico faces a continuing shortfall, and even the news from Libya – that a major field is coming back online – belies the ongoing civil unrest there, and lack of forward production expectations.

The international balance between supply and demand will provide a rising price.

Yet that rise will remain a gradual one.

And this balance doesn’t actually mean that there will only be exactly as much oil available as is needed at any given time.

That kind of “just in time” availability, where crude is lined only to meet immediate demand, is a certain recipe for high volatility and huge spikes in price.

Even a minor problem could create chaos in the markets.

Rather, a stable balance presupposes a continuing surplus of excess market volume.

That not only cushions the pricing dynamics from wide swings in demand, but it also allows producers the luxury of being able to predict the price range.

Anybody in the business will tell you that this predictability is far more important to maintaining profit margins than are the occasional large jumps in price.

An operator’s financial survivability requires that futures sales be calculated into the estimate of the cost of producing the oil and selling it on.

These prices, called “wellhead prices,” are the real revenue a producer receives in the first arms-length transaction as oil comes out of the ground.

These prices are also well below the market price quoted throughout a trading day.

U.S. Oil Production is at Record Highs

But the primary caveat in all of this talk about an emerging balance remains U.S. production.

It’s once again increasing and now has a more immediate impact on global pricing levels than has been the case previously.

That’s because American exports have become a major factor in the global market.

For some time, oil prices have not been determined by what occurs in developed markets of North America and Western Europe.

West Texas Intermediate (WTI) and Brent, the benchmark crude rates set in New York and London, may dictate daily trade. Yet the demand fueling the market is generated in developing areas worldwide.

Until recently, the U.S. only indirectly impacted upon the international determination of price.

In the past, the only effect came from how much the American market imported from elsewhere.

For over four decades, Congress banned the export of crude oil from the country on national security grounds.

Those restrictions resulted from the Arab oil embargo boycott of the U.S. during the 1973-74 Arab-Israeli War.

Today’s situation, where America has huge domestic extractable reserves of shale and tight oil, combined with significant improvements in production efficiency, has turned those security concerns obsolete.

There’s also the simple fact that no producing country in the world (with the possible exception of Iran, for political reasons) can afford not to sell to the U.S.

As a result, as part of a budget reconciliation two years ago, Congress lifted the ban on crude exports.

American refineries by that point were already leading the world in the export of processed oil products.

What followed was a quick move of American crude oil production back into the market…

Despite the Hurricanes, Oil Exports are Breaking Records

Exports had risen to a 1.1 million barrel a day level by the time Hurricane Harvey hit the Texas coast.

The hurricane slashed exports 60 percent. Refineries were also taken off line.

That combination should have pulverized crude oil prices, at least if you listened to the so-called “experts” on TV.

But that didn’t happen.

Instead, what happened next was nothing short of astounding.

Exports swiftly returned. Record levels were reached in each of the last two weeks.

As of last Friday, the U.S. was exporting 1.98 million barrels a day. The rising level of American volume in the broader market now has an impact on global price and the saliency of the OPEC-Russian agreement limiting production.

Because remember, U.S. production is not a party to that agreement.

The rising spread between WTI and Brent has also served as an additional inducement to increasing U.S. exports. The more international Brent prices have been increasing quicker than America’s WTI.

The difference, calculated as a percentage of WTI (the more accurate way of doing this), has now averaged more than 10 percent for the past 30 consecutive daily sessions – something that has not happened in over six years. Related: OPEC Producers Unmoved By U.S. Shale Threat In Asia

The advantage to American producers is simple. Exporting oil that costs less to produce at home into markets were the oil price is higher is a direct route to improving bottom lines.

As long as this situation remains, there will be additional U.S. production coming, because it’s profitable to extract and export.

And the more U.S. oil is exported, the less immediate effect higher production here has on domestic prices.

But this is also resulting in changes to foreign expectations.

Some of these are having spillover effects in other quarters…

Including sending Saudi Arabia and Russia into each other’s arms…

At least for now.

New Home Prices Are Over 50% Higher In Canada Than The US

Authored by Kaitlin Last via BetterDwelling.com,

The price of new homes is quickly diverging in Canada and the US.

 Data from the Canadian Housing and Mortgage Corporation (CMHC) show that new homes are selling for substantially more than the same time last year.

Meanwhile south of the border, data from the US Bureau of Census show that new home prices are on the decline.

This has lead to an even wider gap between the average price of a new home in Canada and the US.

Canadian New Construction Is Higher

The price of a new home across Canada is up for the second month in a row. The average sale price in April was CA$751,881 (US$559,123). This represents an 11% increase from the same time last year, when measured in Canadian dollars. When compared in US dollars, that increase drops to a much more conservative 2.64%. Even after factoring in the loonie’s decreased buying power in Canada, new home prices still climbed.

US New Construction Is Lower

American new home builders aren’t seeing such steep climbs in sale prices. Actually, they aren’t seeing climbs at all. The average price of a new home in the US was CA$495,271 (US$368,300). This represents a 3% decline from the same time last year, when measured in US dollars. In Canadian dollars, this was a 0.49% decline from the same time last year. Both forms of measurement show declining home prices in the US, curious since their economy is in a much better state than Canada right now.

US Vs. Canadian Prices

New homes are trading at substantially higher values in Canada than the US in April. The average new home in April 2017 was 51% higher in Canada than the US. The same time last year, prices in Canada were only 36% higher. It appears in a post-crash United States, new home buyers are taking much more conservative strides. In a hasn’t-crashed-in-decades Canada, new home buyers are optimistic about future values.

The gap between new home sale prices in Canada and the US is growing substantially. The US is a country with a booming economy, almost 10 times the population of Canada, and less land mass. Somehow, new home prices in the US are dropping compared to the same time last year. In sparsely populated Canada, prices are increasing – despite the precarious position of our economy.

Are Americans being overly cautious on homeownership, or are Canadians demonstrating irrational exuberance for homeownership, much like the US did in a pre-2006 America? Tell us your thoughts in the comments.

Who Holds The Power In Today's Oil Market?

Authored by Osama Rizvi via OilPrice.com,

Amidst the din of analysts speculating about whether oil prices will rise or fall, observers may well be overlooking some pressing questions about the very nature of the global oil market. The most significant of these questions relates to whether Saudi Arabia is losing its grip on the global oil market and if U.S. oil and gas producers are replacing the Saudis as the key global swing producer.

By the mid-70s, the Kingdom of Saudi Arabia wielded the power to swing oil prices at its will by turning on and off the taps. Presently, after 44 years, the scenario is quite different. In fact, the recent Vienna accord where OPEC and NOPEC producers agreed to cut 1.8mbpd of oil, and now its possible extension, is symptomatic of the internal weakness. In 2014 when Saudi Arabia refused to cut production to stabilize prices, and instead increased production to protect market share, an oil price war began. But the strategy to drain out the high cost producers has gone awry. U.S. production continues to rise, while Saudi Arabia’s economy is suffering from lost oil revenue. U.S. Shale producers appear to be recovering market share and have managed to lower breakeven prices through a technological revolution.

Welcome to the era of “Fracking 2.0”, where a “company man” 100 miles away from an oil rig can give instructions to his workers via an app called “ISteer.” EOG Resources, one of the largest independent oil and gas companies in U.S. and ranked as Texas’ fifth largest gas producer, is doing wonders as it outperforms its competitors. EOG can now drill horizontal wells in just 20 days, which is down from 38 in 2014. The company has pumped consistent quantities of oil irrespective of the drop in prices.

And that is just one example.

At the same time, the production cost per barrel of oil for U.S. shale operators has decreased. Rystad Energy says that the break-even cost for U.S. shale is now $35 per barrel. Only recently such costs were three times higher than the Middle East and other non-Western producers and the depletion rate for such producers were much more punishing. But now the recovery rate, from 5 percent to 12 percent, may reach 25 percent in coming years. It is not a matter of if but when this technological revolution extends across all oil-producing regions outside the Middle East. There is strong evidence of the aforesaid rising oil production as well, with the EIA forecasting a U.S. daily crude output of 9.2 million barrels this year. It is expected to reach 9.7mpd in 2018. The rise in oil prices and U.S. production are directly proportional. This is one of the reasons that, as prices have recovered over past few months, we have witnessed a historic build in inventories.

 (Click to enlarge)

While the U.S. experiences this continued growth, Saudi Arabia has no option but to curb production and stabilize oil prices as more than 90 percent of their revenue depends on oil exports. In 2015 the Saudi’s were burning through their foreign exchange reserves at a perilous rate, which can create inflationary pressures. Saudi government subsidies and public entitlements were reduced while salaries and holidays were cut. The Deputy Crown Prince, Muhammad Bin Salman, faces an important and difficult task: stabilize the economy or face popular unrest. Therefore, the Kingdom, in an effort to wean itself off oil, launched “Saudi Vision 2030” and the “National Transformation Plan 2020.” The planned IPO of Saudi Aramco, the Kingdom’s national oil company, is a part of the Kingdom’s recovery strategy. By selling a five percent stake of this company, which according to some estimates is worth one trillion U.S. dollars (enough to buy Google, Apple, Berkshire Hathaway and Microsoft combined), the Kingdom is set to create the world’s largest sovereign fund. Such a step would diversify its economy and possibly eliminate the Kingdom’s greatest threat: social unrest. And now that there is a production cut with a more than 90 percent compliance rate, the Kingdom may be feeling more secure. In fact, according to reports, the Saudi’s economy has started to recover. Related: Goldman’s $50 Forecast May Prove Bullish

The OPEC deal, which was set to expire after the first six months of 2017, is likely to be extended for another six months which, given the importance of oil prices for Saudi Arabia’s economy, may mean the difference between survival or destruction.

Another positive move from Saudi Arabia is the reduction in tax rate for Saudi Aramco from 85 to 50 percent. This will help in ramping up Aramco’s value, which is the main revenue earner of the country. Saudi Arabia appears to have come to terms with the fact that it can no longer control the oil markets, and instead is focused on attempting to protect its economy.

Rising rig count, ballooning inventories, advances in shale technology and the already present supply glut. These are few of the signs that, notwithstanding the efforts by the OPEC producers to stabilize markets, the fundamentals remain unchanged and U.S. producers are regaining their strength. If the trend continues, will we see the U.S. emerging as a new swing producer?

In the world of oil there may well be two swing producers now. One is young and growing while the other is struggling to keep up with the times.

How OPEC Lost The War Against Shale, In One Chart

At the start of March we showed a fascinating chart from Rystad Energy, demonstrating how dramatic the impact of technological efficiency on collapsing US shale production costs has been: in just the past 3 years, the wellhead breakeven price for key shale plays has collapsed from an average of $80 to the mid-$30s...

... resulting in drastically lower all-in breakevens for most US shale regions.

Today, in a note released by Goldman titled "OPEC: To cut or not to cut, that is the question", the firm presents a chart which shows just as graphically how exactly OPEC lost the war against US shale: in one word: the cost curve has massively flattened and extended as a result of "shale productivity" driving oil breakeven in the US from $80 to $50-$55, in the process sweeping Saudi Arabia away from the post of global oil price setter to merely inventory manager.

This is how Goldman explains it:

Shale’s short time to market and ongoing productivity improvements have provided an efficient answer to the industry’s decade-long search for incremental hydrocarbon resources in technically challenging, high cost areas and has kicked off a competition amongst oil producing countries to offer attractive enough contracts and tax terms to attract incremental capital. This is instigating a structural deflationary change in the oil cost curve, as shown in Exhibit 2. This shift has driven low cost OPEC producers to respond by focusing on market share, ramping up production where possible, using their own domestic resources or incentivizing higher activity from the international oil companies through more attractive contract structures and tax regimes. In the rest of the world, projects and countries have to compete for capital, trying to drive costs down to become competitive through deflation, FX and potentially lower tax rates.

The implications of this curve shift are major, all of which are very adverse to the Saudis, who have been relegated from the post of long-term price setter to inventory manager, and thus the loss of leverage. Here are some further thoughts from Goldman:

• OPEC role: from price setter to inventory manager In the New Oil Order, we believe OPEC’s role has structurally changed from long-term price setter to inventory manager. In the past, large-scale developments required seven years+ from FID to peak production, giving OPEC long-term control over oil prices. US shale oil currently offers large-scale development opportunities with 6-9 months to peak production. This short-cycle opportunity has structurally changed the cost dynamics, eliminating the need for high cost frontier developments and instigating a competition for capital amongst oil producing countries that is lowering and flattening the cost curve through improved contract terms and taxes.


• OPEC’s November decision had unintended consequences: OPEC’s decision to cut production was rational and fit into the inventory management role. Inventory builds led to an extreme contango in the Brent forward curve, with 2-year fwd Brent trading at a US$5.5/bl (11%) premium to spot. As OPEC countries sell spot, but US E&Ps sell 30%+ of their production forward, this was giving the E&Ps a competitive advantage. Within one month of the OPEC announcement, the contango declined to US$1.1/bl (2%), achieving the cartel’s purpose. However, the unintended consequence was to underwrite shale activity through the credit market.


• Stability and credit fuel overconfidence and strong activity: A period of stability (1% Brent Coefficient of Variation ytd vs. 6% 3-year average) has allowed E&Ps to hedge (35% of 2017 oil production vs. 21% in November) and access the credit market, with high yield reopen after a 10- month closure (largest issuance in 4Q16 since 3Q14). Successful cost repositioning and abundant funding are boosting a short-cycle revival, with c.85% of oil companies under our coverage increasing capex in 2017.

That said, the new equilibrium only works as long as credit is cheap and plentiful. If and when the Fed"s inevitable rate hikes tighten credit access for shale firms, prompting the need for higher margins and profits, the old status quo will revert. As a reminder, this is how over a year ago Citi explained the dynamic of cheap credit leading to deflation and lower prices:

Easy access to capital was the essential “fuel” of the shale revolution. But too much capital led to too much oil production, and prices crashed.  The shale sector is now being financially stress-tested, exposing shale’s dirty secret: many shale producers depend on capital market injections to fund ongoing activity because they have thus far greatly outspent cash flow.

This is the key ingredient of what Goldman calls the shift to a new "structural deflationary change in the oil cost curve" as shown in chart above. As such, there is the danger that tighter conditions will finally remove the structural pressure for lower prices. However, judging by recent rhetoric by FOMC members, this is hardly an imminent issue, which means Saudi Arabia has only bad options: either cut production, prompting higher prices and even greater shale incursion and market share loss for the Kingdom, or restore the old status quo, sending prices far lower, and in the process collapsing Saudi government revenues potentially unleashing another budget crisis.

Fasanara Capital: This Is The Bear Case For Oil

From Francesco Filia of Fasanara Capital

Oil: a weak present and no future

Oil correction (~10% from peak) is not necessarily the foretell of an imminent debacle. Oil corrected by approx. 20% twice in the past months (June-July 2016 and October-November 2016), without derailing the bull trend. Important supports were breached in both instances, and yet Oil managed to resurrect, powerfully.

However, this latest development with Oil offers the opportunity to update views, and record relevant incoming data in either confirmation or denial of our bearish thesis on Oil: so far, we seem to have confirmation.

1.    The most interesting element / ‘new news’ is that the forward oil curve is no longer exhibiting a marked ‘contango’ shape, meaning that long-dated forwards are no longer well above spot. In contrast, it is almost becoming ‘backwardation’. As the contracts are often used by real producers to hedge future output, this may happen in reflection of a market peak. 

2.    As a recent GaveKal research notes, OPEC is less relevant today than it has ever been. Russia, Saudi Arabia and Iran have today no more grip on oil prices (controlling 50% of oil global supply) than Rio Tinto, BHP Billiton and Vale demonstrably have on the price iron ore (of which they hold a 70% market share).

3.    As expected, higher levels for Oil have indeed led to a resumption of production and oil rigs formation in the US, over the past several months. Shale’s reaction function to levels of Oil above 50$ was entirely predictable. So it is predictable for the recent rebound in production to persist: as we noted in December, critically, US shale frackers had managed to notably decrease breakeven costs per barrel; for some shale types down to $29 from $59 in 2014, according to consultancy Rystad Energy.

4.    Promised deregulation of the oil market by Trump, and his friendly views on coal, may further exacerbate structural oversupply issues in the Oil market. This comes at a perilous time, as US crude oil exports are increasing at an alarming pace (see Chart below), and reaching more destinations, after the removal of restrictions on exporting US crude oil in December 2015. (EIA data and US crude Oil exports). The US is expected to export at least 0.8mn barrels per day in 2017 (according to analysts polled by Bloomberg), which would exceed that of OPEC members such as Lybia and Qatar. This is not far off from the 1.2m bpd of OPEC’s budgeted cuts, further eating into OPEC’s market share and therefore possibly undermining the stability of the agreement itself.

5.    Speculative positions on Oil are at historical highs, well above where they stood in the summer of 2014 (just before Oil started its 76% descent). They may be peaking now that China has partially put on hold its steroids-rich fiscal stimulus program, as of last summer, and started some tightening of its monetary policy. The speculation in Oil is reminiscent of the leverage built up for Iron Ore in the Dalian Commodity Exchange in China, reflected in record inventories at Chinese ports (see Chart below from GS Bulks Trading). Now that China slows the rate of credit growth to stem financial speculation, and the property cycle softens, we may see some of the leverage working in reverse. 

Source: CEIC, mysteel GS Bulks Trading.

6.    For what it"s worth, the fundamentally-proven and historically-strong correlation with the Dollar Trade Weighted Index would project a price for Oil sub-40$. We are now nearing a trend-line level, the test/break of which may determine an acceleration of the re-coupling.

In conclusion, not so much in denial of our long-term outlook for Oil, so far: therefore, we reiterate our view that Oil is defying gravity at current levels and is set to revisit lows in the not so distant future, due to overwhelming structural factors such as exponential technologies, shale oil/shale gas/nat gas, substitution effects. Long-term prospects have little bearing in the short-term for price-discovery, but do provide a magnet for prices over time, as cyclical factors like OPEC and speculation fade.

Why OPEC Should Fear The Trump Administration

Submitted by Emad Mostaque via GovernmentsAndMarkets.com,

Oil prices have risen over 20% since the OPEC production cut agreement at the end of November. While concerns abound on quota cheating and increased production from Libya, Nigeria and US shale, the incoming US administration could change the market completely through strategic oil sales and new import taxes.

The paralysis of OPEC between the summer of 2014 and November of 2016 was primarily due to the uncertainty in the equation introduced by US shale oil production.

Shale had much shorter production cycles than other forms of oil and had been financed by a huge debt and equity boom in the sector spurred by low interest rates, piling into exploration and production.

To the Saudis, who would have to lead any cut, this presented a conundrum as it was uncertain if shale producers would rapidly step in to fill any production cuts. This would have been a wealth transfer from Saudi to the shale producers, which was intolerable.

The equation has now changed for Saudi as they tap capital markets for sovereign debt and the upcoming Aramco IPO, meaning they would come out ahead regardless of shale and cheating.

The next few months are vital for the oil market as adherence to OPEC quotas and a potential supply resurgence from disruptions in Libya and Nigeria are monitored, particularly as Russian participation is conditional on no cheating.

However, an unexpected shift in the balance of the oil market in the next few months could be the actions of the incoming US administration under President Trump.

While the President-elect has shown flexibility on many of his pledges, the one area he has shown consistency and made appointments in line with his stated stance is on trade, moving the US in an mercantilist direction.

If trillions of dollars leaving US shores for cheap goods from China is intolerable, the idea of being dependent on OPEC oil, produced at a significant discount, is even worse.

An “America First” stance and renewed focus on North American energy independence could lead to two significant changes: a resizing of the Strategic Petroleum Reserve (SPR) and introduction of a border adjustment tax.

The SPR was established in 1975 after the 1973–74 oil embargo to mitigate against future temporary supply disruptions. The SPR holds 695 million barrels of oil, with a maximum withdrawal rate of 4.4 million barrels per day.

As a member of the International Energy Agency, the US must stock an amount of petroleum equivalent to 90 days of imports. Due to the surge in local production, net oil imports are now oil 4.8 million barrels a day versus a peak of 13.3 million barrels per day in 2005. As such, the SPR now holds 265 million excess barrels of excess oil.

A mercantilist administration could legitimately authorize a release of a million barrels a day to rebalance the SPR.

A drawdown of 190 million barrels has already been announced by the Department of Energy over the next 8 years, but there is no reason this could not be accelerated.

This would completely undo the OPEC deal, based on cuts of 1.2 million barrels a day and likely lead to a rush for market share. This would also drop gasoline prices, helping the US consumer.

While this would pressure US shale producers, many of these companies have taken the opportunity of the recent oil rally to hedge future production. The proceeds from the SPR release, likely over $10 billion, could be used to kick start energy infrastructure investment designed to further increase US energy independence, such as outlined in the “Pickens Plan” from 2008.

This fits with Trump’s plans for a trillion dollars of infrastructure spending, but another of his proposed policies, a border adjustment tax, part of the “Better Way” reform package, could cushion the blow of an SPR release for shale producers.

Under this policy, imports would be taxed at the new corporate income tax rate of 20% and income earned from exports would be tax exempt. While the impacts of this proposal are far-reaching, it gives domestic US oil producers an immediate 25% price advantage over imported oil and would most likely cause the dollar to spike by double digits.

This could cause gasoline prices to increase by as much as 30 cents to a gallon per a recent paper by Philip Verleger and the Brattle Group, but an SPR release would offset this.

Imports from the Gulf would collapse to almost zero in this scenario, with a resurgence of US energy investment potentially leading to a supply surge to fill this gap in future. SPR sale revenue could also discount gasoline taxes in the adjustment period.

While the oil market is anticipating an orderly tightening of supply conditions, these actions would change the game, placing the balance of power firmly with the USA absent a significant change in strategy by OPEC and other major producers.

As such it may now prove wise to be wary on the potential for oil prices in the near term, with demand dependent on whether Trump follows through on his planned mercantalist stance on trade.

Greater Fool Theory, Viewer Questions and Global Markets (Video)

By EconMatters

We discuss the Carry Trade, ultimate demise of the European Union, answer viewer questions, touch on the oil market, and dog financial media for the rating`s whores that they truly are in this video. There is some buy the rumor, sell the news effect in the oil market today, but we are still pretty bearish on the fundamentals of the industry, and the current supply glut in the market as witnessed by the most recent inventory reports. We think higher oil prices ultimately bring down some of the demand consumption numbers over time, as some of the demand gains over the past couple of years, come back in or retrace due to higher gasoline and diesel prices at the pump.

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