The US oil and gas dilemma

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Want to hurt Russia? Lower oil prices. If you want to bring Iran to the negotiating table with its nuclear programme, use oil as a weapon. It is smart and decisive. This was the advice given by foreign policy experts to the US administration. However, Washington finds itself in a dilemma since lowering crude prices will hurt not only the US Middle Eastern allies but also local oil and gas producers in America.

The fall in prices comes at a time when OPEC’s domination of the world oil market is being challenged for the first time in more than 30 years by the unexpected and sudden resurgence of the US as a major producer. During the seventies when Arabs used the crude as a political weapon to prevent the West from supporting Israel, Washington took a number of steps to disarm and prevent the reuse of that weapon. Major among these steps are putting an increased emphasis on domestic oil production and the establishment of a mutual aid arrangement overseen by the International Energy Agency (IEA) that obliged participating nations to share their oil with any member state subjected to an embargo. Moreover, scientists worked hard to find inexpensive alternatives to oil (i.e. wind), opting for fabricated oil (as in the case of Canada), and more importantly using the same weapon (oil) against its producers under the term of economic warfare as was the case with the sanctions imposed against Saddam Hussein in Iraq and currently against Iran which deprives the oil market from at least one million barrel of oil daily and finally Russia.

Now that most OPEC nations rely heavily on oil revenue to sustain their development programmes, the oil market has hardly been run by the organisation. Therefore, at a time when Saudi Arabia and its Gulf oil producers are willing to allow oil prices to fall to unexpected levels hovering around $70 USD per barrel (pb), other member states (Iran, Algeria, Venezuela and Angola) can hardly afford that. The OPEC states – which account for about a fifth of the world’s oil supply combined – are also in danger of losing a greater share of the market to US shale production and none of them are willing to do that.

However, as the OPEC nations are producing about 200,000 barrels per day (bpd) more than their agreed quota of 30m bpd, the demand for the group’s oil is expected to fall as low as 29.2m bpd next year, because of the substantial increase in North American supply. To balance supply with demand would suggest that OPEC will have to agree on cutting up to 1m bpd from its members’ production.

Yet, hovering oil prices around $70 pb, as Deutsche Bank research suggests, would hurt almost 40 percent of US shale oil wells which would essentialy make them unprofitable. However, other experts disagree stating that production would become less costly due to advances in technology and would nonetheless leave a good margin for profit even with oil prices going lower than $75 pb.

In this context, Middle Eastern producers may be more so willing to allow oil prices to fall to levels around $70 pb to help appease the US by applying economic pressure on Russia, which also depends on crude sales for much of its foreign currency revenue. Western sanctions have struck a severe blow to the Russian economy. A 30 percent decline in oil prices has consequently blown a massive hole in the Russian budget, which depends on oil and gas exports for 52 percent of its budget revenues.  The Russian currency, the ruble, has plummeted 25  to 30 percent over the last few months as capital leaks out of the country.

Still, China and Russia finalised a couple of gas deals that may – to some extent – nullify the impact of the sanctions imposed against Moscow. During the recent APEC meeting and under the nose of the US president, the Chinese president and his Russian counterpart announced the second natural gas agreement, this one worth $325 billion, following the unprecedented $400 billion deal struck in March. By 2020, Russia will sell China more gas than it now sells Europe, and the supply is big enough and priced as such that it could threaten US sales in South Korea, Japan, and elsewhere in Asia.

Numerous other agreements came on top of this deal as well. Most important among them is that Russian petroleum sales to China will now double. US experts believe that the rise of the non-West was destined to be a prominent feature of our century, but the US could not have done more to propel it if it tried.

“The use the US makes of the privileges she enjoys for providing the world’s reserve currency are being increasingly contested,” Ken Courtis, a former Goldman Sachs man, said. “Their misuse has, among other things, pushed China and Russia into a tight strategic partnership.”

Moreover, US natural gas producers may be seeing their dream of substantial liquefied natural gas (LNG) exports suffer fatal injury due to Russian exports to the Chinese market, a market that was expected to be the largest and most profitable for LNG exporters. Russian supply will force the price of LNG delivered to Asia down to between $10 and $11, too low for American LNG exports to be profitable.

At that price, US LNG is no longer competitive in Europe. And now, because of the Russian-Chinese natural gas pipeline deals, it may no longer be competitive in Asia. Those are the two largest markets for LNG. Without them, it is doubtful that the United States will be exporting much LNG – except perhaps at a loss, experts said.

Despite rising domestic natural gas production, the United States remains a net importer of natural gas. Natural gas imports accounted for about 10 percent of US consumption through August of this year. The latest China-Russia deal will likely be even more lopsided in China’s favour. This is because Russia’s leverage has been severely diminished in the few months following the May 2014 deal. All of this puts Russia in a weaker bargaining position vis-à-vis gas exports to China.

Even worse, some experts warn that a prolonged period of lower oil prices could reshape the entire political map of the Middle East and the pricing wheel will not be reversible.

Mervat Diab is Assistant Editor-In-Chief of Al-Ahram newspaper.