Petrol and Power

In November of 2014, Saudi Arabia and the rest of the Organization of the Petroleum Exporting Countries (OPEC) be- gan to wage a price war on American oil producers. Fearing the seemingly inexorable rise of sophisticated and productive North American shale producers, OPEC decided not to temper their own production and instead increased global oil supplies. As supply began to outstrip demand there was a dramatic drop in the price of oil. Once prices hit about $50 a barrel many commentators predicted the quick collapse of American shale operators.

After a full year and a half, the story is still unfolding. American shale producers got leaner and meaner and stayed competitive at $50 a barrel. They cut costs, relied on technological ingenuity and focused on developing only the most efficient and economically viable plays. At the same time, key indicators — such as the number of drilling rigs operating in the large shale basins – are pointing towards a looming slowdown in American oil production. What initially looked like a beatdown from OPEC has turned into a staring contest between American producers and their creditors and OPEC governments and their people.

Most OPEC member states’ economies are wholly dependent on revenues from oil sales. This means that when the price of oil falls below a certain threshold, governments have trouble balancing their budgets. In looking at Middle East OPEC members, for example, Kuwait, at the low end of the spectrum, needs oil at $50 dollars a barrel to balance its budget — at the other end, Libya needs oil to be about $220 a barrel for a balanced budget. Saudi Arabia, the leader within OPEC due to its production capacity, needs oil at just over $100 a barrel to balance its budget. Yet while this stand-off in oil markets has captured the world’s attention, there has also been a quiet and revolutionary development in the distribution of natural gas, which has the potential to rewrite geopolitical trends.

A geological side-effect of the North American shale revolution has been the incredible increase in natural gas production within the United States. The U.S. produces so much natural gas everyday amount that it will soon become a major Liquefied Natural Gas (LNG) exporter.

Unlike global oil markets, the LNG market is much more inflexible and opaque. The current major sellers of LNG have control over the market. Prices are set by producers locking customers into long- term contracts, buyers are prohibited from reselling LNG even if other countries are willing to pay a premium and invariably one if not both parties involved are state-controlled companies, lending a strong political tint to the whole transaction. This is the situation facing the European Union with regards to Russia’s geopolitical maneuvering in the Crimean peninsula.

Behind the surge in U.S natural gas production lies an opportunity to rewire the LNG market. Instead of state con- trolled companies like Russia’s Gazprom or Qatar’s Qatargas dictating market fundamentals, the price of natural gas flow- ing from the U.S will be set by the U.S LNG market — a market that is heavily traded, transparent and allows buyers to resell their LNG if they so choose. As a result of US LNG exports, major buyers of natural gas (especially in Asia where most U.S supply will flow) have the chance to force other suppliers to adopt more trans- parent and flexible pricing strategies. This will only happen if importers band together and force these changes through physical LNG hubs, better markets for trading LNG contracts and increased transportation of natural gas. The U.S can supply the disrupting gas, but it is up to Asian importers to take advantage of the North American shale revolution.