16 March 2018
Last week was CERAWeek 2018 in Houston. This is widely considered one of the most informative and critical meetings of the year of ministers, executives, financiers, bankers and other participants in the international oil and gas industry. Representatives of the IEA and the US EIA reiterated their expectations of increasing US production for several more years with several years of production plateau followed by a slow decline. These predictions provide a basis for Trump Administration plans to establish US Energy Dominance announced by President Trump in June 2017 and repeated in the National Security Strategy in December 2017.
Several commentators made more conservative predictions with lower peak production rates and shorter flat production plateaus. Of interest was that these commentators were all CEOs of companies actively developing tight oil reservoirs.
Nevertheless, it is expected US production will increase in 2018 and 2019 and OPEC plus Russia will curtail their production to maintain, possibly increase, oil prices. By 2020 it is expected world demand will have increased enough to eliminate production surpluses, which are only about 1.5%, and put upward pressure on oil prices by 2020. Capital investments were cut dramatically throughout the industry in 2015 and have been at a low level since then; many large projects worldwide were postponed. The industry will probably not be able to re-activate large projects and increase production quickly enough to meet increasing production shortages. With the current pricing system, bidding on open markets for marginal barrels, as an oil shortage develops prices will increase suddenly and significantly. If the US is to establish a revised, stable, supply and price system it has a short, two-year window to do so.
CERA Week, as it often does, caused a lot of comment about peak oil demand, peak oil production, and when, and at what level, each will take place. A lot of this requires differentiating between “conventional” and “unconventional” oil and how “unconventional” oil is so much more expensive than “conventional” oil. Upon questioning “unconventional” seems to be anything produced with a new technology – so I assume that also includes most of the twentieth-century oil produced by wells drilled with rotary drilling. Also, I note that as of this writing, “unconventional” oil is priced based on WTI at $61/bbl or about 4.6% of an ounce of gold. In 1970, “conventional” oil was priced at about 7.4% of an ounce of gold. So much for the idea that “unconventional” oil is so expensive – or that today’s oil price is so high, for that matter.
Also last week, President Trump kicked over the prevailing international trade system by establishing tariffs on US imports of steel and aluminum. He also made it clear this was a first step; the US would revise its international trade relationships. These actions caused quite a storm of criticism and objections in Congress, by various commentators, in the domestic and foreign press, and by foreign governments as breaking the international free trade system, crippling globalism, damaging the liberal international global order, and starting a trade war.
A little investigation reveals that so-called international free trade is not very free, however. Despite claims by the press and globalists, many of our trade partners have had barriers to trade from the US for years and we have done nothing about it. Globalization benefits are largely at the expense of the United States. The liberal international order is not so equally applied to all parties and is crumbling due to attacks by Russia and China with little pushback from so-called supporters.
What is even more obvious is that a trade war is already underway with little opposition from our side; we are the sucker here. Other countries have trade barriers to imports from the US which have not been reciprocated by the US. Examples are: 25% taxes on imports of US automobiles to China and 2.5% taxes on imports of Chinese cars to the US; 10% tax and 19% VAT imposed on US cars imported to Germany and 2.5% tax on German cars imported to the US. Nevertheless, in a show of blatant hypocrisy, Angela Merkel and Xi Jinping were two of the loudest complainers about the steel and aluminum tariffs as being against the free trade system – which they have been violating for years at our expense.
China is obviously trying to establish an alternative system of trade, finance, and infrastructure which it will dominate. Despite rhetoric from Xi Jinping at Davos and elsewhere about China being a benign and friendly partner, China’s actions, as a Communist socialist dictatorship, show it will dominate, coerce, humiliate, and oppress participants in its system. Its trade barriers are impregnable and its technology theft is extensive. It restricts investment and ownership of assets by foreign companies in China but enjoys open investment environments elsewhere. But China is not a friend; a fact the world is slow to realize. Over the last 25 years or so globalization advocates seemed to think that if the world reached out to China it would become a friendly, benign, open society and join the existing global order. People claimed the world was flat, that the world had accepted democracy and history had ended, and we would all go off together into the sunset singing Coca-Cola commercials. Those ideas were naïve to start with; China is run by the Communist Party, a particularly repressive form of socialism and it is more and more apparent that Xi Jinping has consolidated power and intends to rule China as a dictator. He just re-established a commissariat to further tighten his grip and suppress the population. China’s reality is becoming evident; even The Economist, not the quickest responder, is wondering how they got it so wrong about China.
Mr. Trump exempted Canada and Mexico, our two closest neighbors and trading partners and participants in NAFTA, from the tariffs. He also reached out to Australia to discuss an exemption. He made it clear that he is not against trade but that it must be reciprocal and “fair for both sides”; one-way or asymmetric barriers are not acceptable. Mr. Trump made it clear he is willing to negotiate trade relations and exemptions with anyone and everyone and will favor friends and allies. What is to complain about here? This attitude toward trade policy should not be a surprise; it was expressed in the National Security Strategy in December and in his Davos speech in January.
It is obvious the main target of revised trade policies is China but other asymmetric relationships will also receive attention. China and Russia were clearly identified in the National Defense Strategy report (available only in an unclassified summary) published in February as rivals or competitors. Our extensive long-term trade with China and sponsoring them into the WTO was ill-advised; it has mostly served to make China rich and transfer our technology to China to be used against us. A bad idea.
The tariff action and the ensuing negotiations demonstrate waning Wall Street influence on Administration policies. No doubt investment bankers were probably influential on the tax reform considerations with their deep understanding of the US economy. But investment bankers have not been long-term strategic thinkers since about 30 years ago. Up until then, investment banking firms were partnerships and the firms managers were partners with their clients in investments. They took a long-term viewpoint and were careful about the welfare of the US as the environment in which they did business. About 30 years ago the firms went public and their leaders became corporate managers. They are paid high salaries and collect exorbitant bonuses annually for short-term profits. They do not share in losses, however, and therefore tend to take on riskier investments with potential for high profits. Investment bankers have become short-term quick-profit thinkers without long-term strategic viewpoints; trade policy is a long-term strategic issue.
It will be interesting to see how the trade deals play out. Instead of going to each of our trading partners to try to negotiate fair and equal trade conditions with each of them one-by-one, Mr. Trump has put all of them in the position they have to come to him to solicit exemptions and make concessions to get them.
Taking actions to balance trade relationships could also lead to establishing an oil supply and price system with a few friends and neighbors which could take us out of the business of maintaining oil supply systems for other parts of the world. New technologies are already being developed which could bring many more billions of barrels of oil to commercial production within our own borders and with a few neighbors. We should take this opportunity, when our domestic industry is in a strong position, to establish a reliable oil supply and stable price system for ourselves.