DIE BY THE SWORD

There is that movie soundtrack by Paul McCartney which goes “Live and let die”.  If the current drop in oil prices (see figure below) is sustained for any significant length of time, the effect on countries will be highly variable.  A sustained Brent oil price below $90 per barrel will do potentially grievous harm to the Russian economy with or without the financial burden of aggression in the Ukraine.  The latest Russian budget was premised upon oil at $100, and given that over 40% of treasury coffers are filled with oil and gas revenue, a sustained price below $90 would be very difficult to swallow.  Some reports have it that every $1 drop in Brent results in a $2.1 billion annual drop in revenue.  In fact in an earlier blog I had mused on the option of release of the Strategic Petroleum Reserve (no longer needed in the US due to burgeoning domestic oil production), to drive down prices, or the mere threat to do so, to influence Russian aggression. 

The US on the other hand will broadly be unaffected.  A steady Brent price between $80 and $90 (if there is such a thing as steady oil pricing) could dampen some of the shale oil ardor.  Shale oil prospects are highly variable with respect to breakeven price, but the vast majority of them make good returns at $80 per barrel pricing.  Particularly if oil export were to be permitted, the net effect would be minimal.  This is because US shale oil currently sells at a discount to Brent of well over $10, and export would afford it full Brent pricing.  Allowing exports would markedly improve the resiliency of US shale oil production relative to softness in world oil pricing. 

Many oil producing countries could be placed in an untenable situation were the Brent prices to stay below $90 for extended periods of time.  The Gulf monarchies have spent lavishly on their populations especially following the Arab Spring.  Good numbers are hard to come by, but Saudi Arabia is believed to need a $90 price as a minimum to sustain the social benefits.  That number is higher in some of the other OPEC members such as Venezuela and Algeria, as also in Iran. 

The drops in oil price do not appear to be any country’s doing.  As we previously reported, world oil production dropped by 2 MM bpd over the last two years and was entirely made up by new US production from shale deposits.  But more recently supply has also picked up elsewhere, especially Libya.  Demand on the other hand has reduced, especially in the US.  The trend towards demand reduction will continue at least in the US, where methane and ethane will displace oil in transportation and as the feedstock for chemicals such as olefins.  Although unintended, a sustained drop in oil prices will serve the political interests of US and its allies vis a vis containing Russian aggression in the Ukraine.  A sustained loss of oil and gas export related revenue, in conjunction with economic sanctions, would make military expenditures in the Ukraine affair essentially infeasible.  The most related aspect of the sanctions is that with loss of revenue the Russian oil firms would need to borrow and foreign capital would simply not be available. 

This is somewhat ironic because Russia has threatened to use curtailment of gas supplies to Europe as an imposition of political will.  I have maintained in these pages that energy is a much more powerful weapon than armies for exacting pain for behavior seen as detrimental to the interests of a producing country, in this case Russia.  In other words they would be living by the sword of energy.  It seems now that there is a risk of dying (thrown into a deep recession) by that very sword, even if it was wielded unintentionally and by no one in particular. 

Hi Greg,
I too did the Silk Route eight years ago with Mir Travel.  30 days via, road, train, camel and flight.  We overnighted in the same stone ‘hotel’ that MP used 800 years ago on the way out from Kasgar.  Uighur people are the best in the region.  Enjoy the Stans! 

Lower oil prices generally will hurt the displacement of oil by natural gas.  So, for example, a GTL plant with breakeven oil price of $80, which is realistic, could become marginal.  But the spread is still large enough for other displacements, such as in the manufacture of chemicals. 

Nice work.  The key word is sword.  Too often in history a nation has erupted beyond its borders simply to replace a direly needed commodity.  whether it be oil or wheat or human slaves.  Repeated invasions of the Indian subcontinent come to mind. 
I too have argued for the release of the Reserve for similar reasons.  A sustained USD value also aids in the fight against wanton aggression. 
Unfortunately, OPEC seems committed to a race to the bottom.  Its function as a price arbiter has long past. 
Shale capex here at home has stabilized and redirected towards extraction efficiencies.  Witness Cabot Oil’s recent 150 stage four bore pad in western PA using flex fueled power sources and environmentally approved gels and additives.  An increase in EUR combined with a flattening of the IP curve can only contribute to capital as well as extraction functionality. 
And HSE: look at the image in the WSJ today of the rigger in ND: safety goggles, hip high work boots, full body restraining gear, thick work gloves – none of which I saw just three years ago on the rigs! 
The revolution will be televised! 

This was quite a prescient and actionable post.  In the 48 hours since you hit “submit” the market caps of many domestic drillers are down about 5% or more.  Next time, you could do the rest of us a favor by using the word “short” in your closing thoughts (or perhaps “long” in your next post on the topic). 

I disagree with your statement – The US on the other hand will broadly be unaffected. 

We are a global village and there is no such thing as isolated positive or negative impacts that we want/wish/can create with changes in oil prices or with economic sanctions.  In a world that barters (going back centuries – silk road being a vivid example) the human race is interdependent.  You give what I don’t have and vice versa.  So countries that are affected by these oil prices may not have direct impact on US but an indirect one. 

You mention some key politically hot countries and the impact they will have with lower oil prices.  You do not at all touch upon other parts of the world on which the US is dependent that will also be impacted by lower oil prices in a different way.  Countries in South America for instance.  BTW, Bolivia will have Morales elected for an unprecedented third term -they changed the constitution to accommodate that.  These folks have been able to contribute to the trade with US because they are doing well with higher oil prices.  If they go below $80 we could see spikes in prices for commodities on which we depend on them. 

He is right.  I generalized.  I was addressing simply the effect on domestic shale oil production.  Also, by the way, Brent dropped to $87 today.