Broker Check

Aced It!

April 08, 2017

On March 28, 2017, the Wall Street Journal published an opinion piece from Mark P. Mills, a senior fellow at the Manhattan Institute titled, "Saudi Arabia puts U.S. Energy Producers to a Test-- and They Ace It".

"We're witnessing the first signs of a new normal in oil markets. Call it Shale 2.0, characterized by a potent combination: eager and liquid capital markets funding hundreds of experienced (now lean) small to midsize companies that can respond to modest upticks in price with a velocity unseen in oil markets in eons."

Many Americans will recall the humiliating vision of cars lined up for gas during a shortage engineered in the early 1970s by the Organization of Petroleum Exporting Countires (OPEC). The U.S. economy was held hostage by a collection of countries with vast oceans of oil reserves beneath their sandy landscape. In fact, we experienced a painful recession in 1973-4 and much of the blame can be traced to the OPEC oil embargo intended to punish the U.S. for its traditonal support of Israel.

For decades to follow, our dependence upon foreign oil imports actually grew despite lip service from successive administrations promising to reduce our vulnerability to geopolitical black mail. It was only after oil prices crossed the $100 per barrel threshold for a sustained period when U.S. oil producers could afford to exploit huge reserves of shale oil and natural gas.

"This year sees the U.S. not only filling storage tanks to the brim but also exporting more than a million barrels of crude oil a day. Exports are at the highest level in American history, twice the previous crude export peak in 1958. The U.S. is exporting more oil than five of OPEC's thirteen members."

Saudia Arabia tried to thwart American oil and gas prodcution in 2015 by flooding the market with supply to exacerbate price declines that started the year before as U.S. shale production took off. The Saudis expected the price drop from $120 per barrel to less than $30 per barrel to drive many American oil producers into bankruptcy. Certainly this happend to some companies, but they were merely absorbed by domestic competitors with stronger financials. Meanwhile, innovative technologies were introduced that have dramatically lowered shale prodcution costs. "Productivity-- output per shale drilling rig-- has been rising by more than 20% a year."

OPEC has been severely challenged as recent price increases have brought even more shale investors and drillers to the market. Even more frightening from their perspective is "software tools and techniques will now start to invade the shale domain, one of the least computerized industrial sectors." While the U.S. still imports oil, net imports have declined by half. We are now the world's biggest natural gas producer and have become a net exporter of energy. Ed Morse, Citigroup's head of global commodities, states the obvious, "OPEC has lost its clout."

Mr. Mills concludes, "It's hard to imagine a more potent combination than huge markets, willing investors and galloping software technology. It's entirely feasible for America to become a far bigger oil exporter, even one of the biggest. Such is the power of shale and software. It's not what the Saudis had in mind when they launched that stress test." It is no understatement to say capitalism accomplished in five years what forty years of political rhetoric could not-- growing oil independence and the neutering of a geopolitical bully. Aced it!