Simon
Henderson knows quite a bit about the oil industry, but he is of the milieu and
so, he can only hear what the echo chamber in which he lives allows him to
hear, and what the colored windows of the chamber allow him see outside.
Henderson
wrote an article under the title: “Russia and Saudis in a knife fight over oil
–– but we may be the victims,” published on March 10, 2020 in the online
publication The Hill. Henderson tells the history of what happened recently
between Saudi Arabia and Russia that brought the price of oil crashing down. He
then analyzed the data that was available to him, and gave what some will
consider an informed assessment of what's happening now and what may happen
next.
While
that may sound like an adequate explanation of the current situation, it is far
too simple to fully describe the realities that lurk behind a very complex
situation. The truth is that the senior players in the oil patch have known a
few things which they kept to themselves for decades, and are now well situated
to protect their multinational companies. They sit pretty as they watch the
Johnnies-come-lately who rushed into the American shale industry, and began the
process of burying themselves in the wells of despair that cost plenty to drill
and develop, yet produced little or no return for the long suffering investors
who saw their cash evaporate into thin air as readily as natural gas.
To
understand what's happening now, we need to look back more than half a century.
It is that while cultivating excellent relations with the rulers of the nations
where they had an interest, the heads of multinationals also maintained good
relations with America's political class. They knew then about the great
reserves they had in America's conventional oil, but also knew of America's
voracious appetite for consuming oil and natural gas. This condition did not
worry them, however, because they knew of the staggering reserves that were
buried in America's shale and Canada's tar sands, waiting to be developed.
The
strategy they adopted for the development of the world resources as well as
North America's, was somewhat different from what is usually adopted in the
mining industry. So, let's digress for a moment and discuss mining before
returning to oil. When the reserves of base or precious metals are discovered,
a consulting firm is hired to do a feasibility study and recommend the best way
to exploit the discovery.
The
reason this is necessary, is that the ore is not distributed evenly throughout
the area that makes up the mine. Some places have a high concentration of the
metal, and some have a low concentration. The idea of exploiting a mine being
to have a steady labor force producing a steady amount of the metal year after
year during the lifetime of the mine, the consulting firm designs a detailed
plan on where to dig the mine shafts, and when to dig them as the exploitation
progresses. The purpose is to extract the right mix of high concentration and
low concentration ore each day, so that the mine ends up producing the same
amount of the metal quarter after quarter.
When
it came to the multinational oil companies, they too saw rich reserves in some
places of the world, and poor reserves in other places, as well as
expensive-to-produce oil in some places and cheap-to-produce oil in other
places. As it happened, the rich reserves were mostly in the Middle East, and
that's where the cheap-to-produce oil was also found. As a result, the
companies had no trouble deciding to pump a lot more oil out of the Middle East
than America. The plan proceeded unimpeded for several decades.
Then
came the year 1973. For political and economic reasons, the countries of the
Middle East, speaking in one voice called OPEC, decided to sell their oil, not
based on how much it cost them to produce it, but how much it will cost to
replace it. This meant that the consuming countries were now paying for Middle
Eastern oil roughly the same price as they did for Texas or Brent oil.
That's
when the multinational oil companies revised their feasibility pans for the
exploitation of the “home” resources, which included America's shale and
Canada's tar sands. They decided to immediately begin developing the tar sands,
which took them a while before they got a profitable operation going. As time
moved on and the world consumption of oil approached the 100 million barrels a
day, wildcatters and small operators began to think in terms of developing
America's shale. The big companies did not participate, but sat back to see if
the newly developed fracking technology was going to deliver as promised.
Unfortunately,
the wildcatters and small operators proved deficient in the levelheaded quality
that was necessary to undertake a challenge of this magnitude. Instead of
applying rational thought to make a success of the new industry, they let
themselves be guided by the cheerleading voices of the thoughtless pundits who
kept painting the nascent industry as a wrestling match between the smart and
noble Americans who took on the dumb and brutish foreigners, and beat the crap
out of them.
This
kind of talk kept fueling the desire of those in the shale industry to borrow
more and produce more while Russia and OPEC were watching. Both had come to the
conclusion that the overproduction will soon damage the wells, and the
over-borrowing will damage the financing of the venture. They estimated that in
a year's time or less, the Americans will fall flat on their faces, and this
would be the right moment to administer the coup de grace to America’s
ill-advised experiment.
But
history being unpredictable, it pulled the rug from under the Americans before
their time. What happened was that the coronavirus hit the world at a time that
OPEC and Russia were developing differences between them regarding the levels
of production.