We Live In A New World And The Saudis Are The First To Get It

[ Secondary blog source: Tyler Durden / The Zero Hedge / www.zerohedge.com/news/2014-12-24/we-live-new-world-and-saudis-are-first-get-it ]

There are many things I don’t understand these days, and some are undoubtedly due to the limits of my brain power. But at the same time some are not. I’m the kind of person who can no longer believe that anyone would get excited over a 5% American GDP growth number. Not even with any other details thrown in, just simply a print like that. It’s so completely out of left field and out of proportion that you would think by now at least a few more people understand what’s really going on.

And Tyler Durden breaks it down well enough in Here Is The Reason For The “Surge” In Q3 GDP (delayed health-care spending stats make up for 2/3 of the 5%), but still. I would have hoped that more Americans had clued in to the nonsense that has been behind such numbers for many years now. The US has been buying whatever growth politicians can squeeze out of the data and their manipulation, for many years. The entire world has.

The 5% stat is portrayed as being due to increased consumer spending. But most of that is health-care related. And economies don’t grow because people increase spending on not being sick and/or miserable. That’s just an accounting trick. The economy doesn’t get better if we all drive our cars into a tree, even if GDP numbers would say otherwise.

All the MSM headlines about consumer confidence and comfort and all that, it doesn’t square with the 43 million US citizens condemned to living on food stamps. I remember Halloween spending (I know, that’s Q4) was down an atrocious -11%, but the Q3 GDP print was +5%? Why would anyone volunteer to believe that? Do they all feel so bad any sliver of ‘good news’ helps? Are we really that desperate?

We already saw the other day that Texas is ramming its way right into a recession, and North Dakota is not far behind (training to be a driller is not great career choice going forward), and T. Boone Pickens of all people confirmed today at CNBC what we already knew: the number of oil rigs in the US is about to do a Wile E. cliff act. And oil prices fall because global demand is down, as much as because supply is up. A crucial point that few seem to grasp; the Saudis do though. Good for US GDP, you say?

What I see more than anything in the 5% print is a set-up for a Fed rate hike, through a variation on the completion backward principle, i.e. have the message fit the purpose, set up a narrative that makes it make total sense for Yellen to hike that rate. And Wall Street banks (that’s not just the American ones) will be ready to reap the rewards of the ensuing chaos.

And I also don’t understand why nobody seems to understand what Saudi Arabia and OPEC have consistently been saying for ever now. They’re not going to cut their oil production. Not going to happen. The Saudis, probably more than anyone, are the guys who know what demand is really like out there (they see it and track it on a daily basis), and that’s why they’ll let oil drop as far as it will go. There’s no other way out anymore, no use calling a bottom anywhere.

In the two largest markets, US demand is down through far less miles driven for a number of years now, while domestic supply is way up; at the same time, real Chinese demand is way below what anybody projects, and oil is just one of many industries that have set their – corporate – strategies to fit expected China growth numbers that never materialized. Just you watch what other – industrial – commodities fields are going to do and show in 2015. Or simply look at prices for iron ore, copper etc. today.

In an unusually frank interview, Ali al-Naimi, the Saudi oil minister, tore up OPEC’s traditional strategy of keeping prices high by limiting oil output and replaced it with a new policy of defending the cartel’s market share at all costs. “It is not in the interest of OPEC producers to cut their production, whatever the price is,” he told the Middle East Economic Survey. “Whether it goes down to $20, $40, $50, $60, it is irrelevant.” He said the world may never see $100 a barrel oil again.

The comments, from a man who is often described as the most influential figure in the energy industry, marked the first time that Mr Naimi has explained the strategy shift in detail. They represent a “fundamental change” in OPEC policy that is more far-reaching than any seen since the 1970s, said Jamie Webster, oil analyst at IHS Energy. “We have entered a scary time for the oil market and for the next several years we are going to be dealing with a lot of volatility,” he said. “Just about everything will be touched by this.”

Saudi Arabia is desperate alright, but not nearly as much as most other producers: they have seen this coming, they’ve been tracking it hour by hour, and then made their move. And they have some room to move yet. Many other producers don’t. Not inside OPEC, and certainly not outside of it. Russia should be relatively okay, they’re smart enough to see these things coming too, and adapt accordingly. Many other nations don’t and haven’t, perhaps simply because they have no room left. Anatole Kaletsky makes quite a bit of sense at Reuters:

… the global oil market will move toward normal competitive conditions in which prices are set by the marginal production costs, rather than Saudi or OPEC monopoly power. This may seem like a far-fetched scenario, but it is more or less how the oil market worked for two decades from 1986 to 2004.

Whichever outcome finally puts a floor under prices, we can be confident that the process will take a long time to unfold. It is inconceivable that just a few months of falling prices will be enough time for the Saudis to either break the Iranian-Russian axis or reverse the growth of shale oil production in the United States. It is equally inconceivable that the oil market could quickly transition from OPEC domination to a normal competitive one.

The many bullish oil investors who still expect prices to rebound quickly to their pre-slump trading range are likely to be disappointed. The best that oil bulls can hope for is that a new, and substantially lower, trading range may be established as the multi-year battles over Middle East dominance and oil-market share play out. The key question is whether the present price of around $55 will prove closer to the floor or the ceiling of this new range. [..]

… the demarcation line between the monopolistic and competitive regimes at a little below $50 a barrel seems a reasonable estimate of where one boundary of the new long-term trading range might end up. But will $50 be a floor or a ceiling for the oil price in the years ahead?

There are several reasons to expect a new trading range as low as $20 to $50, as in the period from 1986 to 2004. Technological and environmental pressures are reducing long-term oil demand and threatening to turn much of the high-cost oil outside the Middle East into a “stranded asset” similar to the earth’s vast unwanted coal reserves. [..]

The U.S. shale revolution is perhaps the strongest argument for a return to competitive pricing instead of the OPEC-dominated monopoly regimes of 1974-85 and 2005-14. Although shale oil is relatively costly, production can be turned on and off much more easily – and cheaply – than from conventional oilfields. This means that shale prospectors should now be the “swing producers” in global oil markets instead of the Saudis.

In a truly competitive market, the Saudis and other low-cost producers would always be pumping at maximum output, while shale shuts off when demand is weak and ramps up when demand is strong. This competitive logic suggests that marginal costs of U.S. shale oil, generally estimated at $40 to $50, should in the future be a ceiling for global oil prices, not a floor.

As Kaletsky also suggests, there is the option of a return to an OPEC monopoly and much higher prices, but I personally don’t see that. It would need to mean a return to prolific global economic growth numbers, and I simply can’t see where that would come from.

Meanwhile, there’s the issue of ‘anti-Putin’ sanctions hurting western companies, with an asset swap between Gazprom and German chemical giant BASF that went south, and a failed deal between Morgan Stanley and Rosneft as just two examples, and that leads me to think pressure to lift or ease these sanctions will rise considerably in 2015. Why Angela Merkel is so set on punishing her (former?) friend Putin, I don’t know, but I can’t see how she can ignore domestic corporate pressure to wind down much longer. Russia is part of the global economic system, and excluding it – on flimsy charges to boot – is damaging for Germany and the rest of Europe.

Finally, still on the topic of oil and gas, Wolf Richter provides another excellent analysis and breakdown of US shale.

It’s showing up everywhere. Take Samson Resources. As is typical in that space, there is a Wall Street angle to it. One of the largest closely-held exploration and production companies, Samson was acquired for $7.2 billion in 2011 by private-equity firms KKR, Itochu Corp., Crestview Partners, and NGP Energy Capital Management. They ponied up $4.1 billion. For the rest of the acquisition costs, they loaded up the company with $3.6 billion in new debt. In addition to the interest expense on this debt, Samson is paying “management fees” to these PE firms, starting at $20 million per year and increasing by 5% every year.

KKR is famous for leading the largest LBO in history in 2007 at the cusp of the Financial Crisis. The buyout of a Texas utility, now called Energy Future Holdings Corp., was a bet that NG prices would rise forevermore, thus giving the coal-focused utility a leg up. But NG prices soon collapsed. And in April 2014, the company filed for bankruptcy. Now KKR is stuck with Samson. Being focused on NG, the company is another bet that NG prices would rise forevermore. But in 2011, they went on to collapse further. In 2014 through September, the company lost $471 million, the Wall Street Journal reported, bringing the total loss since acquisition to over $3 billion. This is what happens when the cost of production exceeds the price of NG for years.

Samson has used up almost all of its available credit. In order to stay afloat a while longer, it is selling off a good part of its oil-and-gas fields in Oklahoma, North Dakota, Wyoming, and Colorado. It’s shedding workers. Production will decline with the asset sales – the reverse of what investors in its bonds had been promised. Samson’s junk bonds have been eviscerated. In early August, the $2.25 billion of 9.75% bonds due in 2020 still traded at 103.5 cents on the dollar. By December 1, they were down to 56 cents on the dollar. Now they trade for 43.5 cents on the dollar. They’d plunged 58% in four months.

The collapse of oil and gas prices hasn’t rubbed off on the enthusiasm that PE firms portray in order to attract new money from pension funds and the like. “We see this as a real opportunity,” explained KKR co-founder Henry Kravis at a conference in November. KKR, Apollo Global Management, Carlyle, Warburg Pincus, Blackstone and many other PE firms traipsed all over the oil patch, buying or investing in E&P companies, stripping out whatever equity was in them, and loading them up with piles of what was not long ago very cheap junk bonds and even more toxic leveraged loans.This is how Wall Street fired up the fracking boom.

PE firms gathered over $100 billion in their energy funds since 2011. The nine publicly traded E&P companies that represent the largest holdings have cost PE firms at least $12.7 billion, the Wall Street Journal figured. This doesn’t include their losses on the smaller holdings. Nor does it include losses from companies like Samson that are not publicly traded. And it doesn’t include losses pocketed by bondholders and leveraged loan holders or all the millions of stockholders out there.

Undeterred, Blackstone is raising its second energy-focused fund; it has a $4.5 billion target, Bloomberg reported. The plunge in oil and gas prices “has not created a lot of difficulties for us,” CEO Schwarzman explained at a conference on December 10. KKR’s Kravis said at the same conference that he welcomed the collapse as an opportunity. Carlyle co-CEO Rubenstein expected the next 5 to 10 years to be “one of the greatest times” to invest in the oil patch.

The problem? “If you have an asset you already own, it’s probably going to go down in value,” Rubenstein admitted. But if you’ve got money to invest, in Carlyle’s case about $7 billion, “it’s a great time to buy.” They all agree: opportunities will be bountiful for those folks who refused to believe the hype about fracking over the past few years and who haven’t sunk their money into energy companies. Or those who got out in time.

We live in a new world, and the Saudis are either the only or the first ones to understand that. Because they are so early to notice, and adapt, I would expect them to come out relatively well. But I would fear for many of the others. And that includes a real fear of pretty extreme reactions, and violence, in quite a few oil-producing nations that have kept a lid on their potential domestic unrest to date. It would also include a lot of ugliness in the US shale patch, with a great loss of jobs (something it will have in common with North Sea oil, among others), but perhaps even more with profound mayhem for many investors in US energy. And then we’re right back to your pension plans.

Looks like the underlying source of this piece is Tyler Durden (my ass) at ZeroHedge, so, nah.

> “THE Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.” This intriguing prediction is often heard in energy circles these days. If greens were the only people to be expressing such thoughts, the notion might be dismissed as Utopian. However, the quotation is from Sheikh Zaki Yamani, a Saudi Arabian who served as his country’s oil minister three decades ago.
http://www.economist.com/node/2155717

Gas price plunge threatens fuel-cell and electric cars
http://www.freerepublic.com/focus/news/3240898/posts

I see no downside.

Have a Guinness!

Cheap oil benefits the vast majority of humans. The Saudi royal family may find themselves in a pinch: if they can't afford to keep up the handouts, they may be overthrown by the true-believer Islamic fundamentalists their great-grandparents were.

Tough cookies for them, but for us, what's the big deal? The current Saudi government is as near ISIS as makes no difference. Give them a funeral and cut a deal, if we want to, with the replacements, or let them fall back into dung-burning primitivism.

“No plan survives first contact with the enemy. That enemy is Iran. This OPEC move is a Saudi attack on Iran and Russia. Any damage done to US fracking is incidental. If Iran gets their nuke, their first move will be to shut down all Saudi oil exports”

I agree with your analysis. There is more visceral hatred within the Islamic community to each other than people realize

Saudi Arabia does not have the capacity to supply all of the world's oil needs. Consequently, the price will stay well above the $20 a barrel for which they can produce oil.

The decrease in oil will help jump start the world's economies and greatly reduce prices across the board. Areas involved with oil production will have issues, though.

In the end, demand reduction coupled with our fracking boom is what destroyed OPEC and deflated enviro-wackos’ egos for the non-cost effective energy alternatives.

Only if the decrease spending. Their 2015 budget has an increase in soending. They are tapping into their reserves, and that’s at $60 oil much less $20 oil. It doesnt really matter. The cure for low oil prices is low oil prices. Want $20 oil now? Then we’ll be buying it for $120 in a year or two

Ping.

Thought you two would like to read this. It doesn’t get a lot of interest from Freepers, but the readers of RIM and those on ZeroHedge were very concerned.

What the Saudi Royals are doing is destroying the U.S.A.'s ability to finance the access and pumping of petroleum and natural gas from shale sources. It is too expensive to extract, and can not compete with $20 a barrel petroleum from Saudi Arabian oil fields.

There are a lot of big players upset about the Saudis actions here. Iran's first nuke may not be pointed at Israel when it launches. As for the Russians, some of their warheads may not be properly accounted for. That Saudi oil would not be worth .20 cents a barrel if it becomes irradiated overnight.

As terrible as the prospect of feeling the full brunt of the depression that we've seen signs of coming the past 6 years would be, it is far worse for other nations. Worse, they value human life far less than we do and would be less hesitant to embrace extreme solutions.

Interestingly enough, I found an article that supports my own speculation at this (safe) link:

Op-Ed: Saudi Arabia is First on the Iranian Nuke Hit List

I've advocated a tariff on imported oil in order to keep the fracking revolution going in the past, not a popular position with ardent free-traders on FR admittedly. But, we're dealing with a cartel. And not only that, but a cartel that threw our nation into disarray in the seventies with an oil embargo, and again in the eighties with exactly what they are doing here. This is in no way, shape or form free trade. Allowing OPEC to wreck domestic oil production, again, in service to some theoretical "freedom" that only we're embracing, is foolish to the nth degree.

The GDP is about as reliable as any other government statistic. Oil prices have been artificially high for a decade and if nothing else, the lower prices will free up some money for investment in other sectors. The pie-in-the-sky and the sky-is-falling crowds both assume too much stasis. There are many new opportunities and Americans are still in the forefront of developing them—despite our government.

Very, VERY interesting article. The House of Saud is in a quandary, but Hell, they’ve been there before.

Their investment banker in the USA back in the late 60s and into the late 70s was a Jew married to a Lebanese Muslim. He used to call his wife, “my wild Arab.”

The Saudis are nothing, if not, practical. I suspect in the end they will be bombed into oblivion by the Persians.

The Turks will bomb the Persians into nothing - Iran is held together by terror wielded by the Persians (who make up less than 50% of the population), and the Turks themselves will be obliterated by the Russians.

I suspect after the radioactive dust settles the Muslims here in the US won’t be rattling any sabers, but that’s just may guess.

I’m all for an overhaul of our tax system, and that requires bringing back tariffs.

Screw free-traders. Americans have suffered enough because of that silliness.

Love the Automatic Earth blog.

They aggregate a lot of media about energy/finance but the main bloggers there also have original content that is quite insightful.

Thanks for posting

The only downside is if we fritter away all that cheap available energy buying plastic baubles from China and driving around in circles (because we can) instead of ramping up our own industry, infrastructure and means of production in general.

Which we are very likely to do.

I don’t know enough to comment on your seemingly plausible scenario.

What I do think I know is that Putin won’t sit on his thumb while the Saudi royal swinery pushes Russia toward economic ruin.

He will view such policies as an act of war and will respond accordingly, as any imperialist despot would do.

“Now do I beleive the 5% GDP number? No but do I believe our economy is growing? Yes. It is doing so because of all the great Americans getting up every day and going to work in spite of this governement.”

+5% GDP growth is not something to believe or not. It's a fact. Which doesn't mean that US economy is doing so great. Q4 will very likely fall to 3.5-3.8%. You just need to put together a bunch of other indicators and components to see the whole picture. BEA stats don't lie just BLS doesn't lie with total unemployment rate but once the participation rate, involuntary part-time employment etc. are added, It is still far from really good.

“I've advocated a tariff on imported oil in order to keep the fracking revolution going in the past, not a popular position with ardent free-traders on FR admittedly.”

If oil really goes down to $20 a barrel (which I doubt - It will rather stay at around $50, which is much more “normal” than those crazy +$100 prices) that could make sense. Besides, I'm sure there are many other “tools” that could make the fracking going even with very low oil prices.

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