Back in February 2013 the journal “Nature” ran an article by J. David Hughes exposing the rocky economics on which the shale gas-&-oil revolution in the United States rested. Huge levels of debt are required to fund the matrix of horizontal pipelines and the countless wells that have to be drilled before the black gold starts bubbling. And since the money only comes after the event, an oil shale company has to keep borrowing and investing to secure the oil to pay off the debt. The article was poo-pooed by many US pundits and ‘market experts’. Evidently, though, somebody in Saudi Arabia read it carefully, digested it, pondered and persuaded some else in his country to act, slowly but surely. On the NASDAQ today, a barrel of Brent was changing hands at just over 50 dollars. Many commentators have spoken of the shale oil operators requiring a price of at least 60 dollars to stay afloat. We can assume that many a smaller shale oil extractor is looking anxiously at the display each time his cell rings, worried it may be his bankers….
A month ago, on 6/12/2014, “The Economist” wrote guessed what might be coming and wrote: ““The industry’s weak balance sheet is also a vulnerability, says Michael Cohen of Barclays, a bank. Most firms invest more cash than they earn, making up the difference by issuing bonds. Total debt for listed American exploration and production firms has almost doubled since 2009 to $260 billion (see chart), according to Bloomberg; it now makes up 17% of all America’s high-yield (junk) bonds. If debt markets dry up and profits fall owing to cheaper oil, the funding gap could be up to $70 billion a year. Were firms to plug this by cutting their investment budgets, investment would drop by 50%. In 2013 more than a quarter of all shale investment was done by firms with dodgy balance sheets (defined as debt of more than three times gross operating profits). Quite a few may go bust. Bonds in some smaller firms trade at less than 70 cents on the dollar.”
While money is cheap, interest rates low, taking up debt is a possible basis for a business model. When interest rates rise, it won’t be. And the massive investments required to run shale oil fields will suddenly become more expensive. Since Saudi costs are far lower, they can keep priming the pumps at the Arabian oil well heads, until the mass of shale oil producers belly up when the phone-call is indeed a bank with a cash call. The Saudis won’t be attacked by the US Administration for what they are doing, because the low price of oil has, after all, helped the global (and that includes the US) economy bounce back forcefully in recent months. In fact, had the Fed raised interest rates the shale boys would have been sweating a lot over Christmas when checking their balance sheets prior to the New Year.
This is only one side to the Saudi policymaking coin, however. The flip side is not about economics, but about extending political influence beyond the country’s immediate region. In an op-ed back on 22/8/2014 in the “New York Times”, Ed Husain wrote: “Let’s be clear: Al Qaeda, the Islamic State in Iraq and Syria, Boko Haram, the Shabab and others are all violent Sunni Salafi groupings. For five decades, Saudi Arabia has been the official sponsor of Sunni Salafism across the globe….Textbooks in Saudi Arabia’s schools and universities teach this brand of Islam. The University of Medina recruits students from around the world, trains them in the bigotry of Salafism and sends them to Muslim communities in places like the Balkans, Africa, Indonesia, Bangladesh and Egypt, where these Saudi-trained hard-liners work to eradicate the local, harmonious forms of Islam.”
Clearly, Saudi Arabia’s Western ‘business partners’ have not succeeded over time in persuading the country to desist from this course. But then, before the real plummet in the price of oil, the country decided to donate 100 million dollars to the UN to fund a counter-terrorism agency. Ed Husain termed this a “welcome contribution”. Perhaps, however, it was a smokescreen, because Saudi Arabia had come up with a two-pronged strategy that would enable it to achieve the goal of spreading Salafism emphatically without this being noticed.
The drop in the price of oil will potentially hurt the shale oil producers. It already has hurt one country in particular, and I am not thinking of Russia or Iran, both of which commentators have suggested, Saudi Arabia has set out to punish for the policies they have pursued in the country’s backyard – in Syria. I am thinking of Nigeria. Where the country’s level-headed super Minister of Finance and Economics Mrs. Ngozi Okonjo-Iweala had sensibly pegged the budget to an oil price of USD 77.40, a figure she revised downward in December to USD 65.
While the country has some policies in place to diversify away from oil, and the current administration has prioritized promoting agriculture as such a path, it has an awfully long way still to go. A good three quarters of government revenue is generated by oil exports – meaning one half of the figure that looked to be beckoning in January 2014 when the price hovered around 100 bucks a barrel. The Goodluck Jonathan government is quite literally caught over a barrel. Cash-strapped would be kind by comparison.
And this is where the Saudi oil policy becomes foreign policy. If there is a government in the world that at present needs to muster all its resources to repel Salafist-driven Islamic violence it is Nigeria. It needs to invest in materiel and men to counter the insurgency of Boko Haram. It needs to invest heavily in infrastructure to drive socio-economic development in Northeast Nigeria (which is one of the regions with the lowest position in the Human Development Index on the continent). Without money, the largest economy in Africa is staring down the barrel of complete political instability, with Northern Muslims potentially radicalizing and Christian southerners potentially wanting to sever the covenant of the union on which the national federation rests. This is the second, covert goal of Saudi Arabia’s current oil policy. If they can crush the regional and continental ambitions of Nigeria, nip its burgeoning presence in Africa in the bud, the chances of radical Islam taking long-term root in the Sahel and sub-Sahel zones are good – and with these prospects the creation of a region that would be the natural objective for Saudi investment. And it is this that Western, Chinese and Indian foreign policy makers and businessmen should sit up and take notice of – not the few now doubly toxic shale-oil assets…
In fact, it’s a treble play by the Saudi gorilla. As the further it lets the price of oil drop, the more it in the interim trashes the massive investments the moderate Muslims in the Gulf states have made in solar power and in manufacturing. Over the last few years, in particular Abu Dhabi, Dubai and Qatar have consistently been pursuing this course as a means of diversifying their economies in an effort to ramp up life in the post-oil or post-gas world. The investments have been committed to both R&D, panel production, and in a variety of pilot and non-pilot plants. The countries’ various projects cover generating capacity of XXXX specifically commissioned by SolarGCC or the Qatar Foundation. Saudi Arabia, by contrast, boasts a total of only 5 MW in solar power generating capacity, commissioned by Saudi Aramco. The further the price of oil drops below $60 a barrel and the longer it remains lodged there, the less the value of the investments in solar, as diesel gensets deliver power at the same generating cost and are cheaper to buy. The Gulf moderates could find themselves simply having to write off their upfront investments, and their diversification strategy, so proudly touted as showing the emirs’ far-sighted efforts on behalf of their not-so-democratically ruled populace, would be left in tatters. Whether popular support for them then prevails is anyone’s guess.
And then there’s manufacturing, driven in Saudi Arabia by cheap energy prices and the presence of ores, such as bauxite. Alcoa has already entered the market. Or the presence of oil, like petrochemicals. Saudi Aramco and Dow Chemicals have just signed away $20 billion in a joint venture.
These sectors are note exactly known as big local job creators, nor will they suffice to drive a post-oil economy. Moreover, Saudia Arabia with its religious conservatism is not finding it easy to attract the foreign talent required to operate the industries, either. In both respects it is strategically at a disadvantage to its tiny moderate neighbors. Firstly, there the numbers of persons requiring employment in the future will be far lower (population growth rates in Saudi Arabia are far higher as is the absolute size of the population, while the per capita wealth available to create the jobs is higher). Moreover, the more open-minded autocratic societies of the Gulf do not face the same problems of not attracting foreigners. Indeed, they have not been busy building industries based only on cheap energy, but have been looking to an energy future, to tourism, etc., while diversifying into industries far afield. Their success has been prodigious. And perhaps this has spurred the economic big boys of the region on in their willingness to dump the oil price in an effort to shore up an economy originally founded on oil if it enables them to sink the economic and ideological competition for many years to come. Saudi wellheads produce cheaply –so the policymakers evidently do not need to worry about forgoing profits, they are simply forgoing windfall profits.
