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Trading Lessons

The Bigger Oil Story Behind the Headlines

Commodities / Crude Oil Aug 05, 2014 - 04:38 PM GMT

By: OilPrice_Com

Commodities

Michael Levi writes: While we fixate on sexy headlines about Chinese military threats in the South China Sea, for instance, or Washington 'lifting the ban' on crude oil exports, we miss the bigger stories -- and we miss the reality. China's relentless resource quest has the greatest impact on trading prices, which may not make for headline news, but is a very important reality, while the stories about the US lifting the crude oil ban were just wrong.


Michael Levi, David M. Rubenstein Senior Fellow for Energy and the Environment and Director of the Maurice R. Greenberg Center for Geoeconomic Studies, navigates us through today's oil headlines, extracting reality from sensation, and discusses his new book, "By All Means Necessary," co-authored with Elizabeth C. Economy, which takes us through China's resource quest and how it will change the world.

In his second exclusive interview with Oilprice.com, Levi discusses:

- The 'wrinkle' in US oil exports

- Political risk with exports ...

- And what it means for domestic prices

- The greater significance of the BP-CNOOC LNG deal

- US natural gas for China

- Why LNG is to weapons what spaghetti is to swords

- Why natural gas works as a weapon for Russia

- Competitiveness versus security with US LNG exports to Europe

- What the conflict in Iraq means for oil prices

- Why the EPA's new carbon targets are realistic

- But why implementation will be 'patchwork perverse'

- Why the real impact of China's resource quest is on trading prices

- China's resource quest and climate change

- Why Chinese companies still can't out-compete Western rivals

Interview by James Stafford of Oilprice.com

James Stafford: Several weeks ago American mainstream media headlines were awash with sensational news that the US had lifted the ban on crude oil exports, but in the fine print beneath the headlines this news was really just about a loophole for processed condensates. How significant is this 'loophole' for the future of US oil exports?

Michael Levi: I don't even know that it's a loophole. There has long been a general belief that processed condensates can be exported under existing law. The wrinkle in this case is that the processing is very much minimal, and the administration confirmed that it still met the requirements for export. I mean there's a broad view in the policy community that when push comes to shove even unprocessed condensates are likely to be allowed to be exported.

James Stafford: Is it a question more of when the ban will be lifted, rather than if?

Michael Levi: I don't have a particular time scale on that. I don't see a lot of appetite in the administration for blocking exports on policy grounds. I think that this is politically tricky territory, but to the extent that the administration can allow a rational organization of energy markets, I don't see a lot of appetite for going out of their way to avoid that.

By the way, the initial headlines were flat out wrong, which spurred a lot of the confusion. There also was a sense out there that this was a first step to a much broader relaxation. I actually read it in a very different way. This was not a particularly politically risky step to take... so it doesn't give much of an indication of what the administration's political appetite is for more difficult steps. To the extent the administration can take some of the pressure off the system by allowing condensate and condensate-like exports, it actually lowers the need to make more significant reforms.

James Stafford: What would this then mean for domestic oil prices?

Michael Levi: Because this sort of export was generally anticipated, I don't expect a significant impact on domestic oil prices as a result. If there was a full out lifting of the ban on crude oil exports I think you'd see some rise in domestic oil prices a few years out.

You would expect a complete removal of the oil export ban to have a larger impact on domestic prices than on international prices. That's sort of a logical implication of the fact that the domestic market's smaller than the international market.

James Stafford: At the same time as this loophole was announced to great fanfare, you noted that another, much quieter LNG deal between BP and China's CNOOC was "at least as important as the U.S. move." What is so significant about the BP-CNOOC deal, and what does it mean for the LNG market?

Michael Levi: There's a general belief even among a lot of people who watch the LNG markets closely that China has no involvement in exports of US natural gas. It's certainly true that no Chinese company has signed a contract with an operator of a US LNG terminal.

But, I was struck during a visit to China last month to hear people describe what they thought as upcoming exports of US natural gas to China. What they identified were situations where traders who had contracts with US LNG exporters had, in turn, other contracts to sell their gas on to CNOOC. The indicator in these situations was that the contracts they signed, first with BG and now with BP, have prices for delivered gas that are partially indexed to natural gas rather than to oil.

Without seeing the contracts, no one knows whether this is linked to physical flows as well. But at a minimum, it means that the emergence of the United States as an LNG exporter has created an opportunity for buyers, including buyers in China, to diversify some of their price risks that are traditionally being associated with LNG imports.

James Stafford: In terms of LNG for Europe -- particularly the idea of using LNG as a weapon against Russia -- what would an increase in LNG activity do to Gazprom prices in Europe? We understand that the effect would not be immediate, nor would it be drastic, but Lithuania has shown that it is a good bargaining chip.

Michael Levi: I think you have to distinguish between the first... I have this image in my head of someone trying to use a piece of spaghetti as a sword when people talk about LNG as a weapon against Russia. It doesn't go where you want to push it.

You can allow LNG exports from the United States. They're going to go to where the price is best. Right now, the price is best in Asia, and there's a reason to anticipate that will continue to be the case.

If European buyers want to pay extra to get LNG from the United States rather than from Russia then maybe you'll see flows moving into Europe. I don't see a significant appetite for that yet. That's why we're not seeing European contracts, not because of US regulations. US regulations haven't gotten in the way of Asian contracts.

What's in the way of European contracts is a lack of commercial attractiveness. What US LNG exports can do is push down the overall price of natural gas. Even if US exports go to Asia, if that displaces other gas to flow from Europe, it can push down prices that improve European competitiveness.

It doesn't change the ability of Russia to use gas as a weapon. The ability to use gas as a weapon has to do with the ability to cut off physical flows during a crisis. It's important to distinguish that from long-term competitiveness issues.

It's inevitable that Europeans will describe their desire for greater US exports in terms of energy security. It's much more compelling to talk to American audiences about solidarity in the face of Russian threats than it is to say, 'we want you to do this because our chemicals producers will become more competitive as a result.' But, the reality is that the main impact of US LNG exports in Europe would be on competitiveness rather than on security.

Michael Levi: For Ukraine to be more energy secure it needs to have industry that can be profitable without subsidized Russian gas.

That's the basic problem here, right? All Russia has to do is threaten to charge Ukraine the same as everyone else would charge Ukraine, and Ukraine is in trouble.

Everyone worries about countries cranking up prices to above the market price. That usually corrects itself pretty quickly.

The real risks, as Ukraine illustrates, tend to come when a country sells energy below the market price and then threatens to sell it at the same price that everyone else does. There's nowhere to run when that happens. When you're in that situation, your [energy] security is very low.

You saw that with the Soviet Union and Cuba. You see it with Russia and some of the former Soviet states.

James Stafford: In our last interview with you, you discussed "outsized disruptions" of the oil market focusing tightly on the Middle East. Over the past couple of months, nothing could be truer. With the Islamic State (IS) now in control of a large swathe of land bridging Syria and Iraq, fighting for control of a key Iraqi refinery for domestic consumption and arguably in control of all of Syria's relevant oilfields, how outsized do you expect the disruptions to be in the coming weeks and months, keeping in mind that so far the crisis has not begun to affect Iraqi oil exports?

Michael Levi: To understand impacts in the coming weeks, you want to talk to an expert on Iraq and on Kurdistan. I think the big question looming over all this is the long-run impact.

Most forecasts that foresee $100-ish oil prices definitely assume that a significant part of delivering that comes from Iraq, and if the political and security situations aren't conducive to substantially more investments that part isn't there. That's why you're seeing the more distant oil prices perk up by more than near term ones, because people are concerned about this long-term ability to deliver.

James Stafford: Who has been benefiting the most from Iraqi oil?

Michael Levi: Look, the big oil consumers benefit from Iraqi oil regardless of whether they actually import oil from Iraq.

I think one of the big fallacies in people's thinking about the Iraqi oil sector has been the focus on who's making money producing the oil. The bigger impact is on consumers. It's not clear to me that the Chinese make money producing Iraqi oil, at least as producers; but as consumers--to the extent that Iraqi oil production holds world prices down--the Chinese, the United States, and also some other countries benefit.

On a numbers basis it wouldn't surprise me if Jordan benefits enormously, not because of their economic relationship, but because Jordan spends so much money on oil imports. Anything that keeps production up and holds prices down is good for Jordan. I mean that's the way you think about it, not just in terms of who's getting the chance to make $2 a barrel producing the stuff.

James Stafford: Back in the US, how do you perceive the EPA's new carbon emission regulations for power plants? Are the targets realistic?

Michael Levi: There's no question that these targets can be met. The EPA has gone out of its way to propose targets that can be achieved without people needing to be particularly creative.

The implementation will be very interesting to watch. I think a lot will depend on the decisions that individual states make about implementation. If you have a patchwork of different approaches you could see some perverse outcomes.

As a general matter the EPA seems to be trying to have achievable targets and to have as much flexibility under existing law as can possibly be given to the states that have to comply. You still shouldn't ignore the fact that comprehensive national legislation would be more efficient than using this authority for something that it wasn't designed for. But, within the confines of the law, they're trying to create as much of that flexibility as they can.

James Stafford: A number of analysts are suggesting that the EPA's proposed regulations could help revive nuclear energy. Do you see this happening?

Michael Levi: The EPA regulations don't really tell you anything about which sources will benefit, because the micro-level incentives that will affect investments in operation are all going to be determined by the states. The EPA certainly uses the possibility of nuclear shutdowns in determining its baseline.

So, there's a bit of a message there that saving nuclear power plants is one way you can achieve your goals, but it's all up to the states whether that's how they do things or not.

James Stafford: Your new book, co-authored with Elizabeth C. Economy, "By All Means Necessary," takes us through China's resource quest and how it will change the world. What is the key takeaway message from this work?

Michael Levi: To me there are two very large takeaways. The first is, while we fixate on the sexy headlines about how Chinese workers in Africa are changing society there or on how Chinese behavior in the South and East China Sea is creating military risks, by far the biggest consequence of China's resource quest so far has been through its simple impact on trading prices. That's had consequences for producers and consumers all over the world regardless of whether they have direct interactions with China. We often skip over that, but it's enormous.

The second big takeaway to me is that while China's changing the world, China's engagement with the world is changing China in big ways as well. You see that in the behavior of Chinese companies on the ground in the countries where they invest. You see it in the way that China thinks about military deployments, about cooperation in securing sea lanes.

You see that in the way that China is addressing its own demand and its own production opportunities, as it responds by itself to the high prices that it's played a critical part in creating. Its impact on China itself, as China's resource quest evolves, I think is something that's been under-appreciated but that over the long run will be very consequential.

James Stafford: In terms of impacting climate change, how does China compare globally and what can we expect over the next 5-10 years?

Michael Levi: What we do see is an interaction between China's efforts to deal with its local environmental problems, its efforts to provide security of supply for its energy sources, and the climate outcomes that develop. To the extent that China feels more confident, for example, in securing natural gas from a variety of sources--domestic, LNG, Russia, Turkmenistan--it becomes more willing to use natural gas to replace coal as a way of cutting local air pollution. That, in turn, has benefits for global climate change.

I think that's how you think about the impact of China's resource quest on climate change. It's the sort of second order effect. I would've said a few years ago that extreme Chinese concerns about the security of natural gas supplies means that there won't be a substantial shift from coal in that direction, which itself has timing implications, but this changing level of confidence, together with much greater concerns about local air pollution, starts to tilt things in a different direction.

James Stafford: How is China's resource hunger changing the face of competition globally for oil and gas plays in frontier venues in Africa and the Middle East?

Michael Levi: Still, I think you need to distinguish between two different kinds of frontier venues. Chinese companies appear to have considerably more appetite for politically risky places. You've seen that in Sudan, for example. That's a place where they have a peculiar kind of competitive advantage over Western firms.

Where I think the competitive advantage has been overstated, at least by casual observers, is in frontier places that are frontier because of their technical difficulties. The Chinese companies still are not on the cutting edge. They still need to partner, at a minimum, with Western companies, and that constrains their ability to directly out-compete Western multinationals, because in so many cases they need the Western multinationals.

You saw that, for example, in the more technically complicated parts of the Iranian natural gas sector. When Western companies pulled out because of sanctions, there was a fear that Chinese companies would fill in and undermine the impact of sanctions. It turned out that in a lot of cases, the Chinese companies weren't capable of operating the projects, or needed equipment from Europe or the United States that they simply couldn't get.

Source: http://oilprice.com/Interviews/What-The-Oil-Headlines-Miss-Interview-with-Michael-Levi.html

By Michael Levi for Oilprice.com

© 2014 Copyright OilPrice.com- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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