So Much for Energy Independence

With all the talk about US shale production there is a lot of talk about the US becoming energy independent. But as this report from the FT makes clear, the whole world is still highly dependent on Saudi Arabia, Kuwait, and the UAE. 

The US might be drowning in oil, but the world is still dependent on Saudi Arabia.

Indeed, Saudi Arabia is pumping out more crude than at any time since at least the 1970s. In neighbouring Kuwait and the United Arab Emirates meanwhile, oil production levels hit record highs. 

These numbers reflect a profound but easily overlooked trend in the global oil market. In spite of the shale oil revolution in the US, the world has become, if anything, more dependent on a handful of Gulf producers to fill supply shortfalls elsewhere. 

This  is of course great news for Russia. In July, Russian output reached 10.4 million barrels per day, a post-Soviet high. 

The problem is uncertainty of supplies elsewhere. Libyan production is down almost 1 million barrels per day due to turmoil. Iran still faces sanctions, and Nigeria has its own problems. As the world oil market is like a bathtub these are shocks we cannot escape, so Saudi behavior still matters.

Hard to disagree with this conclusion.

The consequences for the global economy – and the world’s biggest oil consuming nations – are significant. Saudi Arabia is already the single largest supplier to many of the large importing countries, including China. But it only sells crude to existing customers, and does not allow buyers to sell on their cargoes. 

For all the talk about the shale boom, then, it is business as usual for the rest of the world in terms of supply. The market will be watching those output data closely.

Energy Security vs Water Security

Interesting article in NYTimes on using fracking to unlock oil supplies. Although fracking uses up valuable water supplies,

The oil industry says any environmental concerns are far outweighed by the economic benefits of pumping previously inaccessible oil from fields that could collectively hold two or three times as much oil as Prudhoe Bay, the Alaskan field that was the last great onshore discovery. The companies estimate that the boom will create more than two million new jobs, directly or indirectly, and bring tens of billions of dollars to the states where the fields are located, which include traditional oil sites like Texas and Oklahoma, industrial stalwarts like Ohio and Michigan and even farm states like Kansas.

“It’s the one thing we have seen in our adult lives that could take us away from imported oil,” said Aubrey McClendon, chief executive of Chesapeake Energy, one of the most aggressive drillers. “What if we have found three of the world’s biggest oil fields in the last three years right here in the U.S.? How transformative could that be for the U.S. economy?”

But I wonder how much gain there is if switch from importing oil to importing water? Not that we can ever insulate ourselves from imported oil, there is not that much to frack. But even if there was, aren't supplies of water also important? Would politicians be so happy to have our water consumption decided by an Organization of Water Exporting Countries?

TNK-BP Part Two

My previous entry discussed the basics of the TNK-BP affair and the opinions of the competing sides. AAR believes the joint venture is ill-run, BP thinks that AAR wants to force them out so they can sell the company to a third party (Gazprom?). Many observers think AAR is really acting on behalf of Putin so that the state can take over the company.

Here is my take. When the partnership was formed both sides brought valuable assets to the table. BP brought technology and marketing skills. The former allowed the company to recover oil economically than previously was considered too costly -- reserves were greatly enhanced. And the marketing skills helped with distribution. This was important because when the partnership was created oil prices were much lower and the cost of Russian oil is relatively high.

What did the AAR partners bring to the table? Of course the Tyumen Oil Company (TNK). But that is not all, or even the most important part -- they could have just sold the company to BP if that was what mattered. What AAR brought was relational capital. This is key asset for any company operating in Russia. It is the insurance that prevents expropriation and the trust that makes contracts operate (see here and here for a discussion of relational capital). AAR had high relational capital due to the investments of its leaders. BP could not buy this. It had to partner with them. The important point is that western companies cannot invest in relational capital because many of the payments are made informally, and adherence to even minimal international accounting standards prevents such payments.

Now return to 2008. Oil prices are much higher. So the profits of TNK-BP are much higher. So the payments the joint venture has to make to maintain its relational capital are higher. But only the Russian partners pay these insurance premiums. So the value of their contribution to the partnership is rising, while with higher oil prices the contribution of BP is less important. Moreover, as this article in the Financial Times discusses, oil services companies like Schlumberger make it easier to tap deposits without the expertise of the oil majors. The conditions have thus changed dramatically since the bargain was formed. Is is odd that AAR wants to revise the contract?

What about Putin? Let's think of this in the simplest way possible using the notion of resource rent distribution that Gaddy and I have outlined in our work (see here). At today's vastly higher oil prices, companies like TNK-BP earn more resource rent, and Putin wants Russia to get its share. Of course the budget is automatically getting more revenue from the oil sector as the oil price rises. But that is only the formal side of the story. Much of the payment of the rent takes place informally. We call this "informal taxation" - payments that range from the innocuous (social spending, philanthropy) to the outright illegal (bribes, kickbacks), with a large grey zone between (so-called "voluntary" contributions to politicians' off-budget funds, and so on). You could call it a "protection racket." As Cliff noted in this article:

Another term for what is going on is “protection racket.” In a protection racket, there is a threat against which someone offers to protect you. The catch is that the threat emanates from the protector himself. Here, the threat is the loss of property rights. Sharing rents locally is one way to pay the protection money. There is also a national version of the protection racket, designed primarily for the very largest companies...Companies are expected, for instance, to pursue certain policies in their foreign activity that further the geopolitical interests of the Russian state, even if they sometimes don’t quite make sense from a strict business perspective...In sum, companies...are expected to do three things: (1) pay their formal taxes; (2) pay their informal taxes (share locally); and (3) serve the foreign policy agenda and promote other strategic interests of the state. It is very important to recognize the informal rent sharing. This is the part of the iceberg that lies below the surface. That’s the part that is hidden, and the part that tends to be larger. It’s the part that can cause
shipwrecks.

Yukos and Mikhail Khodorkovsky were victims of the hidden iceberg. We have used this picture to illustrate the iceberg phenomenon and the distribution of the rent.


To the extent that TNK-BP adheres to international accounting standards, it is highly constrained in paying these kinds of informal taxes. And even if it were able and willing to compensate by paying more formal taxes, there are reasons why that would not be acceptable to Putin. The ability to collect and redistribute informal taxes is at the heart of Putin's system of management of "Russia, Inc." It is their opaqueness that is key. Thus, from Putin's standpoint, formal taxes are less efficient than informal taxes. So I would expect that he would not be displeased if AAR wins this battle.

Addendum: A Tyumen court just ruled against BP in a dispute over the Board of the joint holding.