‘Saudi America’ remains a Washington fantasy

All the terabytes of information the professional investor is expected to master, or, at least, regurgitate in front of the committee in charge of their compensation, could really be reduced to two data series: 10-year interest rates in a major currency, and the price of oil. If some device could tell you what those would look like, even two years out, you could reduce your workload to five days a week.

That would be too much to ask. Interest rates have godlike inscrutability, which is why I had no problem last week in recommending that people buy the five-year Bund for cash. There is no such thing as real inside information in that market, so I can’t be held responsible if anyone should choose to take my advice. But what if you could know where oil prices were going, even two or three years ahead? After all, there are, at least in the short and medium term, some determinate physical properties of the stuff. That has to limit the analytical problem, and give at least a range of possible solutions. Then perhaps you might relax on alternate Saturdays.

So in search of what my mentor Henry Jarecki dismissively calls “a machine to own the world”, I’ve been immersing myself in the best macroeconomic and microeconomic oil research, or what the people selling research call top-down and bottom-up estimates. And I did notice something: both approaches to figuring out where the price of energy will go seem to look right past each other.

For example, top-down analysts (and the policy tribe) would appear to think that whenever the British cabinet decides to allow land-based shale gas drilling and fracking, some Harry Potter character can magic up a couple of hundred rigs and crews. End of energy problem. Yes, well, up to a point. In this world, those rigs and crews won’t be assembled without a truly massive industrial effort, comparable to the initial creation of the nuclear complex.

On the other side of the cultural divide, bottom-up analyses, while more grounded in the physical world, tend to make assumptions about global supply and demand factors that are more aggressive than they think. Iran’s million-plus barrels a day of sanctions-limited production disappear from the spreadsheets. I think that’s unrealistic; one way or another the Iran stand-off will be settled, and the sanctions regime goes away.

The bottoms-up community is also inclined to accept that China’s demand for imported energy will continue to steam along. But the standing committee of the politburo looks like it means what it says about no more credit stimulus for a hypertrophied industrial sector. A hard landing, in their view, would be better than a crash landing. They wouldn’t be distressed by a consequent $15 or $20 decline in the oil bill.

I have a prejudice in favour of the bottom-up work. I have been much more frequently surprised by what I find out in factories and on work sites than what I hear in the hushed antechambers of the great. The bottom-uppers also tend to know more actual stuff, and have fewer pretences about what they don’t know.

Bob Brackett, a geologist at Bernstein, the brokerage, is, as I have mentioned in the past, among the best of the oil and gas microeconomic analysts on Wall Street. He has corrected me on my pessimism about the productivity and economics of the Marcellus Shale gas resource. These days, oddly, he is known on the Street as a “shale bear”, which is hardly the case; he just doesn’t believe trees grow to the sky.

Essentially, Mr Brackett says, shale oil in the US is a far more limited resource than shale gas. The geological conditions that allow oil to be cooked from ancient hydrocarbons are far rarer than those that turn them into gas. It is highly likely, Mr Brackett says, that economic shale oil properties have already been identified.

He considers the possibility of Iran’s suddenly turning on a million barrels a day of additional production. “That would take $10 or $15 out of world oil prices, and markets tend to overshoot.”

From his $95 a barrel US price assumption for next year, given the American industry’s cost structure, that would lead to a 15 per cent reduction in the number of rigs drilling for shale oil, and a smaller decrease in the rise of US oil production.

Even with a more optimistic (for the oil producers) assumption in the price of the stuff, he sees production in the formerly hardscrabble, now rich, state of North Dakota topping out in 2019 at 1.2m barrels per day. Hardly “Saudi America”. With declining conventional and offshore Gulf production, that means US “energy independence” will remain a Washington fantasy.

FT