By Chris Cook
As Sheikh Ahmed Zaki Yamani, perhaps the wisest Saudi oil minister of recent times, memorably put it, the Stone Age did not end because the world ran out of stones, and the Oil Age is not ending because the world is running out of oil.
The US now has the capacity, whenever the oil price rises over (say) $80 per barrel, to rapidly ramp up shale oil production, and this capacity, which has made the US a 'swing producer' of high cost oil has profound geopolitical repercussions.
Former US President Lyndon Johnson brutally said about his long-serving FBI chief J Edgar Hoover (who knew where all Johnson's skeletons were buried) he would rather have Hoover "inside the tent peeing out, than outside the tent peeing in". President Obama's new found energy security frees the US from a historic reliance on Saudi oil which dates back to the Second World War, and means that the Saudis are effectively no longer inside the US tent peeing in, and are now about to be outside the tent pissing out.
The other consequence of oil prices over $80/barrel for five years was the rapid growth of the US renewable energy industry, and of new - 'smart' - technologies aimed at reducing carbon fuel use particularly in road transport. This combination of new high cost production with reduced consumption demonstrates the truth of another astute Yamani observation that "Nothing cures high prices like high prices".
Markets at a Crossroads
International Oil Company market participants like Exxon, BP and Shell now stand at a market crossroads. To the left, as related above, they now see an effective cap on carbon fuel prices: to the right they see the costs of new exploration and development rising inexorably. When I was last in Baku, the head of exploration of a global oil major active in the Caspian Sea made it quite clear that his company regarded the resulting squeeze on profits as unsustainable. Indeed his company has since then taken drastic action, as he predicted it would, to change its business model.
The recently announced merger between the gas-focused Shell and BG aims for survival through achieving economies of scale. But in my view this equates to moving the deckchairs on a 'Titanic' holed below the waterline: oil & gas market trends mean a fundamental and transformational change is inevitable.
So what exactly do these giant companies see when they look forward? The simple answer is Iran and Iraq. The reason why the US and Iran are coming to an accommodation is that the US has finally and belatedly recognised that Iran is no more a fundamentalist seventh century desert theocracy today than China is communist. In other words, US oil corporations can see temptingly before them the low hanging fruits not only of Iran's ageing (but still massive) fields and reserves, but also the enormous reserves of Iraq, where Iran exercises what is essentially a veto over foreign adventurism.
That is to say, that no one will develop Iraqi oil on any scale without Iran's implicit consent. Moreover, the US is in a hurry, because Germany, France & Italy - to name but three - are all over Iran like a rash, and the principal factor holding them back is the difficulty in getting paid via the US dollar clearing system.
Dead Sea Fruit
Unfortunately for the US & EU, this apparently low hanging fruit is in fact Dead Sea Fruit which turns to ashes in the mouth. Iranians are beginning to realise that they do not necessarily need to buy what the US and the EU are selling. Why exactly would they ramp up production and depress $ oil & gas prices further? Why exchange valuable oil for dollars or Euros when so-called risk free dollar assets such as US T-Bills are not risk free if the dollar loses value against other currencies or commodities? And why invest dollar proceeds in T-Bills yielding zero % per annum or Euros in the desperately dysfunctional Euro system: interest rates in Germany are now negative out to 10 years?
There is of course an exchange to be made, but it is not dollars or Euros in exchange for oil and gas. It is the exchange of the value of US & EU technology, knowledge and knowhow for the value of oil and gas production, and particularly for the value of carbon fuel savings.
Indeed, carbon fuel savings are a 'game changer' Why prospect for increasingly costly oil and gas production when you can prospect for oil & gas savings? For every litre of gasoline or diesel saved at the pump, there are probably three to five litres of crude oil to be saved at the well. For every Kilo Watt Hour energy equivalent of heat or cooling delivered in the home, perhaps up to 10 Kilo Watt Hours energy equivalent will be saved of natural gas at the well once the current disastrously inefficient generation and distribution using legacy energy infrastructure is taken into account.
The well travelled conventional oil and gas road is to sell oil and gas as a commodity in order to maximise dollar profits. But of course this road does not lead to carbon fuel savings, because neither oil and gas producers nor middlemen have any interest in reducing demand for their production or sales and therefore their profits.
But there is another oil & gas road: a Road Less Travelled.
Resource Resilience
As reported in Trend, Azizollah Ramazani, the Chairman of Iran's NIGEC and the member of the NIGC board responsible for international affairs, made an important speech in Ashgabat in December at a UN sponsored Energy Charter event on the subject of Reliable and Stable Transit of Energy.
Ramazani had been expected to join Russia's delegate in resisting the Trans Caspian transit of gas for 'environmental' reasons (for which we may perhaps cynically read commercial reasons of competition). However, instead of such a negative position, Ramazani's intervention opened up a very interesting and constructive approach.
Firstly, he suggested that the rational principle to apply in creating the necessary regional Caspian energy transit infrastructure is that of 'least carbon fuel cost', which he explained was simply the principle that for a given use of heat/cooling; electricity and motive power, the use of carbon fuel should be minimised.
While this label of least carbon fuel cost is new, the actual principle has been successfully applied by Denmark for some 40 years. Indeed no-one present in Ashgabat disagreed with the principle, since it is self evident that the more expensive carbon fuel becomes, the more economic sense it makes for a country to save it, and moreover to achieve thereby national energy security, energy independence and resource resilience.
Caspian Energy Grid
Ramazani went on to suggest that the architecture of a least carbon fuel cost Caspian Energy Grid - ie future Caspian energy generation and distribution infrastructure - might be based upon state of the art Combined Cycle Gas Turbine (CCGT) gas to power hubs operating at more than 60% efficiency, with a similar network of efficient High Voltage Direct Current (HVDC) Trans Caspian electricity connections.
So rather than exporting natural gas, and being perceived to be in competition with other gas producers, Turkmenistan might perhaps be better advised to generate electricity from their natural gas and export that regionally?
From the perspective of other Caspian gas producers such as Russia, Iran, Kazakhstan and Azerbaijan the domestic use of such efficiently generated Turkmen power would free more natural gas for export. As I observed at the time, not even the Caspian Sea's economically recoverable gas reserves will last for ever, and such an HVDC Caspian Sea Supergrid will then be available to balance regional flows of renewably generated electricity.
A Road Less Travelled
Of course, such a Caspian Energy Grid - and a new Eurasian Energy Grid to which it would be integral - requires literally $ trillions to finance development and to fund long term operations. This requires new and consensual Caspian legal framework agreements for energy co-operation and energy credit instruments. These must enable conflicting interests to be reconciled not only between Caspian nations with diverging interests, but between competing corporations, and in the conflicted public/private relationship between nations and corporations.
In the course of my research and development work in this field of legal and financial structures and instruments, I have established that not only do such agreements and instruments exist, but that they have always existed and indeed pre-date the financial instruments and public and private institutions with which we are familiar.
The Iranian oil & gas expert, Mr Mahmood Khaghani, who has immense experience of oil & gas generally and Caspian oil and gas in particular, outlined at the recent Athens Energy Forum a crucial element. He pointed out that oil and gas may easily be the subject of energy swaps. These include geographic swaps, such as Caspian crude oil for Persian Gulf crude oil and the gas to power swap - the exchange of a flow of gas for a flow of power generated from that gas. Mr Khaghani was instrumental in just such agreements during his career.
There is also the potential for oil/product swaps, where a flow of crude oil is exchanged for a flow of rights to oil products. I observe that the result is that through the use of swaps, oil and gas need no longer be bought and sold as a commodity: instead oil & gas may effectively be supplied as a service.
Such a switch from the sale of oil and gas as a commodity to supply of oil and gas as a service does not in itself provide a complete financial solution, since an oil producer may have no need for all of the oil products to which he is entitled or a gas producer may find his power entitlements exceed his needs. This is where I observe that the prepay credit instrument now re-emerging in use is crucial in the way that refiners may issue prepay credits returnable in payment for oil products and power generators may issue prepay credits returnable in payment for electricity. This combination of energy swaps and prepay energy credits enables new energy production to be financed and funded in a simple but effective way.
So perhaps new Caspian energy markets with an obvious pricing point at Baku, and operating within a Caspian Energy Clearing Union framework agreement, may be the Road Less Travelled down which the oil & gas industry may now advance?
I look forward to once more making Mr Khaghani and Dr Ramazani's acquaintance and to discussing this question with them and with other eminent experts who will gather at the South Caspian Energy & Petroleum Summit in Vienna on 14th/15th April.
Chris Cook's exclusive article for Trend. Cook is a former director of the International Petroleum Exchange. He is now a strategic market consultant, entrepreneur and commentator.