How OPEC missed the North American shale revolution

"Today, another kind of “oil crisis” is underway – not for the West, but for OPEC. And this latest threat has a name: fracking."

September 02, 2014

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“In addition to the many discoveries of oil and gas in the U.S., Canada and Australia, there are also great discoveries of shale gas, which will lead to a reduction of consumption of our oil.” – Prince Al-Waleed bin Talal, Saudi royal family

As an oil cartel, the Organization of Petroleum Exporting Countries is a fixture of the world’s energy system – not particularly liked, but begrudgingly accepted. The national oil companies within the sphere of OPEC, with their opaque accounting practices and byzantine corporate structures, monopolize vast reserves of easy oil and repatriate to their home treasuries gargantuan stores of western currency. In an increasingly global, transparent and unconventional energy age, OPEC goes against the grain. The untold mineral riches of its member nations, most of which are Middle Eastern, has given them a sense of confidence – some might say arrogance – that lets them, by and large, ignore energy developments elsewhere in the world and continue on with business as usual.

“If trends persist the [Saudi] kingdom could become a net oil importer ’20 to 30 years down the line,'”

During and immediately following the oil crises of the ‘70s, OPEC was at the height of its geopolitical and geoeconomic influence. The cartel’s extreme power, however, soon showed signs of weakening. In fact, it was precisely the high level of commodity prices stemming from OPEC’s market rigging that actually stimulated highly effective large-scale non-OPEC exploration and production around the world. But while the increased competition from these other supply sources such as Alaska or the North Sea may have bent OPEC, they certainly didn’t break it. Today, another kind of “oil crisis” is underway – not for the West, but for OPEC. And this latest threat has a name: fracking.

 

Far away from the powers of Middle Eastern sheikhdom, North America has emerged as the promised land for the shale revolution. Investors from around the world, including France, Norway, China and Poland, have been busily acquiring interests in North American companies to get into the game.

Whether in Canada or the U.S., the revolutionaries are petroleum companies who apply directional drilling and ­hydraulic fracturing to hydrocarbon-soaked source rocks that had hitherto not been targeted because of their extremely low porosity and permeability. In Canada, plays such as the Bakken, the Montney and the Horn River, or latterly emerging ones like the Duvernay, the Muskwa and Exshaw, are delivering impressive production rates. The catch is that these unconventional wells are much more ­expensive. So wouldn’t rich OPEC national oil companies who need the technology be ideal investors for Canada’s capital-hungry, prospect-rich junior and intermediate oil and gas sectors?

Restrictions on foreign direct investment flows may appear to be the issue, but likely are not. The Canadian government tightened restrictions on foreign investment in the energy sector in early 2013, but the purpose was to restrict ­state-owned enterprise “acquisitions of control” of oil sands projects. Other unconventional hydrocarbon assets therefore remain fair game for SOEs of all stripes. Canada has kept its doors wide open for investment in shale gas and tight oil plays, but Middle Eastern ­companies aren’t plying their petro-­dollars for ­Canuck fracking-smarts. What’s going on?

“The letter was couched in assuring language, but an alarmist message shimmered through.”

Last year, Prince Al-Waleed Bin Talal, a high-ranking member of the Saudi royal family, submitted a secret 14-page memorandum to his country’s energy ministry in which he warned about the threat of fracking. The highly oil and gas dependent – that is, the highly undiversified economy of Saudi Arabia – was at risk of being side-swiped by a paradigm shift in petroleum industry practices, especially on the gas side: “In addition to the many discoveries of oil and gas in the U.S., Canada and Australia,” the prince wrote, “there are also great discoveries of shale gas, which will lead to a reduction of consumption of our oil.”

The letter was couched in assuring language, but an alarmist message shimmered through. “At the moment there are no risks to the Saudi economy as a result of the production of this type of gas,” it reads. “The [Saudi Arabian] Ministry of Petroleum and Mineral Resources has a great responsibility to bring these fateful issues to a discussion, debate and internal dialogue, but to this day it has not been done.”

The response to the prince’s letter was muted. With world’s second-largest oil reserves of 265 billion barrels and crude production capacity, excluding petroleum liquids, at around 12 million barrels per day, Saudi Arabia is, after all, the veritable kingdom of oil. Its colossal resources, ­processing and transport infrastructure give the country the latitude to pump more or less depending on how it wants to influence the OPEC Basket Price and, by extension, other international benchmarks.

As the so-called swing producer, Saudi Arabia stands at the commanding heights of global oil markets and holds the means to wrestle all the disparate and competing interests within OPEC under one halfway harmonious roof. With such daunting power, all this talk of revolution is perhaps just a distraction. Incidentally, the Arab Spring was also a revolution affecting several OPEC nations. It was soon put down.

 

With the shale gale howling, U.S. oil production has already surpassed Saudi Arabia’s, according to statistics published by the International Energy Agency (IEA). OPEC’s own forecasts see global crude oil demand rising “by 1.3 million bpd in 2014 to 92.8 million bpd, a modest acceleration on 2013 as the macroeconomic backdrop improves.” Yet the organization does not intend to increase its current production level beyond 30 million barrels per day. What this means is that OPEC will let non-OPEC producers, which are largely responsible for the new unconventional supplies, pick up the slack in the increase in global supply. In short, OPEC is forsaking global market share to places like Canada and the U.S. where oil production is on the rise.

For a Saudi central planner, this should be discomforting news. But even more worrisome is the kingdom’s dramatic increase in domestic energy consumption. If trends persist the kingdom could become a net oil importer “20 to 30 years down the line,” according to Taufiq Rahim, executive director of Globesight, a strategy firm in Dubai. If Saudi Arabia stops exporting oil before it has developed a highly diversified, resilient modern economy, it will end up in a very tight spot. And without Saudi Arabia as an energy superpower, OPEC would be leaderless and, probably, defunct.

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Moroccan workers protest against their government in Casablanca on April 6, 2014 as part of a wave of protests following the Arab Spring
CP Images

The sense of waning power is hardly apparent in Ryadh where the world’s tallest tower is under construction. When the Kingdom Tower is complete, it will stand 1,000 meters, large enough to tuck the 380-meter New York Empire State Building neatly into its overweening shadow. Interestingly, the tower’s owner is also Prince Al-Waleed, the man who wrote the shale threat letter. He is eager to build this prestige object back home, but he is not taking his eye off developments in faraway places like British Columbia and North Dakota.

Saudi Arabia and other OPEC countries face huge, mainly intangible barriers to getting on the fracking bandwagon, although many falsely assume technology is the ticket. But having the right frack pumps, blenders and so on in themselves won’t enable you to undertake a successful frack job. The hardware is the easy part. More difficult and necessary is the existence of an industrial environment with certain very specific conditions.

“If Saudi Arabia stops exporting oil before it has developed a highly diversified, resilient modern economy, it will end up in a very tight spot.”

According to Robert Blackwill and Meghan O’Sullivan, foreign policy fellows at the Washington-based Council for Foreign Affairs, the most important conditions of this frack-enabling industrial environment is the existence of a community of sophisticated financiers with high risk tolerance. Moreover, these risk takers need to work in a legislative-regulatory system, usually in a constitutional state, where landowners and leaseholders can claim rights to the minerals under their holdings. Also, the structure of the country’s oil and gas industry cannot be marked by a single national oil company, but needs a whole myriad of entrepreneurs and service providers who can take advantage of a well-developed delivery infrastructure.

Jim Burkhard, vice president and head of global oil market research at IHS, unsurprisingly doesn’t see OPEC members fracking any time soon. “The growth in the U.S. in tight oil production – and some in Canada – hasn’t spread elsewhere,” he says. “The North American [boom] has a unique set of industry conditions that facilitated this great revival of production and these conditions don’t exist everywhere.”

Some of these conditions may be partially present in Saudi Arabia and in other Middle Eastern oil-producing OPEC countries like Iraq, Iran, Kuwait, Qatar and the UAE, but none of them in sufficient measure. Blackwell and O’Sullivan would likely argue that in autocratic regimes a political revolution, or at least liberalizing reform, is a precondition for the shale revolution to take hold. The political remaking of the tightly controlled theocracies and monarchies of Middle Eastern and Persian Gulf OPEC nations may certainly one day happen, but don’t hold your breath.

Meanwhile Canadian oil companies eager for capital infusions for their shale projects need not wait for the deep-pocketed Middle Eastern players to come knocking. And Saudi Prince al-Waleed, who recently bought into Twitter, should keep diversifying his wealth. The sands under the Kingdom Tower could one day start shifting.

– with files from Graham Chandler

More posts by Sebastian Gault

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