Friday, August 24, 2012

Why China Will Stop U.S. Energy Independence


















Hold onto your hats. Mitt Romney has declared North American energy independence by 2020 (effective 23/08/2012). Lots more drilling of oil and gas on federal turf, alongside offshore plays is the general gist ? and especially in Alaska ? all with a view to stimulating the U.S. economy. The template comes courtesy of the ever bullish Citigroup, who think an explosion in U.S. shale oil, and production upticks from Canada and Mexico will suffice to make everyone else go whistle. This places energy at the crux of the presidential election, precisely because this is U.S. economic policy over the next decade. But the devil (as ever), is in the detail. You?d have to see North American production increase by around 50% (in eight years) to make the narrative stick, but in doing so, no one?s quite sure what the breakeven price for shale oil actually is. Or indeed, whether energy independence is supposed to mean 40%, 30% or 0% of foreign oil filling up U.S. tanks? Answers on a postcard please. But the most critical question from this side of the (British) pond, is who?s supposed to be doing the investing? Get to the bottom of that, and you highlight what?s happening in the real energy world, not just? electoral hype. As much as North American energy independence might win votes, rest assured, the rest of the world, and most critically China, is going to work (and invest) hard, to prevent that from happening. Interdependence, ultimately works best for all.

Enter The Dragon

First up, forget all the 2005 Unocal nonsense about national security threats to the U.S.; China has no interest in planting flags on American soil for political purposes. Rather, Beijing wants to make sure that it has a sufficient physical stake in North American production to influence virtual trades. That applies both to gas and oil, and especially to WTI and Brent benchmarks. North American assets hold the international key to price risk management for China. Beijing is not going to let North America out of its acquisition sights. If anything, it will become one of its key suppliers.

Let?s take the obvious LNG angle for starters. China knows better than anyone that North America is pivotal to making or breaking a new gas world. If America fails to export its surplus gas supplies, Asian consumers face very little chance of getting gas markets working on the basis of gas fundamentals, rather than oil indexation folly of old. That?s exactly why the China Investment Corporation (CIC) is sticking $1.5bn into Cheniere?s LNG export plants at Sabine Pass; it?s exactly why Sinopec has shown interest in $14bn of Chesapeake?s ailing assets; and it?s exactly why PetroChina is lining up 12mt/y exports from British Colombia further north. China wants to see as much North American gas (potentially up to 125bcm/y by 2020) as it can on international tankers. North America is literally the ?swing market? that could make or break a new gas world. What?s more, it?s an aim that China shares with Korean, Japanese and European counterparts. And don?t think for one moment that American IOCs aren?t in on the act. Selling gas in America for a pittance is not part of their script, particularly as everyone in the U.S. shale sector has left themselves overexposed. Reserves were overhyped, companies overleveraged: With Henry Hub prices flat lining under $3/MMbtu, no matter what Presidential candidates tell you, it?s literally a case of take the?RMB as a strategic investment, or die. The more China can commercially engineer North American shale towards international exports, the more Beijing will be able to source all its external gas supplies on a far cheaper (or at the very least) cost reflective basis between the Atlantic and Pacific Basins. That?s good for China, it?s very good for Canada?s 30mt/y of stranded gas ? and ultimately ? it?s good for U.S energy companies (and consumers), who simply can?t continue the fallacy of ?free gas? without prices firming towards sustainable levels.

Turn to oil, and the details are more nuanced, but the same price risk fundamentals apply for Beijing. Despite PetroChina producing more oil than Exxon Mobil on a daily basis these days, Chinese NOCs are continually playing catch up to meet 9.9mb/d demand. As the biggest overall consumer of energy in the world, no one is in any doubt that China has to step up equity deals, both for security of supply, and more importantly, to hedge price risk exposure in future. Once again, physical North American assets play a pivotal role in this respect.

CNOOC?s high profile ($15.1bn) Nexen deal provides the clearest example of where China is heading. As the largest prospective offshore acquisition by a Chinese company, emphasis has understandably been placed on the 900 million barrels CNOOC will add to its 3.3bn proved reserves. Canadian oil sands are the biggest single plays, followed by access to Nexen?s 200 (or so) exploration blocs in the Gulf of Mexico. But don?t think volumes, think price. The deal (in direct contrast to Mitt Romney?s Keystone XL plans), is about making sure increasingly large amounts of Canadian crude finds its way onto international markets, not trickling its way to Texas via the US Midwest. Couple that?with the $18bn stakes China has across Canadian resource plays (OPTI, Syncrude et al), and initial assets acquired in the U.S. such as Chesapeake and Devon Energy, and it?s clear that China is taking initial steps towards fixing a broken WTI benchmark back to international price (re)alignment. That?s good news ? not just for Canada ? but across the entire Americas. Relying on a single source of U.S demand and single source of supply would be the pinnacle of economic stupidity. Even PEMEX guys get it in Mexico, as do feistier Latin American players further South.

But if hedging price risk proves to be true for North America, it categorically applies to the North Sea where CNOOC will acquire vital Nexen Buzzard field assets. Dated Brent is by far the most important international oil benchmark (accounting for 65% of global price points). But just as WTI has frailties to reduce bottlenecks to keep oil flowing internationally, the North Sea is splintered with creaking and aging infrastructure. With production levels dropping to 774,000b/d in August ? the lowest on record, Chinese investment is not only welcomed, it comes in the most critical Buzzard fields providing the bulk of Forties blends (220,000b/d) underpinning Brent prices. This is as strategic as acquisitions can possibly get. For further confirmation of China?s price risk strategy, Sinopec even tabled a bid for Talisman?s North Sea assets on the same day CNOOC made its move for Nexen. Small volumes yes, but vital assets as far as global price implications are concerned. Without reeling off any more facts and acquisition figures, the key point to register is that wherever you look, China is linking physical assets to virtual trades, not just to feed gas market liquidity, but to rebalance WTI and Brent for oil. That has a clear resonance for Urals and Middle East Dubai prices as well.

Upside For All

Admittedly, it?s not exactly global domination yet, but it?s all positive stuff for oil market efficiency and fungibility, helping everyone to share in the spoils. China will narrow international spreads to optimise its energy stake, and its national champions are certainly not afraid of placing international oil onto global markets to drive decent margins. Rather than shutting up shop to overseas investment (and missing very lucrative export potential), the U.S. should be leading the charge to keep energy as a globalised commodity. Whatever Citigroup says, energy independence has close to zero policy merit for Washington. Not only does America lose its international standing, it can never truly insulate itself from international price spikes, wherever they happen to hit. What happens in the Gulf of Aden, inexorably impacts of the Gulf of Mexico. Pure fact. Why work on the basis of fiction?

The added bonus of letting China in on the North American party, is that Beijing will take all the tech and knowhow it has from America directly back to China. Given Chinese shale gas reserves (1275tcf) dwarf those of the U.S. and unconventional oil plays are being revised up and up on a yearly basis in Beijing, both America and China could become energy superpowers in their own right. Perceived resource scarcity would be a thing of the past. Washington and Beijing could feed global hydrocarbon liquidity, set credible benchmark prices, and cut out any unwanted ?riffraff? in between. Energy flows East to West, not just North to South and vice versa.

But the frist step to doing that, is making sure China has a physical (OECD) stake in the virtual energy world to iron out? some inconvenient curves. When cooler heads prevail (post November 2012), that?s hopefully what will happen. China will discretely, but effectively stop U.S. energy independence folly in its tracks. Go the other way -?trying to forge energy into a national good for national consumers at heavily distorted prices -?and we?ll be on a very long, dark, and ultimately futile road indeed.

Source: http://www.forbes.com/sites/matthewhulbert/2012/08/23/why-china-will-stop-u-s-energy-independence/

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