A disruption for China, and the rise of small nations

By the end of the decade, Israel will probably satisfy all its own natural gas requirements, and become a serious exporter of liquefied natural gas. Argentina might produce the world’s third-largest volume of shale oil. Mozambique seems likely to become one of the largest LNG exporters in the world. And the United States may meet most of its own liquid-fuel needs.

Which is to say that the geopolitical fabric with which we have grown up seems to be unraveling in spots, and a new patchwork taking its place in Africa, the Middle East, North and South America, and beyond. Settled power and influence are giving way to a maelstrom of moving parts.

The backdrop is a global revival in the oil and gas business, ignited by energy companies that, after two decades of largely standing still, are finally drilling with purpose. These companies could yet self-destruct if they are not environmentally watchful. Clean-tech could achieve massive advances and economies of scale. But as of now, the colossal hydrocarbons industry — long the tipping point, and at times the singular force, behind countries becoming rich, or falling behind — is serving as the weaver of the new geopolitical fabric.

What could geopolitics look like? It is premature to detect concrete shapes, as Citigroup’s Ed Morse wrote in a much-read recent note to clients. Yet we can discern outlines of the potential appearance of the new world.

We already know, for example, that the heft of the U.S. shale gas boom has challenged Russia’s natural gas grip on Europe. Saudi Arabia also fears shale gas, whose abundance could ultimately contribute to the erosion of U.S. oil demand, as Chris Weafer said last week on this blog (also see remarks below by oil scholar Philip Verleger.).

Saudi has valid reasons to worry, as it seems almost-certain that the fresh big oil finds on other continents will whittle away at the centrality of the mighty nations of OPEC, the bain of Western economies for 35 years. OPEC seems far less likely to call the shots in global oil and, according to Citigroup and other analysts, the per-barrel price its members earn could be much-reduced. The wild card will be demand, meaning China’s future oil appetite, and the continued progress of energy efficiency.

Similarly, Russia, the world’s other current major oil-exporter, will probably be forced into serious political and economic reforms or face decline. Its government spending is too high, its non-hydrocarbon economy too anemic, and now its oil and gas sectors under challenge.

On the other side of the ledger, numerous heretofore basket-case nations up and down Africa’s coasts will have to decide whether to squander their unexpected new petro-fortunes, or build middle classes and stable societies. In addition to Mozambique, that includes Tanzania, Kenya, Cameroon, Cote d’Ivorie, and more. Similar prosperity would be in the line of sight of numerous South American nations.

As for the United States (pictured above, drilling in Pennsylvania), a small but growing number of economists see the potential for a resurgent economy, built on the back of cheap natural gas. Leading the pack is Citigroup’s Morse, who in the report cited above says the U.S. may more than halve its budget deficit by 2020, and experience a radical economic "revitalization and reindustrialization."

Likewise, we have a dissection of a coming U.S. boom in the Financial Times from Philip Verleger, who ran the Office of Energy Policy in the Treasury Department during the Carter Administration, and is a fellow at the Peterson Institute for International Economics.

With all of this turbulence, is it an article of faith that China will rule the world in the second half of the century, as many presume? China still looks on track to have the largest economy, but the many moving parts — including its challenging demography, as the Economist reports — make its trajectory seem less certain.

I separately emailed Verleger asking his opinion of the bullish forecasts of shale oil that we are seeing from Morse and others — what is the data backing up these predictions? Verleger had an answer, but was mostly interested in laying out a case for what he calls a "Kodak Moment" of marginalization for the U.S. oil industry. The email is provocative, and I reprint in full after the Jump.

Verleger:

The low price of natural gas is going to drive oil from the market. Oil in the U.S. is going to have a ‘Kodak Moment.’

The increased fuel efficiency of autos is going to help push oil from the market.  The auto industry ignored fuel economy until its near-death experience in 2008.  Now auto makers cannot improve fuel economy fast enough. The Federal Reserve is helping. Consumers must pay 20 percent on credit card debt, but only a percent or two for car loans. Consumers are quickly replacing gas hogs with efficient vehicles, thereby cutting credit card debt.  Fed data show an amazing move to fuel efficient cars.

Then there are the U.S. renewable fuel standards. By 2020 or so we have to use 2 million barrels a day of ethanol by law. The oil industry would love to change the law. However, an industry that has earned the respect of only 7 percent of the public, according to a Harris Poll, has no clout. Oil executives consistently are viewed as the least-honest of all industries other than tobacco, and they are tied with tobacco executives. How sad. The law will not be changed.

The ethanol rules were designed by the George W. Bush Administration when gasoline use was projected to be around 11 or 12 million barrels a day in 2020.  Under such circumstances, ethanol might have had to rise to 15 percent of the gasoline mix.  Now, though, ethanol may account or 30 percent or more of the fuel mix in 2020.  Market forces will lead to this result. The Environmental Protection Agency has a very clever trading system for ethanol credits. Firms making E-85 will be able to sell credits to refiners selling the standard type of gasoline. The price of the credits will skyrocket. Thus consumers will be able to buy e-85 for a dollar while paying $8 a gallon for conventional gasoline.

Consumers will quickly embrace flex fuel vehicles just as they have realized that they can save money by taking out 1 percent car loans. Refiners will have a Kodak moment.

The switch will be helped by the owners of gasoline stations (convenience stores).  The oil industry idiots keep arguing that cars get fewer miles per gallon with e-85.  That is true. That means consumers have to go to convenience stores more often to buy $1 a gallon e-85 rather than $8 a gallon gasoline. The convenience store operators will love the extra revenues. A few that are not tied to big oil are already moving this way.  Consumption of conventional gasoline will plummet.  Refineries will close.

Lastly, shale oil production will increase. How much — I am not sure. I am an econometrician and the builder of the first energy models back in 1971-1975.  I have learned though experience that energy models are the most expensive, most cumbersome random number generators ever invented. Three years ago, I would have predicted little output from shale oil.  Now I read forecasts that there will be large supplies. I do not know.

I do know that U.S. consumption of oil is going to drop sharply, and that supply will increase. Independence is coming.

I also have enough experience not to put a number and a date on the same piece of paper.