The Power and the Money

Gasoline is too damn high, but by less than you think

 In the most important sense, the title to this post is incorrect. Gasoline prices do not come close to covering all the social costs of driving. They underprice pollution, especially carbon emissions. They underprice the congestion imposed on other drivers. They underprice the damage done to roads and infrastructure: gasoline taxes are no longer sufficient to fund America’s transport needs. So no, gasoline is not too damn high.

In one sense, however, it is: oil is currently worth more than the marginal cost of getting it out of the ground. Brent is currently trading around $111. The marginal cost of getting a barrel out of the ground ran about $92 in 2011. That leaves a 20% spread: some room for prices to fall (even with current demand) but not a whole lot.

How do you calculate the marginal cost of getting a barrel out of the ground? Well, there are two ways to do it. The correct and complicated way has been done by Bernstein Research. They used the annual reports produced by the 50-largest oil companies for which there are data (sans Russian and Kazakh producers) in order to calculate the marginal cost of a barrel. That is the dashed line on the below chart. As you can see, it’s been rising incredibly fast over the past decade, even as world production has more-or-less stagnated.

There is a quick-and-dirty way to replicate their methodology. I’ll walk you through it. Start with the bottom line, which is the average cost per barrel of actually getting the stuff out of the ground. That has risen from $4 to $21 over the past decade, as more and more difficult oil has come onstream. Now add in depreciation, administrative expenses and marketing costs. That’s the second line from the bottom. (It includes direct taxes and royalties on oil production.) It has risen from $7 to $36 over the past decade.

Bernstein then calculated the amount of capex (including exploration costs) that the companies would need to undertake in order to keep their reserves constant. That is the greenish dashed line labeled “Unit costs + est. capex.” There is a quick-and-dirty way to replicate their results, which is simply to use what the companies actually spent on their capital expenditures. That is the greenish solid line labeled “Unit costs − DD&A + capex.” (It subtracts depreciation before adding back in actual expenditures, in order to avoid double-counting.) The result is more-or-less the same. That number, a simple estimate of marginal cost, has skyrocketed from $11 to $51 over the past decade.

Now here’s the rub: oil companies do not actually earn the Brent price unless they are, you know, selling Brent. In 2011, Brent averaged $111, but the average realized price earned by the 50-largest oil companies was only $66 per barrel. In order to calculate the Brent price at which the companies could cover their marginal costs, you need to add that “realization spread” to the basic marginal cost calculation. That is the dark green line that more-or-less parallels the correctly-calculated marginal cost.

	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Lifting costs	$ 4	$ 4	$ 5	$ 6	$ 8	$ 9	$ 11	$ 17	$ 13	$ 17	$ 21
Unit costs	$ 7	$ 9	$ 10	$ 13	$ 15	$ 18	$ 21	$ 30	$ 26	$ 30	$ 36
Unit costs − DD&A + capex	$ 11	$ 15	$ 15	$ 19	$ 25	$ 31	$ 34	$ 45	$ 36	$ 47	$ 51
Above + realization spread	$ 21	$ 24	$ 24	$ 28	$ 41	$ 51	$ 57	$ 82	$ 57	$ 75	$ 97
Marginal cost	$ 25	$ 30	$ 36	$ 45	$ 58	$ 54	$ 64	$ 96	$ 68	$ 83	$ 92
Brent oil price	$ 24	$ 25	$ 29	$ 38	$ 55	$ 65	$ 73	$ 98	$ 62	$ 80	$ 111

What does this tell us about the world oil market? Well, the peak oil people seem to have been half-right. Technology has enabled the world to maintain oil production, and the truth is average production looks set to expand. But technology has not enabled the world to maintain production without using increasingly expensive techniques. I was at a dinner the other day with two hedge fund guys, and we calculated on a napkin (using an entirely different methodology) that it was barely worthwhile to drill in the Bakken at current oil prices. Given that the world seems to have an ending thirst for oil, prices may fall, but not by that much.

What does this imply about American energy security? Well, the U.S. may, if it is willing to carry out the right policies, be able to insulated itself from future price shocks that could take oil up to $200+ per barrel. But it will not be able to bring back the days of buck-a-gallon gas. Not even three-buck-a-gallon gas. Absent some sort of radical demand shift (and raising CAFE standards ain’t that) cheap oil is gone forever.

Delta Airlines provides perspective on the CNOOC-Unocal controversy

 In 2005, the China National Offshore Oil Corporation (CNOOC, pronounced “See-knock” by Americans) made an offer for Unocal. The political reaction at home was ferocious. The opposition came from three sources:

1. Fear of technology transfer. CNOOC might be able to acquire new techniques and abilities from its subsidiary. This is a reasonable fear in general, but not in the specific. Unocal was not really on the technical frontier ... and even had it been, all the evidence is that in the oil industry the benefits of propietary technology flow to the shareholders, not the citizenry. In that sense, then, China might have done the U.S. a favor by liberating whatever technical secrets Unocal might have possessed;
2. Fear of foreign control over American assets. This objection never made much sense, as Bernard Guerrero pointed out here. CNOOC assets in the United States fall under the jurisdiction of the American government, and should the U.S. and China ever go to war (even a cold one) the U.S. government can and will easily do to Chinese assets what it did to German ones during World War One;
3. Fear of foreign control over foreign assets. This was Paul Krugman’s objection to the deal. His worry was that the Chinese government might choose to keep oil from, say, Central Asia off the world market. That would drive a wedge between Chinese oil prices and world prices, damaging the rest of the world. The incorrect objection to this reasoning involved putting words in Krugman’s mouth, and assuming that he was discussing only military confrontations. The correct objection to this reasoning was simple: the Chinese government would incur a large opportunity cost from such a policy. Rather than sending cheap oil home, China could sell it overseas and pocket the difference. So absent the ignition of Cold War Two, what would be the point?

That last counterargument was very convincing. You can follow a microcosm of the debate at Crooked Timber. There is a wrinkle involving pipeline construction (short version: U.S. consumers have an interest in preventing China from building pipelines into Central Asia, just as we have an interest in preventing Canada from building them to the Pacific) but it is both minor and irrelevant to the CNOOC-Unocal controversy, simply because China was going to build those pipelines regardless.

End of argument? I would have thought so, but today I read that Delta Airlines was doing something interesting:

Delta Air Lines said on Monday that it had agreed to buy a refinery near Philadelphia from ConocoPhillips to offset the risk of higher jet fuel prices ... Richard H. Anderson, Delta’s chief executive, said the investment was a modest one, equivalent to the list price of a new wide-body plane like a Boeing 777. The company estimated that it would reduce its annual fuel expense by $300 million, once the refinery was refurbished and operating again. To achieve similar fuel savings, Delta would have to buy 60 new-generation narrow-body planes like the Boeing 737, a capital investment that would total $2.5 billion.

Huh! It looks like Delta Airlines has decided to do exactly what the economic theory predicted that China would not do. After all, there is an opportunity cost to locking up refined products: instead of selling them cheap to itself, Delta could sell it expensive to others. Moreover, it turns out that Delta isn’t alone. BP is also involved. The reason is simply that refineries cannot product only one product: you always wind up with other byproducts. So Delta will need to swap those other products for jet fuel. It could, of course, sell them and buy jet fuel on the open market, but that’s not what Delta has chosen to do:

Delta said it had also struck a three-year agreement with BP to supply crude oil to the refinery. As part of the deal, the details of which were not released, Delta said it would exchange gasoline, diesel and other petroleum products produced at the refinery for jet fuel from other sources like BP and Phillips 66. Combined with the jet fuel produced at Trainer, Delta said these deals would provide 80 percent of its fuel needs in the United States.

Delta has decided that it makes more sense for it to buy a refinery and sell fuel to itself at less than the market price than it does for it to buy a refinery and sell fuel to other people for the market price, pocketing the returns. Similarly, if the above description is accurate, then BP has also decided that it makes more sense for it to swap jet fuel for other products at less than the relative price it could receive from making that swap on the open market.

This is, it would seem, to be exactly the sort of behavior that people are worried that the Chinese government might engage in on a much larger scale. Two questions, then. First, is Delta making a fundamental mistake? (Many analysts think so.) Second, if it is in fact good for Delta, why wouldn’t it be good for China?

A dissenting view on Argentine resource nationalism

 I am often quite left-wing, especially when it comes to resource nationalism. That said, it is probably clear to anyone who reads this that I think the Argentine seizure of YPF is silly. Justice? No sir, you sold it fair and square ... and for a price much higher than YPF’s most ridiculous claim. Revenue? There is that $1.2 billion per year, and you can raise taxes if that is the problem, and anyway the government says the reason for the expropriation was to increase investment. Investment? Argentina has an export policy that makes development unprofitable, even at sky-high prices ... and the reason YPF paid such high dividends was because of the deal with the Eskenazis forced on them by President Kirchner. And then there is the threat of sanctions. (To be fair, the latter threat is a small one, given the European Union’s fetishization of legal authority, something that, say, would concern much less the United States or People’s Republic.)

In short, nationalizing YPF was a dumb idea.

But here is a counterargument from Mark Weisbrot. I like Mr. Weisbrot, but it seems to me that he has recently become a bit knee-jerk in his defense of Latin American heterodoxy. Still, he might be right, and since this blog has implicitly assumed that the nationalization was a silly idea, we should present the opposing view. And here is another.

What say you?

A question for the readership

 How can the fact that Repsol was on the border of selling its stake to Sinopec be reconciled with the fact that it was contractually obligated to buy back the Eskenazi’s stake at $38 per share?

Oligarcas argentinas

 Now Bloomberg Businessweek reports that Repsol is obligated to buy back the Eskenazi shares in the event that it loses control of YPF. I have not gotten direct confirmation of this, but the lawyers interviewed by Bloomberg do not believe that it will be enforceable in the event of expropriation.

It also seems that the Eskenazis borrowed a lot more for their YPF shares than the initial reports indicated. They owe $560 million on a loan put together by Credit Suisse, Goldman Sachs, BNP Paribas and Itaú – worse yet, according to the Financial Times, the balance is due next month. They also owe $700 million to a syndicate of Itaú, Credit Suisse, Citibank, Standard Bank and BNP Paribas.

It is not clear how Enrique Eskenazi gained control of the Petersen Group. The story, perhaps apocryphal, is that he met the owner in a psychiatrist’s office, which would be a very Argentine way of receiving an opportunity. He told an interviewer that he somehow got from that meeting to become “an adviser, then a director and finally ending up with the company.” In Santa Cruz province, he met Governor Néstor Kirchner, who helped Eskenazi take control of the Banco de Santa Cruz and steered construction contracts his way. “Then came what must have seemed a wily business deal to move into YPF without having to stump up the cash.”

We still do not know why they have fallen out with Cristina, but according to Lucio di Matto, she became angry at Sebastián Eskenazi’s “salary and purchase of a $5m helicopter at a time when YPF was paying hefty dividends instead of ploughing profits back into boosting production.”

It can’t really be that petty, can it?

Play it again, Cristina!

 What will happen? Well, Setty pointed out that we have seen this movie before. In general, I think he is correct ... with a wrinkle. 

1. Nationalization;
2. Giant compensation claims from Repsol ... say, I dunno, $10.5 billion;
3. Long loud wait;
4. Long drawn-out arbitration;
5. Payment from Argentina ... well after Cristina’s term ends in 2016!

There is, however, a wrinkle. That wrinkle is that Argentina is the first country to try to stick it to ICSID. They have just said no. That has, shall we say, annoyed other countries. Consider that the Obama Administration has imposed sanctions on Argentina ... the first time that an American president has used the 1974 authority. The diplomatic reaction from Spain ... and Britain, and the European Union, and Mexico and Chile and (OMG!) Bolivia ... has been ferocious. This is looking much more like 1968 or 1938 than it is like more recent expropriation events.

It might play out quicker than we expect. The big if is the European Union. If it uses its muscle, regardless of legality, then Argentina is going to hurt. If it does not, then the Setty calendar will play itself out.

Either way, it will be a show.

Observatorio argentino 15: CFK throws the Eskenazis under the bus

 In our last installment, there were some questions about how badly the YPF expropriation would hit the Eskenazi family, old allies of the President’s late husband. Federico suggested that there had been a falling out. I responded that it really depended upon the details of the loan contract.

When in doubt, go to the source! The SEC is a marvellous organization (write your Congressman and tell ‘em that it needs more money!) and the 20-F is a marvellous form. From Item 7 in the appendix:

Pursuant to the share purchase agreement entered into by Petersen Energía and Repsol YPF in 2008, Petersen Energía purchased 58,603,606 ADSs, representing 14.9% of our outstanding capital stock, from Repsol YPF for a total purchase price of U.S.$2,235 million, or U.S.$38.13758 per ADS. Petersen Energía’s purchase of our securities was financed by the drawdown of U.S.$1,026 million under a senior secured term loan facility provided by certain financial institutions, borrowing of U.S.$1,015 million under a seller credit agreement entered into with Repsol YPF and equity provided by Petersen Energía’s shareholders. The seller credit agreement matures on February 21, 2018. Principal payments are required to be made at certain periodic intervals commencing in 2013 until the maturity date. The loan under the seller credit agreement bears interest at 8.12% per year until May 15, 2013, and thereafter at 7.0% per year, and contains other customary terms and provisions.

Securities purchased by Petersen Energía are pledged as collateral under the senior secured term loan facility and the seller credit agreement. The seller credit agreement is subordinated to the senior secured term loan facility.

The same applies to the loans made in 2011 to finance further purchases. OK, the Eskenazis are on the hook if they cannot pay. What about the buyback clauses? Page 126:

Lock-Ups and Transfer Restrictions

Petersen Energía has agreed not to sell any shares of our capital stock for a period of five years, subject to certain exceptions, including the condition that Repsol YPF continues to hold at least 35% of our outstanding capital stock. In addition, if our dividend payments are insufficient for Petersen Energía to meet its obligations under the senior secured term loan facility, or if Petersen Energía repays the senior secured term loan facility in full, Petersen Energía may sell shares of our capital stock ...

Repsol YPF has agreed to hold at least 50.01% of our capital stock for a period of at least five years, unless Petersen Energía repays the senior secured term loan facility in full.

In other words, there is no buyback clause: the contract just lets the Eskenazis dump their stock if dividends fall low enough to make the loan no-longer self-financing.

The Eskenazis would have been much better off if the Argentine government had expropriated them along with Repsol. Federico is right! Something is rotten in the state of Argentina, it seems. I wonder what they did to get President Fernández so angry at them?

Observatorio argentino 14: clientelismo político

 It seems that Argentina will be nationalizing only Repsol’s stake in YPF. The Eskenazi family won’t be directly affected. This was not what I expected.

Some facts: the Petersen Group, owned by the Eskenazis, owes Repsol $1.9 billion which it borrowed to purchase its stake in YPF. It owes an additional $680 million to various banks. Early reports stated that the debt contracts had conditional buyback clauses that made me think the Argentine government would want to take them off the Eskanazi’s hands. Now it seems that the loans were collateralized by YPF shares. At $38 per share, the purchase price reported by the Financial Times, that comes to 50 million shares, or 12.7% of YPF.

Under the terms of the Eskenazi deal, YPF is supposed to pay dividends equal to 90% of net income. The government wants to stop those payments, of course: the point of the exercise is to increase reinvestment. In that case, the expectation is that YPF will default ... and according to Reuters, Repsol will get the shares.

I am surprised because it means that the Eskenazi family will still have to deal with the banks while holding shares that will only have an option value. I thought the government would have wanted to bail out the Eskenazis via expropriation. Right now, they stand to lose. They own 24.55% right now, or 96.6 million shares. A default on the Repsol loans will probably knock that down to 46.6 million shares. They spent (at $38 per share) $1,769 million to acquire them. They borrowed $680 million and put up $1,089 billion of their own money. Those shares are currently worth $907 million at $19.50 per share. $907 million − $680 million < $1,089 million = a dilemma for the Fernández administration.

It seems to me, based on the limited information so far, that the government has decided that its easier to let the Eskenazis unwind half their stake via default and make the rest up to them in some other way ... that will be cheaper than paying them for their stake.

The other possibilities are (a) the Eskenazis paid less than $38 per share for their non-Repsol-financed stake, but since the price of YPF never went below $34.49 in 2011, that seems unlikely; or (b) they borrowed more than $680 million to somebody against whom they can easily default. But absent those things, the Fernández administration will either need to make them whole ... or risk alienating a very wealthy family that has been a strong supporter.

Perhaps Cristina has decided to cash in those chips. That seems unwise, but sometimes in politics it makes sense to screw over your old friends. Somebody more plugged into Argentine politics should weigh in here. Anyone?

UPDATE: If ... and this is a big if ... courts find in favor of the Eskenazis, then there is a way that this could sort itself out in their favor. The Repsol loans included a buyback clause, as noted above. If YPF cuts its dividend, then the Eskenazis could, in theory, activate that clause. Repsol, obviously, won’t follow through. If a court then declares the contract null but lets the Eskenazis keep the shares, then the family would hold 96.6 million shares worth $1,883 million dollars. Even after subtracting the value of their bank debts, they would avoid losses on the deal.

That, however, is a big if. It depends on the country whose law governs the contract. If it’s Argentina, then I can imagine the above scenario. If it’s the United States or somewhere in Europe, then President Fernández will still have a dilemma.

Observatorio argentino 13: hechos sobre la expropriación petrolera

 I did not expect my prediction to come true so fast! The Argentine government moved to nationalize 51% of YPF today. You can find the text of the expropriation decree here.

What are the key points? First, the decree creates a National Hydrocarbons Council. The Council will have representatives from the both the national government and the provinces, directly. This is less important than it may sound.

Second, the national government will take 51% of the state share of YPF (51% × 51% = 26% of total equity); the other 49% will be distributed among the provinces that currently produce oil and gas. This is also less important than it may sound.

Third, for the time being the federal goverment will run the show. (See Article 9.) In fact, it will run the show for 50 years. Ah.

Fourth, there will be no reprivatization without a 2/3rd vote of Congress. (Article 10.) Do not bet on the Argentine courts holding that constitutional. Future Argentine governments and congresses will do what they will do.

Fifth, compensation will be decided according to Article 10 of the National Expropriation Act, aka Act Nº 24,199. “Compensation will only consist of the property’s objective value and any damages that are a direct and immediate consequence of expropriation.” The National Appraisal Council makes the decision according to a set of published norms, which you can find here and (in more detail, and in English!) here. Key quote:

“In case of appraisals for expropriation, it will be appropriate to determine the property objective value, understood — according to the Act Nº 21,499 — as the sum of money which permits the party subject to expropriation to get compensation for the value of the affected property and for the damages which are a direct consequence of the expropriation, in equivalent conditions to those which were previous to the expropriation, without taking into account personal circumstances, emotional values, hypothetical profits or the greater value which the works to be carried out may confer. Therefore, the objective value can square with the market value when it may be determined or with the depreciated replacement cost (CRD) instead.”

It is easier to parse if you redact it, but I want to post the full text. The upshot is that the law says market value is the correct value. Market value, to answer Bernard’s second question, is “The net amount which reasonably could receive a seller for the sale of a property on the date of valuation.” Given that the book value of YPF’s fixed investment is $9.8 billion, and its total assets are worth $13.7 billion, it seems unlikely that the Argentine government will try to use replacement costs for a company that had a market value of only $8.6 billion on the eve of the decree. That said, it is conceivable that the Argentine government will argue that the company is worth only $4.6 billion, which is the book value of shareholders’ equity.

Under the Spain-Argentina BIT, the compensation standard is simply “adequate.” If the dispute goes to arbitration, it is very unlikely that the panel will use net worth as a standard, rather than market value as either an NPV calculation or, uh, actual market value.

The thing is, arbitration is sloooooow. Article 10 of the Investment Treaty gives the two governments six months to hash things out if Repsol asks for it. Then Repsol has to go through local courts for 18 more months. At that point an arbitration panel can be convened (either under ICSID or Unictral), but there is a three-more-month cooling off period. In other words, unless Argentina makes Repsol an offer it can accept, decisions won’t even start to be made until July 2014. Right in time for the World Cup!

My money is still on a settlement that give YPF shareholders at least the Friday, April 13, value of the company. (Yes, its value on Friday the Thirteenth.) Argentina has the money, and even if Spain isn’t about to park one of its aircraft carriers off the coast (that’s Britain’s job! Although some Argentines are mocking the “English” for lacking a carrier to send) it does have points of leverage. Plus, Argentina needs foreign investment, and lots of it. It is in everyone’s interest to settle.

My next post will go back to the cases that Argentina is currently fighting in ICSID. In those cases, justice is on Argentina’s side. Here, though, not so much ... not that it matters.

La madre patria contra la Argentina

 War in the River Plate! Spain attacks Argentina!

OK, not really. But Spain and Argentina are really going into it over threats that the latter might nationalize Repsol’s oil holdings. In fact, things are so bad that the Spanish foreign minister needed to specify that his country’s position “is not bellicose.” But the minister also said, “Whatever attack on Repsol that violates the prinicipal of legal security will be taken as an attack on Spain.” 

Minister José García-Margallo then added, “[Spain] will take the measures that it considers appropriate and ask for the support it considers necessary from its partners and allies.” The deputy prime minister, Soraya Sáenz, upped the ante. “Spain will defend its interests with all means available.” Now the prime minister himself has threatened a boycott of Argentine soya and beef. The European Union has announced its support for the Spanish government.

The threats may have worked. President Fernández of Argentina had been expected to announce the nationalization on Thursday, but instead limited herself to an anodyne statement that she was “ready to pay all the prices that must be paid” to keep the economy growing. Se then added some words about the triumph of Argentine-made chocolate. YPF shares soared. Repsol shares, not so much.

So what is going on? Putatively, President Fernández wants YPF to invest more. YPF is reluctant, because of Argentine price controls and export restraints. In 2011, YPF’s net income was $1.23 billion, down from $1.46 billion in 2010. So the fight is over $1.2 billion per year. The move has populist appeal.

Can Argentina get away with expropriation? I suspect that most of the talk about trade boycotts is bluster. Perhaps Spanish law allows for unilateral boycotts, but it would create a mess. Spain and Argentina signed a bilateral investment treaty in 1991. It calls for arbitration; sanctions without following the process laid out by the treaty would be illegal unless Argentina categorically states that will not pay compensation ever. Moreover, Spanish consumers do buy 31% of Argentina’s primary product exports to the European Union, but without an E.U. boycott the Spanish government cannot do anything without kissing the single market goodbye. If sanctions are going to be imposed, it won’t be quickly.

Spain’s problem is that ICSID won’t be that directly effective, since Buenos Aires wants the company to increase production aimed at the domestic market. Unless YPF exports its production, enforcement efforts will be even slower than the already slow arbitration process. (The Argentina-Spain BIT slows things even more, since it requires some attempt at local remedies before going to arbitration.) Thus, I suspect, the blizzard of diplomatic threats.

On the other hand, there are some threats that Madrid can credibly make. It can push Argentina to pay its debts to other governments. It can add its voice to the U.S. against Argentina in multilateral lending organizations. It can threaten to support the U.K. in the Falklands. And it can try to eject Argentina from the G20. These are the threats that probably made President Fernández think twice.

Economically, expropriation does not make a whole lot of sense. Argentine needs $250 billion or more to develop the shale fields: tying yourself up in legal knots and wrecking your reputation for $1.2 billion a year is not worth it. Moreover, YPF is currently worth only $8.6 billion. It seems like a big risk to take for the $4.3 billion it would take to get control of the enterprise. In fact, Argentina could get control for even less by sticking to its plan to expropriate the 25.46% of the company owned by the Eskenazi family, which is Argentine. Since the Eskenazis borrowed heavily to finance their stake (at the request of the Argentine government), an expropriation for them would be a bailout ... and cost little of nothing. Of course, Argentina would also assume the Eskenazi’s debts, but half of those are owed to ... Repsol. (Default!) Argentina would still need to get the additional 24.55% needed to gain control of the enterprise, but that would cost only $2.1 billion. The central bank has $47.3 billion in reserves, and there are very few institutional barriers keeping the government away from that money.

It is not as simple as that, of course. The government would need to do some leaning on the Eskenazi family, in order to get them to refrain from exercising their repurchase agreement with Repsol. (Basically, if Repsol looses control of YPF, it has to buy the Eskenazi’s stake at $38 per share ... implying a market cap for the company of $14.9 billion.) The current share price is depressed.

What will happen? Argentina is going to nationalize: it makes political sense. The nationalization will be with enought compensation to keep Spain from going to the mattresses with sanctions. (Or going to war! Not. And not.) It might even be enough to keep Repsol out of court. Considering how Argentine provinces have been yanking concessions, Repsol will likely prefer to settle.

Caveat? President Obama met with President Fernández today. We do not know what was said, although they said that nothing was said. That may have settled things, although I would still bet on expropriation with negotiated compensation. (Yes, I just bought some YPF stock.)

The market for stolen oil

 “In a reversal of the classic Western movie, Mexican criminals have sought refuge with their ill-gotten gains by crossing the Rio Grande to the North, where the Mexican government has no authority to follow.”

—Pemex, in a suit before the U.S. District Court for the Southern District of Texas

So, stolen oil from Pemex makes its way to the United States. How, you ask? It’s a reasonable question. Oil has a high value-to-weight ratio, but cocaine it isn’t. You can’t smuggle economically-viable quantities in jerrycans. Plus, if you’re moving crude oil or natural gas condensate, you can’t then flog it on a streetcorner. You need to sell it to a refinery.

The answer: give the refineries plausible deniability. Fake paperwork to get it over the border, then sell it to a reputable middleman. How did this work?

On May 29, 2011, we got the answer, when Pemex filed a federal lawsuit in the southern district of Texas against a group of American refineries for knowingly buying stolen natural gas condensate.

Here’s the value chain. The condensate is produced in Mexico’s Burgos gas field, located near the U.S. border across the northern stretch of Tamaulipas, Nuevo León, and a little bit of Coahuila. Pemex produces gas from 2,827 wells in the field. It then pumps the gas to 150 collection stations. Pipelines then transport the gas and condensate (the liquid byproduct from gas production, which can be used in oil refineries) from these 150 collection stations to 52 transfer and delivery systems, which are basically small pipeline networks. After collection at the transfer systems, Pemex transports the condensate by pipeline or tanker truck to a storage facility near Reynosa, Tamaulipas. From there, the condensate goes by pipeline to the Burgos gas processing center or tanker truck to a refinery in Cadereyta, Nuevo León.

The Zetas intercept the oil in one of three ways. The major one is to simply tap into the transfer and delivery systems. (To do this, the Zetas needed to build their own pipelines, a pretty impressive accomplishment.) The secondary one is to hold-up the tanker trucks on their way to Reynosa. The final one is to kidnap Pemex officials and force them to divert condensate.

Now, the Zetas can easily fence refined products inside Mexico, but they can’t sell condensate: Pemex operates the only refineries! So they have to move it to the U.S. According to the lawsuit, the stolen condensate was moved by tanker truck (think about that for a moment) to the border. Before crossing, however, the Zetas transferred the stuff to newer trucks that meet U.S. regulations. The drivers then presented forged export documents, sometimes mischaracterizing the condensate as naphtha. They would then sell the stuff to the U.S. defendants.

Big Star and F&M Transportation bought the oil from Ygriega Energy Corporation of Edinburg, Texas, whose owner, Arnaldo Maldonado, has already pled guilty to felony conspiracy to receive and sell stolen goods. F&M transported the condensate, in addition to buying it. Superior Crude also transported stolen condensate, and brokered sales of the stuff. (Pemex fingered Superior because a man named Donald Schroeder coordinated the shipments ... who has also pleaded guilty to felony conspiracy to receive and sell stolen property, specifically Mexican condensate, in his role as president of a company called Trammo Petroleum.) Finally, TransMontaigne operated the storage facilities in Brownsville which the stolen condensate passed through on its way to the final buyers. Finally, Western Refining bought condensate from companies like Continental Fuels, whose president confessed to trafficking in stolen goods.

In other words, according to Pemex, Big Star, Superior Crude and F&M “actively and knowingly participated in a conspiracy to import and market the stolen condensate in the United States.” TransMontaigne, meanwhile, stands accused of negligent participation, since Pemex claims that they should have realized that the goods passing through their hands were illegitimate. Western Refining is accused of no wrongdoing, but Pemex says that it is liable for all its transactions involving Mexican condensate. Recently the company has moved to add subsidiaries of ConocoPhillips and Shell to the lawsuit.

Now here’s the good news: on the U.S. side of the border, several people are going to jail and the rest of the companies involved in buying the stuff are facing a serious civil suit. In short, it is likely that the United States legal system will soon enough shut down the export of stolen Mexican crude and condensate.

But there’s also bad news: there is money to made in stealing refined products and selling them inside Mexico. Lots of money. In fact, as Patrick Corcoran has pointed out, the fact that pipeline-siphoning is shifting to Sinaloa (where the lines carry refined products) is a sign that other groups besides the Zetas are getting into the act. (In this case, likely El Chapo’s people.) The U.S. government can and will help. But it can’t change the fact that Mexico is now a lucrative market for its own petroleum production. Keeping organized crime from taking more of that market is something that Mexico will have to solve on its own.

David Shields got the solution to the problem of internal oil theft right when he wrote:

“It’s very easy to solve this. Total control over the tanker trucks. Total control over every liter of gasoline from the refinery to the gasoline station. That’s the way it was 15 years ago. You move the army in and take control over all the distributors by making sure they have a contract for every single movement of gasoline around the country.”

Where I would disagree with Mr. Shields is that the solution he proposes is far from easy.

Organized crime and oil in Mexico, some numbers

 Organized crime in Mexico is spreading beyond drugs. The cartels have a comparative advantage in transporting and smuggling high-value illicit product. So why not oil? Organized crime can threaten employees, knock over trucks, defend pipeline siphons, and move stolen goods across borders. Pemex is a hard organization to shake down, but a much easier one to steal from.

It turns out to be hard to get an idea of the scale of oil theft. According to Patrick Corcoran, Pemex lost about 3 million barrels of hydrocarbons last year, up 52 percent on 2011. This caused losses of roughly $500 million to the company. That number is large. It is not large relative to Pemex revenues north of $100 billion, but it is large relative to the estimated revenues earned by Mexican Organized Crime Organizations (yes, MOCOs), which is in the $7 billion per year range according to the Rand Corporation.

It is also quite possibly an underestimate. The Excelsior article that broke the story is vague on whether the figures are through Novemeber or from November. If the latter, then total losses could range as high as $3½ billion. Those numbers are possible. Last year the Wall Street Journal, citing Pemex’s CEO, estimated that criminal gangs stood to earn $750 million from oil thefts in 2011. Reuters reported $600 million in losses for the first half of 2011. David Shields estimated (although I am not sure on what basis) losses between $2 billion and $4 billion.

So what do we know? Page 172 of Pemex’s 2009 SEC filing estimated losses of 5.0 million barrels in 2008 and 3.1 million barrels in 2009. The breakdown between refined products and crude was not given. In its 2010 form 20-F, (on page 173 of a report filed in 2011) Pemex gave a little more detail. It estimated losses of 0.9 million barrels of diesel and gasoline in 2009, 1.4 million in 2010, and 1.4 million between January and May of 2011. It also reported losses of crude and condensates of 1.4 million barrels in 2009, 2.3 million barrels in 2010, and 2.0 million barrels between January and May of 2011. (For comparison, the amounts lost in Jan-May 2010 came to 0.3 million and 0.6 million respectively, so the increases are larger than they might seem.)

Using numbers on pages 4 and 5 of Pemex’s 2011 statistical yearbook, it is possible to calculate the gap between Mexico’s domestic supply (production + imports − exports) of refined products and its domestic sales of refined products. (Before 2006 the definitions were different, effectively overstating exports: for that reason, sales were consistently larger than supply.) The excess of supply over sales rose from 4.4 million barrels in 2007 to 9.5 in 2008, 10.6 in 2009, and 31.8 million in 2010. I would assume that most of that is stockpiling, non-theft losses, or refined products used as inputs in petrochemical production, but the trend is ominous.

Again, however, it should be emphasized that the reported losses are not large relative to Pemex production. In 2010, the  company produced 516 million barrels of refined products and 1.1 billion barrels of crude and condensate. That would make theft equal to about 0.3% of domestic production of refined products and 0.2% of crude and condensates. The scary thing is the trend, not the level.

What can be done? As Patrick Corcoran points out, a lot of the stolen oil is destined for the United States. And that raises a possibility for the next post, which involves some of the most entertaining legal documents that I have ever had the pleasure to read.

Is Venezuelan heavy oil less risky than French nuclear power?

 So I’ve been looking through the ICC decision against Venezuela. A few things are different from my back-of-the-envelop analysis. As I expected, they did not consider the change in royalty rates to be a taking. On the other hand, they did decide that ExxonMobil deserved compensation for the income tax hike. The panel included only lifting costs of $3.84 per barrel, not including depreciation. (I’m still trying to work out why they did not include upgrading costs.) These things, of course, raise the value of the project.

So what drove the value of compensation back down? The answer is that the tribunal selected a discount rate of 18%. How did they arrive at that number? First, they received expert testimony (provided by the Venezuelan side) that the “hypothetical return that could be gained if a willing buyer were found for the project prior to any events giving rise to the indemnity” would be 19.8% This was backed up by a report from Gaffney, Cline & Associates stating that an 18% return would be reasonable. Finally, the tribunal noted that the average long-term historical return for ExxonMobil shareholders was 18.4%, while the shareholders of the five larges companies earned 17.1%. (Page 428 of the decision. It’s a long decision.)

Is that a reasonable number? Well, EDF builds nuclear power plants in France. When the cost estimate for the Flamanville plant rose from €3.3 billion to €4.0 billion, EDF announced that the cost of electricity from the plant would rise from €46 per megawatt-hour to €54. From those numbers (plus data on the typical capacity utilization rate of a nuclear reactor in France) it is pretty easy to calculate the company’s cost of capital:

 

(This estimate is actually a bit low, since Flamanville is on the sea, and will therefore probably have a higher capacity utilization rate than the average for the French reactor fleet.)

It seems to me that if a French state-owned company uses 13% to evaluate big energy projects in France, then 18% is a reasonable rate to apply to an American private company evaluating a big energy project in Venezuela.

The ongoing ICSID arbitration is not bound by the ICC decision, of course. But the fact that the ICC included the income tax in its decision makes it less likely that ICSID will decide to give ExxonMobil more money. Unless they decide that the royalty changes were a taking, which I still very much doubt, the fight will all come down to the discount rate.

I should add here that it seems that Exxon spent $24.9 million to pursue the arbitration. (Page 459.) I am sure that it’s spending at least as much at ICSID. This stuff ain’t cheap, but I do think it beats calling in the gunboats or the CIA.

How energy independence could undo globalization

 North America is on the verge of finally achieving the much-vaunted goal of energy independence. In fact, the continent has already achieved that for everything save petroleum, but now the latter is in sight. A combination of increased oil sand production in Canada, shale oil discoveries in the United States, and tightened CAFE standards have certainly made it plausible to believe that North American net energy imports will drop to zero by 2020, if not sooner. In fact, it is possible to imagine a situation where the United States alone achieves energy independence by that date.

But does it matter? Assuming no political reaction, no, it probably doesn’t. North America will still be vulnerable to supply shocks from the rest of the world. If the demand for petroleum rises elsewhere, then domestic prices will rise in line. That said, infrastructural bottlenecks can produce lasting price differentials — it doesn’t matter how much demand rises elsewhere if you can’t ship the stuff to those places — but if North American oil production rises enough, then one can assume infrastructure will be repurposed or built.

Wait ... can no political reaction really be assumed? Consider Argentina. The Argentine government imposes high export taxes on oil. Those taxes partially insulate Argentines from price increases elsewhere. High retail taxes keep consumer prices up, but that is a good thing: policy does not subsidize consumption, but the government captures rents that would have otherwise gone to producers. (The retail gasoline tax runs at 70% of value, with a floor of 53.75 centavos per liter, or 46.9¢ U.S. per gallon. The 21% VAT and 2% provincial tax is then imposed on top.)

Now, the U.S. constitution forbids export taxes. But it does not forbid blocks on export infrastructure. And that is just what you are already seeing in the natural gas space! Last month, the Energy Information Administration reported that LNG exports could raise U.S. prices as much as 54%. Representative Ed Markey (D-Massachusetts) immediately responded: he demanded that the federal government should refuse to certify export projects “before all impacts on American families and businesses are considered,” and stated that he will introduce legislation “that would keep more American-made natural gas in America.”

The same pressures apply to oil, although it will be harder (but not impossible) to stop oil export projects. And while the constitution is crystal clear on export taxes, “No tax or duty shall be laid on articles exported from any state,” it is unclear as to whether the export of a product could simply be banned altogether, under either the necessary and proper clause or as a national security measure.

If the growth of world oil supplies fails to outpace demand, then the result is not likely to be smoothly escalating prices. Rather, the result is going to be ever-increasing volatility in the oil market. Small shocks in either direction will lead to huge price swings. In that environment, export bans would be clearly attractive to consumers ... and some producers might also welcome the market stability that they would bring.

In which case we are back to the pre-1970 world. And let me be clear: I do not think that would be a bad thing. The Persian Gulf would lose its economic significance (at least for North America) even if it continued to grow wealthy from the black gold. The U.S. economy would be insulated from price shocks elsewhere. If imports shrank to a small level (and net imports disappeared) might even be able to get a winning coalition around imposing import duties on oil, which would have all sorts of good effects if the U.S. then again lost self-sufficiency.

If that happens, then the economics and geopolitics of oil will be transformed. The analogy of a big world pool of oil, into which production is poured and out of which consumption is sucked, will no longer hold. A lot of the old-fashioned verities about control of supply will start again to make sense. There is a risk, of course, that as nice as it would be for the United States to insulate itself from foreign shocks, the result might be increased instability and resource conflicts in the rest of the world.

Finally, there is an implication for Canada-U.S. relations: the United States has a vested interest in preventing Canada from building more pipelines to the West Coast. Inasmuch as North American self-sufficiency applies to North America and not just the United States, then the U.S. will only be able to insulate itself from swings in the world oil market if Canada has no other place to send its oil, at least not at a reasonable price and in large quantities. (Oil can be shipped by railroad, but there are bottlenecks, since the number of tanker cars is limited.) Of course, should oil prices become sufficiently volatile, it is possible that Canadian producers would approve of export restraints, in return for steadier prices. But it is just as likely that they will ignore American entreaties and send their oil where it will fetch the highest price. Unless, of course, they can’t.

In short, energy independence does matter, but only in conjunction with political steps that amount to the end of an integrated world market in crude oil.

Argentina beats a dead cow, and finds oil

 Argentina has oil! Lots of oil. The problem is politics. More specifically, high export taxes that effectively cap the price of oil for producers.

In November, Repsol YPF found a billion barrels at Loma La Lata. (That’s “Tin Can Hill” in English, which I really like.) Loma La Lata is in the Vaca Muerta region (yes, Tin Can Hill is in Dead Cow) which has seen previous shale oil discoveries. In December, it made another discovery.

How fast can the oil be pumped out of the ground? Shale oil (also called “tight oil”) is produced by hydraulic fracking, where you drill a vertical well, turn it horizontal through the shale, blast explosives into the rock, and then pump pressurized fluid in to break it up further and liberate the hydrocarbons.

Shale oil wells have hyperbolic decline rates. A typical well might initially produce 900 barrels per day, declining to 200 by the end of the first year, and well under 100 by five years. Wells are generally spaced at 160 acres. So, back of the envelop: YPF is prospecting 428 square kilometers, or 661 160-acre blocks, which at an average daily production (over five years) of 260 bpd translates to about 170,000 barrels per day. Multiply that by two (for the second field) and you have just increased Argentina’s production from around 800,000 bpd to 1.14 million! Actual exploratory wells in the Vaca Muerta have started at 500 bpd, which would still leave you with 990,000 bpd after just these two discoveries.

Existing production will decline, but Argentina is lucky in the sense that it can adopt technologies from elsewhere: oilfield surveillance is two decades behind the U.S. Better oilfield surveillance means better use of secondary recovery techniques. As far as those techniques go, YPF is a world leader. Combine new surveillance technology with YPF’s existing expertise, and there is a good chance that existing fields will continue to produce for some time. In 2010, YPF managed to replace all of its reserves entirely through secondary recovery.

(In terms of gas, the picture is even brighter: Argentina looks to have the second-largest shale gas reserves on the planet, after the United States. But that is for another post.)

The production tax regime is fairly light, as these things go. The provinces charge a 12% royalty, plus a 2% revenue tax on upstream companies. The feds then charge a 35% income tax. Taxes have to be relatively light, because production is expensive! Operating costs in shale plays in Texas are around $8 per barrel; in Argentina they are likely to be around $10. Capital costs are even higher: wells cost about $12 million in Argentina. Total costs, then, could range as high as $56 per barrel. Now that is a worst case scenario: a more-likely number is $27 and it could be as low as $19 ... but the high number is not outside the realm of possibility. Certainly marginal costs will go that high once production ramps up.

And therein lies the rub. Argentina controls oil prices. Well, no, it doesn’t quite control them; it only does that for gas. (And that is why shale gas development is not going to go very fast.) But it has very high export taxes which effectively cap the price of oil at $42 per barrel ... which is a bit of a problem for high-cost shale plays. 

The system actually works as follows: when the international price goes above $42, the export tax kicks in at $18.90 per barrel. When the international price hits $60.90 ($42 + $18.90), the tax effectively becomes 100% of all revenues above $42. Argentine firms have managed to get around that by selling at higher domestic prices: in 2011, some companies realized crude sales as high as $60 per barrel, with an average around $55. (See page 14.)

This is going to be a mess to change. Shale oil could get a special rate, of course. (In practice, that would probably be a rebate of some sort.) Domestic oil prices could be allowed to rise. (Probably not a terrible idea, although who knows? Maybe there are giant increasing returns to oil consumption in the agricultural sector.) Export taxes could be lowered in general. (Which also, of course, means allowing domestic prices to rise ... and would deprive the government of much-needed revenue.) But it is still going to be a mess. No American has any business these days criticizing foreign democracies for having sclerotic political institutions, but President Fernández has a tricky political situation at home. I would not be that optimistic.

And then, of course, there are the Mapuche. As Setty has pointed out, early statements from the industry do not bode well.

I wish Argentina luck. But I think it might take a little longer than the analysts believe.

Old evil vendepatria PDVSA saves new socialist PDVSA!

 On the turn of the New Year, the International Chamber of Commerce (ICC) awarded ExxonMobil $907.6 million in its dispute with PDVSA over the Venezuelan government’s nationalization of its interest in the Cerro Negro project in the Orinoco oil belt. The press has been pretty quick to call it a victory for PDVSA, considering that the company initially claimed that its investment was worth $12 billion. Exxon, they say, received only book value for its investment, and Chávez has run away with the store.

Is that true? My job here is to argue that it’s not. Exxon received from PDVSA what it was contractually entitled to get. The standard used by the ICC was the market value of the assets, not book value. The assumptions used to calculate that market value, however — chief among them estimates of the expected future price of oil — were limited by a clause in ExxonMobil’s 1998 association contract that effectively put a ceiling on the value of the company’s investment.

In the words of Steven Bodzin: “So for all the rhetoric about how the Old PDVSA sold out the patria etc. etc., the only reason the New PDVSA was able to do so well in arbitration was because of clever bargaining by the Old PDVSA?”

I’m going to briefly walk through the Orinoco value chain. Then I’ll briefly describe some key features of the Cerro Negro contract. Finally, we’ll run some numbers.

Let’s start with Cerro Negro. The project is in the Orinoco oil belt — but keep in mind that until 1956 it was actually called the Orinoco tar belt. (The “faja bituminosa del Orinoco.”) The crude oil there is “extra heavy,” meaning that its specific gravity exceeds that of water. At room temperature, the stuff is gunky and practically solid. Put it into a beaker and turn it upside down; the oil will stick.

That creates a bit of problem in terms of transporting the stuff. There are three solutions. The first is to heat it up and sent it out in special ships. That’s expensive and really only done for oil intended to be made into asphalt. The second is to mix the extra-heavy gunk with lighter crudes and export it. Venezuela’s “Merey” blend is a mix of 61.8% gunk and 38.2% lighter “Mesa” crude. (That’s nice, because it means you can calculate a market price for the gunk.) The third is to build an “upgrader,” where you partially refine the gunk, mix it with a diluent and then export the resulting “synthetic crude.”

The Cerro Negro project covers 115 square miles and includes an upgrader. Its costs, therefore, are not low. The cost to get the extra-heavy crude out the ground isn’t that high. Wikileaks documents indicate that it is around $4 per barrel, but it isn’t as though that number is top secret: Bernard Mommer, formerly the People’s Vice-Minister for Hydrocarbons and currently the Bolivarian Republic’s representative on OPEC’s Board of Governors, estimated them at $3.60. Upgrading costs, on the other hand, are significantly more expensive: Mommer reported them to be $9 per barrel. That comes to a total production cost of $12.60 per barrel of syncrude.

Production costs aren’t the only costs, of course. In 2002, the Bolivarian Republic hiked royalties from 1% to 17%. In 2006, it hiked them again, this time to 33%. That same year, it raised the income tax rate from 34% to 50%. Taxes and royalties, therefore, are very substantial.

When Hugo Chávez converted the Cerro Negro oil extraction project into a majority-PDVSA joint venture in May 2007, ExxonMobil rejected Venezuela’s (undisclosed) compensation offer and went to arbitration. It went to arbitration in two forums: the ICC and ICSID. The ICC arbitration was based on ExxonMobil’s association agreement, which established the Cerro Negro venture between ExxonMobil (41.67%), PDVSA (41.67%), and BP (16.66%). Article 15, “Consequences of Certain Governmental Actions,” stated that Exxon could take PDVSA to arbitration if PDVSA refused to “restore the economic benefit that the foreign party would have received had the discriminatory action(s) not occurred.”

What were the lost economic benefits? Well, at the prevailing oil price for Venezuelan blends in 2007 (and assuming a 9% nominal discount rate and 2% inflation) Exxon would have earned an average of $325 million per year (nominal), with a net present value of $3.0 billion. That’s a lot more than $907.6 million! So was Exxon robbed?

Well, no. The first (and minor) point is that in 2007 it was far from clear that high oil prices were going to last. When ExxonMobil signed the contract in the late 1990s, Venezuelan oil was bouncing around $16 per barrel. So it is possible that Venezuelan lawyers might have persuaded the arbitration panel to use a lower oil price, under the assumption that prices might have crashed. If that had been the case, I would unhesitatingly call the $907 million result a victory for the Revolution.

The nice thing, however, is that we don’t need to resort to hair-splitting. Article 15 of the association agreement tells us the price the arbiters had to use:

… after the first period of six consecutive months during which the price of Brent crude oil is in excess of the threshold price [$27 in inflation-adjusted 1996 dollars], Lagoven CN [PDSVA’s subsidiary in the Cerro Negro venture] will not be required to compensate any foreign party for any discriminatory action(s) with respect to any fiscal year in which the average price of Brent crude oil is in excess of the threshold price, and such foreign party received net cash flow commensurate, after taking into account the effect of the discriminatory action(s), with a reference price for the production produced by the parties that bears at least a reasonable relationship, adjusted for quality and transportation differences, to the threshold cash flow for such fiscal year.

Translation: the highest possible oil price that can be used to value damages in the event of expropriation is $27 per barrel in 1996 dollars, or $37.50 in 2007 dollars. Moreover, that’s the highest price — Venezuela, after all, doesn’t sell Brent but rather lower-priced blends. That price can be marked down to adjust “for quality and transportation differences.” E.g., the arbiters can pick a lower one.

Ah hah! Brilliant! When Brent traded at $37.50, Mesa crude traded at around $32. At $32 per barrel (adjusted for 2% inflation), Exxon would have expected to earn an average of $95 million per year through 2035. At a nominal discount rate of 9%, that would value ExxonMobil’s investment at $865.8 million. It only takes a little tweaking of the discount rate or oil price to get us to the figure that the ICC finally came up with. 

What does this imply for the results of the upcoming ICSID arbitration? Damned if I know. That arbitration is against the Bolivarian Republic, not PDVSA. So Article 15 doesn’t apply. Rather, the relevant document is the bilateral investment treaty that defines what the Venezuelan government can and cannot do. Moreover, it is possible that ExxonMobil will be able to argue not only that the 2007 expropriation was illegal, but that the big royalty and tax hikes the year before were also illegal under the Netherlands-Venezuela bilateral investment treaty. My gut feeling is that Venezuela is going to win, but I’m not sure why exactly I suspect that will be the case.

To sum up, then, this case was not a victory for the Bolivarian Republic. Rather, it was a victory for the PDVSA negotiators who wrote Article 15 of the association agreement back when the plain old Republic of Venezuela invited foreign companies in to develop the Orinoco oil belt. ExxonMobil got basically the maximum that it could have expected to get. So what was that initial $12 billion claim all about? Well, as Michele Bachmann would mispronounce, nothing but chutzpah.

Irony of ironies

 There are many things to be depressed about these days. The imminent collapse of the eurozone. The disasterous level of unemployment in the United States. The unstoppable spread of childhood obesity. The rise of the robots. (Artificial intelligence has been particularly depressing me lately.) And ... the declaration by Socialist Party of France that they will form an electoral pact with the Greens to shut down 24 reactors by 2025.

This is insane on any level. French electricity is quite inexpensive; shutting down depreciated reactors will destroy that. Nuclear power is, in fact, becoming competitive with other power sources. This is especially true in France, which would rely on expensive liquified natural gas. (I will post some numbers later, but for not note that investors hammered EDF stock at the news: they would not have done so had nuclear power from existing plants been more expensive than alternatives.) And let’s not talk about climate change: natural gas is better than coal, but still depends on setting something on fire to generate energy. I wish them luck with the whole wind and solar thing, but even Denmark has been unable to get wind above 20%, given its intermittancy, and solar suffers from the same problem.

It’s also a business problem for EDF. In the past, the company has worked hand-in-glove with Areva, the reactor company. EDF wants now to become more international, offering reactors and reactor operation to hedge against insanity at home. That is all well-and-good, but it could destroy the relationship with Areva.

Depressing, although I suspect this is something that the Socialists will walk away from once in office. Anyway, it gives me an excuse to post this awesomely ironic (given the current image of the Iranian nuclear program) advertisement from four decades ago:

Hat tip: William Wu.

Whose empire is this, anyway?

 A little while back, I argued that information that China may have received oil from Venezuela for $5 a barrel does not represent growing Chinese influence in Latin America, but rather lousy negotiating tactics on the part of PDVSA officials. Lifted from comments (with minor edits), Setty argues that the sales likely represent (if they even happened) corruption inside Venezuela:

I hope you’ve now seen the unredacted text of that embassy memo.

In it, you can see that the embassy itself had doubts about PDVSA board member Fadi Kabboul, its source for this $5 a barrel information. The embassy people’s experience with him was identical to mine. He offers meetings and information and never comes through. He revises history. We don’t know anything about his motives.

Hence, I am loath to trust him on that $5 a barrel figure. Especially since there is evidence contradicting the $5 a barrel figure — it’s pretty clear from the contracts that China was supposed to pay more than that.

It is possible that PDVSA received only $5 a barrel for some shipments. But if that happened, I would bet that the gap between market price and $5 a barrel ended up in someone’s pocket. I think it’s a very long stretch to say that this price shows China has an imperial subject in South America.

Indeed, the most telling item in that memo is the hearsay about George Kabboul. George was at the time head of the shipping department of Venezuela’s state oil company. Previously, he headed its food division, an agency called PDVAL. A 2009 U.S. federal lawsuit named him as having demanded a $2 million bribe to let a ship land and deliver perishable food. Around the same time, pro-Chavez Venezuelans also denounced him for corruption. I don’t have independent information about him, and he isn’t here to defend himself, so please take all this with a grain of salt.

Which is why it’s amusing to read that when the U.S. invited him to come and chat with their information-gathering team, he was worried that he might be “in trouble.” Would any Venezuelan worry that the Chinese embassy had called him in because he was “in trouble”?

Whose empire is this, anyway?

I love that last line! Same as it ever was, perhaps.

Perhaps the strangest thing about the Bolivarian Revolution is how it has mishandled PDVSA, which is, after all, the ultimate source of the regime’s resources. Above is a time series of our best estimates of Venezuelan crude production. New estimates from the International Energy Agency show that the country’s oil production has recovered from the 2002 strike ... but even so, the company has done little other than tread water. To be fair, the company’s 2001 goal of increasing oil production to 5.5 million barrels per day (bpd) by 2006 never looked particularly realistic, at least not in that time frame, but it should be doing much better than it is.

There is, of course, a debate about exactly how much PDVSA produces, and how big its decline has been. A good overview of the state of the debate can be found here. Everything, however, points in the direction of decline: the question is about how much.

In fact, there is indirect evidence from the company that it is in trouble. PDVSA recently cut its 2015 production goal from 4.46 million bpd to 4.0 million. The company regularly abandons its production targets. As Setty said on his blog: we may as well autoprogram the headline “PDVSA cuts production goals” to reappear around this time every year.

In short, China has no influence in Venezuela, the U.S. does, and PDVSA is a wreck all on its own.

Pay no attention to the FBI cloud; solar has a sunny future

 The FBI just raided Solyndra, the bankrupt solar-cell company. What’s that about, and what does the bankruptcy and raid say about the future of solar power?

The answer: not very much, and not very much. The FBI is probing the company because it went bankrupt. Why, you ask? Well, Solyndra received a pledge of $535 million in loans from federal government. (The contract can be found here.) The company actually took out $527.8 million from the feds, and an additional $256 million from private creditors, including a $69.3 million loan from Argonaut Capital that had a higher priority than the federal loans. (See here for the details. The bankruptcy filing itself is here.) I should note here that Solyndra received its loan under a long-standing program that far predated the Recovery Act.) On paper the company has more than enough assets to make creditors whole; in reality, most of that consists of specialized capital goods designed to make cylindrical rooftop arrays. Since there isn’t a big market for cylindrical rooftop array-making machinery, the stuff is going to sell at a hefty discount.

Why did it go bankrupt? Well, solar modules have fallen 70% in price over the last few years. Solyndra targeted a cost of $2 per watt ... when prices already hit $1.50. That’s great for the industry (it’s even good for the American industry) but not-so-great for Solyndra’s risky gamble on cylindrical modules. The company turned out to need some incremental capital, and when it went to the markets said capital was not available. Bankruptcy resulted.

Here is the company’s statement. Note the bullshit about “regulatory uncertainty.” Why is it bullshit? It’s complete egregious embarrassing bullshit because the same sentence blames excess capacity and FALLING PRICES on regulatory uncertainty. Real regulatory uncertainty holds back investment, thereby reducing capacity, which reduces supply, and drives up prices. Sometimes, CEOs can really embarrass themselves, but I suppose it is an attempt at dog-whistling that the company likes the GOP too.

The new GOP-controlled Congress then went on a fishing expedition to look for wrongdoing with which they could embarrass the Obama administration. (In this particular case, I don’t blame them at all. If I were a congressperson of either stripe, I’d also want to investigate.) The FBI has gotten involved because Congress has accused Solyndra’s CEO, Brian Harrison, of failing to mention the company’s precarious state when he went for the funding. In fact, Harrison told reporters in March 2011 that the company would need no new financing, but that isn’t actionable.

Since this blog likes predictions, we predict that nothing will come of the criminal charges. Loan guarantees have a long history, start-ups have a long history of going bankrupt, and entrepreneurs have a long record of starry-eyed optimism until the very end. (Or even beyond.) The biggest risk is that other ventures will shun federal loans or loan guarantees out of fear of politicized criminal probes: in fact, Solar Millenium has already turned down a $2.1 billion guarantee.

What does the Solyndra collapse say about the future of the solar power industry? Nothing! First, the U.S. is a massive net exporter of solar power systems. In 2010, we had a net surplus of $1.8 billion in the sector, up from $723 million in 2009. We even retained a $539 million surplus with China. Basically, what we lose on the modules we make on module-making machinery and, surprisingly, ancilliary equipment. (E.g., everything from switches to water tanks.) The sector is growing fast, and I hate to say it, but federal financing has helped, what with the private capital markets still broken.

Solar power does face three problems. First and foremost, the weather. (And the fact that the Earth, you know, rotates.) This limits its use, unless somebody cracks the cheap storage problem. Second, NIMBY. They drive me nuts. Maybe the Californians can be justified — my co-blogger makes a case in comments — but not the people in New Jersey. Finally, Chinese subsidies. So far we’re hanging on, and China’s costs are increasing. But wow, they subsidize a lot. 

 

In the presence of increasing returns, those subsidies could have long-term welfare impacts: good in China, bad in the United States. It’s something to think about, and something to which this blog will likely return.

But right now, solar is doing fine, and Solyndra is interesting only in-and-of itself. Move along, nothing to see here.

Afghanistan gets an oil industry, and China (for once!) gets a good deal

 Ten years ago, the United States went to war in Afghanistan as retaliation for the destruction of the World Trade Center in New York by terrorists linked to (and protected by) the Afghan government. Seven years ago, the United States went to war in Iraq for reasons that remain somewhat unclear, but which many think had something to do with oil. T. Boone Pickens went so far as to complain to Congress: “They’re opening them (oil fields) up to other companies all over the world ... We’re entitled to it. Heck, we even lost 5,000 of our people, 65,000 injured and a trillion, five hundred billion dollars. We leave there with the Chinese getting the oil!”

Pickens wasn’t really correct about Iraq, but he nailed it in ... Afghanistan. In 2004, the USGS published a report examining the resources of the Amu-Darya basin, most of which is in Turkmenistan and Uzbekistan, but part of which extends in Afghanistan’s northern provinces. In 2006, the USGS made a more detailed survey of the resources on the Afghan side of the border. They estimated that the Amu-Darya fields might hold as much as 141 million barrels of oil, which is not a lot ... but the nearby Afghan-Tajik fields likely held 1.4 billion barrels (and might hold as much as 3.6 billion) which is.

In 2009, the Afghan government decided to put the smaller Amu-Darya blocks out to bid. The winner of the bid would be the company that offered the most favorable production sharing agreement (PSA) to the Afghan government. The offer would have to include (a) an offer of a fixed royalty percentage on all production; (b) a specific additional percentage for known fields in the blocks; and (c) a second specific percentage for unknown fields discovered after the bid. As standard for most PSAs, the winner would get 100% of the revenue until they covered their exploration and development costs, including interest. The real reward, of course, wouldn’t be Amu-Darya, but the much bigger Afghan-Tajik fields.

No points for guessing who won: the China National Petroleum Company (CNPC). CNPC beat Australia’s Buccaneer Energy, the U.K.’s Tethys Petroleum, and Pakistan’s Shahzad International.  According to Afghan sources, CNPC offered a 15% royalty, a 30% PSA share (referred to by the FT as a “corporation tax on profits,” which isn’t quite correct but does capture the basic idea) and the construction of a $300 million refinery. (Afghanistan consumes about 1.7 million barrels per year. A ballpark estimate of a refinery capable of processing all domestic consumption comes to a bit less than $50 million ... the implication being that the CNPC refinery is going to be intended to export to neighboring countries.

Three things are interesting about the deal. The first is that the Chinese appear to have gotten a pretty good deal: unless their marginal costs turn out to be astronomical (which is unlikely in a conventional onshore field with next-to-no exploration risk), a 45% government take after cost recovery is not bad at all. The second is that there isn’t any evidence of Chinese sweeteners, in the form of cheap development loans. This is not a loans-for-oil deal of the type signed with Russia or elsewhere. In a sense, then, this contract represents a change from previous Chinese deals, which generally involved overpaying for access to oil. Whether that change is going to be sustained is, of course, a completely different issue. The third is that any later disputes can be taken to the International Centre for the Settlement of Investment Disputes (ICSID), even though China and Afghanistan lack a bilateral investment treaty. ICSID is a remarkably powerful organization even when wielded against large and powerful states — if no big country has yet reneged on an ICSID judgment (although Argentina may change that) a small country like Afghanistan, highly dependent on World Bank funding and American assistance, is extremely unlikely to resist.

Americans will be responsible for creating the institutions (both inside an outside Afghanistan) that give foreign companies the certainty they need to invest, but Americans show no sign to getting any of the fruits of that investment.  The Afghan War, in short, was clearly not about oil. The Afghan peace, however, if there is to be such a thing, just might be.

China doesn’t have an empire, except maybe in one unexpected country and only if you squint hard

 Empire is one of those ill-defined terms. Problem is, define it too narrowly—say, formal sovereignty over a subordinate political community—and you deny the existence of, say, the Soviet empire in Eastern Europe, or the American one in the Caribbean. That’s not a useful definition. Define it too loosely, however, and every power imbalance becomes an example of “empire.” That’s not helpful either.

One useful way to define empire is through the threat of sanctions. If one political community enforces its writ over another by the threat of sanction (active painful sanctions), then you’ve got an empire. Might be strong, might be weak, but it’s imperial. A corollary, of course, is that the stronger political community will extract either political control or economic benefits from the weaker one. (China gets no visible non-commercial benefit from its presence in the Bahamas, for example.)

Chinese energy policy is often accused of being imperialistic, especially in Africa. The evidence comes in three flavors. First, “equity oil”: the tendency of Chinese state-owned companies to buy equity stakes in foreign oilfields and oil producers. Second, the way China ties state-financed loans to oil agreements. If countries want the cheap finance, they need to give China cheap oil. Finally, the long-term nature of such agreements, putatively locking the producing nations into providing China with oil at a discount.

The most famous of these deals, with Russia, turned out to be a lot less when examined it up close. China lent Russia money at market rates to build a pipeline that would deliver hydrocarbons to China at market prices. It’s hard to see the imperialism. Where was the threat? Where was the benefit?

OK, but that’s with the Russian Federation, you say. Russia is a great power, sort of, and not subject to Chinese pressure the way that smaller and poorer places might be. Okay. To test that, we can go over the universe of loans-for-hydrocarbons deals signed by China since the beginning of 2009. How many of them involved the delivery of oil at less than market price? Not Angola, not Brazil, not Bolivia, not Kazakhstan, not Ecuador, not Turkmenistan.

Has China managed to get a price discount anywhere? Yes, once. In February 2009 the People’s Republic inked an agreement with the Bolivarian Republic which provided a $4 billion loan from the China Development Bank in return for 200,000 barrels of oil per day at a $2.00 per barrel off the market price, invoiced monthly. Now, to be fair, a discount in that range is fairly standard. The problem is that Venezuela’s “market price” is completely opaque. Venezuelan crude trades at rather less than WTI or Brent simply because it costs much much more to refine. Only PDVSA is, shall we say, rather opaque at providing information about the prices that it charges. So how to benchmark against the market price, when the market price (while existant) is hard to find?

You would have to go all James Bond to get the answer. Fortunately, the State Department did so in 2009. Venezuelan sources told State that PDVSA supplied China with oil as low as $5 per barrel. That’s a not a discount of $5 per barrel (which would already be above the $1-$3 norm for such agreements); that’s a price of $5 per barrel.

Wow! Now that’s imperialism!

Only ... well ... imperialism is not defined by a smart bunch of Chinese companies taking advantage of the administrative wreck that is Petróleos de Venezuela. Rather, it is defined as the use of sanctions or the threat of sanctions to alter the governing policies of a subordinate political community. I suppose that maybe you could define the possibility that China would withhold its capital as a form of sanction ... except that the only reason Venezuela has trouble raising capital at much better terms elsewhere is the mismanagement of the Hugo Chávez. (For what it’s worth, which isn’t very much, Venezuela now insists, “We don’t cut prices in any of our international agreements.” Except to the Bolivarian Alliance countries. And Spain. But other than that, we should believe Minister Rafael Ramírez. I mean, he said it below portraits of Che and Fidel!)

I suppose you can call it crafty Chinese imperialism, or you can say, “The people now charged with reaching international supply agreements on PDVSA’s behalf couldn’t negotiate their way out of a wet paper bag.”

Ghana, I should add, appears to be doing a much better job. For all the Ghanian deals’ faults, and there are many, Ghana hasn’t even given the Chinese preference for oil contracts in exchange for their money, let alone a price discount.

In short, Chinese hydrocarbon companies are going abroad ... because that’s where the oil is! Other than in cases of truly gross local incompetence they haven’t gotten particularly good deals, despite widespread bribery on their part.

Uranium, of course, is a different story.

Why Oh Why Can’t We Have a Better Press Corps? New York Times Edition

 Credit for the post title to Brad Delong.

Far be it from me to say bad things about the natural gas industry. But I can say bad things about people who shill for the natural gas industry. Today in the New York Times the paper publishes something that it never ought to have allowed to see print (or screens): this op-ed by Robert Bryce. It is the worst sort of cant: rhetoric designed to mislead by sleight-of-hand.

The basic argument is as follows. Renewables should be free to be green. Renewables are not free. Therefore, we should build more CCGT plants and nuclear reactors.

That’s really the argument. There’s this bizarre red herring implying (falsely) that it takes so much energy to build the steel in a solar installation as to make it as carbon-emitting as a natural gas turbine. Then there’s a second implication that it would be possible to greatly expand the number of nuclear power plants in the country without building high-power lines. Followed by a completely bizarro-world claim that the U.S. is short of empty land, or that 129 square miles is a lot of territory. (I have written about this elsewhere, although Doug makes a good case in comments that normal EPA review should still apply. But that is nothing compared to Bryce, who claims that they should not be built at all.) There is, of course, no attempt at either cost or carbon accounting.

I should add, of course, that he misrepresents the environmentalist position on nuclear fission. Only in Germany are greens universally opposed to it. Straw man, there, and irrelevant to his argument, inasmuch as he has one.

If he were calling for conservation and downsizing of energy use, he would at least be consistent, if IMHO incorrect. (I think the costs of photoelectric, solar-thermal and wind are worth the benefits, but there are costs.) Thing is, he’s not calling for conservation. He’s calling for more gas-fired plants. WTF?

Disingenuous, at best.

The Romans to the rescue?

 Anglo-French forces have begun making helicopter strikes from carriers in support of rebel operations. They join the Anglo-French air sorties (which now outnumber U.S. sorties by a growing margin) and the Anglo-French  ships that have been shelling shore targets in support of the rebels in Misurata. (War nerds should click the second link.) William Hague, meanwhile, was in Benghazi two days ago.

It is an excellent level of support. (Everyone should read this comment by Doug Muir, and this post by Alex Harrowell, at which point somebody should answer the queries they raise.) But four days ago one country put them all to shame, a most unexpected country: Italy. Yes, Italy. Home of the oil company that seriously thought it could reclaim its oil from Gaddafi. Home of one of the Colonel’s biggest friends. Land of the supremely bizarre “Friendship Treaty” between the Italian Republic and the Grand Arab Libyan Popular Socialist Jamahiriya. Italy!

Ever since Gaddafi demonstrated that he could hit rebel oil production, the rebel government has been hard up for cash. (The one tanker that they got out has finally been purchased by a refinery in Hawaii.) Legal confusion in the United States has held up the rebels’ ability to access Gaddafi’s assets, or use them as collateral for loans. (The recent sale of rebel oil to Hawaii is an indication that this fog may be lifting.) So how is the rebel government going to get the foreign exchange that it needs?

Enter Italy. Foreign Minister Franco Frattini, said Rome would, through Eni and UniCredit SpA, “provide the [rebel] council for the needs of the Libyan people with a huge quantity of fuel and a huge amount of money.” He added: “We are talking about billions of euros that is not money of the regime. This is money of the people of Libya. [These] important frozen assets can represent a very valid guarantee for this transfer of money to the Libyan people.”

In the absence of NATO forces capable of hitting irregular government troops far inland, then the only way to get resources to the rebels is to let them borrow against government assets. British training is all well and good, but the rebels need air support, and right now they do not have it outside a narrow coastal band. So ... Italy just won huge credit by offering cash. Stratfor likes to insist that the Anglo-French effort is all about securing petroleum contracts at Italian expense: if so, Rome just blew a hole in that idea. The rebels should look at Eni et al pretty favorably ... and the decision to channel the lending through Eni only reinforces that.

On the other hand, Britain seems to be training the rebels on the ground. Serious rebel training would obviate the worries about the oil fields, by allowing the rebels to coordinate with foreign air forces operating at high altitudes. (To be frank, getting the rebels into some sort of recognizeable — and hard to copy — uniform would help.) That will also be quite thanked.

In short, the postwar question will be: does concrete Italian financial support outweigh concrete Anglo-French military support? I suspect that given the legal mess, the former will prevail. But then again, I never did believe the idea that Cameron’s and Sarkozy’s decisions had been driven by a desire to have their national companies (particularly BP) seize formerly-Italian production contracts. That said, Rome seems to have found an easy (and almost costless) way to insure that its interests will survive the conflict.

It would be nice if the U.S. would move as quickly in unfreezing Libyan assets. It was a heroic effect to clear the Hawaiians to import rebel crude, but there is more to do. Britain and France, it is time to start serious lawfare.

Libyan civil war oil update

 There have several important developments in the Libyan civil war, not least the temporary incursion into Tunisia and NATO’s decision to begin attacking Libyan state institutions. (The death of one of Gaddafi’s sons is a result.) These are important, but developments regarding the country’s oil industry are even more so. And so, this update.

Last weekend, government forces damanged rebel-controlled oil fields. How is not certain. Tripoli claims that British warplanes did the damage, but that seems unlikely to say the least. Wahid Bughaigis, the rebel oil minister, said that the damaged equipment included a generator, an oil tank, and several small diesel tanks to fuel the generators. The rebels say they will need at least a month to repair the damage.

The problem is that the rebels do not control the refineries or gasfields. They therefore need to import fuel, and that’s expensive. The Qatari government (working with Vitol, an oil trader) helped the rebels market one million barrels (for an above-market $129 million in revenue). The MT Equator tanker, carrying 550,000 barrels of that oil, arrived in Singapore for refueling on April 28, before steaming on to China. (China is being quite helpful where it counts.) $129 million, however, is not a lot in terms of rebel needs. Bougaighis said: “To put things in perspective, one cargo of gasoline of 25,000 metric tons costs us $75 million, so you don’t go far with $129 million.”

I suspect that he is wrong about that: 25,000 metric tons is around 7.9 million gallons, and I doubt they’re paying $9.44 per gallon. But I am sure that the rebels are facing energy problems. Benghazi used to get its electricity from natural gas supplied out of Brega. Brega, however, is in government hands. As a result, the rebels have cut electricity production in Benghazi by 25 percent to conserve fuel. Of course, in a country without anything resembling a smart grid, electricity cuts mean rotating outtages running as long as 3½ hours. Bughaigis: “We didn’t have this problem when the gas was supplied to the plants, but now we have to supply it (diesel) by sea and get it from the road.”

For what it’s worth, the U.S. cleared up (as best as it could) the remaining uncertainty about the ability of Americans to buy Libyan oil. The Office of Foreign Assets Control (OFAC) declared that said transactions involving Qatar Petroleum or Vitol are permitted provided the entity in Libya is under the control of the rebel-backed leadership. Anyone dealing with Libyan oil purchases must supply a report to OFAC detailing the arrangements within 30 days. The practical significance of this is limited, however, since the Europeans opened the door to rebel oil sales some time ago.

In the Department of Obvious: Vienna-based OMV, which produces some 10% of its total oil and gas production from Libya (33,000 boe a day), is seeing its profits go down. Production at the Shateira oil field shut down at the end of February due to violent clashes between government and rebel forces. Libya provided 20 percent of the crude used by OMV refineries, but it has been able to buy crude from Saudi Arabia, Kazakhstan and the Black Sea region to make up for the slack. OMV will have to upgrade the refinery in Burghausen, Germany, to process non-Libyan crude, but it should be able to do that.

Department of Not so Obvious: Eni’s production is down 9%, but profits are up 15% on high prices. Since April, Eni production in Libya has been about 50,000 to 55,000 barrels of oil equivalent per day, down from 280,000. (Libya accounted for about 10 percent of Eni's overall cash flow.) Eni said since April the company has been producing 50,000 to 55,000 barrels of oil equivalent a day in Libya for local electricity production, all coming from its Wafa facility. No Eni facilities in Libya have been damaged and are currently on “hot standby” ready to produce again once the situation stabilizes.

And finally, Department of WTF: Eni appears to have sent a tanker to western Libya to try to pick up oil from its production facilities. The Aqua got within a few kilometres of the Libyan port of Mellitah before turning away between April 20 and 21. (The booking from Mellitah to Venice probably cost over $500,000, including a risk premium to venture into Libyan waters.) It was there to load up 600,000 barrels of oil. The Libyan government, obviously, refused to let the Eni ship fill up. “They didn't want the crude to go, because they wouldn't have gotten any money for it,” said an industry source, adding, “They could use it to refine into gasoline.” I can understand why NATO would be happy to let the Italians give it the old college try (“Go get your oil! Just make sure that Tripoli knows it won’t get any money for it, 90% tax rate be damned.”) I am less sure as to why Eni thought it could possibly get its oil.

So there you have it. Nothing here changes the assessment that the rebels will win, but the government ability to strike at the fields is unexpected.

Around the Arab revolutions

 Usually an “around the Revolution” entry on this blog refers to left-wing Bolivarian governments on this continent. Here, though, it refers to Libya, Bahrain, Egypt, and Yemen. It will be brief: these are just observations; I have a bad head cold and a boatload of work. (See Laffer blogging.)

In Libya, it is surprising how quickly government forces withdrew from the east in the face of Allied airstrikes. The rebels still seem like a mob, by all accounts. The rapid withdrawal seems like a sign that discipline inside government forces is cracking, but that does not necessarily mean that the regime is about to fall. Gaddafi has a lot of support in Sirte; if his army holds together enough to crack Misurata (which will not be easy with Allied planes overhead) and hold Sirte, then he will probably hold on for a while. On the other hand, my prediction that oil would soon start flowing again seems to have been correct. The rebels now control export facilities with a capacity of 827,000 bpd, and it appears as though Qatar is willing to help with marketing. Oil markets reacted as you would expect. Ironically, it looks as though Chinese and Indian oil companies may in fact help, by being willing to purchase rebel oil without fear of what might happen to their interests in Gaddafi-held territory. That is the exact opposite of what observers expected when the violence first erupted.

I would very much like to go to Benghazi to see how Agoco is faring.

In Bahrain, 11 members of Wifaq have resigned from parliament, which is not a good sign. The party seemed to be willing to compromise in its conditions for talks with the government: all they want now is the release of 250 detainees. the idea of Kuwaiti-brokered talks now seems off the table. Reports are vague about the presence of GCC troops. There are reports that the Saudis are running checkpoints, but those should be taken with a grain of salt. Saudi troops wear the old U.S. three-color DCU pattern (on the right below), whereas Bahraini defense forces wear British-style camoflague patterns (on the left). Unless you are familiar with the uniforms, it is not easy to tell them apart.

The unrest is not good for the economy. The Grand Prix has been cancelled, as have other events. The 2008 race contributed $600 million to the economy, or 2.9% of GDP. Combine that with the proliferation of cancelled events and collapse of tourism, and Bahrain has a problem. The central bank has leaned on local banks to go easy on businesses affected by the slowdown. (It also insists that the financial industry is stable, but it would.) More importantly, on March 10 the Gulf Cooperation Council (GCC) announced a $10 billion fund for housing and infrastructure. Bahrain intends to use the money to build 50,000 new homes at a cost of $5.3 billion over the next five years.

The goal is, of course, political. According to the Economist Intelligence Unit, there are currently 46,000 people on the waiting list for government-subsidized housing. One grievance is that newly-naturalized Sunnis from places like Syria and Pakistan are alleged to get priority; true or not, the government hopes that speeding up the pace of modern housing construction will ease the political conflict. (The government is almost certainly wrong, of course.)

In addition to the housing program, the government is planning a 1% levy on salaries to fund an unemployment insurance scheme, plus a tax on employers for each expat they employ, to finance training for locals. In 2009, the government gave expats the freedom to change jobs, with the aim of raising the cost of employing them versus native Bahrainis.

Unsurprisingly, the political effect of the change was the reverse, adding to Shia grievances. For what it is worth, the markets have perceived a big increase in the risk of Bahraini sovereign debt, but they have perceived that for most of the Middle East and North Africa, including Egypt and Morocco. The interior minister, Rashid bin Abdullah bin Ahmed al-Khalifa, has said that his ministry will “speed up plans” to hire 20,000 new employees, and the King has ordered various ministries to increase employment.

For what it is worth, I do not think that the initiatives are going to work. Bahrain needs to address Shia political grievances. My colleague, Victor Menaldo, has a paper showing that Arab monarchies have been surprisingly resilient to political shocks: very worth reading. It’s implication is that Bahrain will make it through, but it isn’t clear that Bahrain fits the model.

So what about Egypt? Well, here I am going to turn the floor over to Victor (and his colleague, Mike Albertus) once more, from their op-ed in USA Today: “Research that we’ve conducted on the relationship between revolutions and democracy demonstrates that less than a majority of revolutions end in democracy. Surprisingly, however, we also find that the democracies that tend to survive the test of time are those born in revolution.”

Finally, Yemen. All I have to say here are that the reports are terrifying. Abandoned ammunition dumps is not a good sign.

Why the Libyan rebels will (probably) win

 The Libyan civil war is set to be a prolonged one. Others have mentioned the rebels’ astonishing lack of discipline and training, and what thus far seems like their inability to establish even a chain of command. That can be rectified, however, if they can gain enough resources. In Libya, of course, resources mean oil. So what do the rebels control?

 

First, they have the Tobruk oil terminal firmly in hand. They took possession of the Zueitina terminal on Monday, bit whether they can hold that depends on events in neary Ajdabiya. The two terminals have an export capacity of 63,000 and 214,000 barrels per day (bpd), respectively, for a total potential export capacity of 277,000 bpd. The terminals are fed by the Sarir and Misla fields, which according to Agoco are producing about 95,000 bpd, down from 400,000 bpd.

Why is production so low? Agoco was not dependent on foreign expertise. The loss of contractors in the general flight when the civil war broke didn’t help, but it didn’t cause the decline. Rather, the problem is legal uncertainty. With sanctions biting, it wasn’t clear that any of the majors could purchase Libyan oil without opening themselves up to massive liabilities. In fact, that is usually the problem in rebellions and civil wars. When the legal situation is clear, oil companies are willing and able to operate in the most disordered situations—when it is not, they won’t touch anything with a ten-foot pole. Agoco’s management may have announced that it was on the side of the rebels, but that means nothing to the majors in the absence of Western policy. As a result, oil is sitting in terminals without tankers, and production is down since there’s no storage capacity.

This looks like it is about to change. In what may be the most significant development of the civil war since the Western airstrikes began, the rebels just declared the formation of a new “Libyan Oil Company,” and “the designation of the Central Bank of Benghazi as a monetary authority competent in monetary policies in Libya.”  

This is really important. It means that a rebel government, recognized by France, now has an oil company and a central bank. The sanctions imposed by the United States (and in a weaker messier form by the Europeans, something that I complained about to a reporter last week) apply only to the Libyan national oil company and central bank. In the Treasury’s words: “Should National Oil Corporation subsidiaries or facilities come under different ownership and control, Treasury may consider authorizing dealings with such entities.”

The sanctions imposed on the central bank of Libya are similarly flexible: “All property and interests in property that are in the United States, that hereafter come within the United States, or that are or hereafter come within the possession or control of any United States person, including any overseas branch, of the Government of Libya, its agencies, instrumentalities, and controlled entities, and the Central Bank of Libya, are blocked and may not be transferred, paid, exported, withdrawn, or otherwise dealt in.”

Libyan lifting costs are around $3 per barrel. At $105 per barrel, access to the two eastern fields could mean an annual income of $10.3 billion for the rebels. Now, that’s not likely—those Opex figures are misleading. (Libya earned $32 billion in 2010.) Still, even a quarter of that can buy a lot of merce ... er, private military training and uniforms and equipment to turn the rebels into a real army. Add some access to British and French special forces (to call in airstrikes) and they could win this thing.

They won’t win quickly. But with Gaddafi running on cash reserves, it looks as though they will win. At least as long as China and India and elsewhere stay on side.

No-drive zone and the Libyan civil war

 This is going to be ugly, but ground troops will not be needed. (With a caveat.) We can conduct enough sorties to impose a real no-drive zone between rebel-held territories and the west. The problem is that it looks as though Gaddafi’s forces have already moved into Benghazi. The rebels will have to root them out, and that could be ugly. (Preliminary reports look pretty ugly, but maybe not as much as it could have been.)

Minimally-trained infantry should be able to outflank government forces outside the cities, but the rebels seem to be worse than minimally-trained. Maybe this is my own experience talking, but they seem like mobs with guns, rather than a serious fighting force. The West could send in advisors, which would, of course, be serious mission creep. If it happens, I’d bet on the British doing it, not the United States.

The truth is, neither side the Libyan civil war appears to be particularly competent. (This should not be surprising.) In the words of a former RAF officer (and personal friend): “I think holding onto small cities was a mistake, the rebels have bogged themselves down there and waited for the fight to come. Ideally, defence should have been based on the ‘restricted block methodology’ (ie: Stalingrad) freeing up manpower to build SUV mobile platoons heading for Tripoli and locking the government in. Not rocket science, infantry 101 which concerns me about the skills of the regular Libyan NCO/Officers.” This graduate of Fort Benning, for what little that is worth (and truly, it is not worth much at all; the only times I have been in a combat zone have been as a civilian) concurs. Andrew Exum also concurs. (Oh man did his post bring back memories of digging. And getting tear-gassed. But I digress.) 

Historically, Libyan troops have performed very poorly at the operational and tactical level. From Arabs at War: “Junior officers exhibited little initiative, creativity, flexibility, or adaptability ... They rarely thought to manuever in battle, could not make combined-arms operations work properly, and regularly failed to scout or adequately secure their positions ... Information did not flow evenly across the Libyan hierarchy either verically or horizontally, with the result that few had the requisite information to adequately perform their assigned missions.” Strangely, maintenance was a serious problem, while logistics performed amazingly: the country maintained an armored division in Chad, a thousand miles away.

In this war, the logistical advantage is gone: the U.N. forces are going to make sure of that. In the east, you are going to have ugly ugly irregular fighting until the last of the Gaddafi forces are gone. In the west, though, it depends.

One smart policy would be to promise financial rewards to defecting Libyan forces, including foreign-born militia. With economic sanctions on, Gaddafi is down to paying to his troops from his cash reserves. He can’t export oil or gas, he can’t access his foreign assets. Libya is also an importer of gasoline (this is not unusual for oil producing countries). The rebels knew this, and hijacked vessels headed to Gaddafi-held territory, but now NATO navies are enforcing a blockade. Moreover, the Ras Lanouf refinery is damaged and on fire.

Another smart policy would be to call off the International Criminal Court and offer a blanket amnesty. I am sure that Venezuela would be happy to take the Colonel. (Once upon a time, I would have thought Saudi Arabia, and that might still be a possibility, even with the recent collapse in U.S.-Saudi relations.)

In short, the U.N. coalition is going to dismantle Gaddafi’s air defenses and enforce a no-drive zone. The rebels will root out government forces in the east in awful fighting to which the press will probably not pay much attention. Then we are going to get a waiting game. Even with sanctions, Gaddafi can hold out for a long time, especially if his troops think that the alternative is death. Thus, bribes ... but somehow I do not think that is going to happen. In short, we could have a long waiting game, unless

The wild card would be Gaddafi attacks on civilian populations in the west. If that happens, all bets are off. Perversely, that means a rebellion in the areas he currently holds would be worse for the U.N.’s ability to stay out than a long stalemate.

But here’s the good thing: the United States is not in the lead. Yes, we are providing right now most of the firepower. But politically, we are not in the lead. If this turns into a repeat of the containment of Iraq, the onus is not on us, and the decisions are not on us. If we draw back, the Europeans (honestly, the Anglo-French coalition) and the Arab countries will have to decide whether to keep on.

And you know what? As a nationalist American, I like that. I like being the biggest kid but not the alpha dog. The French moved out in front, the Arabs made the call, the U.N. granted the authorization, and we’re in it because we’re big and burly and feel solidarity. (Nobody reading this will understand this save for the few who went to grade school with me: we’re Jimmy, not Brandon.) And this, this is new, and this is good.

The mystery of rising nuclear costs

 What’s the biggest obstacle to greater use of nuclear power? In some countries, like Germany, it’s public opinion. (The German reaction to the disaster in Japan does not make sense to me, but I’m the sort of person who finds these facts about radiation poisoning to be reassuring.) As the Japanese situation continues to unfold, that may re-emerge as a problem elsewhere.

But in most of the Americas and in Asia, though, the problem is that the cost is too damn high. In fact, the cost is high and rising. Here are estimates for American plants from Koomey and Hultman, in thousands of 2009 dollars per installed kilowatt by date of completion:

But this is not true everywhere. Below is a preliminary estimate for France, made along the same lines, and calculated by myself and Carlos Yu. It includes interest costs and decommissioning expenditures. The French data are such that it is not possible to break out the cost of every individual plant, but it is possible to break out the cost for plants of a particular vintage. The dots show the cost per kilowatt in 1000s of dollars on the right axis; the vertical bars represent the number of plants under construction in a given year: 

The overall picture is not all that different from the United States. At first, there are some diseconomies of scale as construction ramps up to an astonishing peak of 37 reactors. Costs then stabilize until 1987, when they begin a relentless march upwards, save for the final plant opened at Civeaux in 1999. New plants aren’t getting any cheaper: the gold triangle is where the Flamanville plant was supposed to clock in; the circle off to the right is where it is going to come in.

While preliminary and subject to change, our estimates are not wildly out of line with these two.

What happened? At first, it looks like diseconomies of scale as the number of plants under construction reaches an astonishing 37 per year, after which things stabilize until 1987, when they begin a relentless climb. What’s the reason? I don’t know, but a highly-placed EDF official pinned it on safety requirements. Another possibility is that the country lost its chance at keeping scale economies when it rolled out the P4 and N4 reactor designs instead of continuing to churn out the old 900-MW plants. The truth is that I have no idea.

What I do know is that the barrier to greater use of nuclear power has been and remains its cost. Safety is a secondary issue, except inasmuch as safety requirement directly drive up the cost. I have trouble believing, however, that investment in actual safety equipment is wasted the way the time spent getting permits is wasted. So if it is safety that is driving up nuclear costs, then nuclear power is not going to be competitive for a long time to come, regardless of the political reaction to the ongoing disaster in Japan.

A primer on radiation poisoning

 Radiation at the Fukushima Daiichi plant peaked around 400 millisieverts an hour, before falling back to 0.6. How bad was that?

The question turns out to be hard to answer. Why? Well, the total dose matters, but so does the rate. After all, DNA repairs itself, so getting exposure over a year and over a day are very different things. That said, there are some general rules about acute exposure that all radiologists know, and since I happen to be married to one, I figure I’ll put them up.

400 millisieverts an hour is enough to cause a transient sunburn over a period of 4-5 hours, although that won’t happen to everyone. (If you got 2,000 millisieverts in a matter of minutes, then you would start to burn.) After 10 hours, you might have some hair fall out 2 or 3 weeks later, but you’d have to sit out in it the radiation for almost a full day to lose the hair permanently.

The threshold for radiation-induced cataracts is about 12 hours at 400 millisieverts per hour, although symptoms might not show up for as long as 8 years. On the other hand, men would go sterile after 8 hours, and sperm counts would start to fall (definitely temporarily, but possibly permanently) after only 30 minutes exposure. (This is why men in careers that involve a lot of flying should probably consider freezing their sperm.)

Now, in theory an acute dose of 10,000 millisieverts is enough to kill you within a few weeks, by destroying the epithelial lining of the gastrointestinal tract. In practice, you’d need to get that dose very quickly: 25 hours unprotected inside the Fukushima Daiichi facility at current levels probably won’t be enough to kill you. But it is not something that you would want to try.

Cancer, well, that’s probabilistic, but your long-term risk would start rising after about five hours or so.

Whether this relieves or concerns is, I think, a matter of temperment. Given that the Yokosuka Naval Base appears to have detected a radiation level of less than a fiftieth of a millisievert per hour, redirecting naval vessels seems like a bit of an overreaction.

Robert Moses and solar power in California

 Americans of a certain age and predilection often like to say things just to be provocative. I am about to say something provocative, and I want to reassure you that it is not because I am trying to be provocative. It is because I am, at the end of the day, very old-fashioned.

So here it is: I love Robert Moses. I think neighborhoods like the one above, the ones he got built, are awesome. I know, I grew up in ‘em. It was a muscly ambitious society what threw up these buildings 5 years before I was born. It is a sad thing for the environment that we no longer build stuff like this.

Robert Moses, he got stuff built.

Which brings us to California and the future of the planet. The great state of California recently approved no less than nine solar-thermal power plants. They would produce collectively 4.2 gigawatts of power, or 4% of the state’s total generating capacity. Keep that up for twenty years, in a place that gets as much sun as regularly as the Mohave desert, and you could shove aside a big chunk of natural gas. I am a fan of natural gas when the alternative is coal or freezing in the dark; in the Golden State, the alternative is sunpower. The Schwarzenegger Administration set the stage with its energy laws, and the Bush Administration helped the goal along when it opened federal lands to development on 2006. (When the opposition does good things, I give credit, and the energy policy of the second Bush Administration was nothing less than a big improvement on the status quo.)

But ... now come the lawsuits. Protection of protected species. “Impacts to Native American culture.” The Sierra Club and the Cuña de Aztlán Sacred Sites Protection Circle Advisory Committee united with the Tea Party people to keep pumping CO2 into the atmosphere. The Sierra Club worries about Calico project and the desert tortoise. La Cuña de Aztlán fears for the impact of the Imperial Valley project on the Quechan tribe’s origin story. The Tea Party all the projects because they hate subsidies. There are reasonable worries over the Genesis Project’s diversion of Colorado River water ... or they would be reasonable if the way we currently use the river made any damn sense.

I cannot sum up my hostile reaction to the anti-solar opposition inside the American political spectrum. Where is our Robert Moses? Anyway, attempts to talk me down would be very welcome. Tell me why I shouldn’t be angry at these people.

How to imply a lie without lying: Bahrain edition

 It is a skill. A Stratfor analyst managed to pull it off. Nothing in the below is false, but it does disagree completely with the internal assessments of the United States chief diplomatic arm:

After Egypt, Bahrain has become the most significant place where street agitation is taking place in the Middle East. ... The country being a proxy battleground for Saudi Arabia and Iran makes it even more significant.

Pro-democracy street agitation is not a stranger to Bahrain ... what is happening is not entirely new. What makes this significant — this latest round of unrest — is that it comes in the context of the overall regional unrest that started in Tunisia and moved to Egypt ...

It’s not just the sectarian dynamic that makes the protests significant in Bahrain. There is also a wider geopolitical contest between Saudi Arabia and Iran that has been going on for several decades and, more recently, since the fall of the Saddam Hussein regime in Iraq.

Since then, Saudi Arabia has been very worried about Iranian attempts to project power across the Persian Gulf into the Arabian Peninsula. And with Bahrain having a heavy Shiite population, this is a cause for concern in Saudi Arabia, as Saudi Arabia is neighbors with Bahrain and has its own 20 percent Shiite population.

From the point of view of the United States, Bahrain is also significant because it is home to the U.S. Navy’s 5th Fleet. The 5th Fleet is one of the key levers that serve as a counter to Iran, or any movement on the part of Iran. It is not clear at this point to what degree Iran is involved in the uprising. There are linkages, but to what degree Iran is playing those linkages is not clear at this point. Nonetheless, it is one of those flashpoints between Shiite Iran and the largely Sunni Arab world, and Bahrain is going to be very interesting in terms of how both sides battle it out in the form of a proxy contest.

Should Bahrain succumb to unrest and the monarchy has to concede to the demands of the protesters at some point in the future, this becomes a huge concern for the security of countries like Saudi Arabia, particularly where there is a 20 percent Shiite population that has been keeping quiet for the most part, but could be emboldened, based on what they have seen in Egypt and now what they are looking at in Bahrain.

Riiight. The above analysis implies that Iran is behind the protests. It also implies that the transformation of Bahrain into a constitutional monarchy would be a de facto expansion of Iranian power. The fact that there is no evidence that Iran is behind the protests does not come into play. Nor does the fact that Bahrain receives a lot of hydrocarbon rents, and a democratic Bahrain would have as much desire to share those rents with Iran as Alberta wants to share its rents with the rest of Canada. (In 2011, the Kingdom of Bahrain expects to earn $5.1 billion from hydrocarbon production, taxes, and royalties.)

There is little doubt that if the United States washed its hands of the Gulf tomorrow, Iran would invade Bahrain the next day. As recently as 2007, Iran floated trial balloons about reactivating its historical claim to the island. And ... well ... $5.1 billion is a lot of money, maybe not for the United States, but for Iran, which has a (nominal) GDP around $335 billion and a government budget around $66 billion.

And it is true that the Saudi government has its own reasons to fear a demo-cratic Shia-dominated Bahrain. The last paragraph of the analysis is spot on.

But jumping from Iranian desires and Saudi fears to some sort of blather about a great game, with intimations that Bahraini democracy would be bad for the United States, is just silly. Moreover, it runs against the perceptions of the United States government. A democratic Bahrain under a constitutional monarchy would be just as much of a threat to the Iranian regime as it would be to Saudi Arabia. (“Look! A Shia democracy! Without an American invasion, and without the occasional car bomb!”)

Given the reality of the situation, I really don’t think there is anything more for the United States to do or say than it already is doing and saying. In short, viewing the situation through the lens of Cold War 1½ would, I think, be a mistake. Analyses like Stratfor’s are misleading without being incorrect, and in a potentially dangerous way.

Thoughts?

The United States and Bahrain: intro

 The big U.S. link with Bahrain is, simply, the Fifth Fleet. We station roughly 3,500 personnel and 16 vessels in Bahrain. My direct contact with the military presence there took place unexpectedly in a bar in the ground floor of a Best Western in Manama. The decor was country-and-western, the music was crunk, the males were mostly off-duty American sailors, and the women were disproportionately from Thailand. Yes, I left immediately; why do you ask?

Bahrain does not provide the use of their territory for free. We currently pay about $9.6m a year for the use of about 66 acres and 15 berths. But that isn’t all: in 2010, we also provided the Bahrain Defense Forces with $20.8 million in assistance; this year’s budget request is for $21.7 million. That comes to a little over $1,500 for every BDF effective; not a small chunk of change. The U.S. presence is governed by a 1992 treaty (T.I.A.S. 12236) ... most of which is classified.

OK. Do we get anything else for our protection? Well, Bahrain has sent troops to Afghanistan: about 125 Bahrainis guard Marine encampments in Helmand. (If you divide all our military aid by 125, you get about $173,600 per Bahraini; a bargain compared to Blackwater.) We signed a free trade agreement in 2006. That agreement (building on an earlier 2001 treaty) included provisions protecting U.S. investments from expropriation. That, plus our help in resolving a border dispute with Qatar, got Occidental a 48% stake in a field that will eventually produce 100,000 barrels per day of oil and 2.5 million tcf of natural gas. Even with a 46% tax rate on oil companies, that will be a lot of revenue. Oxy expects to invest about $1.5 billion in the field. Under reasonable assumptions (say a 10% cost of capital and an $80 oil price), that investment could clear over $830 million a year, which ain’t bad. Try doing that in Ecuador! And since Oxy does in fact pay income taxes to the U.S. federal government, the gain to Americans could come to, uh, about a dollar a year per person.

In addition, to Oxy, ChevronTexaco got an exploration concession in the formerly-disputed area with Qatar in 2001. (Strangely, so did Petronas, from Malaysia, and some goobers from Calgary. I think we could have complained about that ... except eventually they all pulled out in favor of a Thai outfit. The link has a pretty good rundown of the state of play in Bahraini hydrocarbons.) 

In short, the U.S. gets a base that helps us keep the oil lanes open and contain Iran; in return we get some useful soldiers and some oil concessions, guaranteed by the specter of ICSID. Not too shabby. Viva el imperio; maybe Randy McDonald was right.

What about other parts of the relationship? Well, Wikileaks tells us that the Bahraini government likes to claim that the periodic unrest in the Kingdom is due to Iranian and Syrian machinations, but the State Department isn’t buying it. In 2008, they reported, “Small but violent bands of Shia underclass youth, frustrated with persistent discrimination and what they perceive as too gradual a pace of reform, clash with police nearly every week. The Sunni minority, which rules the country and controls all security forces, has generally acted with restraint, but it takes only one mistake to provoke a potentially disastrous escalation.”

In short, if Bahrain does go up (and it is not clear that it will) the United States will not have been surprised.

Is the U.S. exceptional in its policy towards Arab oil?

 I am a bit confused about what Prof. Quiggin is trying to say here:

The point applies most obviously in relation to oil. The idea that the US can legitimately use its military power to ensure continued access to oil resources rests, in large measure, on the (not entirely unfounded) assumption that those controlling the resources are a bunch of sheikhs and military adventurers who happened to be in the right place, with guns, at the right time. Without the Arab exception, the idea of oil as a special case, not subject to the ordinary assumption that resources are the property of the people in whose country they are found, will also be hard to sustain.

Prof. Quiggin is a very smart guy, and when I say I’m confused, I mean that honestly. The governments of Arab oil-producing states keep almost all of the rents from the oil extracted on their territory; this is just as true of Abu Dhabi, which works with the majors, as it is of Saudi Arabia, where state-owned Saudi Aramco monopolizes production. Moreover, only 9% of the oil produced in and around the Arabian peninsula goes to the United States. Put another way, the U.S. only gets 10% of its oil from the Arab countries of the Gulf. The U.S. gets no oil from North Africa. The U.S. does, of course, use its military power to insure that the oil keeps flowing. But I don’t see that as much different from what the U.S. does with other strategic raw materials, or in regions outside the Arab world.

Matt Yglesias got me even more confused:“Certainly if you were just to look at things in coldly rational terms, the resource-rich country the US should be seeking to dominate militarily is Canada, located conveniently next door. And, indeed, in the first half of the nineteenth century that’s how hawkish American politicians saw things. But it would be politically unacceptable in a modern context to try to bully Canada or Norway into coughing up oil.”

Except ... uh ... how is U.S. policy towards those countries different from our policy towards Saudi Arabia? Canada is not about to embargo U.S. oil; Soviet fleets are not about to blockade Norway. American policy would be rather different if either were true. (And policy was different, when the latter was a real threat.) The oil does belong to the provinces in Canada and the national government in Norway; but ditto in Kuwait and Saudi Arabia and Iraq. What does Matt mean when he implies that the U.S. uses military force to make the Arab countries “cough up oil”?

Quiggin’s main point is about overall U.S. policy towards the Middle East, but I honestly do not what he’s trying to say about oil. Nor do I understand Yglesias’s. Can someone explain?

Dog bites man, East Timor loans money to Portugal

 Yesterday, the government of East Timor announced that it would purchase $700 million in Portuguese bonds. (Hat tip: Randy McDonald.) At first glance, that seems kind of stunning. One of the poorest countries on the planet is lending money to a member of the European Union? It sure looks like “an interesting inversion of the standard postcolonial paradigm.”

At second glance, there is a story here, but it isn’t the one you might think. The story is that East Timor is handling its oil boom quite responsibility. The rest is unsurprising. Let me start with the unsurprising part.

First, capital flows from oil-rich ex-colonies to their former metropoles are nothing new. The UAE, Qatar, and Bahrain have been investing a lot of money in the U.K. for quite some time. The nations of French West Africa hold a minimum of 65% of their foreign exchange at the French treasury (and in practice rather more) in essence lending money to the metropole. In fact, such capital flows predate independence: Britain hung on to the sterling zone for a long time because it feared that its colonies would no longer lend to the U.K. without it.

Second, Portuguese bonds are a pretty good investment. The 10-year bond is yielding 6.7% — that’s 2.7 times the yield on German bonds. Unless Portugal repudiates past-due interest payments (and in postwar debt restructurings, only Argentina has done that) bondholders would come out ahead as long as the haircut on debt principal is less than 25%. (To be fair, the math is a bit more complicated, because it depends on when Portugal defaults, but that serves to make the bonds more attractive.) In other words, the East Timorese deal is far from charity.

Third,the purchase has the obvious additional benefit of buying some Portuguese goodwill, which ain’t nothing, considering that Portuguese aid averaged €42.6 million per year between 1999 and 2009. Moreover, Portugal has been cutting foreign aid significantly, so buying goodwill could have a big return. Considering that East Timor will earn €34.4 million per year on its investment, that is a pretty cheap way to buy goodwill.

From Portugal’s point-of-view, however, there is no charity. First, the loan is a drop in the bucket compared to the country’s total debt of €145 billion. Second, the loan is being made at commercial rates, and will involve buying existing sovereign debt, not the provision of new money. Third, it might not all involve Portuguese sovereign debt: the Timorese authorities have added the following weasel words: “Investments could be made in highly successful public or quasi-governmental enterprises that guarantee high returns.” Considering that $700 million is a legal maximum for East Timor, which has to invest 90% of its assets in U.S. Treasury bonds, the implication is that the Portuguese government will get less than that.

In other words, Portugal will get a small amount of help from a source with every incentive to lend it money regardless of political connections. (I suppose East Timor could buy Greek bonds instead.) Not much to feel grateful about. Portugal probably will anyway. That isn’t a bad thing. But it doesn’t make this loan into any sort of new post-colonial paradigm, or give Portugal a serious lifeline. It is, sad to say, a sideshow. Dog bites man.

 

The real story is that East Timor has the money to invest. Why? Simply that since 2004, most of the country’s oil revenues have been placed into a fund and invested overseas. On average, 82% of revenues have gone into the fund, and never less than 74%, in 2006. (See the above chart.) Considering that Gabon, for example, has made a complete hash out of a similar fund, as have many other countries, that is an impressive achievement. other countries haven’t even tried. (It would be churlish to suggest that the extreme level of foreign influence over the Timorese government has anything to do with the success.)

 

In the long-run, East Timor is guaranteeing itself a perpetual income around $500 million per year, which isn’t bad for a country of only a million people, although population growth will reduce the per-capita value of that benefit over time. (That’s the shrinking dashed line in the above chart, which assumes $60 per barrel oil.) It won’t solve the country’s many problems, and it may be invested too conservatively (90% in U.S. treasuries? Really?) but if the Timorese government can stick to it, then the oil discoveries have a good shot at promoting the nation’s long-term good. That’s the big news, not the decision to invest in Portuguese sovereign deb.

Russia is not a satellite of China

 “Isn’t that obvious?” you say. Well, perhaps it is, but yesterday Vladimir Putin opened a pipeline to China, crossing the border near the town of Skovorodino, the financing of which caused many observers to doubt the truth of this post’s title.

In February 2009 the China Development Bank lent $25 billion to Rosneft and Transneft to build a pipeline, in return for 300,000 barrels a day for two decades. The loan was a floating LIBOR-based rate, then about 6%.  At face value, analysts reported that the deal translated to oil at $20 per barrel.  (I calculated $14, but close enough.)

Wow! Taken at face value, that sounds like a great deal. Even you think the Russians will renegotiate when oil prices rise, that is still a great deal. (Renegotiation is expensive and risky, so China would still get below market oil for some time.) The Washington Times was breathless. Bloomberg reported analysts practically yelling “Buy Sinopec!” Philip Zelikow, over at Foreign Policy, called it “informal empire,” and if the above had actually been the deal, I would have unequivocally agreed with him.

Which means that you shouldn’t take things at face value. First, the Russians did promise to deliver a fixed quantity of oil, but at whatever the market price happens to be at delivery. This is exactly the same sort of long-term contract that Saudi Aramco signs: they promise to show up on time with the exact quantity, and you pay whatever the market says it’s worth.

Second, Transneft issued 10-year Eurobonds in August 2008 at an interest rate of 8.7%, more than the rate on the Chinese loans. (The link is to an official Transneft financial statement for the first quarter of 2010.) Admittedly, the Chinese loan was floating rate, not fixed, but for twice the term as the Eurobonds ... it still doesn’t look as if China got a particularly good deal.

This is not to say that it was a bad deal. China got its pipeline, which the Russians were not thrilled about building. The pipeline increased the People’s Republic’s ability to import, meaning that unforeseen Chinese demand shocks (or China-specific supply shocks) will be marginally less likely to cause Chinese prices to spike relative to world prices. Plus, the China Development Bank got a not-terrible interest rate, about the same as on Russian ten-year bonds, and without the currency risk. Russia, meanwhile, got a guaranteed market and $25 billion to develop new fields at time when credit is less-than-available and exploration and development costs are rock-bottoming. It all makes business sense.

But an expansion of some sort of Chinese economic empire into Russian territory this is not. Yet.

MSNBC fail

 Here’s Chris Matthews and Buck Lee, the director of the Santa Rosa Island Authority in Florida, bloviating about help from other countries “with experience in this sort of thing.” Lee mentioned Denmark, then seemed to check himself.

For crying out loud! I want to shoot myself. OK, people, two things. First, a list of all the oil spills in the North Atlantic region (minus the West Cork incident of 2009):

1. March 18, 1967, off Cornwall, England: Torrey Canyon spills 905,000 barrels;
2. April 22, 1977, in Norwegian waters: blowout in Ekofisk offshore oilfield spills 126,000 barrels. No shorelines affected;
3. March 16, 1978, off Portsall, France: Amoco Cadiz spills 68 million gallons;
4. July 6, 1988, in Scottish waters: explosion of Occidental Petroleum’s Piper Alpha rig kills 122 workers but spills no oil;
5. January 5, 1993, off Shetland, Scotland: MV Braer spills 621,000 barrels.
6. February 15, 1996, off Milford Haven, Wales: Sea Empress runs aground, spilling 511,000 barrels;
7. December 12, 1999, off the coast of Brittany: Erika wreck spills 71,000 barrels;
8. November 13, 2002, off the coast of Galicia: Prestige wreck spills 460,000 barrels;
9. December 12, 2007, in Norwegian waters: Statfjord offshore field spills 25,000 barrels;
10. July 31, 2009, off Telemark, Norway: Full City wreck spills 1,440 barrels.

In other words, they don’t have all that much experience with cleaning up oil spills in the North Atlantic, because they seem to be pretty good at preventing them. Only one of the spills came from a blowout, and none of the oil there reached the shore.

Second, European countries have sent us what they could, and we have accepted it. There is no foreign savior waiting in the wings, being kept out by some weird combination of red tape and nationalism.

So enough with the idiocy already. The Europeans are better at keeping spills from happening; they have neither special expertise nor deep stores of special equipment to clean up the resulting mess. Somebody tell Chris Matthews, please?

BP agonistes

  Comparing the Congress and President of the United States to Stalin and Hugo Chávez is not a violation of Godwin’s law, but it took me by surprise. (I may be sensitive, after my wife and a surprisingly pleasant fellow in a “Republicans Make More Money” T-shirt bodily interceded to prevent an altercation between myself and a Larouchite on Newbury Street yesterday.) The comparison is made in light of the President’s recent announcement that BP will have to finance a $20 billion settlement fund and pay the wages of idled oil workers. The idea is that the law is the law, limited liability is limited liability, and any retroactive changes to the law may discourage many good projects.

Hmm. I am confused. First, where has the rule of law been trampled? If President Obama or Congress threatened BP with something illegal, then I would like to know about it! In the absence of illegal actions, I do not understand the premise. (Here is brief rundown of the legalities, now moot since BP has agreed to the fund. Short version: the “necessary and proper” clause gives Congress the ability to retroactively lift liability caps; the ex post facto ban applies only to punitive measures.)

Second, BP is in a high-risk high-reward industry! The market has consistently ranked the company (like most of the majors) as pretty bloody risky compared to the rest of the S&P 500. Only on a few weird occasions has its price-earnings ratio risen up to the S&P average, and it was swimming around in the same depths as right now only two years ago. Yes, high dividend firms are, as the FT avers, very good things. But BP was a very risky high dividend firm! You pays your money and you takes your chances, and BP shareholders took a few too many with the livelihoods of the people in the Gulf region.

 

Third, what good projects would be disincentivized by requiring BP to pay the public costs of its mess? This disaster is likely great news for shale oil. Ditto wind and solar and nuclear and most certainly anything to do with natural gas. Inasmuch as deepwater development is slowed, that would seem to me to be a good thing, given the huge externalities at stake. Would it be bad for companies to drill less because they, say, decided to drill relief wells concurrent with the main well? The FT worries about the precedent, but I the only place I can see a potential spillover is in nuclear power, where firms may decide the the $10 billion liability cap created by the Price-Anderson Act is not credible ... but that seems like an abstract fear. What is the empirical evidence that holding BP responsible will start to freak out other American companies and industries more than, say, the tobacco settlements did a few years ago?  

Finally, although it is true that the U.S. seems to have a comparative advantage in “translating corporate cash flows into paper that someone wants to hold,” is that a good thing for the nation? Personally, the global economic imbalances resulting from foreign desire to hold U.S. paper have me feeling a bit queasy (read: terrified) and I am still not convinced that our dependence on finance is a good thing.

In short, it seems to me that there really is not anything wrong with the government’s decision to make BP clean up its own mess. If you could show that (a) something unprecendented or illegal was happening; (b) BP shareholders have been completely blindsided by the costs; (c) the settlement will stop future Good Things; and (d) the damage from those three Bad Things are bigger than the damages to the Gulf Coast, then I would change my mind. But the onus, it seems to me, should be on those decrying the settlement to prove the above, not to compare the United States to the Bolivarian Republic.

Now is your chance to prove a, b, c, and d, and get me to post yet another retraction. (Shakes fist at that damned Guerrero fellow.) Takers?

Defending David Brooks

 I am not a big fan or Mr. Brooks, or his column, but Brad Delong linked to an unwarranted criticism this morning. It was enough to get me out of my work-overloaded (and World Cup hypnotized) blog hibernation.

Mr. Brooks writes, in an otherwise forgettable column lauding the excellent work of my homeboy from Chelsea (look it up!), Ian Bremmer, “In America, we use the phrase Big Oil to describe Exxon Mobil, BP, Royal Dutch Shell and others. But that just shows how parochial we are. In fact, none of these private companies make it on a list of the world’s top 13 energy companies.”

Prof. Delong then links to somebody called Ioz, hysterically writing, “Do I even have to say it. The world's largest company is Royal Dutch Shell. ExxonMobil, BP, Chevron, Total, and ConocoPhillips are all bigger than the largest 'state' rival, China National. Oh, and here is a ranking by market cap, in which some of the state-owned companies fare a bit better, but the big 'multinationals' ExxonMobil, RDS, BP, Chevron, and Total all make the top 13. WHAT THE FUCK IS DAVID BROOKS TALKING ABOUT?”

Well, uh, um. According to the Energy Information Administration, in 2008 all private producers booked worldwide reserves of 41 billion barrels, putting them right behind the Libya National Oil Company and eighth overall. And since almost all of those reserves outside North America can be (in theory, at least) expropriated at any time, it is not clear what “ownership” of them really means. By that definition, Big Oil really isn't that big at all. (Of course, neither is Sinopec or CNOOC or Petrochina.)

Now, I would still argue that Brooks is wrong, but not for the rather silly data Ioz linked to, which looks at all revenues from all activities. It is clear that Brooks is talking about crude oil production. In those terms, the majors look a bit better, with The oil company formerly known as British, Shell, and ExxonMobil ranking third (after Saudi Aramco and the Iraq National Oil Company), fifth (after the Kuwait Petroleum Corporation), and eleventh, after the National Iranian Oil Company, PDVSA, ADNOC, Pemex, and the Libya National Oil Company.

In short, the majors are still major ... but the main argument (which comes from Bremmer) holds: National oil companies dominate upstream production.

My wife is very sensible

 I am big fan of Rachel Maddow, and I am a green green. But my wife thinks that she is going a little overboard about the Deepwater Horizon disaster, and I agree. “The energy in your studio comes from somewhere, Rachel,” she says.

Do not get us wrong. There were screwups that Petrobras and Statoil would not have committed. Nor do we care if BP goes bankrupt and ceases to exist as a result of the disaster. In fact, that would be a fine outcome. (Lift the caps! Go after them! My wife, the same one who thinks that banning offshore oil is bad idea and demonizing B.P. is silly, would be very happy at that result.) 

Everything has risks and returns. Offshore oil is actually a tiny piece of the U.S. energy mix. It is not as though the waters of the South Atlantic are inherently more valuable than the Gulf of Mexico, but they are our waters, and if we choose not to risk them then that is a fine idea. But we should not get too out of hand in demonizing our inability to contain the leak.

I am working on this stuff pretty thoroughly, and thus the lack of posts. But my wife's opinion seems worth sharing.

Occidental, Iraq, France, Britain, travel, my wife (♥) and whatever else

 The short answer to Bernard's question about Oxy is that they bid too high. They were the minority partner in a field with Eni, Sonangol, CNOOC and Kogas ... and they lost.

The rest of the final post in the Iraqi oil series is going to be held up for a bit. The reason is left for an exercise by the reader, but it is a good one. The worst case scenario is that you will see it here fast.

This month begins a horrendous travel month during which I will go from Boston to Los Angeles to New York to Tulsa to Shamrock TX to Burlington to New York to Miami to Atlanta to home and my wife!!! (Who will be visiting me in both New York stops, thank the Lord.) France was much more fun. Oddly enough, I'm really only looking forward to the Tulsa-Shamrock bit of the trip, although I will enjoy smoking cigars in New York and Miami with my hermanos if I get the chance.

As someone who has a great affinity, even a love, for both Britain and France (maybe it's a color-combo thing, or a losing land wars in Asia thing, or some else ... thing) I present you with the following:

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Sarkozy Visits the U.S.
www.thedailyshow.com
Daily Show Full Episodes Political Humor Health Care Reform

I eagerly await the Ranter's informed commentary.

The new Iraqi oil contracts

 LT asks, “What is your professional-grade suggestion for aligning the interests of oil ministry and oil drillers?”

Have the Oil Ministry pay the oil companies’ development costs. That way, the per-barrel fee turns into a true service fee, and the IOCs really are reduced the status of service companies. Which is exactly what the Iraqi government did in November, in the wake of failed auctions. (Perhaps they had a ringer from my old high school sitting in the HBS class? Omar? No, he was in the nuclear power class. Carlo!!)

Under the new terms, ExxonMobil and Shell retroactively agreed to the Iraqi government’s insistence on a fee of only $1.90. After all, if the government is going to subsidize most of their capex, then they can make money even at such a low fee. They signed a contract in November. In February, the Oil Ministry arranged auctions for a second group of fields.

Unsurprisingly, the next round was far more successful than the first:

Field	Consortium	Percent	Fee per barrel	Target, mbbd	Bond	Annual revenue, $m
West Qurna 1	ExxonMobil	80%	$1.90	2.33	$400	$1,197
	Shell	20%
Majnoon	Shell	60%	$1.39	1.80	$150	$878
	Petronas	40%
Halfaya	CNPC	50%	$1.40	0.54	$150	$238
	Petronas	25%
	Total	25%
Qaiyarah	Sonangol		$5.00	0.12	$100	$411
West Qurna 2	Lukoil	85%	$1.15	1.80	$150	$706
	Statoil	15%
Garraf	Petronas	60%	$1.49	0.23	$100	$106
	Japex	40%
Badra	Gazprom	40%	$5.50	0.17	$100	$340
	Kogas	30%
	Petronas	20%
	TPAO	10%
Najmah	Sonangol		$8.50	0.11	$100	$279
Rumalia	BP	67%	$2.00	2.85	$500	$804
	CNPC	33%

The Rumaila field at the bottom is actually the successful contract from Round 1. I put it in for completeness. The “bond” is actually the “recoverable signature bonus,” in millions of dollars.

A few things stand out about the second round. First, no American companies made it. ExxonMobil got its foot in back in November, but that was technically during the first round. In fact, only one American company even bothered to bid, despite the phenominally good new terms. The other bidders were:  B.P. (U.K.), CNOOC (China), CNPC (China), Edison (Italy ... although really France), Eni (Italy), Gazprom (Russia), Japex (Japan), KazMunaiGas (Kazakhstan), Kogas (Korea), Lukoil (Russia), Occidental (U.S.), Pertamina (Indonesia), Petronas (Malaysia), PetroVietnam (fairly obvious), Oil India (again, fairly obvious), ONGC (India), Shell (U.K.), Sonangol (Angola), Statoil (Norway), Total (France), and TPAO (Turkey).

Second, most of the bidders were state-owned, among them CNOOC, CNPC, Edison (indirectly, by France rather than Italy, via EDF), Eni (the Italian government owns a controlling stake), Gazprom, Japex (the Japanese government owns a third), KazMunaiGas, Kogas (owned by the Korean government), Pertamina, Petronas, PetroVietnam, Oil India, ONGC, Sonangol, Statoil, and TPAO.

Third ... Sonangol? In both fields, the company bid more than the Iraqi government would allow, and decided to agree to a lower price. But still. It is a good company, but this is going to be a reach. Qaiyarah (in Nineveh province, up near Kirkuk) has been in operation since 1936, but produces very heavy oil and poses a lot of technical difficulties. Najmah is a little easier, but not by a lot. And both are in a very politically fraught area.

(The fourth thing that seems to stand out is not really surprising, which is the presence of ostensible gas companies. Gazprom has an oil subsidiary, Gazprom Neft, which will be the operator on the Badra field; Kogas is just a financial partner. The field, by the way, spans the Iranian border.)

If successful, Iraq’s output will rise from 2.4 million bpd (figures vary) to 10.5 million bpd by 2015. That’s a lotta oil, considering as world production was only 84.4 mbpd in the third quarter of 2009, up from ... well, down from 84.5 mbpd in 2005.

Thoughts?

Why aren’t all oil contracts service contracts? Evidence from Iraq

 When I first started to study oil contracts in a serious way, something puzzled me. Why weren’t all oil contracts service contracts? That is, why didn’t countries simply hire oil companies to extract their oil at a fixed fee per barrel? After all, that’s what many oil contracts turned into after the fact. Consider Venezuela: Chávez’s “nationalizations” basically had the effect of keeping the oil companies’ revenues per barrel around a flat $11. Or consider Chad, where the World Bank and major oil producers acquiesced in the Chadian government’s demands for more revenue as oil prices spiked above all expectations. (They didn’t have to: the government’s oil revenues were deposited with the World Bank, E.U. troops protected the facilities, and President Déby relied upon French military support to stay in power. But why not? It avoided all sorts of trouble.) Ecuador temporarily raised its windfall profits tax to 99% of all revenues when oil rose above the price at which the contracts had been signed, but implementation has been spotty. (Hm. Bernard may have been right about Mr. Correa, although the jury is still out.)

	Oil revenue		Payments to Chad
	Actual	Original	Actual	Original
2003	$234	$0	$45	$0
2004	$2,063	$600	$166	$31
2005	$3,138	$1,186	$300	$80
2006	$3,444	$1,197	$774	$88
2007	$3,600	$1,210	$1,220	$96
2008	$5,040	$1,216	$1,564	$1,000
Cumulative	$17,519	$5,409	$4,069	$1,295

Source: Ben Esty, World Bank.

The answer to the puzzle is simple: exploration risk. Lots of fields turn out to be much harder to work than anticipated. Similarly, exploring for oil is a very costly undertaking these days — in general, if the oil were easy to find, somebody would already be extracting it.

And that is exactly what Oil Minister Al-Shahristani realized made Iraq unique: the exploration risk was minimal. The fields had all been explored back in the 1970s. If it hadn’t been for the Iran-Iraq and First Gulf War, they would have been developed and on-line a long time ago. So why not auction off service contracts to the fields? Competing consortia were allowed to bid on how much they would increase production from the fields. They were also allowed to bid on the per barrel fee they would receive above a minimum level fixed by the Iraqi government. The winners would have to post a bond which they would lose if they didn’t invest a specific amount within a certain amount of time.

So how did it go? Not too well in the first round. There were few bidders—most fields were uncontested, in fact—and all the consortiums posted per-barrel fees that the Iraqi oil ministry considered too high. Lifting costs in Abu Dhabi are about $1.50 a barrel, and Baghdad considered $2.00 a reasonable maximum for most fields. The only bid to be accepted came from a consortium of British Petroleum (which isn’t called that anymore, but hey) and the China National Petroleum Company. The two bid $3.99 per barrel on the Rumaila field, but accepted the government’s insistence on $2. They also put up a bond (called, perplexingly, a “recoverable signature bonus”) of $500 million, and pledged to take production up from the current 1.02 million barrels per day to 2.85 million … although they would only earn a fee for production over 1.75 million bpd. The lowest bids on the other fields were rejected.

If that doesn’t sound like a good deal, that’s probably because it wasn’t. There were real questions as to whether BP-CNPC would exercise the option that it had (in effect) purchased for $500 million. Would it? Should it? What was BP thinking? Had Shahristani gotten a deal that really was too good to be true?

Many questions. Thoughts? More questions? Anyone? What about you, LT?

Obedezco pero no cumplo, o al revés

 The oil industry under direct and indirect American rule has an interesting history. It starts out paralleling the old Spanish Empire, and then reverses itself.

 
The Future of Iraq Project, the report by the liberal goo-goo State Department about how the U.S. should run its new satrapy had some pretty radical things to say about the future of the Iraqi oil industry. “There has been a massive trend to privatization or at least de-monopolization of national oil companies throughout the world and we are unaware of a single instance of re-nationalization or re-monopolization of a national oil company.”

That would have surprised Hugo Chávez, who was in the middle of remonopolizing the Venezuelan oil industry, but State used the above stylized fact as the basis for proposing that the industry be privatized.

They came up with three options. The first was straight privatization. Split the Oil Ministry into three or four corporate entities, sell up to 30% of ‘em, then give them and the international oil companies (IOCs) a straight shot at the oil. The second was the same, but keep the three or four resulting companies in the hands of the Iraqi state. The preferred third option, was to do things post-Soviet style, because it had worked so well the first time around. “IOC participation might be induced through their participation in private Iraqi oil companies that are themselves widely-held by the Iraqi public, through the issuance of vouchers to all Iraqi citizens. The citizens are then free to ... sell them.”

The Coalition Provisional Authority appointed Phillip Carroll ( formerly of Royal-Dutch Shell) to head the oil ministry. Carroll was the man in charge of Iraqi oil, he ran the ministry and he represented Iraq at OPEC meetings. He also refused to privatize Iraqi oil assets. The Bush Administration replaced Carroll with Robert McKee (R-ConocoPhillips) ... who issued a report calling for the retention of Iraqi control over a national oil company and self-financing of petroleum reconstruction. This led to a food fight within the CPA ... until Dick Cheney, of all people, intervened to prevent privatization. After all, the IOCs were used to doing business with national oil companies (NOCs), and nobody wanted to set up an institutional environment in Iraq that local governments would immediately start doing their damndest to reverse. Obedezco, pero no cumplo. 

McKee’s report was optimistic about the future of the Iraqi industry. “At oil prices of $25/bbl [barrel], about $12 billion will be available annually as the government’s share of oil revenues, after subtracting the real costs of sustaining oil production at 2.5 mmbd [million barrels a day], and after accounting for domestic consumption. Industry analysts believe that restoring pro-duction to 3-3.5 mmbd over 2 years will require about $5 billion in new investment. Financing such expansion out of current cash flow will take about $2.5 billion annually over 2 years, or about 21% of the government’s share of oil revenues. A more ambitious program, one aimed at reaching production in the 5.5-6 mmbd range is projected to cost about $20-30 billion over 5 years, or $4-6 billion annually. Iraq could afford this as well, though the initial proportion of the government’s annual share of revenues could be as high as 50%. However, during periods of unfavorable crude oil prices, say $18/bbl, an ambitious expansion plan could require as much as 85% of the government’s take.”

Needless to say, the Iraqi industry was not privatized. Problem was, the Iraqi parliament that took over legislative authority from the CPA — I know, in theory the CPA had no legislative authority, but whatever — couldn’t come up with a new oil law. In 2007, Baghdad and the Kurdistan Regional Government came up with a draft revenue-sharing law, but it wasn’t ratified. The Kurdish government was not willing to wait, so it started to issue its own exploration licenses. It stuck to the draft revenue-sharing agreement. In case of commercial discovery, the foreign investor would receive 15%, while the remaining 85% would be paid to Iraqi accounts. The KRG would keep 17% of the Iraqi revenue, and the central government would get the remaining 83%. In addition,the KRG reserved the right to demand equity participation in any oil projects up to 25%. All without any sort of federal authorization. No obedezco, pero cumplo.
 
And so, the Kurdish government started to sign production sharing agreements. Which infuriated Baghdad. Washington, worried about anything that could spark Arab-Kurdish tensions, discouraged American companies from prospecting in Kurdistan. They didn’t completely succeed: Hawler Energy, Hunt, Texas Keystone, HKN Energy, and General Exploration Partners all jumped in. But they mostly succeeded, and Americans mostly stayed out.

Of course, it was all new exploration in Kurdistan. Risky, tough, expensive, huge downside risk for the companies. The real prize was the oil down in the south, where all the really hard exploration work had already been done. But that brings us back to the problem that the Iraqi parliament could neither organize its own oil company to manage the needed investment nor come up with a framework to allow foreign companies to manage it for them. With an insurgency on and the Iraqi oil ministry working the good fields, wildcatting was not going to happen, but neither was any growth. 

So in July 2008, with the Iraqi insurgency winding down (sort of) and the American election coming up, Oil Minister Hussein al-Shahristani basically said to hell with it. If the Iraqi parliament couldn’t come up with a plan, he would come up with one on his own.  No hay que obedecer, pero cumplo.

Thoughts?

Who won Gulf War 2?

 Some say it was China.

T. Boone Pickens to Congress : “They’re opening them (oil fields) up to other companies all over the world ... We’re entitled to it. Heck, we even lost 5,000 of our people, 65,000 injured and a trillion, five hundred billion dollars. We leave there with the Chinese getting the oil!”

Wait … wasn’t the war about nuclear weapons in the hands of a dangerous regime? I won’t deny that’s true. It might even have been what President George Bush had in mind.

One thing that I can say, however, is that when the 369th Corps Support Battalion (aka the Harlem Hellfighters) was preparing to go to war back in 2002, one sergeant liked to motivate his soldiers by saying (among other things) “We’re in, we’re out, and by next year gas will be 60¢ a gallon!”

In other words, it wasn’t just Texan oilmen who thought that the war was fought for the economic benefit of the residents of the United States; cops and roofers and public school teachers (and at least one dude working in the Economic Growth Center at Yale University) pretty much thought the same thing. Moreover, the State Department’s Future of Iraq Project proposed that the industry be privatized after the war, and no less than Ahmed Chalabi promised, “American companies will have a big shot at Iraqi oil.”

So is T. Boone Pickens right? Did China win Gulf War 2? Let me propose here that the answer is “no.” Given the disasterous decision to go to war, America has probably won Gulf War 2, in callous economic and strategic terms. The decision by the Bush Administration to discourage Americans from investing in Kurdistan, followed by the (apparent) decision by the Obama Administration to extend that discouragement to the rest of Iraq, was quite smart. If it works out, two things will follow: (1) the U.S. will gain a huge amount of diplomatic leverage over a dangerous regime that is trying to procure nuclear weapons, and (2) the Second Gulf War may turn out to be a paying propostion in straight-up economic terms.

Don’t believe me? I don’t blame you. I’m not even sure that I believe me. But after writing a case about the Iraqi oil industry, teaching it to a bunch of mostly-American MBA students and then again to a group of mostly-European executives, and running some numbers, I’ve come to think that there’s a reasonable case to be made for the defense.  Over the next few posts, I’m going to try to make it.

Why Venezuelan lights are going out

 Courtesy of Will Baird, here is dramatic evidence of the drought that’s shellacking the Bolivarian Republic and causing power outages.

Awesome. As long as you don’t live somewhere without power. But Will still hasn’t answered my question! What’s with that? 

Oiled up and ready to go

 Barry asks about the labor system and oil, Randy wonders about the Iranian presence, and Peter asks if there is any worry about Saudi Arabia going kablooie. Let’s start with oil. Dubai was built on oil.

You’d be surprised at the number of people who don’t realize that. Yet it’s the truth. The Emirate of Dubai may never have been an oil producer on the scale of its neighbor in Abu Dhabi, but the Maktoum family got the initial income it needed to realize all of its massive development plans from the discovery of black gold.

In a sign of the ongoing decline of the British Empire, London failed to prevent Dubai from giving an offshore exploration concession to an Anglo-French consortium in 1952. They weren’t very successful, so the Emirate granted a second concession to Conoco in 1963. Conoco formed the Dubai Petroleum Company (DPC) to operate their concession, buy a half-interest in the earlier Anglo-French one ... and sell further interests to Texaco, Sunoco, and a German company you’ve never heard of. Three years later DPC struck oil about 55 miles off the coast.  Production started in 1969. (The coolest thing was the giant half-million-barrel underwater open-bottom tank that they used to store the stuff. You woulda thought somebody might have realized that oil and water don’t mix before then.)

In addition to royalties, the Emirate acquired a 32.5% share in the company, and its revenues skyrocketed. By 1975 it earned $1.7 billion (in 2009 dollars, using the UAE deflator) from oil and gas. At its revenue peak, in 1981, it earned a hair over $7.5 billion. That is a hell of a lot for a place with a national population of ... either 25,000 or 100,000, depending on how you define it. The green line shows revenues income, while the orange line shows production.

 

The oil revenues income financed the investments that turned Dubai into the trade hub of the Middle East. The Arabian peninsula is very well placed for a place to transfer cargoes from Asia into Europe-bound ships and vice versa. Similarly, it is a good place to hub flights. Emir Al-Maktoum channeled the oil money into building Port Rashid — against the advice of the emirate’s British advisors — and then Jebel Ali, an even bigger Bronx-sized port complex big enough to service a Nimitz-class aircraft carrier. Dubai built an airport in 1960 (also against British advice), but it was debt mortgaged by oil money what expanded it to accomodate jumbo jets in 1968. Ditto, it was oil what financed the creation of Emirates Airlines in 1985 and all the rest of that good stuff.

Of course, as you can see from the graph, the oil money started to run out in 1981, and the actual amount of oil being pumped out itself started to fall a decade later. So what was Dubai’s business model after that? A subject for another post … and a way to get to the other questions. Keep ‘em coming.

Nuclear power in the UAE

  The below picture does not show a nuclear power plant.

 
While cooling towers can bear a resemblance to the onion domes, I suspect that the nuclear reactors that Korea will build in the UAE will not be as pretty.

The Korean victory in the UAE bidding process came as a huge surprise to Areva, the French nuclear conglomerate. They had the EPR design ready to be rolled out. President Sarkozy had pulled out all the stops. France had a military base in the country and was training Emirati troops. The President had visited Abu Dhabi. Areva could offer a long-term fuel contract, delivering fresh uranium from its mines in Niger (enriched, of course, in France). Moreover, Areva could accept used fuel and reprocess for reuse it at its plants in La Hague and Mercoule. France meant nuclear. It had to happen.

Yet suddenly the South Koreans came out of nowhere. Huh?

I’d been wondering that myself. So I asked some fellows I know in the Abu Dhabi government. They gave me a simple answer. The Koreans offered a cheaper price, guaranteed that price, and offered a long-term service contract. The Korean price came to $3.64 million per megawatt for a 1400 MW reactor. The French offered something similar, but they refused to take on the risk of cost overruns. When pushed to offer a fixed-price turnkey project, they came back with a price of $5.45 million per megawatt for the 1650 MW EPR design.  Now, Areva’s ability to guarantee fuel for a decade or two is a big advantage ... but Areva will sign such contracts with anyone. No need to buy one of their reactors. In fact, the Koreans already have a 10% stake in Areva’s new mine in Niger, which guarantees supplies to their domestic plants under long-term contracts.

Does the deal make sense for the UAE? The UAE government takes a rather long-term view, so a 5% discount rate seems reasonable. (For comparison, EDF uses an implicit discount rate of 13% in its investment decisions.) Assuming that the reactors manage to reach the 89% capacity utilization reached in the United States, the Korean price implies a capital cost around $23 per megawatt-hour. Fuel costs about $4. Operation and maintenance costs are harder to know, but the word is that the Koreans offered to run the plants for their useful lifetime (presumably 40 years) for roughly $5 billion each. That implies a cost around $11 per megawatt-hour, which is in line with the $8 estimated by the OECD for South Korean reactors. Total cost, $39 per megawatt-hour, assuming that Kepco absorbs the inevitable cost overruns.

What about the other options? At those prices and discount rates, nuclear is competitive with coal. Coal costs quite a bit in peripheral areas — $19 in Finland, for example, and $20 in Japan (per megawatt-hour of electricity produced) — and in a world where the United States has begun exporting the stuff to China via the Panama Canal those costs are unlikely to decrease.  The capital costs of your typical coal plant come to about $11 per MWh, but political pressures would almost certainly drive the UAE to purchase the most advanced “clean coal” technology, which would push the cost up to $20. (No, it isn’t that clean, but it emits less carbon by dint of burning the stuff at higher temperatures.) Adding in the O&M costs from the Japanese coal plants (which use high-temperature furnaces) drive total coal costs up to $50 per megawatt-hour.

The rub is gas. Gas is cheap. Capital costs are tiny; less than a quarter of nuclear. Fuel costs are relatively high in most of the world, except the UAE, where Qatar stands poised to export endless amounts of the stuff via the Dolphin pipeline.

Why choose nuclear over gas? Abu Dhabi is making a strategic calculation, not an economic one, at least not in the short term. Perhaps they think that the local price of gas will rise, either due to increasing demand or because the cost of making LNG for export will fall. Perhaps they are making some sort of inexplicable calculation about foreign exchange. Perhaps they are taking a long-term bet on nuclear power. Or they might simply think that Qatar will be unable to supply them with the quantities they will eventually need for electricity generation at any price, considering that the UAE isn’t their only GCC customer.

I honestly don’t know, although I am trying to find out. What I do know is that they aren’t making a political calculation ... otherwise they would have gone with the French.

Should I add some graphs and charts?  

UnMENDed

 Gah. MEND is back. For those of you who don’t know, MEND stands for the Movement for the Emancipation of the Niger Delta, another well-acronymed rebel movement, if not quite as well-acronymed as the MILF.

Two things are not clear. First, why MEND’s command has decided to go back to ground. I don’t know, obviously, but there seems to be little sign that the Nigerian government has decided to back away from its cease-fire promises. For those of you who don’t follow Nigerian politics, President Umaru Yar’Adua has been sick in a Saudi Arabian hospital for a little over two months. This announcement may be nothing more than an attempt at warning shot over Acting President Goodluck Jonathan’s bow, although it sure is phrased in a crazy-threatening way for that. It is also something that MEND leaders have denied. Nonetheless, MEND has been saying for a while that they were dissatisfied with the way talks were proceeding, and there was a “warning” attack on a pipeline in December.

Second, whether MEND still has the ability to limit Nigeria’s oil production the way it did back in 2005. Most of its commanders accepted the cease-fire. They haven’t reneged.

That said, it is hard to see an upside in this news. Does anyone know more about what exactly happened in the negotiations? I honestly thought it was a done deal.

Bolivian energy and the neighbors

 The New York Times has an article today entitled, “Neighbors Challenge Energy Aims in Bolivia.”  It is quite informative.  But it gives the wrong impression about the effects of Bolivia’s energy policy under Evo Morales.  The article makes it seem as though Bolivia shot itself in the foot by nationalizing the gas.  That is probably not true.  Rather, Bolivia has shot itself in the foot by refusing to build a pipeline to Chile.

Argentina’s energy policy has nothing to do with Evo.  In fact, inasmuch as Argentina has a coherent energy policy, it currently revolves around importing more Bolivian natural gas. Its roots lie in the peso devaluation of January 2002.  The government froze the peso-price of natural gas, in order to protect Argentine consumers who were already suffering an economic downturn considerably worse than the Great Depression.  The effect was to knock down the residential gas price from $1.88 to 66¢ per MMBTU. 

That wasn’t a problem until the southern hemisphere winter of 2004, when gas companies cut supplies to large industrial customers. After all, they could get much higher prices from exporting the gas to Chile.  Well, the Kirchner administration reacted much as you’d expect:  they banned gas exports. The Interior Minister of Argentina apologized to the Chilean government for the interruptions — but in May 2005 the Argentines once again slashed exports to Chile. The story repeated itself in 2006, when Argentina cut exports altogether for two weeks.  In fact, Buenos Aires added insult to injury when the government raised export taxes from 20% to 45%.  

Eventually, however, as the economy recovered, Argentina stopped being an exporter.  So the Fernández administration began to walk back the policy.  First, she allowed prices to rise to around $2.50 per MMBTU. Second, she created incentives to increase the domestic supply.  Finally, she moved to try to lock-in relatively low gas prices from Bolivia. Argentina imports LNG, but it costs twice as much as Bolivian gas.  The country’s LNG terminal offers a useful hedge against any Bolivian attempts to renegotiate the contract, but both parties would prefer to buy Bolivian gas for $5 instead of Trinidadian gas at $10.  (In fact, the terminal goes unused for long periods.)  

What about Brazil?  Well, what about Brazil?  It is true that the nationalization provided some impetus for the country to become self-sufficient, but less than you might think.  First, the Brazilians pushed back hard, even threatening to dismember Bolivia if it messed with the price or volume terms of the contract.  And Brazil won.  So while Petrobras may have been disillusioned, the situation worked out well from Brazil’s point of view. 

In fact, Brasilia had a good reason to want to allow Bolivia to retain more of the rents from resources, as long as Brazilian consumers weren’t affected.  Simply put, the bet was that a wealthier Bolivian government would result in a more stable Bolivia, and it’s politically easier for Brasilia to aid La Paz by resisting pressure to defend Petrobras profits than it would be to write checks.  The logic is identical to that behind the 2009 renegotiation of the Paraguayan hydropower contract — the primary difference being that since Brazil initiated the hydropower deal, it has been able to extract more political benefits from Asunción than it has been able to receive from La Paz.

Now, many people in Brazil say that Petrobras is upping domestic production in response to Bolivia’s tax hike. It may even be true.  But we don’t know!  Domestic exploration was good business with or without  Evo Morales.  The increase in Bolivia’s government take made it more so, but we don’t have the numbers to say that domestic supply would not have increased regardless.  I’m not faulting the article;  it’s a subtle point. I am faulting them for getting Argentina backwards ... but with Brazil, we just don’t know if Evo really mattered.

Chile is where the article is spot on.  After Argentina cut the taps, the Chilean government attempted to strike an agreement to build a pipeline from Bolivia, but the negotiations ignited a firestorm in Bolivia.  The anger surged over the fact that the pipeline would pass through territory that Chile had seized from Bolivia in 1878.  Horrors!  The Chilean government periodically floated a trial balloon of transferring a strip of land along the Peruvian border to Bolivia, but Lima protested, since Chile’s far far north had been originally seized from Peru. 

Nobody in Peru seriously contested the border ... but accepting a century-old annexation and allowing the annexed land to be transferred to a third country were very different things.  After a brief and goofy Bolivian flirtation with the idea of building an underground pipeline that would surface far out to sea, the idea died. And thus Bolivia lost a natural market, and whatever possibility it had of producing LNG. 

The article makes no effort — not that it should! — to produce a cost-benefit analysis of Bolivan policy for Bolivia. The country lost opportunities in Chile and it may have lost opportunities in Brazil ... but it got a lot more revenue at a politically-dicey time. That, I have to say, is not nothing. 

What should Evo do now?

Dubai bailout, nothing to see

  No, really.  Here’s the opinion of a Saudi Arabian banker on the Dubai default, dated November 27th:  “We believe that Abu Dhabi will come to the rescue… but like all rescues it would have a price. In that case it may well be first of all a political price.” Why did they believe that Abu Dhabi would rescue it’s neighbor?  Simple:  ADIA, Abu Dhabi’s sovereign wealth fund, has enough assets that if it seemed like bailing out Dubai world might preserve market values, then ADIA had enough of a stake in those markets to make the bailout a paying proposition.  Saudi did too, but Abu Dhabi, unlike Saudi, could more easily extract political gains in addition to the economic returns from a bailout.  

Thus, the bailout.  Stocks still seem to have reacted well, despite its wholly predictable nature.  Ni modo.