Hedging Threat and Venezuela Oil (Pre-Publication)

By Dr. Daniel Fine For Energy Magazine

How can Saudi Arabia and OPEC behind them strike a second blow
against shale oil producers in the Southwest? The first was the
2014-2017 price and market share war in which they raised production
to put the higher cost Americans out of business. This was partially
abandoned at Algiers in a reversal to opt for a higher price for
crude oil from $26 to the high $40 range. The marketing tool is
lowering their production by 1,800,000 barrels per day.

The second blow is process. The Saudi Arabian Oil Ministry

and its state company, Saudi Aramco, negotiated in London
with Glencore (worlds largest trading combined with mining),
banks and hedge funds to see if they could reduce the liquidity
necessary for American oil and gas shale producers to hedge
forward to obtain a higher price. Without access at only financial
transactions costs to the strip or the forward price of oil
at at least 10% higher than current prices spot, WPX and
all the Permian-Delaware significant producers would
not have survived the recent downturn in their current form.

If there is no difference between the price oil today and

September 2018, which is called the contango, this would
be a problem of liquidity no entity taking the other side
against the oil and gas producer on a contract. No cash
would be bet against the oil and gas producer who sells
forward one year. One side, for example, sells 70% of
2018 oil production at June 2018 prices in the present
while the other side buys or covers, as the counterpart, the contract.

Saudi Arabia correctly followed data which demonstrated

that despite the decline in the price of oil from $100 in
2014 to a low of $26 per barrel, oil producers hedged
against the fall and largely survived. Without hedging
the producers would have negative cash flows and serious
problems of debt to keep going.

In the Permian-Delaware, without hedging, 60% of revenue

in three years would have been lost to the producers and
the State of New Mexico would have faced a shortfall of
$4.5 billion or a fiscal collapse.

It is not certain that the financial services and traders in

the London discussions would go along by raising the
cost of hedging to choke off liquidity. The legality of a liquidity squeeze
in the U.S. with exchanges officially regulated is a roadblock to the
Saudi tactic.

The effort to target liquidity and thus the ability of oil and gas
producers to hedge in New Mexico and in other states demonstrates
that Saudi Arabia and OPEC will resume market aggression and
for oil market share that subsided in the last several months to
capture higher prices with lower output which would benefit
the Initial Public Offering of 5% of Saudi Aramco shares by next
year. This outcome is part of the making of the Second Downturn
in 2019 in the Four Corners and the Permian-Delaware Basins.

The Trump Administration is conducting a review of the situation

of the Venezuelan dictatorship. It is considering an import ban
on Venezuelan oil which involves substantial refining in the Gulf
Coast and Citgo. Venezuelan imports were a principal part of
the national energy policy in reaction to the OPEC embargo on
its exports to America in 1973-74. That policy had two parts: (1)
conservation, stockpiling, and alternative fuels; (2) diversity of supply
away from OPEC import dependence which is now in doubt as a
consequence of the shale oil horizontal drilling technology breakthrough
in the Southwest and North Dakota.
Venezuelan crude oil is heavy sour which called for expansion
of refining investment in the Gulf and East Coast to process and
substitute for Middle East lighter grades. These refiners are currently
opposed an Administration rule against importing Venezuelan crude oil.
They, rightly, followed Government diversity of supply policy
and provided capital outlay during the last 40 years.

This heavy sour Venezuelan investment in plant, however, disqualified

them as major refiners of the five million additional barrels of West
Texas Intermediate light sweet due to technology in shale recovery.
This created a bottleneck and discount in the Midland price
which led producers in Texas and New Mexico to lobby successfully
against another 1970s policy reaction to the OPEC embargo the
prohibition on exporting American crude oil.

The Administration is faced with the strategic big question. Is there

need for Venezuelan heavy sour today with America having the largest oil
reserves in the world, as Norway has concluded? Venezuelan crude oil
was a lowering of the risk of foreign oil denial or disruption. It is
impossible to defend it as such today when domestic oil is produced
in abundance. America is now indifferent to OPEC supply disruption.
We are beginning to sell off the Strategic Petroleum Reserve, the other
insurance policy. It, too, is not needed for that purpose.

Finally, the three New Mexican oil refineries including the 26,000
barrel capacity at Gallup use heavy oil only for blending purposes
with light and they obtain it from Canada. Inland refiners can
obtain small and limited quantities in North America for blending.
They need not import or buy Venezuelan heavy sour crude. The East
and Gulf Coast refiners could pursue incentives, if needed, to
convert to light crude supply from the Southwest and North Dakota and
end imports from Venezuela.

Oil import control and suspension is supported Harold Hamm who

led producers against the OPEC embargo policy response that denied
exports of domestic crude until 2015. He advises President Trump on
Oil and Gas. As head of Continental Resources, he is consistent. In 1999,
He led a petition with New Mexico producers and its Washington
elected officials to reduce or suspend foreign oil import.

Imports of foreign oil is now a matter of case-by-case action leaving the

future with respect to Saudi Arabia and OPEC open. President Trump
will consider the Venezuela refugee impact on Florida along with his
preference to lower foreign intervention and pursue an America First
policy.