How Venezuela Came to Be – Part 2

Ten days ago, I re-posted my article ‘Venezuela has Completely Run Out of Other Peoples’ Money‘ which goes some way to explaining how the disaster that is today’s Venezuela came about – and why it should matter to Australia, where 50% of people pay no net tax.

It’s a harrowing account of how a perfectly functional country became tired of living within its means and allowed envy, socialism and, eventually, totalitarianism, starvation, violence and preventable death to take root.

At the time, I promised the corollary to that story. This is that corollary (originally written on 10 January 2017):

Saudis Lose Game of Chicken With USA

One thing that should give us cause for optimism for 2017 and beyond is oil. You know, the stuff the left-intelligentsia said we were supposed to have run out of by now – but which the Saudis recently reminded us that there’s more than we know what to do with.

Contrary to popular belief, low oil prices are not necessarily a good thing. Even when economic times are good, low oil prices are inflationary and can be the sign of bad things to come (e.g. the 1990s leading up to the Asian Economic Crisis). Alternatively, as we’ve recently found out, low oil prices can also be a symptom of tough economic times due to low demand and activity in key economies in Europe and the USA. Indeed, you don’t see many people cheering the super low petrol prices we’ve seen recently. After all, there’s little use in having plenty of cheap fuel to put in your car if you’ve got nowhere to go.

In my previous job, I was general counsel for a company heavily involved in the oil game (among various other things). The oil game is a funny one by modern-Western standards. This is because it runs mainly on free market principles – for better or worse. Under our system, any time someone takes advantage of a free market, the typical outcome is for governments to intervene, change laws and distort the market. This is usually done in a misguided attempt to ‘make everyone happy’ (except the ‘greedy’ capitalist and those employed by them). In the global game of geopolitical musical chairs, this simply doesn’t apply to the world’s limited oil producing countries, particularly the ones that get to sit on the UN’s human rights committee.

Hence, the oil market is much freer than anything we’re used to seeing under our ‘capitalism supporting socialism’ style systems – and subject to a lot more volatility.

A brief history of oil prices

The limited countries that produce and supply the world’s oil often band together and play voodoo with supply in order to manipulate price… and other things. As a result, the world’s oil price has done things like this over the years:

oil_prices_since_1861-svg-1

The major spikes you can see during the 1970s/early 1980s and mid-2000s can be (very) briefly explained via the following graph:

world-oil-prices-1970-2008

In a nutshell, the price of oil began doing funny things following the 1973 Yom Kippur War. History records the Yom Kippur War as the occasion where the Egyptian/Syrian coalition significantly improved on its previous effort of lasting six days in a fight with Israel (in the aptly named Six-day War of 1967) – this time lasting almost 20 days.

When the Arabs realised the degree to which Israel had been assisted by the US (and that the Western World relied heavily on oil), the 1973 Arab Oil Embargo and 1973 oil crisis ensued.

Having had a taste of the fruits of market manipulation, the Arabs thought it would be a great idea to keep fiddling around with oil supply in order to maximise their gains. Naturally, it couldn’t be sustained. By the time the mid 1980s came along, the Saudis (*) saw the writing on the wall and abandoned their role as swing producer. Prices then continued to crash back towards trend in accordance with supply and demand principles.

Very interestingly, it was during this time that fracking (first tried during the 1940s) and shale exploration began growing some serious legs:

In the gas industry, an exploration area tends to be described as a “play.” In 1981, George Mitchell, one of the most powerful natural-gas barons in Texas, began to look for a play in an unlikely place: the Barnett Shale, a thick layer of rock, thousands of square miles in area, located deep under the land around Fort Worth. For years, oil and gas companies had succeeded in bringing up fuel from above and below the shale. Mitchell decided to drill into the shale and fracture it with highly pressurized fluids, freeing natural gas to be drawn to the surface. “We had people who told us we were nuts,” Dan Steward, a geologist who helped manage the Barnett project, recalls. “But for George Mitchell” — whose North Texas wells were drying up — “this was survival, this was need.”

Mitchell did not invent hydraulic fracturing, or fracking; it was first tried in the late 1940s and helped along by Department of Energy research in the 1970s. Before Mitchell, however, fracking had not been used commercially to free natural gas from shale. During the 1980s and early 1990s, Mitchell Energy drilled well after well, many of whose sites were determined personally by Mitchell, an expert geologist who dropped by his company’s engineering department daily to check for good news.

[TMR: none of this could have happened without oil being at such obscene prices – have another look at the above graph].

Now who would have thought that the abuse of market power would lead to consumers trying alternatives?

You go back, Jack, do it again

To people of moderate intelligence, the 1970s oil crisis confirmed that:

You. Cannot. Beat. The. Market.

To communists, socialists and other garden variety totalitarians, this fact has either:

  • not been absorbed;
  • been stored somewhere within the Bermuda Triangle of their brains; or
  • been treated as an invitation to ‘have a go’.

Hugo Chavez made this abundantly clear when he incredibly tried to repeat the same oil supply trick in 2005:

Chavez also played a leading role within OPEC to reinvigorate that organisation and obtain members’ adherence to lower production quotas designed to drive up the oil price. Venezuelan oil minister Alí Rodríguez Araque‘s announcement in 1999 that his country would respect OPEC production quotas marked “a historic turnaround from the nation’s traditional pro-US oil policy.”

While oil prices sky-rocketed for a few years, it was fittingly only a matter of time before the market won again and the Saudis saw the writing on the wall:

In the last quarter of 2014, in the face of possible oversupply, Saudi Arabia abandoned its traditional role as the global oil market’s swing producer and therefore it role as unofficial guarantor of existing ($100+ per barrel) prices.

In October, Saudi sources first prepared the market with statements that the country would be comfortable with oil prices as low as $80 per barrel for “a year or two.”

Aside from the fact that the market was winning yet again, the Saudis were concerned that the high price of oil was making US shale exploration economically viable and a major competitive threat. That is, the very same types of businesses that the Saudis helped put in business in the first place during the 1970s and 1980s (Saudi Arabia, meet irony).

However, rather than letting usual supply and demand principles dictate price, the Saudis decided to play a different game by:

  • doubling down;
  • flipping the switch in the opposite direction;
  • flooding the market with oil; and
  • driving price down to unsustainably low levels.

The Saudis were more than happy to take the hit to their bottom line for a year or two as long as it drove US shale explorers and producers out of business.

Helping things along for the Saudis was the fact that the economies of Europe and the US were still languishing under Obama and EU socialist inspired policies (many of which discouraged shale exploration and which encouraged more expensive ‘renewable’ energy). The combined lower activity from these economies helped keep the oil price low – and the US shale explorers whistling Dixie for any support under Obama.

All going to plan, shale producers would be out of business within a year or two and the Saudis would be free to keep beating the market.

As far as Australia was concerned, it was a disaster with project after project after project being scrapped and countless jobs lost.

Man’s best laid plans

The big problem for the Saudis was that the price of oil went well below what they had anticipated – crashing to as low as $26.55 in January 2016 (West Texas Crude). If $80 a barrel was the Saudi’s comfort point, then what was this?

To those who understand that markets cannot be beaten, there was only ever going to be so long that the Saudis could keep going this way. As it turns out, the election of Donald Trump appears to be the final straw which will end the Saudi’s two year game – with the following announcement coming barely a month after the US election:

Saudi Arabia has told its US and European customers it will reduce oil deliveries from January, as Russia says it is confident non-OPEC producers will fully join OPEC’s output limits in the first such move since 2001.

Suffice to say, Trump is about the last person on Earth who’ll stand in the way of US shale exploration – and the Saudis know it. Consequently, the price of oil is starting to return to trend:

Oil prices rose on Thursday after Saudi Arabia started talks with customers about a reduction in crude sales to support a plan by OPEC to lower global supply.

The Organization of the Petroleum Exporting Countries promised in November to cut output to help prop up prices.

Under the deal, Saudi Arabia agreed to cut output by 486,000 barrels per day (bpd), or 4.61 percent of its October output of 10.544 million bpd.

Investors have been suspicious that OPEC may not cut as much as promised, but several sources told Reuters on Thursday the world’s biggest oil exporter intended to lower exports to comply with the OPEC reductions.

‘There remains a question mark over whether OPEC, with a long history of non-compliance, will actually follow through (with the cuts). Very few respondents expect full compliance,’ Singapore Exchange (SGX) said, citing results from a survey of its participants.

If this can be sustained, then more of Australia’s onshore, offshore and shale oil and gas exploration will become viable again – which means economic activity and jobs. However, more importantly, more economic activity in the US means more Americans buying Matchbox cars (and other less important things) made in China using Australian iron-ore and coal. The early signs look positive:

graphengine

Isn’t it interesting how the media only seems to be interested in arbitrarily foreshadowing a world of doom under Trump,  when the simplest of economic dots are staring them in the face?


(*) To understand why the Saudis play such an influential role when it comes to the world’s oil (and why OPEC comes and goes at its whim), you need only look at the following production and cost graphics:

oil-production-as-percentage-of-world-total

total-cost-of-producing-oil

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25 Responses to How Venezuela Came to Be – Part 2

  1. Bruce of Newcastle

    How Venezuela Came to Be

    Socialism.

  2. As one whose oil knowledge is restricted to memories of queueing at petrol stations on even numbered days, I say thanks for a clear and informative post.

  3. Dianeh

    Very interesting. Thanks Marcus

  4. Bruce of Newcastle

    Ok, I’ll be good and address what you say Marcus. Excellent post, btw.

    The oil game is a funny one by modern-Western standards. This is because it runs mainly on free market principles – for better or worse.

    No it ain’t. In MENA it is an arm of politics and religious warfare. In the West it is a golden goose. Taxes approach 100%. No joke. Here is an example from the UK North Sea oil fields:

    Producers of North Sea oil are taxed in three ways:-

    1) Petroleum Revenue Tax (PRT) – this only applies to fields operating, or with consent, prior to 1993.

    PRT is charged at 50% of profits, specifically for that field. In other words, losses from one field cannot be offset against the profits from another.

    2) Corporation Tax – this is normally at 30% of profits (after PRT has been accounted for). Note that this is higher than normal corporation tax, which is now 20%.

    3) Supplementary Charge – this is an addition to Corporation Tax, and is set at 20%, calculated against the profit before Corporation Tax.

    In many places around the world governments take 80-90% of the oil producers’ profits.

    Can you imagine what the oil price would be if governments didn’t denude the goose of all its feathers? $30/bbl would be quite achievable I suspect.

    In my business (metals) the prices swing wildly. In the long periods of low prices the producers are decimated until those with decent assets are all that are left. They spend that time doing redundancies and making everything still work with fewer staff. So when demand spikes for whatever reason, and the price trebles, they reap the benefit for a few short years in the sun.

    The oil business is the same basically. Low prices discipline the industry and destroy the flabby state-owned organs like PDVSA. Efficient producers like the shale guys undercut them. So the government padded oil co’s die, and the efficient private producers thrive. That is free market capitalism in a nutshell.

  5. Nicholas (Unlicensed Joker) Gray

    Of course you can beat the market! What else explains the high price of diamonds? It is artificially inflated by a cartel acting exactly like a monopoly.

  6. Anthony Park

    Thank you Marcus. Interesting that oil production in Venezuela is middle of the pack, being more expensive than Saudi, Iraq etc.

  7. Bruce of Newcastle

    Interesting that oil production in Venezuela is middle of the pack

    If they could produce any.

    Some history. In 2002-3 the oil workers went on strike. Chavez sacked most of the workers and replaced them by party members.

    Embrace Hugo Chávez’s ideas or be fired, Venezuelan oil workers told

    The oil industry has been at the heart of Venezuela’s transformation under Chávez since he defeated a strike by PDVSA workers in 2002-03. Thousands of employees were sacked and replaced with government supporters, who swelled the payroll to 80,000.

    As you might expect, replacing technical experts by party apparachiks didn’t work out entirely well. In 2012 their biggest oil refinery exploded killing 48 people.

    Since then productivity in the Venezuelan oil sector has cratered. Which is not surprising when you staff such an industry with socialist drones.

    The place still barely works. A union official recently reported it is operating at 42% of capacity. I suspect that is an extremely rosy number.

  8. Mark M

    Trump’s AG Tillerson signs climate change declaration “noting with concern” the Arctic is warming

    http://www.michaelsmithnews.com/2017/05/trumps-ag-tillerson-signs-climate-change-declaration-noting-with-concern-the-arctic-is-warming-.html

    Guess Trump’s not gonna need these …

    U.S. Navy and Coast Guard need more icebreakers now
    https://www.navytimes.com/story/opinion/2016/06/08/us-navy-and-coast-guard-need-more-icebreakers-now/85603456/

    This won’t make Trump haters like him, just gives them ammunition to ridicule him.

  9. Macbeth

    Interesting; but what is this “doubling down’ thing? Seeing it everywhere these days.

  10. RCon

    low oil prices are not necessarily a good thing.

    WTF?

    Let’s slap a tax on sunshine and rainwater too, need to make sure there aren’t too many low priced resources around.

  11. Mark A

    RCon
    #2382227, posted on May 17, 2017 at 3:55 pm
    Let’s slap a tax on sunshine and rainwater too, need to make sure there aren’t too many low priced resources around.

    We have been paying tax on rainwater on our farms for yonks.
    There is a charge on the dams collecting runoff.

  12. Nerblnob

    As Bruce’s numbers make clear, nobody is more “in the pay of Big Oil” than those living on government handouts.

  13. Tel

    Can you imagine what the oil price would be if governments didn’t denude the goose of all its feathers? $30/bbl would be quite achievable I suspect.

    I noticed that during the Bush years with the Iraq war and high oil prices, the petrol price at the pump in Australia went right up (hardly surprising). Then when oil prices went back down again with the fracking and the shale and all that… low and behold prices at the pump in Australia kept right on going up.

    Of course I’m used to getting ripped off (been Australian all my life) but we do notice. Just keep that in mind, we see the pocket stuffing.

  14. Notafan

    Would be great to see Australia back in the game again, no doubt our governments federal and state will make that as difficult as possible.

    Despite all Obama’s best efforts he couldn’t stand in the way of American exceptionalism.

    Fracking broke SA’s back. Good.

    Wasnt Scotland looking to survive on North Sea oil?

    Everytime I see lefty clowns demand companies get taxed on gross income rather than net profit I shudder at the stupid.

    Of course Morrison already has that ball rolling.

  15. Oh come on

    This is the thing I’ve long thought about the Saudis – they just aren’t all that bright. They seem to keep picking strategic fights they can’t win. It’s a bit like their effort a few years ago to ramp up production and drive down oil prices to turn the screws on Iran and its nuclear program (and, IIRC, Russia, who had also done something to piss off the Saudis, can’t recall what). The Saudis had a near-trillion dollar asset pile, but with the lower revenue they received as a consequence of the oil price fall they’d caused, they started burning through their savings at a blistering rate. And, as the Sauds know only too well, they rule their kingdom based solely on the largesse they’re able to dole out to the rest of the population who would otherwise send them the way of many other ME monarchies. If Saudi oil revenue becomes insufficient to buy off the Saudi population, the Sauds are screwed.

    Yet they still tried to use the low oil price weapon against Iran, a country that has been under a near-global trade embargo for decades and is thoroughly used to getting by without the oil crutch for lengthy periods of time. Of course the Sauds were going to break before the Iranians! What’s another couple of difficult years to the Iranians? They could have effortlessly waited out the time it would have taken the Saudis to spend their cash reserves and start going deep into the red. As for the Russians, well, they seem to almost relish hardship. Same deal. The flabby-arsed Saudis again were always going to blink before the Russians, too. And of course the Saudis did.

    The Saudis are one-trick ponies. And yes, it’s for sure a pretty good trick. But it often seems to be the Saudis bringing their clever pony to compete against others who are in a Formula One race instead.

  16. john constantine

    Isn’t it just as well that their chavez could get Venezualas oil industry to embrace diversity before things could really go bad?.

    Which chavez policies is Australia moving away from?.

    Can’t decolonise a country without breaking a few eggs.

  17. RobK

    Thanks Marcus,
    Good over view.

  18. Fulcrum

    The one certainty we know is those in power will not claim even partial responsibility for the mess.
    The figure head might change but thats how totalitarians work.

  19. Brian

    I don’t know how many players you need to destroy a country, but I just saw an ad by AGL vowing to remove all coal generated power and replace it by renewables. I know there are similar stupid sentiments by other large businesses, but if the generating companies pull out, what is left to power the country?

  20. Zipster the leftoid torturemeister

    I don’t know how many players you need to destroy a country, but I just saw an ad by AGL vowing to remove all coal generated power and replace it by renewables. I know there are similar stupid sentiments by other large businesses, but if the generating companies pull out, what is left to power the country?

    hmm… maybe we should start trying to corner the market in hamsters…

  21. john constantine

    De-electrification of industry from their ruinables grid, means we go back 50 years to where those that require service the grid cannot provide either go without, or install their own.

    Direct gas and coal fired boilers used to be the big thing.

    Diesel gennies, coal and coke fired central heating.

  22. Nerblnob

    The Saudis aren’t all that stupid. They’re getting into fracking themselves now. I was just talking to a bunch of Saudi engineers about it last month.

    The main reason they want a high price is to fund their social welfare programs to try to keep the peasants placid. They’re also fucking around with intensive agriculture programs . One said to me, “We’re diversifying our economy. Let’s face it, nobody’s gonna come to Saudi for the beaches”.

    They seem very aware of the risk of Venezuela-ing themselves. Much more than Australia is.
    And surrounded by fundies and more than a few to deal with internally too.

  23. Chris M

    low oil prices are inflationary

    I’d like to understand this…?

    Diesel gennies, coal and coke fired central heating.

    Timber, burn timber. Renewables, it’s the green thing to do.

  24. Oh come on

    Sorry but the Saudis have been crapping on for decades about how they’re going big into diversifying their economy away from oil. It never happens and they never manage it. The oil curse gets them every time.

  25. rickw

    Some history. In 2002-3 the oil workers went on strike. Chavez sacked most of the workers and replaced them by party members.

    They also nationalised a number of Oil CO’s assets.

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