You’ve probably heard it a lot already this week, but as it’s my first time writing to you in 2018, happy New Year!
I hope you all enjoyed the festive period, and spent it in good company. I used the time to visit my hometown, and reconnect with family and old friends.
And while I had a great time, I couldn’t help but notice the fallout in the air – from an economic nuke.
Nobody I spoke to, even those most affected by the blast seemed to know who dropped this economic bomb – they were more focused on its effects.
It reminded me a little of the boom of the 1920s and the Great Depression which followed; the generations raised throughout were so traumatised by the experience they wouldn’t touch the stockmarket even after the economy recovered.
What happened?
The city became collateral damage in an oil war between East and West, which is still raging today.
The nuke was dropped by Saudi Arabia.
The silver city reliant on black gold
I was born and raised in Aberdeen, in the north-east of Scotland. Known as the “silver city” for the way its granite buildings gleam on the odd occasion we get any sunshine, it is the oil capital of Europe. Almost all fortunes in the city stem from North Sea oil, one way or another.
The days of $100 oil made the city home to the highest concentration of millionaires in the UK, with oil companies and their contractors spending extravagantly on their employees, and awarding generous bonuses.
Oilmen working offshore for much of the year would start families and buy property and get mortgages there, which bid up property prices and caused a citywide economic expansion.
By night, bars and clubs thronged with revellers. Luxury vehicles became ever more common.
A survey even declared that Aberdeen was the happiest city in the UK – “We are living the dream” a local newspaper proclaimed.
Then came the nuke. The oil price suddenly plummeted.
The fortunes of the city were suddenly reversed. While oil had given, it took away in spades. Thousands of jobs were lost. Mortgages were reneged upon.
The nightlife changed noticeably. Binge drinking, although common throughout Scotland, became even more pronounced in Aberdeen. A distinct tinge of despair flavoured the cold air. Those still hitting the bars had just lost their jobs, or felt they were going to. Questions of how the mortgage would be paid or how to break the news to the wife were replaced with queries as to who serves alcohol at four in the morning.
None I spoke to could point to the cause of the crash. But if they could, they’d point East.
A hand on the world’s heart
Despite their vast wealth, Saudi Arabia has never had nuclear weapons – a condition of its cosy relationship with the US. Whenever this relationship is strained, rumours generally begin to emerge of a Saudi nuclear programme, which evaporate when they get friendly again.
But the Saudis don’t need nuclear weapons to assert their dominance in the world. They have an economic nuke of their own: lots and lots of oil.
All developed countries are dependent on energy – and although methods of capturing renewable energy become ever more sophisticated, oil is still the lifeblood of the world.
Major oil producers effectively have control over this blood supply, which grants them great power. By cutting or increasing the amount of oil they draw from the earth, they influence the price of energy around the world. This influence can and has been used as a weapon.
The country with the biggest grip on this weapon is Saudi Arabia. Although Russia has recently overtaken Saudi Arabia as the world’s largest producer of oil, Saudi Arabia is still the world’s biggest player in the oil market as it controls the Organisation for Petroleum Exporting Countries, or OPEC.
OPEC members make up 40% of global oil production, and 60% of the oil traded internationally. The influence of this oil cartel on the global energy market is second to none.
The OPEC committee dictates to its members how much oil they produce. Saudi Arabia controls OPEC by merit of being the biggest oil producer and having the lowest production costs. If OPEC members step out of line and produce more oil than they’ve been told by the OPEC committee, Saudi Arabia will punish them. It does this by dumping huge quantities of oil on the market and forcing the price down, which reduces the profitability of the rogue countries. Although this inflicts pain on Saudi Arabia too, it has a higher pain tolerance as it costs it less to bring a barrel of oil from the ground to the market than almost any other country in the world.
Saudi Arabia controls OPEC the same way OPEC controls the global energy market. Produce more oil than they want you to, and they’ll force the price down with excess supply and make it unprofitable for you.
To hell with the frackers
The “fracking” method of drawing oil from the earth is very expensive compared to traditional drilling. But high oil prices of the early 2010s made these dreams become feasible.
Eventually, fracking technology, which was originally limited to the natural gas sector, was unleashed on the gas market in force. Fracking rigs in North Dakota and Texas went online and began producing huge quantities of oil, threatening to steal a significant share of the global oil market from the old guard – Saudi Arabia and OPEC.
Although the stated mission of OPEC is to “ensure the stabilization of oil markets”, this was set aside in an attempt to drown the American frackers in a deluge of oil. In 2014 OPEC maintained its production ceiling of 30 million barrels of oil per day, even though this was a million barrels above its own estimate of global demand for oil. Saudi Arabia overruled the poorer countries within OPEC who saw the bear market in oil coming and wanted a production cut.
With billions in foreign exchange reserves, the Saudis could survive low oil prices, Venezuela and Iran be damned. Huge amounts of oil were brought to market from East and West – and the price crashed.
As fracking is more expensive than traditional drilling, forcing the oil price lower would destroy them – or so the Saudis thought.
In reality, it only made fracking operations more efficient. Today, fracking rigs can go online as soon as it is profitable, and offline as soon as it isn’t, dodging each fall in the price that would make a slower operations bankrupt.
North Sea oil – and Aberdeen by extension – was just collateral damage.
The crash that never ended
Since the crash, oil has recovered. The war between the frackers and OPEC remains, but demand for oil is on the up.
Events like the recent unrest in Iran (which some claim is a result of the poor economic conditions there – another result of the oil crash), the temporary shutdown of the Forties pipeline and Libyan oil pipelines being blown up have lent further support to the price.
In a recent issue of The Fleet Street Letter, our own Charlie Morris gave a bullish prediction for oil next year:
Inventories are now falling quite quickly. Normally at this time of year, inventories are supposed to be rising. That they are still falling at the fastest rate for many years, can only mean that an oil spike is on the way.
Our new energy specialist James Allen is also optimistic:
I wouldn’t be surprised if we see crude prices inch further forward in 2018, despite the strong start to prices so far this year, although no doubt we’ll see some downward corrections along the way.
With the extension of OPEC-led production cuts through to the end of 2018, we should see supply/demand balances tighten, or at least not loosen in most producing countries.
And geopolitical risk remains high because of developments in Venezuela, Iran, Iraq, Nigeria and Libya. Life could get very interesting indeed if production disruptions come to a head in several of these countries at the same time.
However, I can’t see oil prices advancing too high. An expected rise in fracking output this year – even if it’s not as significant as previous forecasts – will temper gains. And downward corrections could derive from a slowing Chinese economy, as well as rising output from Brazil and Canada, which both have projects starting up this year.
Back in Scotland, oil companies in Aberdeen see a great year ahead for oil. And yet the atmosphere in the city hasn’t changed from the depths of the crash. On a bar crawl with some buddies on “mad Friday” (supposedly the busiest night of the festive season), the centre of town was absolutely dead. The radiation from the Saudi nuke remains.
All my acquaintances in the oil industry want to remain in the oil industry – just not in Aberdeen. They’ve set their sights on the US and Canada.
I did meet one man who seemed very happy in the current environment. With a cashmere coat over his shoulders, and a giant gold watch hanging from his wrist, his friends lauded him as “the don of the NHS”. When the happiest men in town are taxpayer-funded bureaucrats, you know things aren’t going well.
As for the spirits of those still in the oil industry…
Over Hogmanay, a friend of mine in the employ of a major oil contractor managed to consume a 70cl bottle of rum and many beers before the night was over.
Cheers!
Boaz Shoshan
Capital & Conflict
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Category: Economics