By Chris Cook, Senior Research Fellow at ISRS - University College London

Molecules of Freedom

June 10, 2019

“With the U.S. in another year of record-setting natural gas production, I am pleased that the Department of Energy is doing what it can to promote an efficient regulatory system that allows for molecules of U.S. freedom to be exported to the world.”

This expression molecules of freedom used by US Assistant Secretary for Fossil Energy Steven Winberg to describe the wave of US Liquid Natural Gas (LNG) exports has spread rapidly via social media to become the object of humour and derision by comedians and politicians around the world. As is often the case, this expression has taken on an ironic meaning and significance far beyond the speaker's intentions.

It has been said that the only human impulse stronger than the Will to Power (freedom to dominate others) is the Will to Freedom (freedom from domination) and some would argue that the Will to Freedom is (under God) central to Iran's Islamic constitution.

In this article, I explain the zero sum US physical and financial market strategies which creates molecules of US freedom, and in a second article I shall outline smart market strategies to address this US challenge.

Energy Dominance

President Trump announced on 29th June 2017 a new US energy strategy of “Energy Dominance”. It is now clear that the aim of this US energy strategy is to dominate and control global physical energy markets through an export wave of US natural gas molecules of freedom and their close cousins, shale oil molecules of freedom. But while this new wave of US physical energy supply is clearly visible, the innovative financial market strategy for funding investment in US shale oil and gas has been less than transparent.

In my analysis, while President Trump and his White House team were convinced to pursue the Energy Dominance physical energy strategy of flooding the world with molecules of freedom, they are probably unaware of precisely how it is that the extremely energy intensive production of US shale oil, and its associated natural gas could be afforded.

It is increasingly clear that since the beginning of 2019 there has been a  fundamental change in the relationship between the US dollar and other currencies, and between financial and oil markets. In order to understand this, it is necessary to understand the previous US energy strategy and how it has changed.

Transition through Gas

President Obama was a Wall Street Democrat President, and followed a smart Wall Street energy strategy. Immediately after taking office in 2009, the Brent/BFOE benchmark price was inflated by fund capital and US Quantitative Easing (QE) liquidity. The oil price was maintained between $80 and $120/barrel for five years to mid-2014 which led to a US shale oil production increase of 5m barrels/day and a fall in US product consumption of 2m bpd. The oil market became over-supplied, and as I predicted it would be in Tehran in late 2011, the oil price collapsed to $45/$50 per barrel in 2014 when the US Federal Reserve Bank ceased QE.

This new shale oil capacity fulfilled Obama's strategic objective to rid the US of reliance on Saudi oil, and to control natural gas through a dominant US presence in Qatar, along with opening up the Southern Corridor to Europe from the Caspian region and the normalisation of relations with Iran.

PetroEuro

Once the Saudis realised they had been fooled by President Obama, they ceased the long standing petrodollar policy, whereby financial surpluses from oil sales ironically funded US investment in shale oil which ended US reliance on Saudi oil. In early 2015, the European Central Bank, which since the beginning of the Euro had coveted PetroEuro status, began the process of Euro Quantitative Easing (QE). While the public reason given for this Euro QE was economic stimulus, the real reason was the need for new Euros to enable Saudi Arabia (and possibly GCC countries) to purchase € denominated sovereign debt, from Germany and others.

This US Transition through Gas strategy would have continued under a  Clinton Democrat presidency but it ground to halt upon the unexpected election of President Trump in November 2016.

A Double Act

The architects of the Energy Dominance strategy were both surprising Trump appointments: Gary Cohn was the former Goldman Sachs COO/President and Democrat while Rex Tillerson was former CEO of Exxon. Between them they possessed a strategic understanding of financial and physical oil markets while Gary Cohn was a co-founder in 2001 of the Intercontinental Exchange (ICE) global oil market platform.

President Trump's Energy Dominance speech came a week after the appointment of Prince Mohammed bin Salman as the powerful First Deputy Prime Minister of Saudi Arabia. Just two days later, on 1st July 2017, Saudi Arabia announced that their oil would after 16 years no longer be priced against the Brent Weighted Average (BWAVE) formula of electronically traded ICE Brent/BFOE futures contracts but would instead be based on reported trading of forward physical Brent/BFOE contracts.

In the second half of 2017 the oil price recovered dramatically from $45 to $75/barrel as 1.4 million oil and products futures contracts representing some 1.4 billion barrels were purchased by unidentified managed funds. Almost exactly nine months after the Energy Dominance announcement, at the end of March 2018, both Gary Cohn and Rex Tillerson left office within days of each other.

During the following nine months to the end of 2018, the US Energy Dominance strategy continued to be rolled out. So existing Petroeuro energy, foreign exchange and financial positions were wound down, while new Petrodollar market positions were put into place.

Macro Market Manipulation

One of the basic rules of commodity markets is that whenever commodity producers can support prices by funding stockpiles of surplus production, then they will. Moreover, such macro market manipulation may persist for decades: examples include International Tin Council 30 year support of the tin market until the 1985 Tin Crisis overnight price collapse, and the ten year copper market manipulation by Japan's Sumitomo.

From 2001 to 2017, Wall Street and a couple of major oil companies have been able to routinely support the global oil market Brent/BFOE benchmark price. They have done so whenever sufficient capital has been made available by market participants willing and able to fund oil inventory. This has been achieved by using the same opaque tripartite prepay funding method, facilitated by major US investment banks, through which Enron was able to defraud investors and lenders for a decade.

The Oil Standard

So at the end of 2018 a new Petrodollar era began as the brief flowering of the Petroeuro came to an end along with the European Central Bank's QE programme accommodating it. The relationship between those funding macro manipulation and the market is now direct, rather than via investment banks. Through the use of option strategies the global oil Brent/BFOE market price appears now to be pegged between a cap of around $75/barrel and a price support collar at $60/barrel.

Historically, US shale oil development has been financed by a combination of equity ownership and enormous amounts of cheap debt funding, which had in turn been made possible by Saudi petrodollar funding of the US financial system. We now see the oil majors, led by Exxon entering the US shale oil industry in a big way, through the acquisition of smaller and indebted shale oil businesses.

The oil majors are able to sell shale oil forward in US futures markets, where these future oil sales are purchased by unidentified funds with both an interest in maintaining a high oil price and $ billions of US Treasury Bill collateral. The outcome is that oil prices have been maintained at prices high enough to finance production and export of the shale molecules of US freedom which we now observe. Production of this extremely light US crude oil quality has now created a global glut of light oil products such as gasoline and to an increasing shortage of heavier products such as diesel fuel.

Another effect of macro market manipulation and support of the Brent/BFOE contract has been that the price has increasingly become detached from the US West Texas Intermediate (WTI) benchmark price. So the WTI price has suffered from a glut of light US shale oil, and has sometimes been more than $10 per barrel under the Brent price. This has even led to the crazy situation that it has been economic for US crude oil to be shipped half way round the world to China to be refined with gasoline then making the return journey.

The Art of the Deal

Even a brief read of President Trump's book, the “Art of the Deal” reveals that he is at heart a developer who loves nothing more than transacting deals from a position of market power.  The Energy Dominance strategy is not a political strategy following an ideology: it is a market strategy conducted as a zero sum game with winners and losers – and President Trump likes to be a winner.

President Trump has no time for ideology, whether between Socialism and Capitalism or an imaginary religious Clash of Civilisations. President Trump is throwing away the international institutional rule-book and is now quite shamelessly using sanctions as a commercial weapon to destroy competition for US LNG.

So in Europe we see that it is now dawning upon the EU that US sanctions related to Russia's Nordstream supply of gas to Germany (an existing customer) are simply a means of coercing Germany to buy US gas molecules instead of Russian gas molecules which, as Rosneft CEO Igor Sechin pointed out only recently, are 30% cheaper than US molecules. Meanwhile in Iraq, sanction waivers for Iranian energy supplies are being traded for concessions to US Big Oil in major Iraqi oil fields.

As for alleged concerns of security of supply, anyone who believes that a second pipeline reduces security, or that Russia, who reliably supplied natural gas to Germany throughout the Cold War, is a less reliable supplier than the US under President Trump is deluding themselves.

Molecules of US Freedom

Let us conclude where we began, with molecules of US freedom.  President Trump's transactional approach to energy strategy is based on a zero sum transactional market in molecules of energy traded as a commodity.

This transactional energy commodity market is coming to an end, as easy to extract oil and gas runs out and expensive and energy intensive 'hard' oil is all that is left, and the more expensive this hard oil becomes, the more profitable it is to substitute renewable energy and to invest in energy efficiency.

The reality is that molecules of raw energy must be converted to useful energy delivered to end-user consumers. We now see a new smart market emerging in efficient delivery of energy as a service; heat/cooling, power, mobility and electromagnetic energy. This is driven financially firstly by the fact that savings of energy services give rise to a multiple of savings of molecules produced at the well. Secondly, we see the displacement of finance capital by 'smart' intellectual capital, the Fifth Fuel, in which Iran is rich not only in raw human material but in university refineries!

This emerging smart market in services requires relationships, not transactions; competition for quality and cooperation on costs; and sharing of risk, cost and surplus to achieve mutual positive sum benefit. In other words, Iran may use molecules of freedom to generate electrons of enlightenment and in my next article I shall focus on how that may be achieved.

Leave a Comment

8 + 9 =