Evolution 4.0 Analysis | Petroleum Industry Macro View
What is a commodity war? Or rather, what is a valuation of commodities war? For those unfamiliar, observing current commodity values, particularly within the petroleum sector, will give a fairly accurate representation of what we are going to illustrate in this article. Few global economic marketspaces do as good a job as the petroleum industry when it comes to straddling the fine lines between private sector, global political, and military.
In order to properly illustrate our point, before we can speak about petroleum as a commodity, or the petroleum marketspace as an industry, we must first understand the bigger picture. It goes almost without saying that petroleum as a commodity certainly represents power on the world stage. Controlling as much of the petroleum logistics chain (not only the discovery process) as possible gives nations (and multi-national corporations) tremendous power which in some cases extends even beyond the control of duly elected sovereign governments.
Firstly, we have seen what can only be described as a serious paradigm shift when it comes to the production side of oil. With each passing week, Russia (the R in the BRICS acronym) continues to assert itself on the world stage as the premier petroleum producing nation. Those that are old enough to remember living through the 1970’s fuel crisis in the United States will clearly remember the “bad guys” in that scenario being OPEC (Organization of Petroleum Exporting Countries).
Of course OPEC is essentially synonymous with the Middle East and various Middle Eastern oil / petroleum producing nations. Amongst many other components that make the Middle East unique in terms of a geopolitical sphere, the vast amount of desirable resources (most notably petroleum) is statistically top of the list. But the Middle East, Middle Eastern petroleum producing nations, and the various storylines therein is only part of the global petroleum puzzle. In order to understand what is seen in terms of end consumer pricing in the form of unleaded gasoline, diesel fuel, and home heating oil, a few other components must also be taken into consideration.
As we have already stated, the ability to produce, refine and ultimately export petroleum products represents power. In an increasingly industrialized world, one of the few constants that have been seen economically is the steady uptrend in demand for oil. The late 20th century and current economic climate with many larger nations becoming true emerging markets signal only increased demand for all petroleum products. The increased demand comes not only for oil as a fuel / energy source, but also as a vital component in the manufacturing of a nearly endless variety of consumer goods such as plastics.
What that means is that in addition to being able to effect global fuel supplies / pricing and the dynamics therein associated, those that are able to exert some level of control in the petroleum space also have a direct link to many other components of manufacturing / consumer goods. Essentially petroleum effects consumer goods pricing not only on a transport and logistics level, which much has been written about, but also in the very manufacturing sense too. A logical question to ask at this point is what can be expected in terms of end user pricing of petroleum products as what essentially amounts to be a commodity war continues to play out.
Perhaps the most important component to understand when it comes to end pricing is toward the very beginning of the equation which is something slangy called “breakeven price”. That is the price per barrel that a nation can extract oil, transport oil, refine petroleum into some end user product, and then export said end user products and keep the supply chain at all levels funded. Based upon Evolution 4.0 research and analysis, right now the global average for that breakeven price is between 30 to 40 US dollars per barrel.
Important note: We are not speaking in terms of alternative extraction methods such as oil shale, which is critical also in understanding what we are seeing in terms of the macro narrative in the petroleum marketspace. Notice also, that Evolution 4.0 put the breakeven point at between 30 and 40 US Dollars per barrel. The ten dollar difference is critical in understanding what is being seen as far as the volatility in petroleum pricing. The equation albeit rather simple is as such:
If nation A’s breakeven price through production is 35 dollars per barrel and nation B’s breakeven price through production is 40 dollars per barrel, fundamental laws of economics clearly state: Nation A has a 5 dollar advantage per barrel when compared to nation B in terms of overall petroleum production costs. Now selling at a breakeven price in any business is not sustainable or desirable, however the short term effects of doing so explain a lot of what has been seen so far in said petroleum marketspaces. Firstly, on average, according to the Evolution 4.0 system’s analysis, the BRICS nations specifically Russia and to a lesser extent China, have lower extraction and productions costs than many western nations.
This can be attributed to a variety of components such as environmentalism, workplace safety mandates, as well as efficiency throughout the logistics chain. However as in the example of Nation A and Nation B, let us now replace Nations A: BRICS and Nations B: Anglo Western / Middle Eastern petroleum producing nations. The example five dollars per barrel advantage means that with BRICS nations selling at cost they can “starve” the Anglo western banking nations oil infrastructure and production abilities to the point of ineffectiveness. In addition to economic ramifications, there are also the geopolitical effects such as many western nations rightfully questioning the relevance of the Middle East as the be all and end all of petroleum production.
As we mentioned earlier, alternative petroleum extraction processes such as the usage of Oil Shale (example: the Marcelleus oil shale projects) do in fact require oil to be valuated at approximately 70 US dollars per barrel for the sale of oil shale petroleum at breakeven pricing. This is due primarily to the additional costs associated with refinement processes that are still being developed / perfected. By the BRICS nations (again, most notably Russia) selling petroleum on the open market at what comparatively would be considered “deeply discounted” pricing, they have essentially obliterated the North American oil shale industry in its entirety.
This is a fantastic example of what we mean in terms of a commodity “war” or commodity valuation war: Nations or economic alliances using specific valuations of commodities to produce a given effect on other nations / alliances GNP/GDP/overall industrial output. A more simplistic example being the one penny per gallon “price wars” that often occur between two gas stations on opposite corners of a busy street. The equation becomes: who can sell at or sometimes even below cost longer, with the end goal essentially being to put the competitor out of business entirely (therefore gaining a dramatically larger piece of market share).
Evolution Consulting would like to point out that there are dangers associated with any kind of pricing / commodity war, especially when it comes to an industry as significant as the global petroleum trade. Unlike in purely private sector marketspaces (think Circuit City vs Best Buy or Computer City vs CompUSA) as examples, no governments were destabilized during those entirely corporate pricing wars. In the petroleum industry however, the risk for entire nations to destabilize because of the fact that nations’ GNPs and GDPs (and real economies) are affected by such commodity wars is very real.
To simplify one of the real dangers associated with pricing wars, we can once again use our earlier example of Computer City vs Best Buy. As we know, Best Buy did survive and ultimately gain a tremendous amount of market share from circuit city closing its doors permanently. Ultimately the way they were able to do that is simple, Best Buy at the time (and currently) had much deeper pockets than circuit city did. Therefore, again, to use elementary examples, they were able to sell at or below cost in order to gain market share, for much longer than Circuit City was able to.
Therefore, in that instance, Best Buy did in fact win that “price or valuation war”. Often times, for those that watch main stream media outlets, we hear the phrase “buying market share”. That is another way of saying “pricing war”. Buying market share is basically a reference to losing money on some or all sales in order to gain customers. Please note that this can be an effective short term strategy, but can be detrimental longer term for both businesses and more importantly, entire industries and marketspaces.
Please note that examples that we used above (electronics retail stores) deal in consumer goods that are not considered “needs” by economic / sociological standards. Petroleum on the other hand is at this point a “need” as far as global industrialized economies go. Items or commodities with inelastic demand such as petroleum are usually far more easily “weaponized” in commodity wars when compared with items or commodities that do not fall under the heading of optional / discretionary purchase. The two “sides” that are presently involved in our Circuit City / Best Buy like commodity war would be the Anglo Western nations and the BRICS nations. When we used Evolution 4.0 to analyze the likely outcome from a prolonged commodity war between those two sides, the results were in a few cases predictable, though in many cases, quite shocking.
Add to the global oil trade commodity war the fact that global currencies are affected and what we start to see is how truly interconnected the petroleum industry is with almost every facet of a nation’s (and the global) economy.
At the very heart of the Anglo Western vs BRICS petroleum war is the Petrodollar. Without going into any excessive level of detail in this piece, the Petrodollar, and the circumvention of the Anglo Western banking system’s monopoly on oil trade is one of the very reasons the BRICS nations exist. As other pieces that have been published accurately illustrate, a straight line can be drawn to the increasing strength of the BRICS nations / BRICS banking system and the stability of the US dollar as a world reserve currency. Please note that we do go into much more detail in the “2015 Grant Street Notes Petroleum Report).
