From Pawn to King: How the Permian Changed Oil's Game of Thrones

(Bloomberg) -- When President Donald Trump talks about U.S. energy dominance or tweets about Iranian sanctions, it’s underpinned by a startling American achievement: The global emergence of the Permian Basin.

The giant oil patch in West Texas and Southeast New Mexico has given the U.S. the kind of leverage it could only dream of just a few years ago, enabling it to implement a full-blown ban on Iranian crude without fear of oil spiking higher. Four decades after the Islamic Revolution saw prices triple, the White House has been able to isolate two of OPEC’s five founding members, Venezuela and Iran, without disrupting its own economy.

Major oil companies that began to drift away from Texas in favor of the lower-cost North Sea and Alaska in the 1970s are now coming to the Permian with multibillion-dollar expansion plans. The heightened level of corporate interest helped fuel the bidding war for Anadarko Petroleum Corp. earlier this month. Those investments and consolidation promise to make the shale play more efficient and OPEC’s life more complicated.

But before isolationists get too excited about a new era of U.S. energy independence, it’s worth remembering what the Permian is not. It doesn’t supply the heavy crude that refiners need to make diesel and jet fuel, nor does it have Saudi Arabia’s 260 billion barrels-plus of reserves. And it wouldn’t be thriving if a Saudi-led coalition hadn’t rescued oil from its free-fall toward $20 a barrel in 2016.

“It is a complete game-changer in terms of leverage that the White House has, being able to use oil sanctions as a geopolitical tool,’’ said Ellen Wald, president of Transversal Consulting and a senior fellow at the Atlantic Council’s Global Energy Center. “However, it’s not the silver bullet. It can’t solve everything.’’

A sedimentary basin of oil-steeped rock covering an area that’s almost the size of the U.K., the Permian currently produces more than 4 million barrels a day, more than any OPEC nation but Saudi Arabia and Iraq.

The massive shale formation is the main driver of growth that will take American output to an average more than 13 million barrels a day next year, according to the U.S. Energy Information Administration. By comparison, Saudi production reached about 11 million before the kingdom started cutting production to bolster prices.

The abundance of shale supplies provided a cushion that made April a relatively calm month for the oil market, despite unrest in Venezuela, the looming end to Iran sanction waivers, and strife in Libya.

“One could safely say prices would be in the $90s, if not the $100s, without this oil,’’ said Joe McMonigle, head of energy policy at Hedgeye Risk Management LLC and a former chief of staff at the Energy Department.

The shale revolution has emboldened the Trump administration to pursue a clampdown on Iranian oil. That confidence was underscored in early November when Trump tweeted that "sanctions are coming" (echoing the tagline “Winter is Coming’’ from HBO’s TV series Game of Thrones).

But just like in the TV show, there isn’t just one king, glory can be fleeting and the plot is never simple. To be sure, Trump went on to tweet requests for OPEC to pump more and get oil prices down.

“The very fact that, despite the shale revolution, the president feels the need to go on Twitter and berate the Saudis to increase supply is a reminder of how connected we still are to the global oil market and how dependent we still are on OPEC supply decisions,’’ said Jason Bordoff, head of the Center on Global Energy Policy at Columbia University.

Things were simpler in the post-war era. Oil hardly ever traded at more than $2 a barrel until the Arab embargo of 1973 pushed it to almost $12 in a matter of months. The Iranian Revolution of 1979 saw prices surge again, hitting more than $35 two years later.

Becoming independent from Mideast oil has been a dream ever since. The shale boom has brought that closer to reality as it made the U.S. the world’s top producer once again. And thanks also to the commoditization of oil in recent decades, the country is now less vulnerable to any single supplier.

However, the Achilles heel of the U.S. shale sector is its role as the so-called marginal producer. The price of oil at which it breaks even remains higher that in the Middle East, leaving it more vulnerable in a downturn.

“If OPEC+ fails, I believe the price will collapse again, and shale is not the winner in a price war, it’s the loser," said Bob McNally, president of Rapidan Energy Advisors LLC and a former oil official at the White House under President George W. Bush.

Shale explorers’ ability to make long-term strategic decisions is also limited by shareholder pressure for returns and the need to meet payrolls. “That’s a completely different mindset than where Saudi Arabia is coming from -- it’s almost so different that it’s like apples and pancakes,’’ said Wald, who’s also the author of the book ‘Saudi, Inc.: The Arabian Kingdom’s Pursuit of Profit and Power.’

The kingdom, she added, doesn’t “see the Permian as an existential threat, they see it as a major producer right now that is part of the market that they have to deal with. But for all they know, those companies may not even be there in 20 years.’’

In the meantime, thanks to its newfound bonanza, the U.S. can enjoy the most clout in the oil market since the 1960s –- at least until the next price crash.

--With assistance from Caleb Mutua and Catherine Ngai.

To contact the reporter on this story: Carlos Caminada in Calgary at ccaminada1@bloomberg.net

To contact the editors responsible for this story: Simon Casey at scasey4@bloomberg.net, Joe Carroll

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