China, oil, and the dollar

By Ed Crooks

The US dollar’s position as the dominant global reserve currency has been resented by other countries for decades. The perception that the US wields outsized influence was encapsulated back in 1971 when John Connally, Richard Nixon’s Treasury secretary, told European finance ministers: “The dollar is our currency, but it’s your problem." Whenever a financial innovation looks like it might have a chance of dethroning the mighty dollar, there is always a flurry of excitement.

All eyes this week have been on the threat of a possible trade war between the US and China.

But commentators have suggested China’s new renminbi-denominated oil futures contract, launched last week, could also be seen as a sign of international tensions over shifting economic relationships. Intelligence group Stratfor’s assessment was that through crude oil futures, and gradual financial liberalisation, “China is hoping to break the dollar's stranglehold on the global financial system”. However, it noted, for as long as China is the world’s largest oil importer, and exporting countries prefer to be paid in US dollars, then the dollar is likely to remain dominant. Analysts warned that China’s capital controls would limit the international appeal of the contract. The South China Morning Post observed that the contract resulted from “China’s ambitions to secure bargaining power” over oil pricing, but it was described as just a “baby step” in that direction. Huang Lei, an independent commodity futures analyst, told the paper the contract was far from becoming a regional benchmark, adding: “Globalisation is a long, long process”. John Kemp of Reuters struck a more positive note, however, arguing that the contract had “a good chance of confounding the doubters” to become a success.

One point to watch will be whether China starts paying for its oil in renminbi instead of dollars. Reuters reported that China planned a “pilot programme” of renminbi payments, possibly starting in the second half of this year. The first buyers could be Russia, which has long been interested in breaking the dollar’s dominance, and Angola, which was recently forced to scrap its currency’s dollar peg. Nick Cunningham for pointed to one development that could give the new contract a boost: the reimposition of US sanctions on Iran. Marc Chandler explained some of the reasons why the dollar is expected to remain the dominant reserve currency for the foreseeable future, regardless of how the renminbi oil contract fares. China's holdings of US Treasury bonds are often described as giving it a "nuclear option" in a trade dispute, and Kate Duguid and Trevor Hunnicutt for Reuters explained why the metaphor is highly appropriate: dumping US debt would be likely to prove a self-destructive tactic for China.

Royal Dutch Shell is one of the international oil companies being pushed by investors to adopt more ambitious goals for addressing the threat of global warming, and last week it set out a vision of what that might mean. It published what it called its “Sky scenario”, described as “a technically possible, but challenging pathway for society to achieve the goals of the Paris Agreement”. The agreement committed the signatories to holding the increase in the global average temperature since pre-industrial times to "well below" 2C, and to "pursuing efforts" to limit it to 1.5C. There is a lot of detail in the report, which is worth reading in full, but this is one chart that particularly struck me, comparing the “Sky” scenario with two others — "Mountains” and Oceans” — that are not consistent with the Paris target. The Sky scenario is the right-hand bar in each group of three. Up to 2025 there is little difference, but by 2050 the scenarios diverge significantly. Sky has a lot more solar power — the orange bar — less coal, and less gas. The scenario is neither a forecast nor a policy prescription, Shell says, but it does give an idea of the expected tradeoffs and the consequences of different choices.

Mike Scott of Forbes said the Shell report, like similar but less detailed publications from ExxonMobil and Chevron, was “hugely welcome”, although far from the last word on energy and climate. David Roberts wrote a lengthy analysis for Vox, arguing that the Sky scenario looked "wildly ambitious". He suggested Shell’s strategy was “to appear game, to appear to take climate change seriously, but also to leave itself room to manoeuvre”, in case governments do not follow through with policies to achieve the Paris objectives. Simon Evans of Carbon Brief pointed out that, like other similar scenarios, Shell's analysis was heavily reliant on "unproven negative emissions technologies to suck excess CO2 from the atmosphere".

A week after Shell published that Sky scenario, it was threatened with legal action aimed at forcing it to shift away from fossil fuels. Roger Cox, the lawyer leading the case, said: "Shell’s current policy is on a collision course with the Paris agreement."

In the US, some oil companies are fighting back against investor pressure on climate, helped by a sympathetic regulator. Amy Harder at Axios reported on how the Securities and Exchange Commission had broadened its definition of “micromanagement”, a change that apparently makes it easier for companies to reject votes at their annual meetings on resolutions calling for them to set greenhouse gas emissions targets. However, there are still almost three dozen climate-related resolutions that will be voted on at oil, gas and power companies' annual meetings this year.

One key issue for Shell and other oil and gas producers is that, regardless of climate policy, renewable energy sources are becoming increasingly viable competitors to fossil fuels on purely economic grounds. A review by Bloomberg New Energy Finance of the levelised cost of electricity from different sources found “the economic case for building new coal and gas capacity is crumbling". The Global Trends in Renewable Investment Report 2018, published by BNEF along with the UN Environment Programme and the Frankfurt School of Finance & Management, showed that installations of renewable electricity generation capacity far outstripped net additions of fossil fuel capacity last year. It warned, however: "It is also evident that we need to continue to push the acceleration of the global renewable energy revolution." The report is full of striking charts, including this one showing how China (the darker green slice) dominates global investment in renewable energy.

A potential shift of the world's energy system away from oil is one of the central issues for Crown Prince Mohammed bin Salman of Saudi Arabia. At 32, he could quite possibly be ruling his country 50 or 60 years from now, and surviving in a world with constraints on fossil fuel use and much greater electrification of transport is of more than academic interest to him. MBS, as he is familiarly known, has brought his travelling “charm offensive” to the US, and capped his visit with a dramatic announcement: a plan to join forces with SoftBank of Japan to invest up to $200bn in solar power in the kingdom. As is often the case with such eye-catching announcements, the words “up to” are important here. The initial investment will be about $5bn, of which the Saudis and SoftBank will be putting up about $1bn each. Still, as Quartz put it, the ambition of the plan is certainly “eye-popping”. Prince Mohammed gave an interview to Time magazine, in which he suggested that the IPO of Saudi Aramco might be delayed because "we believe oil prices will get higher in this year and also get higher in 2019". In the New Yorker, Dexter Filkins had a long profile of the prince.

Saudi Arabia is doing its best to make his prediction of higher oil prices come true. After the success so far of the Saudi-Russian accord in boosting crude prices, the two countries are now talking about a 10-20 year alliance. One concern for Saudi Arabia might be whether Russia can be relied on to keep up its end of any longer-term deal. Despite the agreement between Opec and leading non-Opec producers to curb crude output, Russian hit an 11-month high in March.

Bahrain, Saudi Arabia's much smaller neighbour, has oil production and proved reserves that are correspondingly meagre, but its announcement of an 80bn barrel discovery raised the prospect that it could change that. Although the headline number is impressive, Bahrain still has a long way to go before it can turn the discovery, which also includes substantial gas resources, into revenues. One important obstacle: the discovery is in shale rock offshore, and no-one has yet managed successful production from that type of reserve.

The electrification of transport has hit a few bumps in the road recently, in the shape of troubles at Tesla. The company disclosed last week that one of its cars that crashed last month, killing the driver, was under the control of its Autopilot software at the time. It decided to recall 123,000 Model S sedans to fix possible excessive corrosion in the power steering bolts. Its debt was downgraded by Moody’s, the rating agency. And it is battling to increase output of its new Model 3 car, with chief executive Elon Musk taking direct control of production. For FT Alphaville, Dan McCrum argued that expectations that another carmaker would ultimately have to buy Tesla were probably misplaced. Meanwhile, Mr Musk is also facing a lawsuit over Tesla’s 2016 acquisition of SolarCity, where he was chairman. Tesla had better news this week, however, reporting it had stepped up production of the Model 3, although it is still running below target.

The debate over the environmental impact of electric vehicles has been running for a while, and most of the arguments have been thoroughly aired, but Thomson Reuters had a fresh take, using a series of striking graphics to discuss whether EVs would “create a cleaner planet”.

President Donald Trump’s attempt to “bring back coal” has not been making much progress in the US electricity industry, and now his administration faces a tough decision about whether to intervene directly to prop up coal-fired plants threatened with closure. FirstEnergy, the Ohio-based utility group, over the weekend said that subsidiaries with coal-fired and nuclear plants in the competitive electricity market were entering Chapter 11 bankruptcy protection, so that it could become a fully regulated company with more stable earnings. Those plants are seeking a federal bailout to keep them open, arguing that they need support under emergency powers designed to make sure the lights stay on. An intervention from the administration could allow the plants to earn above-market prices for their power; they have found it hard to compete against lower-cost electricity provided by gas-fired plants. Bloomberg New Energy Finance estimated that half the coal-fired plants in the US would lose money without regulation to support them.

Rick Perry, the energy secretary, now has a decision to make about whether to tell consumers to pay more to keep the coal and nuclear plants open. At an appearance in West Virginia, Mr Trump said the administration was "looking at" whether to issue the emergency order.

CNBC carried an interesting story on how the descendants of John D. Rockefeller have managed to stay rich down the generations. One factor that seems to have been important: the break-up of Standard Oil in 1911, which split the family fortune across multiple companies and trusts. The antitrust action against Standard Oil was fuelled by the reporting of Ida Tarbell, who exposed Rockefeller’s unethical practices. It turns out that ultimately she may have done his family a favour.

And finally, if you have been wondering how Rex Tillerson, the former ExxonMobil chief executive, has been spending his time since being fired as secretary of state, Golf magazine has the answer: he has been at the Augusta National golf club, "working the driving range, observing ball distribution to the players".

With tensions running high in the UK’s relations with Russia, concerns about the country’s dependence on imports of Russian gas have risen up the political agenda. The Oxford Institute for Energy Studies has published a paper looking at UK fossil fuel imports, concluding that the greatest challenge to UK security of gas supplies in the medium term (to 2022) was not dependence on Russia, but rising exposure to price volatility on the European market. The UK's reliance on gas imports is set to grow: its production is declining, and there has been a dramatic shift in its power generation mix away from coal and towards gas and renewables. The chart shows coal generation, the black line, plunging since 2012, while gas, the blue line, has been soaring. The UK's shift away from coal towards gas and renewable energy has cut its carbon dioxide emissions, and led to suggestions that it is an example that other countries could follow. Energy security considerations could raise a question mark over that conclusión.

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