The American Retreat, Part I: Oil

Read the other installments in this series:
 
The American Retreat, Part II: Soldiers of Fortune
The American Retreat, Part III: the Korean Peninsula

I’m going to do something I loathe and quote something I read on Twitter June 24. In a pair of posts U.S. President Donald Trump asserted:

Diction and statistical issues aside, these tweets comprise the 92 most important words used by anyone in the past three decades. Trump just made clear the days of America protecting global shipping – particularly of oil shipping in the Middle East – are over.

There is an easy argument to be made that the United States’ shale revolution will make the United States a net exporter of crude oil in the current calendar year, but to understand just how critical that is for the Americans we must first pick apart just how horrible that is for everyone else.

Let’s talk importance:

In the pre-Order world if you couldn’t obtain fossil fuels yourself, first coal and later oil, you failed to industrialize. Your manufacturing would at most be a step above cottage industries, so no mass education and no consumer goods (aka peasantry and mass poverty). Lack of fuel condemned you to having an at-best rudimentary transport system meaning your cities were very small, only able to exist in regions that could grow their own food (aka high living costs and low quality of life).

The handful of locations that could secure fossil fuels – either by producing it locally or by seizing it from others – could advance into something we today recognize to broadly mean “civilization,” which includes among other things homes that don’t leak and gadgets and full bellies.

This all changed in the late 1940s. After World War II the Americans created a global Order – a mix of security and trade guarantees which they used as a bribe to induce others to join their side in the Cold War against the Soviet Union. With global security now a thing, oil could be shipped safely and at volume without military escort, meaning that countries that didn’t have a military capable of escorting could now access fossil fuels. BAM! Civilization goes global.

Remove the Order, remove global oil markets, and civilization itself goes into screaming reverse in any location that lacks either the ability to produce oil locally, or the ability to venture forth and secure someone else’s.

Let’s talk vulnerability:

Crude tankers are huge. A modern supertanker can shuttle around oil weighing more than four Nimitz-class aircraft carriers. They are so big expressly because of the Order.

Pre-Order, merchant shipping used small, fast vessels because they needed to be able to scatter and hopefully outrun predators whether those predators wore eyepatches or naval uniforms. The Order ended such predation under the watchful eye of the U.S. Navy. Instead of commercial advantage coming as a result of speed and distributed risk, it instead came from efficiencies and economies of scale. Ships evolved to became slower to save on fuel costs, and bigger to get more bang for the buck. Today’s oil tankers are the slowest and biggest of them all and are nearly 50 times the size of some of the biggest cargo ships of the WWII era.

A similar logic holds with ports: size generates economies of scale. In addition, as ships have gotten larger, ports had to expand to match – a city with a small dock simply cannot handle a ship that is longer than the Empire State building is tall. Bigger, slower ships forced fewer, larger ports. Disrupt anything within the system and the damage quickly becomes extreme.

Between oil’s criticality to and ubiquitousness in modern life, oil is by far the most commonly traded product on Earth comprising some 18% of all maritime shipping traffic (by volume). About a third of all waterborne crude and product shipments originate in the Persian Gulf.

Let’s talk stickiness:

There are no shortages of politicians out there who agitate for relocating manufacturing capacity to their countries, provinces or cities. Making a speech is one thing, but actually building industrial plant and infrastructure is another. It costs billions and takes years for large industrial shifts, and even then there is no guarantee that a new industrial park will prove economically viable.

But at least manufacturing can be relocated. Commodity production cannot. Either you have it or you don’t, and the Persian Gulf has the greatest concentrations and volumes of easily-produced conventional crude oil on the planet. It can never not matter.

There’s also the impossibility of substitution.

Simply put, greentech isn’t ready. Most advances in greentech have to do with electricity generation, and since so few countries burn oil for electricity greentech’s impact upon oil markets has been negligible. As a rule greentech is shit for transport. High cost combined with insufficient energy density makes electric cars little more than a niche sector for early adopters, with Tesla’s recent sales figures crash indicating that market may already be saturated.

Even if the medium for most modern batteries – lithium – was sufficiently energy-dense to provide a viable long-term improvement in capacity (it isn’t), the stuff still needs to be mined and processed and fabricated into battery assemblies. Each step along the value-chain is so energy- and transport-intensive that very little of it can even be attempted without fossil-fuel-based energy for processing and transport across the world. As counterintuitive as it sounds, we need more carbon-heavy fuels to get to a lighter-carbon world. And that means coal and oil. A lot of oil.

There’s also the issue of lifespan. Most vehicles put on the roads since 1990 have a long lifespan to the point that even if every passenger vehicle sold from now on was an EV, we’d not see an end to oil in passenger transport for another two decades. Even then, even if every passenger vehicle and light truck were an EV right now, that would only make a dent in global oil demand. About 2/5ths of oil is used for transporting people and heating. The rest is much more difficult to do away with. Another 1/3rd is used for air transport, industry, and other modes that require far more range or power than electric engines can manage. And another 1/5th isn’t going anywhere ever, as it is what makes petrochemicals as varied as paints, plastics and pesticides possible.

(None of which means greentech won’t eventually solve the petroleum problem, but all of which means technology needs another couple decades to give it a go – and even that assumes the capital and educational structures around the world which have made the Digital Revolution possible hold steady at their current historical highs.)

Let’s talk protection:

At the end of World War II every nation of consequence aside from the United Kingdom had lost its navy. The United States in essence inherited the global ocean. America’s creation of the Order gave everyone aside from the Soviets a vested economic interest in not floating a new one. Fast forward to today and the American Navy is over ten times as powerful as the combined blue water fleets of every other country combined. Putting that force disconnect at the service of the global commons is what makes the Order work, and what makes global energy shipments and markets possible.

The world’s second- through sixth-most powerful navies in terms of long-range power projection are (roughly in order) Japan, the United Kingdom, France, China, and Russia. Of these only Russia need not sail forth for oil, as it has plenty of its own. France and the United Kingdom can secure what they need from the North Sea and North and West Africa. China has only 30  combat-capable surface ships of size that can effectively operate over 1000 miles from shore; unfortunately (for the Chinese) Southern China is a cool 5800 or so miles distant from the Persian Gulf. Only India – keeper of the world’s seventh-strongest navy – is even remotely proximate.

End result? Today’s oil markets comprise the greatest concentration of risk in themost critical economic sector at the most vulnerable part of the global system and no one can do anything about it if the Americans leave.

And that’s just the beginning.

By the way, for more on oil’s role in a world without American strategic oversight, I’m happy to refer you to my 2016 book, The Absent Superpower: the Shale Revolution and a World Without America. 

To Hack Or Not To Hack

The New York Times dropped a fun piece last week asserting a coalition of like-minded national security and intelligence professionals are neck-deep in an offensive cyber operation against the Russian electricity system. The article suggests the hacking was meant to provide a cudgel to beat Russia with should it intervene in American elections again. The real kicker was the assertion made by a host of anonymous sources that not only was U.S. President Donald Trump unaware of the operation, but that the sources were afraid to tell him for fear the White House would shut the operation down.

There’s a bit of peeling required for this particular onion:

Computerization didn’t happen all at once. At first computers were multi-billion-dollar monuments of circuitry that only major governments could afford, to be used “simply” to compute complicated math (ergo the term computer). They certainly weren’t hooked into civilian infrastructure. Besides, there was nothing to “hook” into. Pre-1980s tech was analogue and manual, not digital and automatic.

Fast forward to the 1980s and this changed rapidly. The marriage of now-more-attainable computers to telephony brought us modems long before it brought us smartphones. That linkage enabled the first computer networks to snake through the worlds of finance, media, energy, academia and manufacturing. As computers became ubiquitous, the possibility of extreme damage being inflicted upon the average American citizen expanded exponentially.

A new policy was required for this new era.

The president at the time was Ronald Reagan. His executive guidance was threefold:

First, the U.S. government would provide no cyber protection to any part of the civilian system. Individual firms and citizens were wholly responsible for protecting their computer systems from outside threats.

Second, the U.S. government would maintain an absolutely massive hacker corps with standing orders to hack everything and put malware and backdoors into every imaginable foreign system.

Third, the U.S. would deign to identify precisely where its red lines were.

These three points explain why it is so simple for Nigerians to defraud your grandmother, why the Russians could interfere in the U.S. elections with ease, and why everyone is so afraid to go after the really important stuff: infrastructure in the United States. In essence, America’s cyber policy is a lot like the rest of its armed forces: you can poke and prod the exposed flanks of the behemoth and you might or might not get swiped at for your trouble, but if you ever do something that really draws its attention, well… you’d better have a great bunker.

In the event the U.S. ever did decide to cut loose, it would have a remarkably shitty quarter. The lack of cyberdefense would ensure that power grids would fail, vulnerable city bureaucracies would be left helpless, and all the businesses that forgot to update their Windows operating system from last decade’s would find they no longer have computers. In other words, it would hurt. But whoever the U.S. was going to war with would find themselves facing off against nearly four decades of surveillance, planning, and preparation by skilled, vengeful nerds. In the best-case scenario (for the targets), they would regress a century as everything from power to water to communications to shipping simply seized up, never coming on-line again until a complete computer-free overhaul was completed.

The Reagan administration’s guidance on cyber sat broadly unchanged for the next four presidents. Offensive cyber was used rarely and the U.S. refuses to discuss it. It is only under Donald Trump that some shifts have occurred. In Trump’s early months as executive the U.S. government leaked it had done something I find hilarious:

It didn’t simply identify the specific Russian agents who had interfered in the United States’ 2016 presidential elections, it sent cease-and-desist letters to those agents at their home addresses complete with enough personal touches to drive home to the Russian hackers that the U.S. government knew more about their personal lives than the Russian government itself.

What all this makes clear is that the U.S. realized it had undersold itself and underutilized its tools, which is quite literally the last thing you want to do with a deterrent. But times are changing and so, it appears, the pace of operations is picking up.

These operations involve extremely detailed pre-operational surveillance and planning so that when the time comes, the real break-in can happen easily. It creates options. The operation can go farther and, as the Times claims happened here, an implant ready to hurt critical infrastructure can be left at the ready. It’s a line that until recently the Americans claimed they did not cross except in exceptional cases.

The problem, of course, is that none of this, right up until the attack occurs, is public. Which makes deterrence more than a little bit of a problem.

So let’s look at that Times article again:

Is the U.S. hacking the Russian power grid? Certainly. The U.S. has been hacking the Russian power grid since before Gorbachev.

Is there a conspiracy within the U.S. government against Donald Trump? Certainly not. Anyone hacking the Russian power system is simply doing their job as demanded by Reagan and HW Bush and Clinton and W Bush and Obama… and Trump. It’s about planning and, if the Times is right, prepositioning assets. Not executing a broad-scale attack.

Is Trump aware that the Russian power grid is being hacked by American agents? Of course. Everything that matters in Russia is being hacked by American agents. Ditto for China. And Iran. And a follow-on list of countries so long I’m not going to go into because of the hate mail it would generate.

Does the national security establishment dislike Trump? Well duh. Trump is upending seven decades of tradition. That’s awkward even on a good day.

As to the issue with the Times article, however, I’m going to call bullshit. If an anonymous source is concerned the president will shut down his favorite top-secret anti-Russian program, blabbing about his favorite top-secret program to the Times — which makes its bones publishing everything in a public forum — would indicate that said agent isn’t all that bright.

In fact, the only people this article seems to be alerting are the Russians. But as the author pointed out, the government raised no national security concerns about the article. That suggests this is all about sending the Russians a message.

The context of that message is one I can only guess at, but I must underline repeatedly that the United States is not on the verge of shutting off the lights in Russia. There is an enormous difference between hacking something like the Russian power system to install malware and activating said malware. The former is rude… and a normal part of state policy. The latter would crash air traffic control and shut down mass transit and darken hospitals. It would kill a lot of people and be a flat-out act of war.

It also isn’t going to happen without a change in strategic relations far more radical than anything Donald Trump has brought to the table to date.

But the Americans now have drawn a line in the sand, publicly. The question is who is going to cross it.

My Way or the Huawei

On May 15 the U.S. government put Chinese telecoms giant Huawei and nearly all its affiliates and subsidiaries on an export black list, which prohibits American firms from selling them high-tech products. Much has been made of Huawei’s position in global telecoms and the role it might play in Chinese surveillance of, well, everyone. The American decision largely ends the concern.

To this point I’ve tried to stay out of the Huawei battles for a pair of reasons. First, the people who really know what is going on when it comes to global data surveillance either do not talk publicly about it or have a vested interest in lying. In the former camp sits the United States National Security Agency, the institution responsible for monitoring global electronic communications. In the latter is the Chinese intelligence directorate, who would like to monitor global electronic communications.

Some background:

Back in the 1960s, the American government started collaborating with the U.K. government on a global monitoring system known as Echelon, a sort of semi-public codename for the series of satellites, towers, fiber optic taps, server farms and software backdoors that span the planet. Echelon soon expanded to include the Anglophone allies of Canada, Australia and New Zealand, becoming the core of what is known today as the Five Eyes intelligence alliance. Echelon’s original raison d’etre was to battle the Soviets, and in time it found new life in the Global War on Terror. According to informed scuttlebutt, if a communication is transmitted using electrons, Echelon sees it.

Or at least it used to. Telecoms have evolved radically in the past half century. Even before the recent fascination of all parties with encryption, the simple fact the United States is no longer the middleman in all telecoms traffic means Echelon is more a tool of yesterday than today, much less tomorrow. Regardless, the ability to scan, read or listen for key words remains essential to America’s tech-heavy intelligence gathering networks.

Enter the Chinese, who found themselves behind the Americans by several decades, and that before considering China lacks the alliance system to create anything of Echelon’s depth or scale. Beijing’s bid to catch up is Huawei, a massive telecoms firm which produces everything from the fiber optic cables and telecoms towers of the physical internet to the phones and computers needed to connect.

While the internet is an infamously unorganized mass of connections, the modern network has central exchange points where the tributaries of information coming from all over the world become torrential flows. Such “core” systems are what Huawei is after. Control the cores and a spy is wired into everything that passes through it.

Huawei’s corporate strategy – which is to say, the strategy of China’s intelligence services – is to grant massive discounts on the installation of a network’s less critical bits on the condition that Huawei can also install and maintain the cores.

Beyond the not-so-minor technical fact that there are people beyond China who understand how the internet works and so might object to handing over all their communications on principle, the plan has an amusing political flaw. Like nearly all of China’s tech industry, Huawei is not technologically self-sufficient. It remains heavily dependent upon tech imports from none other than the United States. Which is the second reason why I’ve never taken the Huawei talk all that seriously: The Chinese not only expect the world to pay them to monitor global communications, they expect the Americans to enable the scheme.

At first the Americans didn’t take the Huawei plan all that seriously, mostly because it was a seriously stupid plan. Then Huawei had some success using heavy subsidies to convince some countries to install their gear. That generated a diplomatic reaction in Washington. American bureaucrats started warning countries not simply of the dangers they seemed willingly oblivious to, but that any country who used Huawei in their cores could kiss any intelligence sharing with the Americans good-bye.

That was enough to shut Huawei out of New Zealand and Australia outright. (The Brits got cute and accepted Huawei gear for their system’s edges, but not their cores, a smug near-miss which undoubtedly infuriated the Chinese to no end.)

But three things have changed that have sparked stronger action out of the Americans.

First, the transition from fourth- to fifth-generation cellular technology blurs the line between core and non-core systems. Huawei penetration into any part of a cellular system now generates complications and vulnerabilities.

Second, despite the risk of communications exposure, enough countries have decided to proceed with Chinese equipment that the Americans can no longer just let it roll. In particular, China’s targeting of Five Eyes members – most notably Canada – has snapped the Americans to attention.

Third, after seventy years of expressly keeping economic and strategic issues separate in American foreign policy, a more standard intermingling is now occurring – and that puts everything Chinese in the Americans’ crosshairs.

Bilateral trade talks with China more or less collapsed last week. I can’t say I’m shocked. At the talks’ onset the Americans laid out a series of non-negotiable demands including an end to cybertheft, an end to forced tech transfer, an end to the hyper-subsidization of Chinese industry, an end to functional prohibitions on American firms’ access to the Chinese market, granting the Americans the right to impose any investigation at any time on any issue without any consultation complete with the ability to impose any desired punishment on any Chinese economic sector.

The fact the Chinese even began talks with those swords hanging over them indicates just how weak the Chinese knew their hand was. China exports over four times as many goods to the American market as vice versa and China is completely dependent upon American global security commitments for access to raw materials, energy and end markets. There is no modern China without active American involvement.

Last week it became apparent to the lead American trade negotiator – one Robert Lighthizer – that the Chinese were backing off what commitments he had previously convinced them to make. It was Lighthizer’s recommendation to Donald Trump that American tariffs on China be more than doubled May 10. He then put an even bigger set of tariffs in the pipeline to be applied within a few weeks.

The Americans’ Huawei announcement has the feel of Lighthizer’s work: he likes to throw the odd sharp elbow and knows his boss is particularly fond of bold, direct, splashy actions that cut to the heart of the issue.

That issue is pretty straightforward. The Americans may be done managing the world, but that doesn’t mean they are going to help someone else do it – especially someone who doesn’t have a ghost of a chance of pulling off such a feat without deep and active American collaboration. Better instead to put China in its place.

The Chinese, understandably, have proven less than enthusiastic about accepting that message.

So the Americans decided it is easier to simply end China’s global surveillance ambitions by killing Huawei’s international position outright. It isn’t very subtle, and if it doesn’t generate the desired Chinese cave-in in the trade talks it makes me wonder what Lighthizer will take aim at next. I’ve got lots of ideas.

I’m certain Lighthizer has more.

Alberta’s Tryst With Destiny

By Peter Zeihan and Michael N. Nayebi-Oskoui

Local politics, even at the national level, are rarely a focus for students of geopolitics. Personalities play too big a role in the mishmash while local outcomes often play too small a role globally. Local affairs take up an outsized amount of oxygen in terms of local media coverage and public opinion, yet things usually keep chugging along, be the results good, bad or indifferent.

The key word there being “usually”.

The Canadian province of Alberta held elections yesterday (April 16) that have been on our radar for three years, and the implications of their results are anything but usual.

Alberta is a quirky place. Strong economic growth, a robust energy sector, and center-right political leanings have defined Albertan politics in recent decades—trends broadly disconnected from the reputation and reality of the rest of America’s northern neighbor.

Within that disconnect lies the problem.

Alberta has long been the Canadian province suffering from the largest “gap” between the monies it pays into national coffers compared to what it gets back in terms of federal spending. The rest of Canada has shown its appreciation by consistently stymying the energy industry that forms the backbone of the Albertan economy with everything from carbon taxes to blocking transport routes for the landlocked province’s crude to reach foreign refineries. For the most part, the rest of Canada doesn’t even use Alberta’s crude themselves, deigning to invest in refineries capable of processing Alberta’s tar sands crude, opting instead for lighter, sweeter imports.

If you think hamstringing a region’s economic growth while depending on its tax payments is a less-than-tenable long-term strategy, you’re not alone. While more people are aware of Quebec’s…independent streak, plenty within the Albertan political mainstream have had enough. And thanks to Quebec’s long-standing political wrangling to wrench itself free, any future Albertan separatist referendum would be perfectly legal.

Which gets us to the current state of play. The province’s conservative-leaning voters staunchly backed the Progressive Conservative majority governments from 1971 to 2014, to the degree that after some elections there wasn’t even an opposition in the local legislature. But in 2015 in-fighting within the conservative house generated a political split. The Wildrose Party ran separate from the Progressive-Conservatives in the 2015 elections on a ticket of fiscal conservatism, healthcare reform and direct election of the province’s senators. The fissure split the conservative vote down the middle, enabling the New Democratic Party—a party that is most definitely not of the center-right—to seize control of the Albertan government for the first time.

In a near textbook example of how geopolitics forms politics rather than the other way around, the NDP and premier Rachel Notley quickly went to work not only adopting many of its predecessor conservative government’s policies, but went to the mats with both Canadian Prime Minister Justin Trudeau and neighboring British Columbia over all things energy-related, most notably on pipelines. (Obviously, going to the mats here is relative. For a self-styled, Green/Leftist party to support oil sands in any measure is a big shift. Notley went so far as to embargo British Columbian products.)

It was fun while it lasted. Just as a political spat among the center-right brought the NDP to power, a recent fracturing of the center-left in Alberta combined with a healing of the rift on the right has now escorted it out. While the counting continues, it appears a reunited Conservative-Wildrose alliance—operating under the banner of United Conservatives—now hold at least 62 seats in the 87 seat parliament according to Tuesday night’s provisional results. With victory cemented, many Albertans now look forward to a fundamental shift in the provinces’ fortunes.

The awakening will be a rude one.

The United Conservatives are running on public dissatisfaction against carbon taxes, a lack of pipelines, and an unequal system of taxation by a federal government many Albertans see as being not only out of touch and unhelpful but actively working against Albertan interests.

Alberta’s new government will take the issue of a carbon tax to court.

They will lose. Canada’s provinces lack the legal standing to challenge the central government on such topics, or more accurately, Ottawa has means of enforcement that bypass legal challenges.

Alberta’s new government will sue to allow the Trans Mountain Pipeline to cross British Columbia and so enable Albertan Tar Sands to reach the Pacific.

They will lose. Even if Alberta wins the case, BC will still find a means—with the unofficial blessing of a green-leaning central government—of preventing the pipe’s construction.

Alberta’s new government will push back against the federal government’s heavy reach into Albertan coffers.

They will lose. With Canada’s population aging into mass retirement, transfers from Alberta to the center will increase.

Alberta’s new government will attempt to redefine the relationship between Edmonton and Ottawa in an effort to carve out more policy and financial autonomy.

They will lose. Trudeau’s shiny, Instagram-able veneer aside, his ruling Liberal Party faces what is shaping up to be horrific national election in October. Collapsed positions vis-à-vis the Americans on trade has gutted Liberal support in Quebec, British Colombia has outflanked Trudeau to the left, Alberta’s Prairie Province neighbors have never been strong Liberal territory, and Ontario is slipping into a decidedly non-leftist populism. Trudeau needs Alberta’s tax dollars to hold Canada together, and any concessions to Alberta would immediately be demanded by other provinces. What Alberta is asking for is quite literally an end of Canada. Even if Trudeau wanted to give ground (and he does not), he absolutely cannot.

Something’s gotta give.

This Alberta Question has two possible outcomes.

The first is an Albertan collapse.

Economically, the province’s strength is resource extraction. Without a significant change in how Canada functions, the Albertans inability to bring their crude to market leaves them staring down an economic depression Greek in depth while also facing ever higher financial extractions from Ottawa. It is enough to hollow out Calgary on the scale of Detroit. As a government town, Edmonton wouldn’t do much better.

Politically, Alberta’s United Conservatives face an impending litany of defeats on absolutely every issue that they say matter to them. Barring impossible shifts in Ottawa’s position, a repeat of the sort of infighting which brought the NDP to power in 2015 is all but guaranteed.

All that needs to occur to guarantee the rudderless and hopeless outcomes of this option is that the Albertans continue to do what they’ve done for the past decade: hope things get better and hope what they say matters.

Outcome Two requires a sharp break with convention, as it is nothing less than Albertan secession.

The logic of Alberta leaving Canada is difficult to deny. If the rest of Canada remains hellbent on cramping the Albertans’ style, why not quit the Canada Show? Alberta isn’t dependent on the federal government’s financial handouts like other provinces. It has an energy sector, public infrastructure, educational system and workforce that has drawn plenty of international investment interest on its own. Negotiating export pipelines directly with the United States would be infinitely easier than with other Canadian governments, especially since the U.S. Gulf Coast is home to the only concentration of refineries in the world that can process Albertan heavy crudes. The money the Albertan government would save by not having to underwrite the rest of Canada would be gob-smacking.

But just because secession solves a bunch of problems doesn’t mean the Albertans are chomping at the bit to make it happen. No one in the Albertan public space is using the “S” word just yet. None of the major parties campaigned on separation, either in 2015 or 2019, but that doesn’t mean that the topic isn’t about to dominate provincial political discussions.

The United Conservatives now face a truly weird combination of factors: a complete lack of ability to get anything they want from within the Canadian system, and the utter ability to leave that system. It isn’t that anyone in power in Edmonton is agitating for independence, but it will become obvious very soon that discussions of and processes towards independence are the only thing Albertans are actually in charge of.

We’ll save the implications of at-this-point-still-theoretical Albertan independence for another time. Even if the incoming Albertan government were dead-set on a secession referendum—and they are not—simply going through the motions to achieve that end will take a few months.

But as a teaser consider that Alberta by itself is the world’s fifth-largest oil producer, Canada is the tenth-largest economy, and the bilateral American-Canadian bilateral trade relationship has been the world’s largest for the bulk of the past two generations. One way or another, all things Canadian are now firmly on our radar, reaching up to the level of importance of the Saudi-Iranian rivalry, the ongoing Japanese and Russian resurgences, and the pending European and Chinese disintegrations.

For Canadians everywhere, that alone should be terrifying.

And Now For Something Completely Different…

Early April 3 United Kingdom Prime Minister Theresa May met with the leader of the Labor opposition, Jeremy Corbyn, to discuss a common way forward on the UK’s impending divorce from the European Union.

Drama ensued. Markets and media immediately swooned that a softer Brexit, in which the UK retains significant links to the EU, was in the offing. One of May’s ministers quit her cabinet in fury over the very idea that the prime minister would speak to an elected representative from across the aisle. In recent days protestors in the hundreds of thousands have descended upon London to protest Brexit, while millions have signed a petition hoping to overturn, stop, or at least delay the process. A particularly fun resolution circulated in Parliament intending to dock May’s pay.

(Yes, I’m having an unabashedly good time here.)

The May-Corbyn is less “too little too late” and instead “not relevant at all”. It isn’t so much that a softer Brexit is no longer an option, but instead that it was never an option.

The first step of the Brexit process has always been not to determine what the British might be happy with, but what the remaining 27 members of the EU might tolerate. Under EU law each and every member state must sign off on the big issues — such as divorce agreements. It only takes one EU member to force the UK into a no-deal Brexit.

Any “soft” deal that grants the UK some of the EU’s benefits without all the EU’s costs and responsibilities is one the Union ruled out from the very beginning. Moreover, the UK’s firmest allies within the Union — most notably the Netherlands — have repeatedly and explicitly ruled such deals out for the simple reason that if the UK can get such a deal, so will everyone else, which would render the idea of the EU rather pointless. And since it only takes one country to veto any deal, the idea that the UK has any leverage in these talks is silly.

The result has been the “deal” Theresa May managed to negotiate. It obliges the UK to pay into the EU budget and abide by all EU regulations but forfeits any ability to influence what those regulations are. The Brexiteers have a point when they say the deal is worse than membership, but that deal is the only way the UK retains trade access at all. Unsurprisingly, Parliament has voted it down three times.

Anything shy of a no-deal/hard Brexit requires EU unanimity, UK government approval and Parliamentary ratification. A no-deal Brexit requires none of that. A no-deal Brexit is the default. So, a no-deal Brexit is where this ends. In nine days.

Everything else isn’t simply beside the point, it has always been beside the point.

Still, the Brits have obsessed over setting up a bunch of political dominos. It’d be rude to not knock them down.

  • May isn’t going anywhere. Normally when a British political leader proves unpopular within her caucus, a vote of no confidence is held within the party to eject him or her. May was subjected to just such a vote back in December. She survived it. According to the Conservative Party’s rules, she need not fear another vote until December 2019.
  • Nor is May’s government going anywhere. Normally when a government proves unpopular a vote of no confidence is held within the Parliament to eject it. May’s government was subjected to just such a vote back in January. She survived it. While another no-confidence vote is always a risk, its passage would trigger general elections. Not only is this something the Tories want to avoid desperately but resolving elections would take (a lot) more than the nine days remaining before the Brexit crash-out.
  • Nor can May negotiate a new deal. Parliament reclaimed her power to do that back in March. May is still prime minister, but she no longer has any legal or political influence over the issue of the day.
  • Nor can Parliament negotiate a new deal, or at least not competently. No party has a majority in Parliament, and that was before the parties started fracturing. Because the government has been stripped of negotiating power, any new negotiating team would have to come from Parliament, but not from the factions of the Conservative party that supports the government. Instead the negotiators would need to come from the anti-government Tory faction as well as the opposition. The leaders of these two groups are Boris Johnson — the leader of the Brexiteers — and Jeremy Corbyn, who also supports exit from the EU despite much hemming and hawing. So that option has a bullet in its head right from the get-go.
  • Nor will the EU shift its position. The April 12 date is already the EU’s second delay, this most recent delay was only of two weeks, and there is no longer anyone in London for the EU to negotiate with. May doesn’t even retain the legal standing to request an additional delay.

Nor will there be a new referendum. May is opposed to asking the population the same question twice (and she has a point), while Parliament is split on the topic. The Tories are majority against a new referendum, while Labor favors a new election instead of a consultation on the narrow topic of Brexit. And again, a referendum couldn’t be held within nine days anyway.

Which means those hoping for an outcome that is anything other than a hard Brexit must pray for one of two exceedingly unlikely outcomes:

Option A: May herself decides to go back on everything she has felt she had no choice but to try to achieve and unilaterally roll back the Article 50 process. Considering that Parliament initiated the Article 50 process it is unclear if May has such authority; she would immediately find her decision in court. Lawsuits move faster in the United Kingdom than they do in the United States, but getting constitutional law sorted out in less than two weeks is not in the cards. Chance of this both happening and ending in Brexit delay, stall or revocation? Less than 1%.

Option B: Queen Elizabeth II skips tea, sashays out of Buckingham, mounts a fabulously over-decorated horse, trots to Parliament, declares her royal non-confidence in the government, flourishes a gleaming sword in an attempt to rally the crowds to dismiss the government. (Ironically — hilariously — until recently the Queen had the power to dismiss the government without first summoning the people, but in 2011 the Brits updated some of their laws for the 19th-century and revoked that specific power.) Chance of this both happening and ending in Brexit delay, stall or revocation? Slightly more than Option A.

(Of course, this is the United Kingdom. Unlike every other country in the world, the British couldn’t be bothered to write their constitution down. So much in this newsletter as well as much of everything you have ever read anywhere else about the British constitutional system of government is based on interpretation of tradition.)

It is time to start thinking about something completely different, about life beyond a (hard) Brexit. To be blunt, the British government has a lot of other things they need to get cracking on.

First, they need to overhaul forty years of regulation and legal structures to function in a world beyond the European Union. Once a country joins the EU nearly every aspect of their domestic economies along with every aspect of their import and export systems becomes integrated into EU law. That now all needs unwound and reset to the new reality. Under normal circumstances I’d estimate that’s a half-decade process.
Second, the UK needs to negotiate replacement trade deals. One should probably be pursued with the EU itself, but that is — minimum — a decade process. In my estimation the EU doesn’t have that much road left so probably best to go just through the motions. Far more important are deals to be made with every member of the Commonwealth — where London still holds considerable strategic and political sway. Bilateral agreements with Turkey, Japan, Korea, Taiwan, and Brazil would probably be a good idea as well.

Third, NAFTA looms large, and is more important than all other potential deals combined. The Brits were already eyeing bilateral agreements with the United States and Canada, but since the new NAFTA has not yet been ratified, now would be an ideal time to shoehorn the UK in.

Fourth, time to figure out how to work without global capital. London serves as the financial bridge between the United States and the European Union. Or at least it did. With the UK out of the EU, that role has ended. Add in the general chaos and pretty much the entire financial district of London will liquidate or decamp. Some will go to the EU, while most will go to the United States. (The terms of any UK-US trade negotiations will force that issue). Expect four-fifths of the City’s financial business to relocate. The Brits need a fundamental economic overhaul.

Fifth, as the Americans back away from providing global maritime security, countries are going to discover that guns are at least as important as butter. The Brits have a fairly respectable gun collection, and a fairly robust reputation for using gun policy to complement butter policy. Call it gunboat diplomacy. Call it neo-imperialism. Call it a creative use of special forces. I call it a historical propensity to be a trendsetter in the application of security policy to diplomatic and trade affairs. Very few other countries will think that’s a good idea, but very few other countries liked dealing with the British Empire back in the day either. Just because it isn’t popular doesn’t mean it can’t work. (How the world’s former naval superpower interfaces with the world’s current naval superpower on issues like this will be particularly interesting.)

Which brings us to one final issue: the Brits need to move on.

All the above requires leadership, and while I may personally have great respect for May’s tenacity and endurance, I am not the person whose respect she needs to earn. Whoever was responsible for negotiating Britain through the thankless Brexit process knew from the beginning it would consume them. May was always going to be a transitional leader, and today she is a spent force. It is time for someone else, and that requires an election.

It is a heady time. The global Order is collapsing as the Americans back away. The EU now must confront all the issues that they faced back before the Brits started the Brexit process. Whether the issue is debt or banks or refugees or demographics or trade each and every one of them has the capacity to utterly wreck the Union. Turkey is on the rise. China is wobbling like a spinning plate. Russia is on the warpath. Everything is in motion and the United Kingdom, despite its hang-ups and challenges, is one of the few countries with a capacity for independent action.

Whoever rules the United Kingdom next will make the decisions that will shape its role in the world for at least the next half century. Based on your read of the British political environment that is either the most encouraging or most terrifying thing you’ve ever heard.

The Art in the Forest

I woke up Monday morning to find a bit of a debate on my Twitter feed over assessments of my ability (or lack thereof) to pontificate on trends in the energy sector. Specifically, Art Berman — @aeberman12 — noted:

“I told Peter last time we met that I believed he should stick to what he knew–demographics & geopolitics. His view of shale plays & US energy independence/dominance is that of most oil analysts with no experience in O&G business–partly right & dangerously wrong.”

Let me start by saying that while those sound like fightin’ words, Twitter has a way of making us all sound like hot-headed jerks. I’ve met Art a handful of times and I know he is one ultra-polite cat. Art was just pointing out in under 280 characters that he’s a specialist in his field and I am… not.

He’s correct about that, but he is not correct about the rest. I am not a demographics expert, and I’d argue geopolitics is too multi-tentacled of a beast for anyone to truly command.

I also don’t know more about the Chinese DF-26D ballistic missile than the folks in the U.S. Navy who worry about it striking an American carrier, so I’m an avid reader of Aviation Week. Nor do I know the minutiae of demographic trends, so I follow Vikram Mansharamani. Nor can I keep up with the wild insanity of European security policy, so I rely upon the insights of Francois Heisbourg and Ivo Daalder. Nor do have the time, inclination and focus to follow the ins and outs of Chinese finance, so I keep tabs on what Michael Pettis is doing. Rose Gottemoeller for nuclear policy. Liam Denning for global energy markets. Borzou Daragahi for the Middle East. Milo Hamilton for rice. Max Roser for delightfully unexpected data visualizations. Jake Bramante for great backpacking analysis.

I’m not a specialist in any of these things. I mean, come on, I’m from Iowa. How sophisticated do you think I can be?

All these folks I follow are the true experts. The specialists who know all the details and relationships of their respective niches. I think of them as tree people.

I’m more of a forest guy.

Since Art started this little journey, I’ll use him as an example.

Art’s specialty is petroleum economics, in particular he analyzes the relationship among a firm’s finances, its reserves, its production rates, and ultimately its profitability. The bread and butter of his consulting business is to help folks identify which firms will and will not prove financially viable over various time horizons. (Apologies to Art if I didn’t get that quite right. After all, I’m not a specialist.)

If you are interested in the U.S. shale industry from an investment or profitability standpoint, and for some reason you have not spoken to Art, you are doing yourself a disservice. He’s clearly the headliner for his business niche.

But Art is probably not who you would go to discuss the newest technologies in the shale sector, and why would you? He’s not a specialist in that very specific subfield. For that the University of Texas’ Bureau of Economic Geology (BEG) is a better match. I watch what both are doing.

I follow Art both for a reality check on how much the shale sector can grow with current models, as well as to understand what sort of firms might be able to enter the shale patch to displace players less stable. Its about figuring out the future corporate makeup of the shale patch. Without Art I would have never known to even look at the shale sliver of bond markets.

Conversely, I follow the BEG to get an idea of what new techniques might work at what price points in what petroleum basins so that I can grope towards an understanding of what the operational geometry of the shale patch might look like in three to five years. Without the BEG I wouldn’t have even heard of multilateral drilling until it became widespread and could have never projected forward.

I don’t pretend to know more about the specialties of Art or the BEG because I do not, and I never will. But I use the work of both as well as Vikram and Ivo and Rose and Borzou and Milo and many, many others to game out the bigger picture over many sectors on multiple continents over a (much) longer time horizon.

I look at the world. It is a very big forest. It requires me being as well-rounded as possible. I’m certainly not the smartest person on topics oil when in a room of oil operators, but I bet I know more about agriculture. And when I’m in a room of farmers I bet I know more about manufacturing. It isn’t about being the smartest person in the room on any given topic. It’s about being able to draw connections among all topics.

Energy informs electricity informs manufacturing informs trade informs China informs finance informs real estate informs civic development informs educational patterns informs technological advance informs geographic advantage. Not exactly the circle of life, but such interconnections form the context of what I do. I’m a sort of advanced generalist. A professional novice.

So, with that in the proverbial back pocket, let’s talk about shale today.

The biggest point of friction between Art and myself is over output horizons.

I’ve pretty consistently been among the more optimistic forecasters of future shale output, while Art has pretty consistently been among the more pessimistic. We’ve both been wrong. Shale has always done better than the forecasts.

Take a look at this screen grab. This is all data from the U.S. Department of Energy’s Energy Information Agency–EIA is by far the best piece of the U.S. government infrastructure for collecting and understanding the details of any energy question. The dotted lines are the EIA’s annual estimates for what shale output will be in the future. In the legend you can see what year EIA made each estimate.

The solid line at the top is actual output.

Notice that the EIA has never gotten it right. They’ve always under guessed. That’s because they cannot factor in technology that has not yet been invented. There is oil in shale formations, but the EIA–and I daresay, Art–didn’t know how to get it out of the ground. Toss in the profit motive, and BAM! People found a way. Shale boom.

The problem is predicting the impact of new technology. Whenever something comes out that no one has seen before, it is no simple task to predict what it will do once it is applied en masse. As recently as five years ago there were hundreds of producers in the shale space. Each was developing new techs. Even if 90% of those innovations proved unworkable, the rest eventually caught on and transformed what was possible. Things like micro seismic, multilateral drilling, better data and water management are not simply being continually refined and improved but combined into best-practices systems that have steadily–meteorically–increased American oil output to generate that thick line.

That unpredictability is step 1.

Step 2: Enter Art.

Art is absolutely correct: Many of these small companies have not been profitable. Many hemorrhage money. Yet that hasn’t mattered because international instability has funneled ridonkulous volumes of scared, stupid money into the United States. That money seeks investment products that have a hard asset and a revenue stream. A net loss is not considered overly problematic since if the money stayed at home the fear is it would all be lost. Shale bonds, as imperfect as they are, fit the bill. Add in the general swollen nature of the American financial community in the aftermath of the subprime crisis and the availability of financing hasn’t often been a limiting factor. Art doesn’t have to be wrong for the overall sector to grow.

Where I get interested is that the very financial weakness of these barely-profitable or unprofitable firms provides openings for stronger firms.

Enter the super majors. For the first decade of the shale revolution, the supers barely touched the sector at all. Their concern — like Art’s — is profitability. They saw an experimental industry with razor-thin to nonexistent profit margins and they stayed away.

But all those new techs are now combining into a best practices suite, and whenever a piece of the oil patch is determined not by chutzpah and innovation and financial…creativity but instead by brute force and iron-clad internal finance and technical acumen, bet on the supers every time. The supers are now sweeping into the shale patch and buying up financially-stressed independent operators by the dozen.

In a young industry ingenuity is everything. In a mature industry scale is more important. The independents have ingenuity. Ingenuity has made shale ever more efficient, dropping overall production costs from in excess of $100 a barrel to something under $40. But the industry is now maturing, and the supers have scale. The torch is passing.

ExxonMobil has rather boldly opined that some of their newer, larger production schemes for the Permian Basin will be have costs as low as $15 a barrel.

As that’s a figure cheaper than oil production costs in Saudi Arabia, that sort of claim grabs my attention even though we know that the Exxon plan is not an apples-for-apples comparison. Exxon didn’t note whether the $15 figure includes exploration or tax or transport costs or is limited to production and lifting expenses. Much more importantly, the supers operate in a starkly different manner than the smaller mom & pop firms that have dominated the shale sector until now:

In part the supers have the advantage of scale (internally-sourced finance, better data crunching, the best engineers in the world, etc.). A bigger piece of it, however, is the supers won’t drill a well they don’t think will be profitable. Most smaller players — in part because they are experimenting — will drill every possible spot on their leases. That’s what happens when cash-flow is king. The supers think on a longer time horizon and so tend to only drill the really good spots. That generates more output per unit of input, even if it leaves a bunch of crude in the ground. It might generate less production, but it is better optimized. Profitability looks better. (I can hear Art nodding approvingly.)

This evolution in players probably means that the pace of output increases will slow but considering 2018 output gains were the largest single-year gains ever, that really isn’t saying all that much.

Which brings us to point three. Even assuming the pace of increase in 2019 is half that of 2018, the United States still becomes a net crude exporter at the end of this calendar year. Yes, that’s a notable milestone, but it in no way signals the end of the shale story. Even assuming future annual increases are only one-third that of what they were in 2018, the American oil patch will add a new Saudi Arabia of output within a decade.

Now there are a hundred shades of subtlety within that statement, and a thousand events that will unfold before that happens, so I’d not get too enthusiastic with the chick-counting. But most of the things that will go wrong will happen well beyond America’s borders, and there is little to nothing in Art’s world that will change the petroleum switch-over from somewhat financially-stressed small firms to the more stable super majors. This is cooked in.

It is indeed time to start noodling over what it means when the world’s largest supplier of internationally-available crude comes from a country that no longer has much interest in global stability.

That’s my new forest. The trees in this scary forest are not reserves and debt tables and drill bits, but Japanese missile ranges and Swiss insurance brokers and Saudi assassination manuals.

Time to meet some new specialists.

The Decivilization of Venezuela

Of late, Venezuela has had a wretched time of things.

As a rule I attempt to be judgement-free when it comes to evaluating governing systems. For the most part, governments—like economies and cultures—are products of geography. Germany’s proximity to so many competitors makes it focus on organization and quality. America’s territorial insulation and richness enables it to get by with a much smaller, more laissez faire system. China’s regional splits force it to gyrate between central clampdowns and peripheral spin-outs. I try not to criticize or play favorites, and keep my personal preferences to myself.

But then there’s Venezuela.

Venezuela is a country of geopolitical advantages in a region where those are hard to come by. It has oil and agricultural wealth, an educated populace, a commanding position on world trade routes, and easy access to the world’s largest consumer market. It is far from the most advantaged country, but Venezuela had what it needed to thrive…until a reckless, selfish cult took that wealth for itself.

The Venezuelan system isn’t socialist at all. It hasn’t been for a long time. When a socialist government takes over a productive asset, it runs that asset with an eye towards furthering some government goal. Perhaps not competently, but keeping seized assets operational so they can provide this or that input is sort of the point. For at least the past decade when the Venezuelan government has taken over something—say a farm—they instead loot it like a flock of locusts and simply leave it to lie fallow.

This isn’t socialism, or even mismanagement—this is kleptocracy. (Yes yes yes there’s an argument to be made that most socialism-flavored governments concentrate so much decision-making into government hands that such cronyism is a constant danger, but that’s a debate for another time.) Suffice to say, since roughly the middle of the Chavez era in the late 2000s, the only thing socialist about the Venezuelan system has been the propaganda.

Under the misgovernment of President Nicolas Maduro, Venezuela has suffered one of the worst economic depressions in human history—so far we’re at an estimated 50% contraction in GDP and seven-digit annualized inflation growth.

The crisis can be seen, and felt, most acutely in terms of food prices. A Venezuelan earning the official minimum wage would need five months of savings to purchase a single can of olive oil. Private grocery stores struggle with supply issues thanks in large part to corruption in government-controlled supply chains. “Non-essential” items like condoms, diapers, and medicines are all but inaccessible. Venezuelan fuel is now sold just across the border in Colombia to Venezuelans by corrupt government officials who keep the cash.

Venezuela used to have a modern healthcare system, but now basic supplies are so scarce that intensive care units have shut down. Doctors have emigrated. Over 70% of the hospitals that are still open don’t have running water and frequently lose power. An estimated 3.4 million, or 10% of the population, have fled the country, mostly to Colombia and Peru.

Those who stay have begun the process of dying from malnutrition and preventable diseases. The average Venezuelan lost 24 pounds in calendar year 2017. The pace of decline is accelerating. At the time of this writing, the bulk of the capital of Caracas has not had power for a week. No power means no running water means no refineries means no gasoline means no food distribution.

Summed up, Venezuela in 2019 is teetering on the edge of a complete decivilizational event.

Decivilizational. It’s a big word with bigger implications. But first we need to unpack what we’re going to unpack: civilization itself.

Everything we know about human civilization is based on the simple idea of organization. Once a government lays down some basic ground rules like “don’t kill your neighbor” people start doing what people do: raising families, growing food, hammering out widgets. People start trading, so that the farmer doesn’t also have to make flour. This specialization makes us more productive in our chosen fields—be it farming or milling or blacksmithing. This society gets richer and expands. More land, more people, more specialization, more interaction, more internal trade, greater economies of scale.

Eventually we become so specialized and our technology has advanced so much that we become totally incompetent at tasks which used to be essential. Try producing your own electricity or enough food to live on while keeping up your full-time job. What makes it all possible is the idea of continuity: the idea that the safety and security we enjoy today will still be here tomorrow and we can put our lives in the hands of these systems. After all, if you were pretty sure the government was going to collapse tomorrow, you’d probably worry less about whatever work-related minutiae your manager insists is so important and instead focus your time on learning how to grow and can vegetables.

What the Americans have done in the post-World War II era is to vastly expand continuity via the global Order. Instead of specialization and interaction being limited to the internal affairs of individual nations, the Americans imposed security on the global system. Think of Europe, a place where dozens of ethnicities have fought wars with one another for millennia. Yet with the exception of some hiccups in the Western Balkans there hasn’t been a shot fired in anger between armies since May 1945. That’s flat-out unprecedented. Labor hyper-specialization is now the norm, and trade has become so complex entire economic sub-sectors (independent logistics providers, trade negotiators, contract mediation, and warehouse planning consultancies), now exist to facilite it. The civilizational process is reaching for its ultimate, optimal peak.

But “optimal” is not the same thing as “natural.” The Americans deliberately forced the Order into existence to fight the Cold War. The Americans have a deep continuity and large economies of scale without the Order, but the global system is wholly artificial. Making matters worse, the Order does not and cannot maintain itself. Someone must pay the bill to keep it going, and the American right, the American left, and the American center have lost interest and are all arguing for a more constrained American role in the wider world. No one else has the spare economic heft or the large market or the globe-spanning naval capacity to force an Order. Break the global continuity and everything that makes our world work quickly cracks apart.

There are a number of ways down, but they all share something in common: reduced interaction means reduced access means reduced income means fewer economies of scale means less labor specialization means reduced interaction. Shortages force people to look after their own needs directly. The value-added advantages of continuity and labor specialization whither. Everyone becomes less efficient. Less productive. And that means less of everything: not just electronics but electricity, not just automobiles but gasoline, not just fertilizer but food. And it compounds. Electricity shortages gut manufacturing. Food shortages gut the population. Fewer people means less chance of keeping anything that requires specialized labor working. Say, things like the electrical grid or food production.

Whether the country in question is high-tech export-led manufacturer (Germany, South Korea, China), a mid-tech supply chain link (Thailand, Poland, Turkey), a resource exporter (Kuwait, Russia, Morocco), or a major agricultural supplier (Brazil, South Africa, Kazakhstan) the differences are one of scale rather than kind. Lack of continuity means disruption of what we think of as civilization to exist.

Just how vulnerable is everyone? Think of it this way:

While “only” about one-fifth of global foodstuffs are traded internationally, the vast majority of global foodstuffs are produced with industrialized inputs like fertilizers and pesticides. Those inputs on average more than triple yields. Those inputs are largely petroleum-derived and four-fifths of the world’s oil is traded internationally. Unless you live in a country lucky enough to produce enough oil for its own needs and have the ability to process it into agricultural inputs and have the climate and land necessary to grow your own food, all it takes is one small tweak to the physical security of trade routes in the general vicinity of places like the Former Soviet Union or the Persian Gulf to shift you from living in a world of plenty to a world of want.

What would you do—what wouldn’t you do—to get a full belly? To feed your children?

That is what decivilizational means: a cascade of reinforcing breakdowns that do not simply damage, but destroy, the bedrock of what makes the modern world work. And that’s just one example in one sector.

What is going on in Venezuela is horrible by any measure, and in a world of Order Venezuela is the very definition of outlier. But a world of Order is not the natural state of things. Pay attention: Some shade of what the Venezuelans are going through is what many of us will need to deal with. Soon, the only thing that will truly make Venezuela stand apart is that its pain is self-inflicted.

Brexit: The End of the Beginning

The United Kingdom stands at the precipice of its greatest change since the collapse of empire. It will be just as painful.

This week Britain got a new parliamentary grouping – the Independent Group – that might in time form the kernel of a new political party. It started with a breakaway of seven opposition Labor MPs, and on Feb 20 picked up an eighth defector as well as three MPs who ditched the ruling Conservatives.

The environment shaping the splintering, unsurprisingly, is Brexit.

Let’s start with the Conservatives. Prime Minister Theresa May arguably has the worst job on the planet right now. May believes the 2016 referendum in favor of the United Kingdom leaving the European Union obliges her to lead the United Kingdom to leave the European Union. We can debate whether referendums truly are the will of the people (I’d argue that since referendums ask explicit questions they are purer gauges of the popular will than elections), but the point is that May’s interpretation of the results are that hell-or-high-water the UK will leave.

It was always going to be messy. There was never going to be a divorce deal with the European Union. EU policy dictates that in any big issue each individual EU member must approve of the final text. The Irish want to maintain restriction-free access to Northern Ireland. The Spanish want a path to recovering Gibraltar. The Dutch want the British as close to the common market as possible, but not if it means they have to follow rules the British do not. The French want to gut the British geopolitically. The Germans seek to maintain market access but deny London any rule-making influence.

There simply is no iteration of any deal that can satisfy all these divergent interests, much less in the short two-year timeframe the Brexit negotiations allowed. Getting a comprehensive trade deal with Canada took the EU a decade. Even if there were a path forward that would please all of Europe, any such deal couldn’t get through the British Parliament. In losing those three MPs, May has lost her majority – which was already razor thin and only in existence at all with the help of a minor Northern Irish party which has some pretty uncompromising views on issues Irish.

No, there is zero way forward here that is anything other than a hard crash out. I’ve held this position from the beginning, but now the United Kingdom cannot get anything done that requires a parliamentary majority.

Those of you on the political left, don’t get cocky. British Labor’s mess is just as bad with the added problem of not being in power. Between 2016 and 2018 the Labor Party came back from the bleeding edge of dissolution under the leadership of Jeremy Corbyn by tacking to the hard left and bringing in a lot of youthful energy.

The problem is that young Brits tend to be exceedingly pro-Europe while Corbyn is anti-…. pretty much everything, with Europe near the top of his list. When you’re not in power it is easier to paper over such differences, but with many in the Labor Party agitating for a second referendum to undo the first one and with Brexit the issue of the moment, it is getting harder to hold the party together. The seven Labor MPs who founded the Independent Group did so expressly because they want the UK to remain in the EU and felt their leader was on the wrong side of the issue.

I see a few things here:

First, the United Kingdom’s party structure is in freefall. Neither the Conservatives nor Labor are unified on the issue of the day and so MPs are breaking off in an attempt to form new poles of power. Something similar is occurring in the United States, but features of the British system enable the shift to occur much more quickly.

The United States distributes power among local, regional and national levels, while the presidency is elected independent of Congress. In such a system the level of direct/local democracy is higher, but on the big issues change tends to come more slowly because a party breakdown doesn’t immediately or necessarily change the national government. (This design quirk is part of why any American administration always seems so tone deaf while Congress seems so feckless.) The biggest shock to the American system, the end of the Cold War, is only now – three decades later – working its way through the political framework. And it has taken that combined with things like digitization, the ongoing Baby Boomer mass retirement, and the rise of China to force a long-overdue political reshuffling.

In contrast in British national elections the various elected representatives meet in Parliament and select the national leader from among their own number. If the ruling party cracks, it can no longer command a majority in Parliament. A vote of no confidence can bring the government down in a day, force new elections in a month, and voila! New parties, new government, new policies.

Second, in the United Kingdom the next few weeks to months will be utter political paralysis. May has lost her majority so even if the European Union could stomach a Brexit deal more favorable to the UK, May can no longer get any deal approved. Only five weeks remain until Brexit occurs. With the reality of a hard Brexit belatedly sinking in, Parliament should be incredibly busy with a mass of enabling legislation that would help smooth the process within the United Kingdom in preparation for what happens after nearly a half-century of laws and regulation are invalidated in a day. No such luck. This is going to make the transition much more difficult than it needed to be and it was already going to be very difficult.

Third, if anyone wants to take advantage of the United Kingdom, now is the time. Upon leaving the EU the Brits will lose access to half of their trade portfolio and there is zero vision within the country’s political and cultural structures as to how to move forward.

Politically, the Brits cannot chart a route forward. May undoubtedly is not in it for the long haul, and Brexit challengers within the Conservative Party are, how shall I put this, not exactly carved out of honesty, thoughtfulness or creativity.

On the other side, Labor is led by a man who makes Donald Trump look honest, thoughtful and inclusive. The defectors who formed the Independent Group had some choice words for their former leader that included things like bigot and Stalinist. Considering how fast a single election in the United Kingdom can change policy paired with the epic possibilities for rapid change that Brexit provides, the election of Jeremy Corbyn would be a disaster that would take the United Kingdom a generation to recover from.

For Brits reading this, please take to heart that this criticism of Corbyn’s character and policy preferences comes from a citizen of the United States, a country with a well-documented and respected track record in recent decades of selecting the absolute worst candidate from among a wide range of suitable options. I know a damp squib who is chuffed at his own chunder when I see one.

The country most likely to seek advantage over the Brits is a country that has done it before: the United States. In World War II the Americans nailed the Brits to a borderline-usurious deal known as Lend-Lease in which the Brits received some shoddy, outdated ships in exchange for almost every bit of the British Empire in the Western Hemisphere. That deal subjugated the United Kingdom to American strategic preferences for the next two generations.

Post-Brexit Britain will be its most geopolitically desperate since those dark days when it stood alone against the Nazis, and the American administration is already in the process of rewiring all its foreign relations. Any deal negotiated in the post-Brexit chaos will be at least as disadvantageous as Lend-Lease and will – at a minimum – result in most of the British financial sector decamping to New York City.

Finally, a few words about what the Brits are leaving. The drama of Brexit has enabled the Europeans to shift attention from all those issues that were already past the point of no return in 2016: immigration, refugees, the Ukraine War, Russian aggression, the Syrian War, overloaded pensions, demographic collapse, sovereign debt, Greek insolvency, Italian banking, the failure of the German political center, the deliberate destruction of liberal democracy in Poland and Hungary, the end of productive relations with Turkey, etc.

Not only have none of these issues gone away, all have gotten worse. Many are fully capable of killing the European project independently. All of them combined simply make the end of the EU an issue of a betting pool for the date. With the Brexit “process” about completed, all European eyes will refocus back upon these unsolvable issues. For Europe, the year 2019 will suck as much as it will for the Brits. The EU was always going to end, so the Brits getting out before the collapse and getting a head start on whatever is next will a decade from now broadly be remembered as the right call.

But it didn’t have to be nearly this hard.

Fire in Venezuela, Part III of, um, II

Read Part I and Part II

Geopolitics has two speeds.

The first is glacial. The sort of huge, multi-generational trends that I spend most of my time studying and charting don’t shift easily or quickly. Whether the issue is pushing an army over a mountain range, or attempting to encourage a country full of people to have more children, or finding a substitute for gasoline, change – or at least change that is big – comes slow.

This is part of the power of geopolitics: if the rules change only rarely, it is fairly straightforward to draw trends deep into the future.

Of course, there is that other speed. The forces of geography may be unstoppable and inevitable, but that does not necessarily make their destined results imminent. Political forces don’t simply resist them doggedly, but often pathologically. For a solid example, consider the Cold War: the Soviet economy was never much more than an organized mess, yet from the time Soviet leadership realized it was all hopeless in the early 1970s, it still took another two decades for it all to go to pot. Only a fool would assert the Soviets did nothing of relevance during that time.

Yet leaders resist forces geopolitical at their risk. Pressure builds until the inevitable release. The greater the delay, the greater the pressure, the greater the subsequent explosion. In such moments truly epic forces are unleashed all at once: the Berlin Wall’s fall, the Asian Financial Crisis, the September 11 attacks, the release of Avengers: Endgame.

At such moments, the speed accelerates to lightning and people in my line of work have a heyday. It’s professional vindication, personal validation, and a helluva lot of excitement all at once. We all look for these moments.

Last week I saw something in Venezuela that I knew had to happen eventually. After two decades of mismanagement well past the merely criminal, it appeared the socialist government of Venezuela had finally collapsed under its own incompetence. Forces geopolitical, I thought, had finally gotten their revenge.

Part I and Part II of this series were, to be blunt, my wallowing in the moment.

Aaaaand I jumped the gun.

Please take this newsletter for what it is: part mea culpa, part explanation, and part a look forward at what it means that Venezuelan strongman-president Nicholas Maduro is not quite done making history.

First and most obviously, Maduro is still large and in charge. Initial reports that he had fled the country or slipped in the shower and fell on some bullets were wildly untrue. The Venezuelan military – the only faction in Venezuela that really matters as concerns Maduro’s survivability – remains more-or-less unified and in support of their boss.

Nor has the Venezuelan opposition made meaningful progress. Consolidation around self-declared interim president Juan Guaido appears no more coherent than any of the other failed opposition efforts to close ranks. The only item of substance that has changed from the past 20 years of Chavez-Maduro rule is that nearly every country in the Western Hemisphere has now called for Maduro to step down. There is zero indication that any of these countries, however, is willing to do much more than mouth the words. A military invasion is firmly off the table (and with the Venezuelan capital of Caracas not being a coastal city, any such effort would be, in a word, complicated).

Second, there is one power that is doing a bit more than voice its concerns. Since that power is the United States, best to pay attention. On Jan 28 the Americans levied blanket sanctions on the Venezuelan state oil firm, PDVSA. While the United States will still allow Venezuela to sell crude to American entities, Washington will not allow any cash from the sales to flow back to Caracas. In addition, the Americans froze the assets of Citgo – a PDVSA subsidiary in the United States that’s primarily a refiner.

Formally, about 32% of Venezuela’s crude oil exports end up in the United States, but this vastly understates how dependent Venezuela is upon the American market for a pair of reasons that can only be the normal state of operation in a country as broken as Venezuela has become.

Of the seven-tenths of Venezuela’s oil exports that do not flow to the United States, the majority – technically –goes to China and Russia. However, Venezuela gets no cash from these “sales.” Instead, the oil is accepted as payment-in-kind to whittle down the billions of dollars of loans those two countries have extended to Venezuela over the years. Nearly all this crude oil is then sold on to the American market where the Chinese and Russian intermediaries are paid in cash.

Bottom line 1: the direct sales to the United States are Venezuela’s primary source of income. Without them, Venezuela’s humanitarian/economic/political catastrophe – a mess that has already resulted in widespread famine – will become truly apocalyptic.

Bottom line 2: It is unclear if the new U.S. sanctions will touch these flows as well. If they do, the Chinese and Russians will be left holding gobs of crude they – and nearly anyone else on the planet – lack the capacity to refine. With no one able to take Venezuelan crude in appreciable volumes, PDVSA will have no choice but to shut down nearly all operations and experience a massive skilled labor bleed. That would add – at minimum – two years to any theoretical future recovery.

Third, this now has reverberations throughout North America.

Most American oil production is now shale crude, a specific sort of crude oil that has extraordinarily low concentrations of contaminants such as sulfur or mercury and has the consistency of nail polish remover. That makes it almost hilariously easy to refine into finished products.

Or that’s how it should work anyway.

Starting in the late 1970s the American oil industry believed that the global stream of crude oil was becoming heavier and more sour, so they invested bajillions of dollars in upgrading the entire network so the Americans could import crap crude no one else wanted (big discount!) and refine it into top-of-the-line products for sale at home and abroad (big margins on the upgrade and arbitrage).

One of those crappy crude grades U.S. refiners sought out was Venezuelan crude which is as heavy and sour as U.S. shale crude is light and sweet. Buy low, sell high. Life was good.

Recent events have made life less good.

American shale crude is now being produced so cheaply – on average full-cycle costs are now below $40 a barrel – it is crowding out America’s domestic low-quality crude production. The American crude stream is becoming increasingly light and sweet to the point American refineries cannot easily process it. New refineries are being built and older ones expanded and/or dumbed down, but that’s an expensive and time-consuming process and refiners needed to be sure this whole shale thing would last before really buying in. Despite being on the very cusp of technical oil independence, of late the United States energy complex has become more dependent upon imported crude in order to gain access the specific heavy/light/sour/sweet mix that works best for the refining complex while the excess shale crude is exported.

The three imported grades that figure most prominently are collapsing.

The first is Mexican. While the mainstay of U.S. refiners for decades, the general collapse of oil production in Mexico has all but eliminated Mexican crude oil from the American diet. There was hope with the energy reforms of the outgoing administration that this would be reversed, but freshman Mexican President Andrés Manuel López Obrador has made it clear those reforms will at best be slow walked. Don’t expect any fresh flows of Mexican crude in the U.S. market until at least 2030.

The second crude grade U.S. refineries like comes from the Canadian province of Alberta. Dealing with Albertan tar sands is sloppy, expensive work – requiring a cost point in excess of $70 to break even. Today U.S. crude is selling for $55.

It gets worse for the Albertans. Alberta is landlocked and has wildly insufficient transport options to get its crude into the U.S. market. Between that and a general political paralysis in Ottawa on energy issues that (almost) makes Washington look functional, Albertan crudes are now regularly selling at a $30 or higher discount to American crudes. The Albertan provincial government recently ordered reduced output in an attempt to level out price problems. (The political reverberations of this in Canada will be extreme, but that’s a newsletter for another day.)

The final crude grade U.S. refineries prefer is, of course, Venezuelan crude. Based on how the Trump administration handles the new sanctions regime, Venezuelan crude may vanish from the American market completely.

In the short term this is not looking very good as it will force U.S. refiners far abroad to search for crap crude. The Middle East is probably the only region that can provide the volumes the U.S. needs. Ironically, on specs alone, Iranian and Russian crude might actually look pretty good.

In the longer term this is not looking very good for everyone outside of the United States. Events in Venezuela (and Canada and Mexico) are forcing U.S. refineries to change their slow-walk shifts from preferring crap crude to preferring shale crude into more of a panicked sprint. Once completed – give it two to four years – the United States, beyond simply having no interest in protecting oil flows out of the Persian Gulf, will have no interest in protecting oil flows from anywhere.

The United States maintains the only global navy and it has been the American commitment of that navy to global commerce and security that enables a global oil market to exist at all. No one with possible exceptions of France and Japan will have the military capability to reach the Persian Gulf in force at all. The ultimate result will be oil shocks of the sort the world hasn’t experienced since World War II… except in the United States which will be a sequestered market.

Fire in Venezuela, Part II of II

It is always dangerous writing about unfolding events. With that in mind, Part I is just about where we are now. Part II is about the future.

Assuming for the moment that Nicholas Maduro has indeed fallen from power and his regime is crumbling, everything that happens in the next few weeks are details. Venezuela’s constitutional system of government has been suspended to shattered since at least the mid-2000s, and any new government will literally be making things up as it goes along. Even if the new government is truly representative of the popular will and makes no mistakes whatsoever, Venezuela’s mid-term future is for chaos and degradation. The damage of the Chavez/Maduro years has simply been too deep-rooted and catastrophic for this story to unfold any other way.

Four main problems:

First, food. Venezuela used to be a significant food exporter, but a combination of outright theft, corruption, supply chain breakdown and state expropriation of private assets that resulted in those assets lying fallow, has reduced the country to importing roughly three-quarters of its foodstuffs. As other economic sectors decayed the ability of anyone to afford what food is available has shriveled and starvation set in.

In the best-case scenario with perfect management, political unity and deep international assistance, bringing Venezuela back to food-neutral will take three years. Venezuela is in the tropics, and when tropical lands lie follow they tend to go riotous pretty quickly. Add in the infamous low fertility of tropical soils and the Venezuelans will need to reform all the supply chains for fertilizers and pesticides and such just to get things started. That all takes time. And money.

In the meantime, the 30-million(ish) people who remain in Venezuela will either continue to starve or live on handouts. Either way, the political system will remain fragile and so very, very desperate for years to come.

Second is oil – both a problem in its own right and perhaps a partial solution to the money issue. The money part is obvious – oil brings in income that could be used to regenerate Venezuela’s agricultural sector. But neither is this quick or easy.

Venezuelan crude is some of the most expensive to produce in the world, and fetches some of the lowest prices. It is high in sulfur and thicker than toothpaste. Only highly-specialized technicians can coax it out of the ground, and many Venezuelan crudes require specialized equipment just to get it to port. There are also very few countries that can process it. Add in economic chaos and a whiff of political desperation and there will not be a long line of companies wanting to pour large volumes of cash into the country in the near-term. Adding as little as a million barrels per day of new output is likely at least a five-year project. Venezuela currently produces only about 1.6 million bpd, down from 3.4 million bpd when Chavez took power.

(Side topic: When the Saudi government saw Chavez angling for power, they did everything they could to encourage him, hoping his economic populism would wreck the country’s oil output. They picked the right horse.)

Making matters worse, technically – legally – Venezuela owes any new production to Chinese and Russian entities who have provided the Chavez and Maduro governments with billions of dollars of loans. Loans that were to be repaid with crude oil.

Third, Venezuela in the best of times is a very shooty place. The political culture of the country has always been shaped by extreme economic inequality, which has generated crime and violence rates as bad as Colombia’s while Colombia was in a cocaine-fueled civil war. The oil largess succeeded in pacifying large parts of the population, in essence buying off the poor with absolutely massive subsidies on energy products and food.

It isn’t so much that any economic rectification effort must abandon those subsidies, but instead that the country cannot afford them now. Expect broadscale unrest to be the norm for years.

And that’s hardly the worst of it. Chavez’s first attempted rise to power took the form of a coup. After becoming president more conventionally, he later survived a coup. It all made him a bit nervous. In order to establish a force that would be loyal to him personally, he flat out bribed a few tens of thousands of neighborhood thugs to be his unofficial militia and equipped them with Russian-provided AK47s. They are now unmoored and unpaid – but not unarmed. Expect them to take whatever they damn well please.

Finally, Venezuela had no real release valves. If Maduro is truly gone, there is no one left to blame except whatever poor bastard tries to pick up the pieces and lead the country to a better future. There is no food-exporting country next-door that Venezuelans could theoretically migrate to. (Brazil produces food, but the trackless Amazon is between Venezuela and Brazil’s agricultural lands). The only country Venezuela shares a land border with that folks can walk to is Colombia, and the Colombians have already taken in over two million Venezuelan refugees.

(Another side topic: Most Latin American countries have enacted restrictions on Venezuela migration to prevent swarms from coming. Colombia has not. During the Colombian Civil War the Venezuelans accepted droves of Colombian refugees. The Colombians feel it is their duty to return the favor. Despite all the bad blood between recent governments on both sides, along with the general descent into nationalistic-populism around the world, it is nice to see the two powers not being complete jerks to one another.)

Whether Venezuelan refugees being largely stuck in-country is good or horrid of course depends upon what you think of people who are refugees due to internal political mismanagement, but the bottom line is that there is nowhere for Venezuelans to go.

And there won’t be for years.