Hey everyone. Peter Zeihan coming to you from Colorado where fall has firmly set in. Today we’re into the third part of a three part series on the shale revolution. The third shale revolution. Phase one was the production side. Phase two is processing and turning things into fuels and intermediate materials that we use in pretty much everything. And the third revolution is everything.

One of the truisms of the last 70 years of globalization has been that material production and manufacturing moves to wherever the competitive advantage happens to be, regardless of national identity. And that means that a lot of energy intensive industries moved out of the United States, particularly after 1973, because oil prices were cheaper or electricity high prices were cheaper, natural gas prices were were cheaper.

Or the processing process was less expensive, usually due to things like labor and environmental restrictions that we might have here that we don’t have in places like, say, China or Egypt that is in the process of unwinding that between globalization and a new appreciation for national security as a component of economic activity. More and more things are being reassured, and the shale revolution has gotten us a jump on this because the shale revolution has provided the United States with cheaper oil, cheaper natural gas, cheaper electricity and cheaper chemical products than anywhere else on the planet.

In part, that’s because natural gas is largely a byproduct here, but mostly it’s because the break even price and a lot of shale fields is now very, very low. And in fact, in the Permian Basin, which is the largest one in the United States, which is responsible for over a third of our overall energy production, it’s less than $11 a barrel on average compared to, say, places like Saudi Arabia, where it’s really cheap but still more than 20, or places like Russia, where with all of their Siberian work, you’re talking 30, 40 and even $50 a barrel.

So huge price advantage. In addition to the changing understandings of security. And what that means is the United States already this isn’t something that’s in the future, already is the lowest cost, highest quality, lowest pollution index producer of every one of the intermediate industrial materials that can come from energy products. And what we’re seeing now in this third phase of the shale revolution is those are being turned into manufactured goods.

And it’s really difficult to find a manufacturing subsector where this is not a game changer. Let me just hit a few of the highlights. First of all, agriculture, natural gas is turned into nitrogen based fertilizers. So where the U.S. is now the world’s largest producer and we’re seeing more and more of that value add chain come back. Even when the United States became the largest producer of natural gas and ethane, we were still shipping the intermediate products abroad, primarily to places like the Middle East or China for processing to finish fertilizer.

That is changing day by day for those who you think we should go organic help god. You are so bad at math. Organic fertilizers require multiple applications over the course of the year, which requires a lot more carbon input. In addition, they require about an order of magnitude more energy to produce in the first place. And if you’re going to be moving six, seven, eight, ten times as much of the stuff, you can imagine what the carbon footprint is for transport.

The same goes for pesticides. Most pesticides in the United States now are a once or twice and done for the season, as opposed to something you have to put on every few weeks in case you want to go organic. Another industry that’s seen a lightning change is wiring, which I know doesn’t sound very sexy until you realize you just go through your life and look at everything that uses electricity that includes your car.

Even if it’s not a an electric car. Anything with a wire has to have a protein. And those coatings are almost exclusively if you produce with some sort of petroleum derivative. Normally the wires are pulled from the metal close to the point of manufacture. So every industry that reassures is going to do more and more of that at home.

And since the coatings come from a petroleum derivative, the United States now has a huge economic advantage in addition to the security advantage over almost every other player. This means that whether it is automotive or electronics or semiconductor, there’s there’s a fairly large petroleum footprint that has nothing to do with energy. One of the things that folks forget is that we use petroleum for a lot more things than just burning.

And before 2015, about one fifth of the oil that the United States used was used in refined products that were not fuels. As we double the size of the industrial plant over the next several years, that number is probably going to at least double, especially if we continue down this path of ever more fuel efficient vehicles. More and more of the petroleum we use will be used for things where it’s not burned, which means that the carbon footprint is an order of magnitude less than it is for, say, gasoline.

Okay, what’s another one? Textiles. Not everything is cotton anymore. Any type of synthetic fabric. Like, you know, what I’m like or what I’m wearing right here. That is 100% of natural gas and petroleum derivative. And as such, that is the frontier in low carbon clothes making, because you don’t have to grow this. It’s just a byproduct of a natural form, of a natural, but of an industrial process where very little is actually emitted.

Polymers are all like that. Let’s see what semiconductors. I mean, obviously, the silicon is important and obviously you need dopey materials. But those dopey materials, as a rule, involve a lot of petroleum materials and there’s wiring throughout the entire process. In fact, it’s difficult to find a manufacturing sector where a petroleum derivative is not one of the top three or four components in it.

That’s true for automotive. That’s true for aerospace. That’s true for white goods. That’s true for heavy equipment. And now that all all of these materials are already being produced here, it’s really easing the pace at which the United States is reshoring industry from the rest of the world. So we have seen industrial construction spending, spending in the United States expand by roughly a factor of eight since just five years ago, and it’s almost tripled in just the last 18 months.

This is a good start. We need to do a lot more because we need to expand what we’ve done in these last five years by at least a factor of four and hold it there for at least another five years. And that will be inflationary and that will lead to labor disputes. And there’s a fierce competition among the American states as to where this stuff is going to go.

But the fact that the shale revolution has given us cheap power and cheap materials to do it at whatever scale we want. From a certain point of view, a lot of the hard stuff is already done. Everything else is a known quantity. Anyone else who wants to do this ultimately is going to have to import those materials, and there are only three real sources for them at scale.

China. The Persian Gulf. And here.

Okay. So yesterday we talked about the first shale revolution and how it basically gave the United States top level energy independence and natural gas and oil. Today, we’re going to talk about the second shale revolution, which is what we did with that. Crude by itself is of limited use. That’s if anything, it’s a big negative. You have to turn it into something else.

And so the second shale revolution largely is about building out the industrial plants starting in roughly 2013 to 2017 in order to massively expand the footprint of the American refining industry. And we added huge amounts of distillation capacity based on whose numbers you’re using somewhere in the equivalent of 6 to 7 million barrels per day of oil and oil equivalent to take all this oil and all this natural gas into turn into other things.

Now, natural gas you can use as a power plant, fuel, and it is the single largest source of electricity in the country, sometimes where between 30 and 40%, based on which state you’re in on average. And that has broken the connection between the United States and coal, which for a long time was our largest source. And so that switch by itself made the United States, the country on the planet that had reduced its carbon emissions the most in relative terms on a sustainable basis.

Now, there is more to it than that because it has also set the stage for the green transition. One of the big problems with solar and wind is, as you know, the sun doesn’t always shine and the wind doesn’t always blow. And so you need to have another source of energy to step in when green tech cannot deliver, especially if you’re not in a place like West Texas, where the sun is bright and the wind is strong.

The best fuel source for that that we have discovered so far is natural gas, because a combined cycle natural gas plant can spin up and down and in as little as 10 to 15 minutes, whereas a coal plant can take up to 8 hours and like a lignite plant, looks like what they use in Germany can be 3 to 4 days.

As a result, the Germans have actually seen the carbon footprint go up despite spending over €1,000,000,000,000 on green tech and transmission. And all of this is a side effect and I’m sure that the frackers who put all the natural gas in the system weren’t really thinking about natural gas and the green transition when they were doing their work.

The second thing to keep in mind is, for the most part, natural gas is a waste product with Michail sector. It doesn’t earn nearly as much on the open market as, say, oil or liquefied petroleum. Gas is like propane do, and it often comes up as a byproduct or co-production. And so it’s typically sold into the system at a loss.

So not only is the shale revolution made the United States the single largest producer of the stuff and user of the stuff, it’s at a price point that is significantly lower than everyone else, which is one of the reasons why the debate around things like the green transition in the United States actually hasn’t been nearly as rancorous as you might expect because the math has been a lot easier to do.

Having that backup fuel is all part of the Second Shale Revolution, and of course there’s more to it. Something called ethane often comes up as a byproduct of natural gas production, and ethane is a chemical that’s a little bit different from methane has an extra carbon molecule. And you can use it as the base material for any number of chemical processes.

For example, the creation of things like methanol and butadiene, which provides a whole product suite that includes things like fertilizers and plastics. And so the United States has become the largest producer of all these intermediate products as well. But the same happens with oil. There’s more to producing oil than simply making diesel and gasoline. You can make an intermediate product called naphtha, which goes on to make everything from bowling balls to insulation to diapers.

And the United States is now the largest producer in all of those as well. This second shale revolution has seen a tripling of investment into the space of industrial construction to bring all these refineries and chemical plants online. And we’re not done with the Second Shale Revolution yet. One of the freaky things about oil is it’s not all the same.

You have different grades based on contaminants and you’ve got heavy sours, which is what most of the American Petroleum Complex is designed to run on. And then you’ve got light sweets, which are rather very easy to refine. But our understanding back in the seventies, the eighties and nineties is the world had run out of that. Well, everything that comes out of shale is light sweet, because it’s trapped at the moment of formation.

It never migrates through the rock strata. It never picks up mercury, the sulfur or anything else. And because of that, we actually have a massive oversupply of light sweet in the country to the tune of 5 to 7 million barrels a day of crude oil. That’s the final stage of the second shale revolution will be building up the processing capacity to process that as well.

Now, the United States is already a net exporter of pretty much every energy product. And as we build out the refining complex in order to take advantage of this local surplus, we’re also going to become the world’s largest exporter of pretty much every energy and energy derived product as well. And that’s all probably all going to go down in the next 5 to 6 years.

And that sets the stage for the third shale revolution, which we’ll talk about tomorrow.

Hey everybody. Peter Zeihan here coming to you from Colorado, where the big news from last week, which was a believe the 10th of October, was that ExxonMobil, the energy supermajor, has bought up a company called Pioneer with an all stock by about $60 billion of stock. Pioneer is the single largest producer in the shale fields in the Permian Basin, which is the most productive energy basin in the world now.

So I thought it would be great to kind of take a walk down memory lane and then take us forward into what’s going on with the energy sector in the United States and the wider world starting Michele. So short version is that there have been multiple phases to the shale breakout. It all started back in the early 2000s when the United States found itself facing kind of a double bind.

We had had a coup in Venezuela, which had taken one of the major suppliers of crude for the Western Hemisphere off. And the Iraq war had started. So a major source in the Eastern Hemisphere was offline. And energy prices hit near record levels in a very short period of time. And there’s nothing like high prices to trigger the sort of activity that’s necessary to bring new supplies to the market.

And a lot of technologies that had been part of the energy matrix for decades, in some cases over a century. They started to play with them in new ways. So the two issues in question were something called fracking, which is basically injecting water into a well with a suspension of sand in order to crack the rock. And then you pull the water back out and the sand stays behind and props open the cracks.

We’ve been doing some version of this for over a century, but that was now being combined with something called horizontal drilling, where instead of just going down and punching through a cap rock to get to a reservoir, you go down and then you go laterally across a rock strata. Shale is different from normal crude. Normally, the crude migrates through the rock formation until it hits some sort of non-porous rock that it can’t pass through.

And then it builds up into kind of a pool with a lot of pressure. So when you punch through the tap rock with a drill bit, you get pressure that pushes the oil out. And then eventually you can pump water down into that formation in order to loosen up more of the oil and get even more out. Shale is different because the rock itself was never porous, and so the little bits of energy are trapped almost at the moment of formation within the rock strata.

And so you’ve got to break them out. It’s neither of these technologies were really new, but combining them was. And as is normal, when new technologies come to the fore, it’s not the big players who do it. It was the small players. So this is not ExxonMobil or Chevron or ConocoPhillips or Total or any of the rest. These are mom and pop operations who only own a few acres of mineral rights, who would drill everything that they had.

Now, the economics of that are maybe questionable, but remember, we’re in an environment of much higher oil prices. So you had small operations that were desperate to find a way to crack the code on new technologies in order to stay in business. And since we had high prices from roughly 23 until 2008, they had a long period of high prices that they were able to operate in.

And for small companies, that meant a lot of innovation. And so we developed dozens of new techniques, kind of clustered into these two general categories. And that brought a lot of natural gas, which was easier to produce into the market. And by the time we get to 2008, we’re starting to do the same thing for oil. And of course, we had the financial crisis, so everyone got hammered.

But then we had Wall Street, who was looking for new investments. And since these small mom and pops had done so well for the last few years, there was a lot of money that came in from the stock market or bonds or joint ventures, whatever it happened to be. Now, by the time we get to 2013, 2014, these technologies had matured quite a bit, and the United States was very, very close to achieving technical energy independence.

And that meant that the super majors started to come to play. Now, starting back in the 1970s, when U.S. energy production really started declining and force the super majors knowing that there wasn’t anything left in the United States with how they understood energy production, they went abroad and well, things got ugly. Most of the countries that they started producing energy and whether it was in the Middle East or off the coast of Africa or South America, didn’t have very strong rule of law.

The local energy partners were tended to be pretty corrupt and it was a crapshoot, especially since a lot of these projects were in areas with limited infrastructure. It could take ten years of investment before you saw any return, and then it might just be nationalized. So they kind of had a crap sandwich for 30 years. Well, then they look back home and they see this flotilla of small companies just making bank.

And so they started coming back to the United States and buying of the shale plays and buying up the engineers. And sometimes even these smaller companies in total in order to learn what had been developed back home. They saw a lot of familiarity because, you know, these two technologies were not breakthroughs. And of them themselves, the the the technique of combining them, that’s where the interest was.

And so year after year after year, the companies came back in greater and greater force. The company that was first for that was ChevronTexaco, because it had a lot of legacy production from the Permian Basin in West Texas, which had been part of previous oil booms. But it also had 20 layers of shale. So they were able to use their preexisting mineral rights and buy up some of the talent that was available and apply it to what they already had.

Exxon didn’t have that option. Exxon just had to come in and bye bye, bye, bye bye. And in the meantime, Pioneer, which is a company that dates back to the T Boone’s Pickens days, if you guys know that name was a legitimate producer in its own right, but it too was just basically was hoovering up all of these small companies for a decade.

You fast forward today, ExxonMobil is like, okay, okay, okay. The crap sandwich that is the international energy industry that’s not nearly as hopeful as we thought it was going to be. So we need to do something a little bit bigger. And so they found the single largest player in the Permian Pioneer. And just and when when Exxon does a merger, whoever is after the Exxon part is still, you know, technically it’s ExxonMobil, but Mobil’s long gone.

So basically, there’s been absorbed into the Borg behemoth that is ExxonMobil. Which brings us to today. This is probably the end of the first shale revolution because the character of it all, these small companies doing massive innovation that is now pretty much gone. And the majority of the shale production in the United States now is owned by the super majors again.

So we’re back to where we were in the seventies. That doesn’t mean that production growth is going to stop. That doesn’t mean that innovation is going to stop. But things are definitely going to slow down now. Exxon has a lot more market control. It has a lot more market discipline. And when you’ve got a small company that only owns a few acres, they will drill every theoretical spot that they think they can get oil out of.

But when a huge company owns hundreds of thousands of acres of mineral rights, they’re going to drill the best spots. And when those are tapped, they will then do a little bit more targeted innovation on the next best spots and so on, which means we should expect production growth to be less frenetic than we’ve seen in the past.

It doesn’t mean it’s going to stop. But, you know, in the last 15 years, the U.S. shale sector has set records for added production, I think, in nine of those years. Those days are probably behind us, will probably never add more than a million barrels a day a year again. But, you know, records exist to be broken. We’ll see now from the point of view of a normal person at the end of the first show, revolution isn’t going to seem very much different, but from within the industry, it’s going to be pretty significant.

Kind of the defining characteristic of ExxonMobil is it has all the stuff that it needs in-house. So it can’t just use these technologies or carry them forward. It can do so at scale and kind of turn it to an assembly line process. It’s much more reliable and gets more output for less input. Perhaps just as importantly, the defining characteristic of small companies is they don’t have a lot of cash, so they take it from wherever they can get.

Most of these aren’t publicly traded. So you’re talking about loans or bonds or joint production ventures or whatnot, whereas Exxon can fund whatever it wants. So in the old days now, 5 to 15 years ago, small companies were dependent upon getting capital either from regional governments or banks or Wall Street. Well, that pretty much ceases to be a concern with Exxon.

And they can do the investment day in, day out, based on their own short, mid and long term economic forecasts. And this should generate a lot more smoothness in terms of production output. But it also means that a lot of the financial ups and downs that we have seen in the energy sector that were related to things that had nothing to do with the energy sector, those are probably behind us, and it should make all of this a lot more reliable in the time to go.

And it’s time now to start talking about the second shale revolution, and we’ll hit that tomorrow.