Q&A With The Accidental Superpower Author Peter Zeihan by Gavekal Capital
We recently had the pleasure of a visit by Peter Zeihan, author of The Accidental Superpower: The Next Generation of American Preeminence and the Coming Global Disorder. The book outlines the global impact of US moves to pull away from the Bretton Woods Agreement that has been in place since World War II. We read The Accidental Superpower in our quarterly book club and highly recommend it to readers of our blog. We had some follow up questions for Peter on recent events like the migrant crisis in Europe, the devaluation of the Chinese Yuan, the future of the emerging markets, global quantitative easing, and more. The article below is the first in a 3-part series we will publish on the conversation.
GavekalCapital (GC): In the book, you describe how the US has been retreating from the Bretton Woods system that has been in place since World War II. Can you briefly describe the global landscape that existed prior to Bretton Woods and what happened at the end of World War II?
Peter Zeihan: Absolutely. Prior to the Bretton Woods system, the industrial world was one filled with imperialist ambitions. Back in the 1800s, imperialist countries such as Britain and Japan utilized their navies to establish and control colonial territories. Colonies provided a source of raw materials for the industrial country as well as a dedicated export market. Colonies also provided a way for industrial powers to continue to have access to resources if a war broke out on the home front. Imperial ambitions among the most industrial countries led to a world with many strong, competing navies. This was generally the way the world was until World War II. World War II was such a destructive war that at the end of the war, the United States looked around and realized that for all intents and purposes they were the only viable Navy left in the world. Not only did the US have the only viable Navy, they also escaped World War II rather unscathed in terms of their industrial base and consumer base. Their strong economic and military stature allowed the US to dictate terms to their allies as well as the Axis powers of the war. To the surprise of most everyone, the US happily opened up their home market and allowed the most devastated countries to export their way back to prosperity through the security promises of the Bretton Woods System. The US could see that the Cold War with the Soviets was around the corner so they setup an entirely new hegemonic structure in which the US didn’t have economic interests but one where they could create a strategic system so their chosen allies could thrive under the US security umbrella.
GC: And now the US is retreating from the strategic system that has been in place for the past 70+ years?
Peter Zeihan: Yes and the pace of the retreat is quickening. Even though we may all feel more connected than ever before because of technology, the US system is actually far less internationalized now than it was in the 1980s. Only about 7% of the US’s GDP is reliant upon exports, which puts the US in the same group as Angola and Afghanistan in terms international trade. This is far less than most industrial nations such as Germany whose economy is about 60% reliant upon exports. It is important to remember the Bretton Woods system has always been a strategic interest for the US, not an economic one. And the strategic rationale for Bretton Woods isn’t there anymore. There are three main reasons that explain the retreat from Bretton Woods in my opinion. First, the Cold War is over and has been for 25 years. Like I said Bretton Woods was designed to give a security guarantee for our allies mainly in Europe against the communist threat. That threat is gone. Second, internationalization has really run its course already. NAFTA can be viewed as a success and has increased the regionalization of the US economy. However, all of the low hanging fruit in terms of economic integration is gone. New types of economic integration would have to come through naval trade only and the potential clients that exist don’t share the same cultural and ethnic linkages that the US shares with Mexico and Canada. Third, our last strong tie to the global economy was through our imported energy needs. The shale revolution going on in this country over the last decade has completely taken the energy argument and thrown it out the window. The US is now the most disengaged economically from the rest of the world that it has been since the end of War of 1812.
GC: What about globalization? Hasn’t the US always been a big proponent of globalization?
Peter Zeihan: The US always likes to talk about globalization but if you look at the actions of several of the past presidential administrations you can see the retreat that has been happening. The last big push for globalization in the US was 25 years ago at the end of the Cold War when WTO and NAFTA negotiations were happening around the same time. For the US, NAFTA can be viewed as a success while the WTO was not. The US is more integrated economically with its neighbors now than it was prior to NAFTA but it isn’t any more economically integrated to the rest of the world. If anything, it is actually less integrated than it was in the late 1980s and early 1990s. Unfortunately, the economic gain from NAFTA is one that cannot ever be replicated since the US isn’t connected to another continent. And while globalization is an easy boogey-man to blame for a myriad of economic problems, the fact of the matter is the US is just not that economically dependent on globalization.
GC: Why is the shale revolution so important to the US?
Peter Zeihan: In the post-Cold War era, the US was at its most internationalized in the 2004-2006 period due to the combinations of the military conflicts in Iraq and Afghanistan as well as the energy price boom that was taking place. Just a decade later, the US has vastly scaled back its global military presence and oil prices have fallen significantly. A gap between US and international energy prices has developed as the US has been able to increase domestic crude oil production above 1970s levels. Oil prices, and especially natural gas prices, are cheaper in the US than they are in other parts of the world because of US shale oil production. I expect the US to be energy independent in just two years. At this time, outside of special circumstances such as a Saudi owned refinery that will demand to use Saudi oil, the US will not be importing any oil from outside of North America. And the US is now becoming a major player in the export of refined product. The US now exports about 2.5 million barrels of refined product each day and has built more distillation capacity last year than they did during the entirety of World War II.
As the US moves closer to energy independence, or at least energy independence in North America, the massive costs associated with keeping Bretton Woods in place are harder and harder to justify.
GC: Will the slump in commodity prices, specifically in oil prices, push back the date when the US can achieve energy independence?
Peter Zeihan: I don’t believe so. I believe breakeven costs for new wells are around $45 dollars right now (WTI is currently $45.55) and will probably be below $30 by the end of next year. There have been many major advances in drilling that are driving down costs. For example, drillers now are regularly using 4D seismic technology. In the old days, drillers only had a two dimensional picture to drill from and could only see little lines where oil could exist and had to guess whether or not they would find oil. Now, drillers have a 3D seismic picture that changes second by second as they are drilling. The fourth dimension here is time and drillers can now see how the rock responds in real-time and can adjust their drilling accordingly. It used to be that drillers would frack along every stage because they weren’t sure if they would find oil. Now, if they go to a spot that doesn’t have oil they know immediately and can move on and not waste their resources. This has reduced sand and water costs by half, and the US hasn’t drilled a dry well in over 18 months. Pipe costs have also been cut in half because instead of having to lay a vertical pipe for every horizontal pipe, now you can lay one vertical pipe and do half a dozen horizontal pipes at a certain depth. When the drillers are done at that depth, they can move higher and lay down another half dozen horizontal pipes and still use the original vertical pipe. You can now have 20 miles of pipe connected to just one vertical pipe. These advancements alone have brought down the breakeven level to around $45 now. The next stage is utilizing more techniques developed in conventional fields such as secondary stimulation using water flooding or CO2 injection. You can go to a well that was fracked six years ago, refrackit with today’s technology, and for 10% of the costs you can bring it back up to full output.
GC: There has been a lot of news recently regarding bad debts in energy sector. Presumably, a lot of the money borrowed was facilitated by easy monetary policy. Do you see monetary policy as a headwind to the development of shale?
Peter Zeihan: Not really. We are certainly likely to see a consolidation in the industry as bad debts in any industry usually lead to some consolidation. And consolidation will most likely reduce drilling. However, I don’t believe it will impact production. It will just impact the amount of drilling that is being done with obsolete technology. Keep in mind that about 60% of the rigs that are now idle will probably never operate again, at least in the US, because they utilize the old horizontal drilling techniques. The old rigs will probably be sold off to countries who are just starting to frack. The techniques are more efficient and productive which is why I believe production should continue to increase.
This is part 1 of a 3-part series.
See full PDF below.