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Peak Oil Review - December 17th, 2007

1. Production and Prices
2. Mortgages and Inflation
3. Iraq
4. 2008
5. Energy Briefs

1. Production and Prices

Oil prices remained volatile as fears of oil shortages alternated with fears of an impending recession depending on the news of the day. Starting at $88 on Monday, oil climbed to $95 at midweek only to close at $91.58 on Friday as bad economic reports accumulated.

The IEA calculates that world oil production increased by 55,000 b/d to 86.5 million because of increased production in Mexico, China, and Brazil. The Agency says OPEC production dropped by 180,000 b/d in November while Platts says there was a small increase. Higher production from Saudi Arabia and Iraq helped offset a temporary maintenance-related drop of 400,000 b/d in the UAE’s output. Iran and Kuwait boosted output by 50,000 b/d while Algeria, Libya, Nigeria and Qatar increased output by about 10,000. With the UAE back to full production in December, production could be still higher.

The IEA reports that commercial OECD stockpiles dropped by 22.4 million barrels in October. (The EIA says 16 million.) A sharp drop in European stockpiles led the decline. Preliminary indications suggest that a similar decline will take place in November. The EIA says it appears that US domestic oil consumption will increase by 0.4 percent in 2007 with gasoline increasing by 0.6 percent.

The EIA and a number of independent analysts are forecasting a slight drop in oil prices over the next few months. While the fundamental supply/demand balance remains tight and stockpiles continue to shrink, they cite increased OPEC production of 400,000 b/d in the 1st quarter, forecasts of warmer weather, and the increasing likelihood of a recession as reasons for this judgment.

2. Mortgages and Inflation

It now seems likely that the housing/mortgage/credit situation will play a central role in the peak oil story for years to come. Already a veritable avalanche of bad economic news competes daily with routine oil-related stories in determining the course of oil prices. Until recently, the OECD world seemed relatively immune to the inflationary pressures of $90 oil and $3 gasoline and, thanks to droughts and biofuels, soaring food prices -- but that is changing.

The Federal Reserve’s actions to improve liquidity and stave off a recession have played a large part in the decline of the dollar and the consequent $25 surge in oil prices this fall. Record oil prices turned up in the inflation numbers last week with a vengeance as producer prices showed their steepest gain in 34 years. Inflation in Europe took a similar bounce. If oil-price-induced inflation continues much longer, the Fed is going to have to think long and hard about further interest rate cuts for the feedback loop of lower dollar, higher oil, more inflation will only make the situation worse.

In recent days, however, more ominous insights into the credit situation have emerged. As government efforts to restore liquidity seem to be making little progress, observers are suggesting that many of our financial institutions have taken on so many loans that have or soon will go bad that they are insolvent. To remedy a problem of this magnitude, housing prices will have to decrease by 30 percent to restore their normal relationship to incomes, and financial institutions will have to come clean as to the real extent of their potential losses.

This suggests it will take many years to stabilize the current credit situation and it will be very painful. It is clear that the peak oil is already inextricably involved with the credit situation just as peak oil is involved with global warming. It is a two-way street; rising oil prices from inadequate supplies will affect the credit-induced economic situation and serious economic problems will affect the demand for oil.

3. Iraq

The improving security situation in Iraq has led to a surprising increase of nearly 400,000 b/d in Iraq’s oil production, which Baghdad claims is now 2.5 million b/d. Exports are now approaching 2 million b/d which is above the pre-2003 levels. Nearly all of this increase is due to the opening of the Kirkuk-Ceyhan, Turkey pipeline that until recently had been closed by sabotage.

How long this situation remains is difficult to predict. Although extraordinary efforts are being made to protect the northern pipeline, there has been little letup in insurgent activities in northern Iraq. Last week three pylons on a power line sending electricity south to Baghdad were blown up. The Kurds vs.Turkey situation continues to fester with Turkish air strikes on Kurdish villages in Iraq last week. With a national oil law stalled in parliament, the Kurds are continuing to sign agreements with foreign oil companies, much to Baghdad’s displeasure.

In the south, British forces pulled out of Basra yesterday, turning the city over to 30,000 Iraqi troops and security personnel. Maintaining security and oil exports in the factionalized city will be the biggest test yet for the Baghdad government. Given the current world supply situation, the loss of even part of Iraq’s 2 million b/d of exports to insurgent attacks is bound to have a more significant impact on oil prices than in previous years.

4. 2008

The possibility that serious economic difficulties are in the offing has made projections of oil demand through 2008 more controversial than usual. During the last week, three major prognosticators – the IEA, the EIA, and OPEC – and several major financial institutions came out with their estimates of what demand will look like next year.

First out was the OECD’s IEA which now foresees world oil demand growing by 2.1 million b/d next year. The upward revision is based on an expected increase in demand for ethane and other petrochemical feedstocks in the Middle East, notably Saudi Arabia. This forecast assumes that there will be economic problems in the US and other OECD countries, but continuing robust oil demand growth in non-OECD countries, where subsidies protect people from the impact of high oil prices.

In contrast to the IEA, OPEC economists foresee a growth of only 1.3 million b/d because of increasing world economic problems. The US’s EIA foresees a “mild slowdown in global economic growth” and comes up with demand growing by 1.38 million b/d. Observers have pointed out that these are all “politically correct” forecasts reflecting the goals and biases of the organizations’ sponsors.

Goldman-Sachs remains bullish, believing that oil demand remains robust in the US and Japan, and is accelerating in China and Korea. "The softening of the balance in 2008 will likely be modest and short-lived," while the second half of the year could see "demand recover more quickly than OPEC supplies increase." Goldman-Sachs foresees oil going to $105 a barrel next year. Other prominent commentators see economic problems forcing oil prices lower in 2008 and believe they certainly will not break 2007’s highs.

Judging from the scale of the pressures that are building up in the financial markets, the answer to all this will probably depend on how fast and far the impending economic troubles spread.

5. Energy Briefs

  • Beijing turned the tables on the US on Wednesday after years of criticism from Washington of its handling of the Chinese economy, warning of the serious global implications of the weak dollar, recent US interest rate cuts and the subprime crisis.
  • South Africa’s economy is facing serious power shortages after the government failed to heed pleas by state power utility Eskom to invest more in electricity generation.
  • Syria, now a net oil importer, is having trouble affording the subsidies it pays to keep petroleum products cheap. The government is afraid that removing the subsidies will fuel inflation and spark discontent among people used to cheap oil products.
  • Spanish gas consumption hit an all-time daily high on Thursday because of high demand from electricity producers and increased domestic use due to low temperatures.
  • The airline industry has cut its forecast for profits next year by a third as soaring fuel costs and the credit crunch begin to take their toll. Global aviation would make profits of $5 billion in 2008, compared with a previous forecast of $7.8 billion. The greatest burden on airlines next year will be fuel prices, with the increase in prices set to add $14 billion to the industry fuel bill, to $149 billion.
  • The cost of shipping oil in supertankers from the Middle East to Asia may extend gains from a three-year high because of dwindling supplies of ships available for hire in January. Freight rates for supertankers have almost quadrupled in the past month. The oil spill caused by a tanker collision off South Korea last week increased demand for double-hulled vessels that are less prone to leaking their cargoes.
  • Nigeria is beginning the first major overhaul of its petroleum industry in decades, a move expected to make it tougher for international oil companies to make profits. The planned changes include “rebalancing the relationship" between the state and foreign energy companies -- code for handing over more oil profits. Contracts are up for renewal and were signed when oil traded at about $20 a barrel.
  • Darfur rebels said they attacked a Chinese-run oil field in Sudan last week and vowed to launch more assaults on other installations. The Chinese government has stated, “the safety of Chinese personnel in Sudan must be effectively guaranteed."
  • A lack of precipitation has led to wide-spread power shortages in North Korea which generates much of its electricity from hydro power. With the winter dry season coming up, the situation is bound to get worse.
  • Saudi Arabia is on a $600 billion building binge to diversify its economy. Many of the projects underway – aluminum, chemical, and plastic plants—will consume large quantities of oil. This raises the question of just how much Saudi less oil will be available for export when the projects become operational.
  • Much of the Middle East’s new oil production will never leave the region. A Lehman Brothers report predicts that oil needs in Saudi Arabia, Kuwait, the UAE, Qatar and Bahrain will jump by almost 200,000 barrels a day next year alone.
  • Mexican crude exports will decline over the next decade if the industry is left with insufficient funds to invest in exploration and production. The oil ministry's worst-case scenario has exports slipping to 289,000 barrels a day by 2016, down from an estimated 1.7 million barrels a day this year. Mexico relies on crude exports for around 40% of its budget and is a top crude supplier to the U.S.
  • China increased crude oil output by 1 percent to 3.74 million b/d last month to meet rising energy demand in an economy that expanded by 11.5 percent in the third quarter.. The nation's coal demand growth may slow to between 6 percent and 8 percent as the government's efforts to control economic growth take effect. Coal-fired electricity generation, however, may rise 12 percent next year.
  • Japan is speeding up its drive to promote biofuels. Tax changes aimed at encouraging motorists to use bio-gasoline are expected in a few months as the third-largest oil consumer started to sell bio-gasoline at a limited number of gas stations earlier this year on a trial basis.
  • Toshiba announced plans to start selling rechargeable batteries next year. Describing its new Super Charge ion Battery, or SCiB, as a "breakthrough rechargeable battery", the company says it can be fully recharged in five minutes and has a lifespan of more than 10 years if completely run down and recharged once a day.
  • Congress is ramping up political pressure for increased government regulation of US crude markets to curtail speculative trading and market manipulation in electronic markets. The House Agriculture Committee is expected to give the Commodity Futures Trading Commission greater power to regulate the market when it re-authorizes the agency and the Senate is working on an amendment to the farm bill that would give the CFTC even greater authority to police unregulated electronic trading markets.
  • Pakistan’s oil reserves have plummeted to the lowest-ever level in the country’s history and the stocks of major oil products — kerosene and diesel — are sufficient for six days only.
  • Unions representing striking Italian truckers said on Wednesday they were suspending a three-day-old blockade that cut off fuel supplies, closed factories and stopped food reaching the shops. The unions said they decided to halt the protest after the government promised to address their main concerns, including reducing diesel costs.
  • UK truck drivers gathered outside oil refineries around the British Isles on Saturday to protest rising fuel costs. Organizers won't block refineries and depots as they did in 2000 when U.K. fuel distribution was brought to a standstill. Demonstrators are seeking to have the government scrap proposals to raise fuel taxes by 2 pence a litre in April and defer a similar increase that went into effect in October.
  • Iran signed a $2 billion oil contract with Sinopec of China last week, sending a signal to western companies that they might miss out on potentially lucrative contracts if they continued to heed US-inspired sanctions against Tehran.

Quotes of the Week

  • [It is no longer true that food and energy costs don't tend to rise faster or slower than other prices over time, for two reasons.] “One, food prices driven by increased long-term demand for meat and milk rise with the growth of China and other developing countries and as; Two, global oil supply peaks lower and sooner than had been contemplated earlier.”
    Alan Greenspan, retired chairman, U.S. Federal Reserve (Wall Street Journal)
  • "What we need to realize is whether peak oil production is here or is coming ... isn't really the question. The [problem] is that our share of what's available is going to continue to decrease, because the rest of the world is demanding more and is willing to pay for it--more than we ever have."
    Rodney Andrews, executive director of University of Kentucky’s Center for Applied Energy Research (CAER), addressing Kentucky lawmakers last Thursday.

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