1. Oil and the Global Economy
After rallying on Monday following a precipitous drop the week before last, oil prices fell steadily for the rest of the week with NY futures closing at $65.84 and London closing at $69.07, the lowest closing since July 2009. On Thursday, the Saudis lowered their price for oil coming to the US, indicating that they will continue efforts to maintain their market share. The Saudis’ price cut was the steepest in records going back to 2000. While US employment numbers were stronger than expected last week, commentators are noting that many of the newly employed are in low-paying jobs and are not likely to result in much of an increase in the demand for gasoline.
Conventional wisdom is saying that the plunge is not over yet and that lower prices are ahead as there is still too much oil being produced, and too little demand. Market technical indicators that have turned strongly bullish are being ignored by the markets, suggesting to some traders that prices are headed still lower. The Saudis are saying they see the market stabilizing around $60 for Brent which is now less than $10 away; Credit Suisse says US oil will average $62 a barrel in the first quarter; the Russians are joking that we will soon see $63, which is President Putin’s age; and the real pessimists are talking about $35 a barrel which would come when the world runs out of storage capacity for the excess oil production. Somewhere along the line, however, the US is likely to start buying for its strategic reserve, dumping the oil into storage caverns to support prices. The Chinese are already taking advantage of low prices to build their strategic reserves.
The question now is just what does $60 or lower oil mean for the global economy and the continuation of drilling for high-cost oil? EIA and OPEC analysts calculate that some 1 to 1.5 million barrels per day of oil will have to be removed from the market in the first quarter to stabilize prices. Obviously large consumers of oil products such as the US, the EU, China and Japan are going to be doing much better in the short term as large amounts of wealth that had been going to the oil exporting countries will stay with the oil importers. US gasoline prices are now averaging $2.68 a gallon with a few gas stations selling for less than $2. Some are saying that at least of third of the companies drilling for shale oil are in serious trouble despite a stream of reassuring pronouncements from CEOs.
For drillers in North Dakota, Colorado and Wyoming, wellhead oil prices are already around $50 per barrel because of the costs of moving this oil to refineries, which are mostly located along the coasts. For small drillers who are in the business only because of ever-increasing debt, there are serious troubles ahead unless prices rebound significantly soon.
Some analysts are starting to raise more ominous concerns. These people note that some 16 percent of the outstanding junk-bonds consists of loans to nearly insolvent energy drillers. Should many of these default, it is possible the US could see another financial crisis similar to the one in 2008.
A new issue emerged in the financial media last week as to just how long US natural gas production will continue to grow. Last week the EIA announced that proven US natural gas reserves rose 9.7 percent in 2013 to 354 trillion cubic feet, the largest ever. The government says that the US will have plenty of natural gas at least until 2040. However, the University of Texas released a far more pessimistic report saying that the four biggest US shale gas production areas could peak as early as 2020. The Texas study was based on a far more detailed analysis than the government used to reach its conclusion and is in line with what many in the peak oil community have been saying for many months. The Texas study is already raising concerns, even in the Wall Street Journal, that the billions of dollars to be spent on US LNG export facilities may not be money well-spent if there is little natural gas to export five years from now.
US natural gas futures rebounded to $3.77 per million on Friday following a 16 percent decline in the previous six sessions. The rebound was largely attributed to profit-taking as there are no unusual cold spells in the immediate forecast
2. The Middle East & North Africa
Iraq/Syria: The major development last week was the agreement between Erbil and Baghdad on the sharing of oil revenue from wells in Kurdistan. Now that ISIL controls much of northern Iraq and has closed Iraq’s northern export pipeline to Turkey, the only way to get oil from Iraq’s northern fields to market is through Iraqi Kurdistan into Turkey. Under the agreement, the Kurds will sell the 250,000 b/d that is produced in Kurdistan through Iraq’s State Oil Marketing Organization, and both sides will work on exporting oil from the disputed Kirkuk oil fields through Kurdistan to world markets. The agreement may add another 500,000 b/d to world markets. Also included in agreement is the allocation of a portion of Iraq’s national defense budget to the Kurd’s autonomous Peshmerga forces that are making a major contribution to containing and pushing back ISIL.
The US has established a new military command to oversee operations in Syria and Iraq, suggesting that Washington is setting up for the long haul. US airstrikes on ISIL forces and infrastructure continue to increase. The US State Department says some 60 countries are now members of the anti-ISIL coalition; however only a handful is taking part in the airstrikes. Some 1,000 airstrikes on ISIL forces and infrastructure targets have taken place since and according to Secretary Kerry have arrested the momentum that ISIL had before the attacks began.
Iranian involvement in the fight against ISIL seems to be increasing. Although there has been little public acknowledgment that this intervention is taking place, Iran is thought to have supplied fighter planes to Iraq, possibly with pilots. There are rumors that Iranian armored forces have been involved in moves against ISIL and last week the Pentagon acknowledged that Iranian aircraft have conducted airstrikes inside Iraq, although Washington denies there has been any coordination of military activity with Iran.
Last week’s news seems to have brightened the prospects for Iraqi oil production and exports despite falling prices. While ISIL’s access to petroleum that can be sold is being reduced, the organization is adept at extracting money, supplies and manpower from the territory it controls. Given the increasing capabilities of the forces arrayed against ISIL, the chances of further gains seem to be fading; however the organization is working its way into the fabric of the area under its control and will likely be a viable organization for some time.
Libya: There was little news of Libya’s oil production last week, but fears are increasing that ISIL will take over parts of the country amid the increasing turmoil. Washington says that ISIL has already set up training camps in the country and that several hundred recruits may already be undergoing training. The internationally recognized government in Tobruk has appointed the once-renegade General Hafti as head of whatever armed forces remain loyal to the Tobruk government.
Iran: Tehran has drafted a new budget that is based on $70 a barrel oil, but also increased military spending as the country becomes more deeply involved in the Iraqi situation. Relations with the US deteriorated when Tehran indicted the Washington Post bureau chief in Iran on as yet unknown charges. The move suggests that the Iranians are no longer as interested in a settlement with the US after reiterating that they will make no more concessions. In Washington, Vice President Biden said that he thinks the chances of a settlement are less than even, but that the US will never allow Iran to acquire nuclear weapons. In the meantime the Republicans in Congress continue to plan for new sanctions.
In his “state of the nation” speech last week President Putin sought to reassure the Russian people that his aggressive foreign policy in Ukraine and annexation of Crimea would not bring economic ruin to the country. An Islamist insurgent attack in Chechnya last week, which left 20 people dead, simply added to Moscow’s problems by reminding Russians that the insurgency never really ended. In general Putin was defiant of what he called Western attempts to weaken Russia through sanctions and predicted that they will fail like the Nazi invasion.
Last week, however, the government conceded that the country faces a recession next year which independent economists say will be at least a 2-3 percent drop in GDP provided oil prices do not fall further. Moscow’s biggest problem is the $700 billion owed to western banks that cannot be rolled over given the sanctions. This amount is larger than the sovereign wealth fund that Moscow accumulated during the years of high oil prices. It is not clear how Moscow can repay this debt, but some Russians are saying the sanctions will end in a year or so allowing the debts to roll over.
Inflation in Russia continues to increase, reaching 9 percent in November. The ban on food imports from the EU, US, Canada, Australia, and Norway in response to the sanctions is running up the costs of imported foods which now must come from food exporters with higher transportation costs. It is doubtful it the Kremlin can make up for the losses in imported foods with increased domestic production anytime soon. The good side to the falling ruble story is that the 40 percent of Russian exports that are not oil and gas are becoming more competitive and are increasing.
The Russian situation will be a long running story, depending largely on the future of oil prices. Moscow is not going to pull out of the Crimea anytime soon and the sanctions are likely to remain in place. Putin is still popular and will likely be in office for sometime even with an economic downturn.
4. Quote of the Week
- “We are becoming poorer, our savings vanish, prices grow; however we see an opposite effect to the one that is wanted by people who wish to see Putin knocked down.”
— Olga Kryshtanovskaya, sociologist, Russian Academy of Sciences.
- “Russia’s real problem is not a risk of a crisis, but the fact there is no way out of the current situation. A catastrophe is possible only if some really dramatic decisions in foreign or domestic policy will take place in the near term.”
— Konstantin Sonin, professor, Moscow’s Higher School of Economics
5. The Briefs
- President Putin said he will scrap Russia’s South Stream gas pipeline, a grandiose project that was once intended to establish the country’s dominance in southeastern Europe but instead fell victim to Russia’s increasingly toxic relationship with the West. It was a rare diplomatic defeat for Mr. Putin, who said Russia would redirect the pipeline to Turkey. He painted the failure to build the pipeline as a loss for Europe and blamed Brussels for its intransigence. (12/2)
- Eastern European nations reacted with shock and anger to Russia’s decision to abandon South Stream, its $50 billion gas pipeline across the Black Sea into Europe, as shares in some of the companies involved in the project dived. Bulgaria, Serbia and Hungary said they had received no advance warning that Moscow was scrapping South Stream, even though they all have substantial financial and political capital invested. (12/3)
- In Norway, big investments in the oil sector have helped keep the Nordic country’s economy humming in recent years while many of its European peers faced sluggish growth or even recession. But signs are piling up that one of the world’s wealthiest petro-economies is in for a significant slowdown. A survey said oil companies expect to reduce investment spending by 14% next year, which could drag the country’s economic growth down to 1% from an estimated 2.6% this year.(12/5)
- The plunging oil price is giving an unexpected lift to Europe’s crisis-battered southern periphery as decreasing fuel costs help spur demand. Spain, Europe’s fourth-largest economy, could add as much as 1 percent to annual growth with oil prices between $80-90 a barrel, the government said. Italy, which is in its fourth year of recession, stands to boost GDP 0.3 percentage points with a sustained $10 oil price drop. (12/3)
- The plunge in crude presents China with an opportunity to end control over retail fuel pricing. Fearful of slowing growth, China has pledged to give markets a decisive role in its economy. The drop in oil is a test whether the country will follow through on Premier Li Keqiang’s promise by giving PetroChina and Sinopec the freedom to set prices. (12/5)
- Australia is expected to become the world’s largest supplier of liquefied natural gas by the end of the decade, but significant cost overruns and delays in building new LNG projects are threatening its future competitiveness as companies move forward with major projects in the U.S. and Canada. The solution for Australia may be floating LNG plants, because they can be built overseas, where the costs of labor and materials are generally lower. (12/2)
- Algeria’s financial budget and commitment to government programs will not be affected by sliding oil prices, Minister of Finance declared in Algiers. Despite the impact of the oil price fall on the national economy’s financial balances, the minister stressed that Algeria has “mechanisms likely to cope with such situations” thanks to the “cautious policy” the country has adopted for more than 10 years. (12/4)
- In Nigeria an industry-reform bill first sent to lawmakers six years ago that sought to change the way oil and gas investments are funded and regulated to give Nigeria a greater share of profits still hasn’t passed. Failure to pass the bill over the past six years has created a climate of regulatory uncertainty that has seen oil exploration activities drop to the lowest in more than a decade. The recent drop in crude oil prices is forcing a major reduction in national budgets, where oil revenues comprise 70 percent of total government revenues. (12/3)
- In Venezuela there is a growing exodus of skilled oilfield workers, since real wages for engineers have fallen to the equivalent of less than $400 a month, about 9 percent of the global average. The world’s worst inflation, swelling crime rates and a plunging currency are prompting others to move abroad, dragging down oil production at a time when slumping crude prices threaten the country’s export revenue. (12/5)
- Venezuela: Some Caribbean and Central American countries are bracing for cutbacks in shipments of cut-rate oil from Venezuela, as Caracas struggles with sliding crude prices and a spiraling economic crisis. For a decade, the 13 beneficiaries of Venezuela’s largess have depended on the oil to finance social spending and infrastructure, and rewarded Caracas with diplomatic support on the international stage, regional diplomats said in interviews. The country’s oil exports to the 13 countries fell about 20% through October. (12/6)
- Ecuador expects to surpass by about 3 percent its initial oil production target set for 2014, reaching an average of 560,000 b/d, government officials said. For next year, the Andean country expects to reach an output of 566,000 b/d, before jumping to about 700,000 b/d in 2019, when oil block 43 will be producing oil. (12/3)
- Brazil said it’s moving toward limiting fossil-fuel pollution as part of a global deal on climate change, making it the latest major developing nation to indicate it’s ready to set an emission goal. (12/6)
- In Mexico, the recent plunge in oil prices is prompting the government to consider scaling back the initial bidding for its plans to reopen its oil and gas industry to private companies, and to offer them better terms. The government is now likely to delay or scale-down tenders for some of the oil fields and areas that it planned to offer in the coming months, especially in areas with shale oil where recovery costs are higher than in traditional oil fields. (12/6)
- In Mexico, Pemex announced a $4.6 billion reconfiguration of its Tula refinery to produce cleaner diesel and expand processing capability, saying the project was a better deal than moving forward on a new refinery nearby that had a price tag of at least $10 billion when it was proposed in 2008. The Tula project will increase gasoline and diesel production at the refinery to 300,000 barrels a day from the current 160,000 barrels. (12/4)
- In Canada, Petronas, Malaysia’s state-owned oil and gas company, delayed giving the final go-ahead for its planned investment in a $11 billion liquefied natural gas export terminal in British Columbia, citing high costs and other outstanding issues. (12/6)
- Exxon Mobil Corp.’s Canadian subsidiary said it has resumed production at one of its largest oil sands mines “to pre-shutdown levels” after it halted operations in November due to a mechanical problem. Imperial Oil suspended production three weeks ago after detecting a vibration issue in the mine’s core ore-crushing machinery used to extract heavy oil. Output had averaged 92,000 barrels of crude a day in the third quarter. (12/3)
- Schlumberger, the world’s largest oil services group, is cutting back its fleet for offshore geological surveys and taking an $800m write-down on the value of its ships, in the first significant cutback in the industry following the recent fall in crude prices. The company also said it was cutting jobs, without giving a number, in response to lower oil prices and expected slower growth in oil exploration and production company spending. (12/3)
- US rig count: While oil prices are moving near the point at which drilling may be too expensive, oil services company Baker Hughes said Friday the US rig count was static. The average rig count for November was unchanged from October at 1,925 and up 169 year-on-year. (12/6)
- US oil exports: Collapsing crude prices have given oil producers a new argument for ending a 39-year-old US ban on exports. With US output at a 31-year high and imports at the lowest level since 1995, producers seeking the best possible price for crude are straining at having to keep sales at home. Removing the ban could erase an imbalance between US and foreign crude prices by expanding the market for shale oil. (12/5)
- Chevron announced that crude oil and natural gas production has begun at the Jack/St. Malo project in the US Gulf of Mexico. The Jack/St Malo semisubmersible floating production unit is the largest of its kind in the Gulf of Mexico and has a production capacity of 170,000 barrels of oil and 42 million cubic feet of natural gas per day, with the potential for future expansion. The Jack and St. Malo fields are among the largest in the Gulf of Mexico. They were discovered in 2004 and 2003. (12/3)
- The Eagle Ford shale play in South Texas produced its one-billionth barrel of crude and condensate last month and 70 percent of that total over the last two years. Today, the Eagle Ford accounts for approximately 16 percent of total US daily oil production. In 2015, 2.8 million barrels of oil equivalent per day of production is expected from the Eagle Ford, and the largest share of US Lower 48 spending next year will be in the Eagle Ford with $30.8 billion. (12/6)
- Cheapest gasoline: It took $1.99 and about four hours for the gas war to break out in Oklahoma City. A month-old station in the Oklahoma capital yesterday became the first in the U.S. to sell regular gasoline for less than $2 a gallon since the recent crude oil nosedive began. (12/4)
- The American Petroleum Institute said it would accept proposed rules on pollution from oil wells in order to head-off a broad federal standard for methane leaks. The API has fought US mandates on everything from smog rules to renewable fuel quotas. The proposed rules are already in place for gas wells, and the EPA is considering expanding them to oil wells. (12/5)
- Rail tank cars: The US Pipeline & Hazardous Materials Administration’s proposed rail tank car rule could cost the US economy as much as $60 billion, a report commissioned by the Railway Supply Institute found. The high cost is largely due to expenses associated with modal shifts from rail to highways, potential modifications to tank cars, early retirement of existing tank cars, and lost service time for tank cars under modification or awaiting modification. (12/3)
- Canada’s Transport Department said 2,879 tank cars were deemed too risky to carry liquids such as shale oil and chemicals in the country. In late April, Canada gave rail operators 30 days to stop using the least crash resistant types of DOT-111 tanks cars to transport such goods. Those DOT-111s still transporting dangerous goods have to be refitted with thicker steel and stronger reinforcements within a three-year period, or else be pulled off the rails. (12/3)
- Coal exports from Virginia’s Hampton Roads region totaled 2.77 million tons in November, down around 33 percent from November 2013. While there is no comment on monthly export data, the decline is attributed to weak overseas pricing (down 14%) for both metallurgical and thermal coal due to lower demand and global oversupply. (12/5)
- Offshore wind: The Bureau of Ocean Energy Management said it was assessing the potential impact of a planned 12-megawatt project backed by the Virginia Department of Mines, Minerals and Energy. Described as a research project, BOEM said the two wind turbine generators planned by Virginia would set the course for a future offshore wind industry in the state. (12/3)
- Renewables: While OPEC is helping drive down global prices for crude, it’s having less success squeezing the $250 billion clean power industry. Green energy will receive almost 60 percent of the $5 trillion expected to be invested in new power plants over the next decade, according to the IEA. That’s because the U.S., China, Japan and the European Union are all pushing for global limits on greenhouse gases and promoting alternatives to fossil fuels. (12/2)
- US Oil Sands Inc. says its method will cut the cost and reduce the energy needed to separate oil from sand, lowering the environmental impact. Opponents are far from convinced. The Calgary-based firm is developing its PR Spring project on a 32,000-acre lease about 280 kilometers (174 miles) southeast of Salt Lake City. It plans to start producing 2,000 barrels per day next year with the potential to reach 10,000 barrels per day. (12/2)
- International energy markets depend on reliable transport routes. About 63% (56.5 million barrels per day) of the world’s oil production in 2013 moved on tankers. World chokepoints for maritime transit of oil, such as the Strait of Hormuz and the Strait of Malacca (32 million b/day combined), are a critical part of global energy security because of the high volume of petroleum and other liquids transported by these routes. Blocking a chokepoint, even temporarily, can lead to substantial increases in total energy costs and world energy prices. (12/2)