1. Oil and the Global Economy
Oil prices continued to fall through Thursday when New York futures traded below $80 a barrel and London as low as $82.60. Prices then rebounded to close Friday at $82.75 in NY and $86.15 in London. As has been the case for several weeks, the 25 percent price drop from the year’s highs was based on the perception that there is a glut of oil on the world market; the Saudis and other Gulf Arab states refusal to cut back production immediately; and fear. There are mixed opinions as to whether we have seen the bottom of the price plunge. Better economic data appeared on Friday and Goldman Sachs issued a report challenging the notion that the world markets are over supplied. They believe prices have overshot on the downside. Others, however, note that the pause in the price decline may only be profit-taking and that there is unlikely to be any change in OPEC policies until at least the end of November. Taking advantage of the relatively low prices, China seems to be stepping up its imports, likely to bolster its strategic reserves.
Beyond the issues of where the bottom to the bear market might be and how long it will be before prices rebound, the other major question arising from the price drop is whether OPEC will reverse its current policy and cut production enough to drive prices higher. There has been much discussion of a conspiracy between the Gulf Arabs and the West to drive prices lower in order to bolster western economies and hurt those of Russia and Iran. Some are even suggesting that the Arabs have opened a price war with US shale oil. By keeping prices low, high-priced oil from North Dakota and Texas will no longer be economical.
Thus, another much-discussed issue is the price level that will cause drillers to begin cutting back on new drilling for shale oil. North Dakota’s Bakken oil is not only expensive to produce, it is expensive to get to market and has been selling at a discount of $15+ a barrel to West Texas Intermediate. This means that with West Texas oil at $82 a barrel, Bakken oil is going for circa $65. This discount is not a problem in Texas where most oilfields are connected to pipeline systems that can quickly and cheaply move the oil to market.
Ever-optimistic Wall Street banks are saying that the price drop is nearly over and that NY oil will stay above $80 a barrel. The NY Times ran a story last week concluding that shale oil production would only slow modestly if prices fall another $15 or $20 to $60 a barrel. The paper does not get into the issue that North Dakota oil is now selling for $66. The Times also noted that the EIA concluded this week that only 4 percent of US shale oil production needs prices above $80 a barrel to break even due to recent advances in drilling efficiency.
There is little doubt that the current pace of US oil production would be difficult to slow. Contracts and equipment are in place and any cutbacks in drilling would likely be in the least productive areas. US consumers are obviously benefitting from lower fuel prices with average US gasoline prices now approaching $3.10 a gallon. Citigroup says that the global economy has received a $1.1 trillion stimulus for lower oil prices as more money is now staying with oil importers rather than going to exporters. This stimulus is already showing up in the US with oil imports down 7 percent from last year and many economic indicators looking better.
US natural gas prices fell to their lowest of the year last week as mild weather kept heating and cooling demand to a minimum and record supplies are building up inventories for winter. Prices have fallen 6.8 percent in the last two weeks and are now below $3.80 per million BTUs. The low prices seem to be having little effect on drilling, however, despite much production taking place at a loss. Weather forecasters say the weather will get much colder in the northern US until the end of the month.
2. The Middle East & North Africa
Iraq/Syria: There was little good news from the region last week. Washington says that its air strikes have cut Syrian oil production which was going to help the Islamic State by 70 percent. The US and its allies say they are digging in for a long war in the region.
The only people who seem to be making progress are the Kurds who with the help of US airstrikes have at least temporarily broken the siege of Kobane. Moreover the Kurds seem to have gotten oil production going from a Kirkuk oil field which they took over after the collapse of the Iraqi Army and are pumping the oil into Kurdistan for processing. Taking “Baghdad’s oil” is almost certain to further harm relations with the Iraq government.
The Norwegians are working on a new 24-inch export pipeline from Iraqi Kurdistan to Turkey which is now scheduled for completion by the end of the year. The Kurds currently export 90,000 b/d through an existing pipeline. The new line will not only give them redundancy, but will also give a large jump in their export capacity. As the Kurds are now the favorites, and perhaps only hope, of the Western coalition fighting the IS, their political position has been considerably strengthened in the interminable oil revenue sharing dispute with Baghdad.
The military situation around Baghdad continues to deteriorate. The Iraqi Army seems unable to stop the offensive against the IS and insurgent forces continue to move closer to the city despite the involvement of the US and coalition members with airpower and advisors. There is general agreement that IS forces will not be able to overrun the city in the immediate future, due to its size, US airpower, and the large numbers of Shiite militia defending the capital. The political situation in Baghdad, however, is worse with feuding breaking out between the current and former prime ministers. New defense and security ministers have been appointed but are already controversial and seem unlikely to further the Sunni/Shiite/Kurd unity government the US is demanding. For now, the Kurds have agreed to participate in the cabinet, but relations between Erbil and Baghdad are likely to worsen.
The most worrisome problem from the perspective of continuing Iraqi oil exports, however, is the situation in Anbar province where government resistance to the Sunni insurgents seems to be melting. Should Anbar fall completely to the IS the path to disrupting the southern oil fields and Iraqi oil exports would be much easier.
Libya: It is difficult to reconcile reports of Libya producing 800,000 barrels of oil per day with what is happening on the ground. The optimistic production reports are coming from the “official” government and parliament which are holed up in an old hotel in the city of Tobruk near the Egyptian border — 620 miles from the capital. The Oil Ministry which is supposed to be in charge of exports has been taken over by Islamist militias and according to the Ministry’s web site, there is a new Islamist oil minister in Tripoli – but it is not clear who controls what. The Tobruk government, which is the one with international recognition and a media presence, says it is getting the oil revenues, but it is not clear how this is happening as the banking system in Tripoli is under Islamist control.
There have not been any media reports of tankers hauling away oil from Libyan export terminals for two weeks, as reporters are confined to Tobruk, the only safe place in the country, and are only talking to government officials.
Turmoil continues across the country with remnants of Libya’s army battling the Islamist militias, possibly with the help of warplanes “rented” from Egypt. There is more discussion of Egyptian involvement with what can only be called a civil war in Libya. In the meantime take any impressive oil export numbers with a grain of salt until the situation clarifies.
Iran: With the drop in oil prices and the rise of the Islamic State, which is challenging Shiite Iran as much as anybody, the nuclear negotiations have taken on a new dynamic in recent months. Despite much brave talk from Tehran, it economy is clearly hurting from the drop in oil prices and Gulf Arab efforts to keep or increase market share by lowering their selling prices. Paradoxically, the US air strikes on the IS are a major help to Tehran in its struggle to keep the current Shiite Syrian and Iraqi governments in power,
The key issue of course is the nuclear negotiations. Unless they are successfully concluded, the Israelis maintain they are able and willing to bomb Tehran’s nuclear enrichment facilities, likely setting off one of the biggest oil crises in decades. The nuclear negotiators met for two days last week with the intention of concluding an agreement by November 24th. Negotiators say they are “chipping away” at the various issues, but that significant gaps remain. The US maintains it will not extend the negotiations for a second time.
Where this goes in the next month has a lot to do with domestic Iranian politics. The situation is similar to that prior to the US invasion of Iraq when Hussein could have easily given in to US demands to inspect his non-existent nuclear program, but was unable to face the humiliation of admitting that he did not have one. In much the same manner, the Iranians, who staunchly proclaim they have no weapons program, yet are unwilling to face the perceived humiliation of giving the West iron-clad guarantees and thereby admitting that they will never have a nuclear deterrent and will forever be militarily at the mercy of Israel’s and several other states’ nuclear arsenals, which in the end trump all. A lot may depend on the next month or so.
3. Russia/Ukraine
Despite the ceasefire, skirmishes and occasional shelling continue in eastern Ukraine. The UN estimates that 3,700 have been killed and 9,000 wounded since the crisis began.
Ukraine’s President Poroshenko announced Sunday that he has reached a temporary agreement with Moscow to resume natural gas settlements through March at $385 per 1,000 cubic meters. This is down from the $485 that Ukraine was paying for its gas under a 2009 agreement. A new contract is expected to be signed Tuesday. The Russians had been demanding that Ukraine pay the $3.1 billion owed for previous deliveries before shipments would be resumed. There is some discussion that the IMF might loan Ukraine the money to pay off the debt to Gazprom.
With the natural gas crisis seemingly out of the spotlight for the moment, attention is turning to the effect of the sanctions and lower oil prices on Moscow’s economy. Last week the Russians were adamant that that they have the resources to withstand what they consider will be a temporary decline in oil prices and the Western sanctions on their economy. Moscow’s planning for the next three years envisioned $100 a barrel oil and even at this price required withdrawing money from the reserves to cover a budget deficit.
A $20 a barrel drop in oil prices which along with natural gas sales provide cover about half of Russia’s national budget would normally not be a problem. However, when the sanctions on borrowing money from outside the country is added in, Moscow is facing some real problems. Economic growth is already close to zero, capital is fleeing the country, the ruble is weak, and given the country must import much of its food supply, inflation will be difficult to control. Some observers believe this will all come to a head in about two years, unless oil prices rebound back above $100 a barrel. For now, President Putin must rally his country with the line that it is surrounded by foreign enemies and must stick together much as it did during the German invasion.
Moscow signed some 40 economic agreements with Beijing last week. Increasingly isolated from the West, Russian is trading its natural resources, including oil and natural gas, and advanced weapons in return for Chinese financial support. Given Russia’s precarious economic condition at the minute, the Chinese are said to be getting very good terms.
4. Quote of the Week
- Oil] “Prices…have fallen and we don’t know if in the future there will be enough to cover the costs of these mega-projects. It’s a big challenge that means the industry has to improve its efficiency rates, lower costs and increase capacity.” Cipollitti estimated that more than half of the world’s 163 biggest oil projects required a $120 price for crude.
—Luisa Cipollitti, with Statoil Venezuela
5. The Briefs
— Two of OPEC’s biggest members say they won’t immediately reduce oil production to offset tumbling prices, a signal the group is unlikely to heed Venezuelan calls for an emergency meeting. While producing nations would like higher prices, there’s “no room” for them to achieve that by lowering supply. Saudi Arabia, which pumped almost one-third of the group’s output last month, won’t alter its supplies much between now and the end of the year, a person familiar with its policy said Oct. 3.
— OPEC must keep cutting prices to displace competing supplies from Latin America and West Africa, Indian refiners said. Saudi Arabia, Iran and Iraq, which account for about half of OPEC’s output, will sell crude to Asia next month at the biggest discounts since at least January 2009. (10/16)
— BP will restart the Rhum gas field in the UK North Sea, half-owned by Iran’s National Oil Company, four years after the field was shut down due to Western sanctions. Production from the field, which supplied 4 percent to 5 percent of Britain’s demand before its shutdown, was expected to begin this past weekend. BP received approval from the British government to resume production after the government put the field under a temporary management scheme whereby all revenue due to Tehran will be held until sanctions are lifted. (10/18)
— The Kashagan oilfield, discovered in 2000 in the Caspian Sea, was the world’s biggest oil find in three decades. By now it was supposed to be pumping 1.2 million b/d. A year ago, when the first trickle of crude briefly flowed, it was already eight years behind schedule having cost $43 billion, some $30 billion over budget. Production lasted only a few weeks before leaks of poisonous gas forced its suspension. Earlier this month a government minister admitted it would not restart until at least 2016. (10/14)
— Offshore Tanzania: Statoil and its joint venture partner, Exxon Mobil, announced the discovery of about 1.2 trillion cubic feet of natural gas in place at the Giligiliani-1 exploration well offshore Tanzania. The new discovery pushes the total of in-place gas reserves above the 20 trillion cubic feet mark. (10/15)
— In Venezuela, last week’s plummeting world oil prices are throwing into doubt financial stability. The country relies on oil exports for most of its income. Oil exporters from Russia to Iran are suffering with the lowest crude oil prices since June 2012. But few are as vulnerable as Venezuela, where a free-spending populist government had already been grappling with a recession, widespread shortages, and massive protests earlier this year. (10/18)
— In Mexico, the CEO of Pemex hopes to regain its position as Latin America’s biggest oil company. But compared to expanding Brazilian oil major Petrobras, Pemex’s crude production has fallen for 10 years straight as the company’s shallow-water fields declined and much of its investment budget went toward squeezing more oil from older fields. (10/18)
— Canada estimates the Gulf of St. Lawrence may hold as much as 1.5 billion barrels of oil and 39 trillion cubic feet of natural gas. The bulk of the Canadian oil reserves come from the heavier bitumen found in Alberta province. Offshore petroleum production accounts for about 6 percent of total crude output and 1 percent of natural gas. (10/16)
— US drilling rigs targeting oil fell by 19 to 1590, the largest decline in two months as producers curbed drilling following the biggest price rout since 2012, Baker Hughes said. The counts dropped in almost every major U.S. oil play and the slide threatens to slow a drilling boom in US shale formations. (10/18)
— US oil imports were 7.4 million barrels for the week ending Oct. 10, down 7.4 percent from the same week in 2013, according to the US EIA. (10/18)
— Kinder Morgan may expand their natural gas pipeline system in Illinois by 430 million cubic feet per day in order to facilitate the use of more natural gas from the Utica and Marcellus shales. Total production from the Utica shale should increase from 155 million cubic feet per day in January 2012 to an expected 1.3 billion cubic feet per day in September. By 2020, Marcellus could be responsible for about 25 percent of the total U.S. natural gas supply. (10/18)
— Capturing flared gas: A new $4 billion polyethylene production facility in the Bakken shale could soon help oil and gas producers in the region reduce natural gas flaring in North Dakota. CERES estimates that up to 30 percent of gas produced in North Dakota is flared—more than $100 million a month of natural gas that is just burned off. The plant will employ 500 workers and will be able to produce 3.3 billion points of polyethylene annually. (10/18)
— In Ohio, some 400 micro-earthquakes in Harrison County are connected to hydraulic fracturing of wells, according to a new study. Three wells operated from September through October 2013 in the Utica Shale. Ten of the quakes registered between magnitude 1.7 and magnitude 2.2, but the tremors were too deep to cause damage or to be easily felt by people. The new study is the second report this year of fracking-linked earthquakes from drilling in the Utica Shale. (10/16)
— Nuclear fusion: Lockheed Martin said on Wednesday it had made a technological breakthrough in developing a power source based on nuclear fusion, and the first reactors, small enough to fit on the back of a truck, could be ready for use in a decade. An official said that a small team had been working on fusion energy at Lockheed’s secretive Skunk Works for about four years, but were now going public to find potential partners in industry and government for their work. (10/16)
— Total costs of generation: A European Union commissioned report—written about over at Recharge—finds that onshore wind is the cheapest energy source of all once externalities such as climate change impacts and health effects are taken into account. (10/15)
— Cold winter coming? The snow in Siberia is piling up, and if it keeps coming, people in New York may have to bundle up this winter. There’s a theory that the amount of snow covering Eurasia in October is an indication of how much icy air will sweep down from the Arctic in December and January, pouring over parts of North America, Europe and East Asia. (10/15)
— China’s environmental protection authority on Friday invited public comments on four draft ordinances on enforcement of environmental protection regulations. The four drafts concern fines for polluters, closure or seizure of pollution sources, production suspension punishments and environmental information disclosure. (10/18)
— China’s environmental protection authority on Friday invited public comments on four draft ordinances on enforcement of environmental protection regulations. The four drafts concern fines for polluters, closure or seizure of pollution sources, production suspension punishments and environmental information disclosure. (10/18)
