1. Oil and the Global Economy
Oil traded in a narrow range last week as the usual factors of faltering economies balanced off against the prospects for disruptions in Middle Eastern supplies. On Friday, however, NY prices jumped almost 5 percent after better-than-expected US employment numbers were released. The week closed with NY crude futures at $91.40 and London’s Brent at $108.94. NY gasoline futures continued to climb last week, closing at $2.92 a gallon -- up by nearly 50 cents since late June. Retail gasoline prices continue to climb and now average $3.61 a gallon, up by 25 cents in the past month.
Natural gas futures climbed on Monday on forecasts of more hot weather but fell 8 percent on Thursday after the EIA reported that natural gas stockpiles rose by 28 billion cubic feet during the week ending 27 July which was 5 billion cubic feet more than the markets were expecting. A new forecast shows that the East Coast should be seeing normal August temperatures as the summer cooling season draws to a close. Tighter supplies have raised natural gas prices by 68 percent to a late July high of $3.21 per million since the April low of $1.91. While new drilling for natural gas has dropped markedly in recent months, higher prices will encourage utilities to cut their consumption in favor of coal.
Hopes that the US Federal Reserve and the European Central Bank would step in with new stimulus measures early last week faded after it became clear that any major moves were not imminent. The outlook for Europe continues to grow darker with Spain likely to join the ranks of those seeking a sovereign bailout shortly. While there are many proposals of how to deal with the EU’s fiscal crisis, most require major restructuring of the various EU agreements – a process which is likely to take many months if not years.
It is now more than a month since the stricter EU sanctions on Iran came into effect and Iranian oil sales are reported to be down by about $133 million a day. Although prices remain firm, they are still below where they were last March and April, when the war drums were beating the loudest and even below much of 2011.
2. The Middle East
There was little movement in the Middle East last week. The fighting in Syria drags on with heavy engagements taking place in Damascus and Aleppo and increasing numbers of refugees fleeing the country. Conventional wisdom says the end is drawing near for the Assad government as the Syrian economy has collapsed and the government is reduced to shelling and bombing its own cities. It is hard to imagine that the passions unleashed during 18 months of fighting will subside quickly. While there are no major threats to Middle Eastern oil exports in sight at the minute, given the extensive list of countries involved in the Syrian situation, the possibility that the Syrian uprising will lead to further troubles is substantial. Iran’s Foreign Minister, not a disinterested party, warned the Sunni-led
Arab States and Turkey that the fall of the Assad government will destabilize their own countries and the entire region.
The Iranian nuclear confrontation continues. The best estimate seems to be that Iran is unable to market about 1.2 million b/d or 52 percent of last year’s rate of exports. This is costing the country about $133 million per day or $48 billion a year is lost revenue. The US Congress approved new sanctions aimed at punishing banks, shippers, and insurance companies that help Iran sell its oil. In response to the insurance sanctions, India has agreed to offer state-backed insurance to shippers who cannot find coverage elsewhere. Substantial quantities of oil are still moving to China aboard Iranian-owned tankers.
Tehran has responded to the embargo by threatening to sue the US and the EU coupled with the routine bombast that the sanctions are ridiculous and will not be effective. Supreme Leader Ayatollah Khamenei did note that Iran has become too dependent on oil exports and needs to diversify its economy. Khamenei blamed this situation on the pre-1979 government that “trapped” the country into its dependence on exports.
Washington is concerned about stories emanating from Israel concerning a unilateral strike on Iranian facilities this fall -- prior to the US elections. US Defense Secretary Panetta showed up in Israel last week to reassure the Israelis of continued US support and to remind them that all options must be thoroughly tried before any military action is launched.
High level talks between the P5+Germany and Iran remain suspended although lower level talks continue to explore options.
3. India’s power grid
During peak demand periods India suffers a power deficit of 8 to 12 percent. This deficit is usually managed with rolling blackouts that keeps demand within the limits the generators can handle. If demand gets too high, automatic switches which prevent damage to the generators will cut in. This can result in cascading blackouts as more and more generators take themselves off line. Such was the case in Northern India last Monday and again in Northern and Eastern India on Tuesday when some 600 million people lost power – the biggest blackout in world history.
Although India’s power generating capacity has increased from 66 Gigawatts in 1991 to 185 in 2011, the system is plagued with many systemic problems. There is a growing coal shortage with 10 percent of India’s power plants currently having no supply at all. The coal monopoly is unable to deliver sufficient coal to the power stations due to inefficiencies and environmental controversies. Although imports of coal are increasing, its high cost is bankrupting utilities that cannot pass on the higher costs.
India’s electrical distribution system is highly politicized. Farmers get free power to pump water, but much of this is diverted to other purposes. Local officials have inordinate control over distribution. Total distribution losses in India including theft and poor metering amount to 30 percent of generated power, double that in most countries. In short, there is no end in sight to India’s power shortage and it is likely to get worse over the years as global temperatures continue to climb and India’s economy grows.
All this raises the question as to whether India can continue its rapid economic growth without a concomitant growth in electrical power. Nearly every major facility in India already has backup diesel generators to cope with the rolling blackouts. As power problems grow, India’s demand for diesel to keep operating with these relatively inefficient sources of electricity will increase too.
In recent years, Iraqi oil production has been one of the bright spots of the world’s petroleum industry. After years of neglect and without the former political constraints, the new Iraqi government, with reserves on the order of 140 billion barrels, has embarked on a program to become one of the world’s largest oil producers in a class with the Saudis or Russians. Following a series of auctions, many of the world’s major oil companies were awarded contracts to boost Baghdad’s oil production for what amounts to a flat fee of $1-2 a barrel – a pittance in these days of $100 oil. With the foreign help, however, Iraq has been able to boost oil production to 3 million b/d and is talking about reaching 6 million by the end of the decade.
As Baghdad, however, has never been able to reach a consensus on a law governing the distribution of oil profits, semi-autonomous Kurdistan went its own way and started awarding contracts with relatively small foreign oil companies to increase its oil sales. The Kurds offered more generous terms of up to $5 a barrel to the foreigners to increase production from reserves estimated at around 50 billion barrels.
Starting last November, first Exxon, then Chevron, Total, and Gazprom have signed contracts with the Kurds to develop their oil. Others are said to be considering joining in the rush to Kurdistan. Baghdad of course is furious about this, but so far has not moved to cancel the contracts of those companies that currently have contracts to work in the South. Several major firms including BP, Shell, Lukoil and CNPC, however, have decided to stick with Baghdad – so far. In addition to the obvious financial benefits from doing business with the Kurds rather than Baghdad, the companies moving north may be looking at the growing turmoil in Iraq. Recent weeks have seen a renewal of sectarian bombings, and the government shows no signs of sharing power with the minority Sunnis who were dominant under the Hussein government. With Syria splitting along religious lines, the possibility of wide scale sectarian violence or even civil war in Iraq seems more likely. The relatively homogenous Kurdish provinces seem to be in a better position to maintain the security necessary to produce and export oil should there be increased violence. The Kurds have already announced their intention to build their own export pipeline into Turkey that would hook up with the one already running to Ceyhan. Whether the Turks, who have a long-standing Kurdish problem of their own, would be happy to see an oil-rich Kurdish province on its border is an interesting question.
There are many possible outcomes to this situation ranging from civil war, to more favorable terms for companies doing business with Baghdad, to passage of an oil law specifying the division of profits between the central and regional governments. The best bet for now is that Baghdad will have troubles reaching its goal of becoming the new swing oil producer.
Quote of the week
"Plenty of ink has already been spilled by oil depletion experts exposing some of the wildly optimistic assumptions contained in Maugeri’s report. More damning is that the work is shot through with crass mistakes that render its forecast worthless."
- David Strahan
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)