1. Gasoline stockpiles remain a serious problem

The EIA reported last Wednesday that US gasoline stocks rose by 400,000 barrels the previous week, the first increase in 13 weeks. A closer inspection of the report, however, shows that the increase was due to a 1.1 million barrel increase in inventories on the West Coast, not across the country. The news caused gasoline futures to jump 9.5 cents to $2.326 a gallon on Thursday, and an additional 2.6 cents on Friday to settle at $2.35 a gallon.  In this week’s retail price report, nationwide gasoline prices are likely to exceed the record of $3.069 per gallon set in September 2005. The all-time, inflation-adjusted high of $3.22 per gallon, set in March 1981, is in sight.

Over the last few weeks, however, the demand for gasoline has been dropping and is now just one percent above last year’s demand for the same period. This is down by about 1.5 percent from the abnormally high demand of two months ago.

The government remains optimistic that high prices will dampen demand, attract more gasoline imports, and encourage refiners to increase production. The EIA projects that although gas prices will be over $3 in May; they will drop back into the $2.90s during June and July and possibly increase again in August. The EIA says flat out they do not expect gas prices to get anywhere near $4 so long as there are no significant unplanned refinery outages, losses of crude production, or hurricane damage.

In defending the industry, an American Petroleum Institute economist told Congress last week that high gasoline prices are largely due to high crude prices and the costs of environmental mandates. He maintained that improvements to refineries allow the industry to squeeze more gasoline and diesel from each barrel of crude so that this year’s average gasoline production of 8.85 million b/d is a new record.

Many paint a darker picture of the prospects for gasoline prices and availability later this summer (see this week’s Commentary).  The IEA is talking about a 1.6 million b/d shortfall between demand and production later this year and notes that significant drops are occurring in North Sea and West African production. In March OECD stockpiles fell by 17.1 million barrels, or an average of 550,000 b/d. This brought the average stock draw during the first quarter to what the IEA called a "dramatic" 930,000 b/d. The IEA also noted last week that "gasoline stocks are tight and may tighten further in June unless refinery capacity rises more sharply than current forecasts suggest."

2. Nigeria

The situation deteriorated markedly in Nigeria last week, increasing the prospects for additional reductions in Nigerian oil exports in the near future. One observer who works in Nigeria fears that the militants "certainly have a chance" of halting much of Nigeria’s oil production -- at least temporarily.

On Tuesday, the main militant group, the MEND, bombed three major oil pipelines forcing the Italian oil company, Eni, to stop production of 150,000 barrels a day feeding the Brass export terminal. The crisis further degenerated on Wednesday, when gunmen abducted four US oil workers from a barge near Chevron's Escravous crude export terminal. The MEND, dominated by members of the Niger Delta's Ijaw ethnic group, has told all oil workers to leave the region and vowed to bring Nigerian exports to a complete halt to press its case for more autonomy from the federal government.

On Friday Chevron announced that it was withdrawing hundreds of workers and contractors from Nigeria's offshore waters. The company's action, however, will not affect Chevron's current oil production, which has already been cut by 57,000 b/d due to the militant attacks. No workers are being taken off production rigs. The company was producing about 390,000 b/d before the recent assaults.

The events in Nigeria point toward more violence and the prospect of more companies taking action similar to Chevron's. Total oil production shut down in Nigeria now is about 815,000 b/d, or about a third of the country's effective production capacity of 2.5 million b/d.

3.  Pressure on OPEC

Beginning last November, OPEC pledged to cut oil production by 1.7 million barrels a day, in order to shrink high global inventories that were believed to be depressing prices.  About a million barrels per day of production was actually cut.

Last week the IEA warned of troubles in global oil and products markets this summer unless OPEC hikes output substantially in the near future. The IEA is concerned by the "dramatic" and sharpest draw of first-quarter OECD inventories in 11 years with stocks at the end of March falling 17 million barrels on the month to 2.6 billion barrels. The Agency notes that already in May production has been cut by 220,000 b/d due to militant attacks in Nigeria and another 60,000 b/d due to a platform fire in the Congo.

OPEC spokesmen, however, continue to insist that the oil market is “oversupplied” despite the major production cuts. They insist that 20 percent of the cost of crude is the result of geopolitical, security and refining problems, so that there is no reason for OPEC to reconsider production levels until the next scheduled meeting on September 11.

If, as many expect, oil and gas prices should increase markedly in the next two months, OPEC will come under heavy pressure from the consuming countries to increase production. We are already seeing hints that OPEC may be willing to change its position, based on recent statements such as “OPEC was always ready to meet if circumstances require,” and “in the end it is in our interest to protect the market. It is necessary that we don’t look at short-term profits that can destroy the market.”

The IEA expects global oil demand to increase 1.8 percent this year to 85.7 million b/d.  Some believe that an increase of this size will be very difficult for even a combination of increased OPEC and non-OPEC production to fulfill. If OPEC is pressured into pledging higher production this summer, we could begin to see just what the current limits on world production really are.

4.  Energy Briefs

• Kurdish and Sunni officials have expressed deep reservations about the draft version of a . These misgivings could derail one of the benchmarks of progress in Iraq laid down by President Bush.
• Total has declared force majeure on contracts related to oil supplies from the Republic of Congo following a fire that forced the French company to halt 60,000 b/day of production from the country's largest oil field.
• Venezuela has levied the largest tax bill in the nation's history on an oil project led by ConocoPhillips, the lone holdout in President Hugo Chavez's oil nationalization crusade. The move comes only days after the nation's energy minister said Venezuela is in "conflict" with Conoco over its refusal to sign an accord recognizing the OPEC nation's takeover of four multibillion dollar Orinoco heavy crude projects on May 1.
• A recent study by PFC Energy shows political factors are limiting capacity increases in Mexico, Venezuela, Iran, Iraq, Kuwait and Russia. PFC Chairman Robin West said: “Should demand outstrip supply, you will have a run-up in prices, massive demand destruction and substitutions. It will create tremendous pressures in the international petroleum system, the international economic system, the international political system.”
• The state-run Nepal Oil Corporation said it had run out of fuel stockpiles after the Indian Oil Corporation reduced supplies by nearly 40 percent due to the non-payment of bills. Hundreds of .cars and motorcycles are lined up at petrol stations in the Nepali capital.
• U.S. drillers have less to lose this year in the Gulf of Mexico after market forces prompted them to move their most storm-vulnerable rigs elsewhere before hurricane season. There are about 20 percent fewer rigs in the Gulf now than a year ago and there is an above-average chance that a major hurricane will hit the U.S. GOM this year.
• Both houses of the Alaska Legislature have approved a bill establishing a multibillion dollar natural gas project designed to tap natural gas and transport it to the rest of the country. The bill is designed to stimulate competition, but also has requirements that BP, ExxonMobil, and ConocoPhillips oppose. The oil companies warned they would not submit bids unless the stringent requirements were removed.
• A new study suggests that the choke point for Alberta's oil sands expansion may not be the huge carbon dioxide emissions arising from mining and processing the sands, but a lack of water.
• The leaders of Russia, Turkmenistan and Kazakhstan reached a deal to build a pipeline along the Caspian Sea coast to ship Turkmen natural gas to Western markets via Kazakhstan and Russia, The agreement is a blow to the U.S. and European countries' efforts to secure reliable sources of oil and gas outside the Middle East that also would be independent from Russian influence.
• According to a Platt’s survey, the OPEC 10 produced an average of 26.57 million barrels of crude per day in April. This is up 30,000 b/d from March's 26.54 million b/d and 770,000 b/d above their 25.8 million b/d production target established last month.
• A new GAO study will report that billions of dollars' worth of Iraq's declared oil production over the past four years is unaccounted for. The report does not conclude what happened to the missing oil, and provides alternative explanations including corruption, smuggling, or possible Iraqi overstating of its production.
• Iran is set to begin gasoline rationing on May 22; however, no decision has been made on how many liters each car will be allowed per day or month. The IEA says the plan should help curb imports and raise fuel efficiency but may provoke considerable domestic opposition.
• The Earth Policy Institute says that a worldwide shift from incandescent bulbs to compact fluorescents could close 270 coal-fired power plants.
• Ontario is considering building eight new nuclear reactors if older ones cannot be properly refurbished. The new nuclear power generating plants are part of the Ontario government's plan to wean the province off coal-fired electricity and move towards what it sees as clean nuclear energy.
• Kuwait’s Oil Minister said the country will never disclose the size of its oil reserves for reasons of national security. There are reliable reports that Kuwait’s reserves are only half the official number of 99 billion barrels.
• The U.S. House of Representatives will not vote on energy legislation before July 4, and a bill now under development is unlikely to include revisions to Corporate Average Fuel Economy standards, which a Senate committee approved earlier.
• Bohai Bay in northern China may hold oil reserves equivalent to 146 billion barrels, the official China Daily reported Thursday, citing an upstream expert with the Chinese Academy of Engineering.
• Statoil, Norway's largest oil company, cut its 2007 production target by as much as 12 percent after the closure of a North Sea field and delays at projects from Azerbaijan to Algeria.
• Japanese automakers say it is not possible to meet the EU’s 120 gco2/km target for automobile emissions by 2012.
• Zimbabwe is to cut electricity to some residential areas for up to 20 hours a day in the coming months to meet higher demand for irrigation power from farmers amid persistent food shortages.
• Eni, Italy's biggest oil company, said first-quarter profit fell 13 percent after attacks in Nigeria and expropriations in Venezuela cut crude output. The company raised its production target through 2010 after acquisitions.
• Shell no longer believes it is realistic to be targeting a possible Colorado commercial oil shale decision by the end of this decade. At best, they do not foresee a commercial decision prior to early in the next decade.
• U.K. motorists appear undeterred by record-high U.K. gasoline prices. New government data shows a 1.2% increase in road traffic during the first quarter. The price of gasoline grew 7% to average GBP4.26 a gallon last year against GBP3.96 a gallon in 2005.

Quote of the Week

• "The only thing that will make a difference is reaching the limits to growth. More data won't stop an alcoholic from drinking and more data won't stop us from driving."

 -- Debbie Cook, Huntington Beach (CA) City Council

Commentary:  Gasoline Picture Looking Grim for Dog Days of Summer

By Matthew R. Simmons

(Note: Commentaries do not necessarily represent ASPO-USA's positions; they are personal statements and observations by informed commentators.)

Here is a quick run down on the possible disaster we face this summer as we head into Memorial Day with the lowest beginning-of-driving-season stocks in US history. It would have been convenient had someone found out exactly what Minimum Operating Levels* really have become. I suspect we will answer this riddle this summer.  

Minimum Operating Levels of petroleum inventories are when all cushions have been used up and the system is now starting to “rob Peter to pay Paul." At this stage, the risk of shortages starting to crop up is Red Alert.  Sadly, the last serious study of where this invisible line of minimum stocks is was a NPC study done in 1988.

The reality of gasoline demand is that it will rise during July and August unless we have some roads blocked off to stem demand. Rising late-summer demand has happened almost every year, even as prices rose from $1/gallon to over $3!

To supply this market, several things have to work in unison.

1. Refineries need to crank up to over 16 million b/d instead of current 15 as they struggle to get into compliance from too little maintenance for too long.

2. Imports need to average well over 1 million b/d, and probably need to hit 1.5 million b/d, matching the all-time record set last year.

3. No hurricanes can hit the Gulf producing region.

4. Stock draws are the last plug in the dike. 

From the looks of things as we view Memorial Day weekend starting in just over a week, we fail on all four counts.

The burning question is how much lower stocks can drop before shortages sweep our fragile gasoline supply system.  Historically, it has been critically important that we build up gasoline stocks during the spring shoulder season (April-May) so that they can be liquidated during peak demand to prevent shortages. We seem to have run out the clock to fix the problem this summer.

I did some quick inventory numbers this morning [May 10]. At the end of February (which is the latest data we have on the location within five PAD districts) we had 116 million barrels of finished product and 99 million barrels of blending stocks (that are now far trickier to blend than when we had RFG) in inventory.

In the course of the next 10 weeks to May 4, we dropped 13.5 million barrels of finished stock and 10.3 million barrels of blending components.

But almost all of the drop probably came from Bulk Terminals as stocks at refineries are essentially works in process and stocks in pipelines and barges are steady flows.

If this is the case, bulk terminal drops were 30% for blending components and 27% for finished products.

The painful last 13 weeks ran out our USA gasoline clock.  We must be right at the edge of genuine "minimum operating supplies" in at least a handful of states.

I am certainly glad I drive a diesel where the stock pool or inventory is tight but not nearly as tight as MOGAS [motor gasoline].

This could get really ugly real fast.

On that cheery note....

Matthew R. Simmons is founder and currently Chairman of Simmons & Company International, an independent investment bank specializing in the entire spectrum of the energy industry.

[*Editor’s note:  A description of this Minimum Operating level clipped from an EIA publication follows.  “…maintaining minimum operating levels (e.g., gasoline must be present in the pipeline at all times to push product further through the pipe. When actual inventories drop below minimum operating levels, the system effectively may be running on empty. EIA reported that PADD II inventory levels in May and June 2000 were at or near minimum operating levels.]