1. Oil and the Global Economy
After falling to one-year lows below $75 a barrel on Tuesday, oil prices rebounded by $6 a barrel on Wednesday on optimism that the EU ministers would find a way out of the ongoing financial crisis. NY oil futures closed at $82.98 a barrel and London’s Brent closed at $105.70 after briefly falling below $100 a barrel on Tuesday.
Despite the widespread pessimism about what renewed recession in the US and EU economies would do to the demand for oil, the underlying fundamentals of the oil market for now remain “exceptionally” tight. The rebound from last Tuesday’s lows was the biggest two-day gain for oil prices in seven months, and came even as Fed Chairman Bernanke was warning that the US economy was “close to faltering.”
On Saturday the Saudi Oil Minister announced that Aramco had reduced its oil production to 9.4 million b/d in September from the 9.6-9.8 million b/d maintained in June, July and August. Although this cut in production may eventually be made up from renewed Libyan exports, for the near future it is yet another reason why oil prices should hold above $100 a barrel despite concerns of a renewed recession.
Among those arguing for continued high oil prices is Goldman Sachs which notes that seasonally adjusted global supply demand remains in deficit and that crude inventories outside of the US are down to the lowest in nine years. This view was reinforced by an unexpected decline of 4.7 million barrels in US crude inventories the week before last. Goldman Sachs believes that while the Saudis produced 9.8 million b/d this summer, effective OPEC spare capacity was down to less than 1 million b/d. Although there is much talk concerning the resumption of Libyan production, only insignificant amounts are as yet being exported. Goldman’s analysts also note that much of the increase in global “oil” production is made up of natural gas liquids, not the more versatile crude.
The Financial Times notes that the demand for physical oil remains unusually strong despite the concerns engulfing the futures markets. Backwardation, a situation where the price of oil for near-term delivery is higher than for more distant deliveries, has surged to the strongest in recent years. The Saudis recently raised to record levels the premium it charges for deliveries to Asia adding to the evidence for a tight market.
Demand for oil in the fourth quarter normally increases as the winter heating season arrives. The IEA is only expecting an increase in demand over the next 3 months of 400,000 b/d, down from the 700,000 b/d increase seen in 2009 and 2010.
2. The EU’s financial crisis
For the past 18 months Europe’s sovereign debt crisis has dominated the headlines. It is becoming obvious that the Greek economy and political system cannot muster the strength to pay off the debt, mostly to European banks, that has accumulated in recent years and that default is inevitable. While the big European banks and their bondholders may be able to handle a default by Greece, waiting in the wings are the economies of Italy and Spain that many believe will shortly follow Greece into default.
Many hold that there is simply not enough money in Europe to bail out the EU banks from defaults by Spain and Italy so the problem is likely to be transferred to European governments. Last week a major Belgian-French Bank, Dexia, ran into troubles and was taken over by Paris and Brussels, thereby setting the precedent that government will bail out failing European banks.
If Greece defaults, private investors will likely flee from Italy, Spain, Ireland and Portugal leaving more German and French banks in a lot of trouble. The problem only gets worse when we learn that Wall Street has loaned Eurozone banks roughly $2.7 trillion. Over $1 trillion of this has gone to the German and French Banks that face collapse if Spain and Italy default. Wall Street’s loans to the EU are likely covered by credit default swaps meaning that some group of financial institutions is ultimately on the hook to pay for all those losses which are likely in the trillions.
The European problem becomes still worse when we consider that the EU is showing signs of falling into recession. Greece, Ireland, Portugal, and Spain are already there due to all the austerity measures that have been required of them. As they are no longer exporting as much to the countries in recession, the French and German economies are being dragged down.
The implications of this potential trouble ranges from serious to devastating even if only a fraction of the looming dangers should come to pass in the next few years. The oil markets are reacting violently to every scrap of news emanating from the nearly continuous ministerial meetings that are taking place across Europe. To many observers, the various schemes that have been announced in the last week for central banks and the IMF to buy bonds, make loans, and print money are simply too little, too late in avoid the inevitable -- the key remaining question is how bad the situation gets.
While renewed recession in the EU and US would cut global oil demand, a collapse of large parts of the financial system would create untold havoc. There are already complaints that the economic troubles in Europe have reduced the amount of money available to drill for more oil. Given that global oil depletion requires constant investment in new production facilities, a long-term reduction in available financing will eventually lead to faster oil depletion.
3. The Middle East
The final attack on Sirt is underway, where the remnants of Gadhafi’s supporters are holding out to the last rather than facing trial or the wrath of the insurgents. More ominous for swift resumption of Libyan oil exports are reports of increasing disagreements among the various insurgent groups as to the form a new Libyan government would take. With nearly everyone in in Libya now heavily armed from the vast munitions stores captured from the Gadhafi regime, the outlook for resumption of the 1.3 million b/d of high quality crude exports seems uncertain at best.
The Syrian situation which has the potential of morphing into all sorts of Middle Eastern turmoil continues to fester as crowds of protestors are still being dispersed with lethal force. Last week the Beijing and Moscow vetoed a mild UN resolution condemning the Syrian government, likely fearing that any UN action was a step toward NATO airstrikes on Assad’s forces. Damascus seems to be having trouble exporting its oil in face of various embargos -- a problem that could eventually force the government from power. The Saudis, Kuwait, and Bahrain have turned against the Assad government while Iraq, likely at the urging of Tehran, is supporting the regime with financial assistance. Such are the Byzantine politics of the Middle East today.
The big news of the week came from Saudi Arabia where anti-government riots broke out in a Shiite village in the oil-rich eastern province. The government blamed Iran and promised to crack down on dissent with an “iron fist.” Shiites constitute only about 15 percent of the Saudi population but comprise more than 75 percent in some of the more sensitive oil producing areas. As the Saudi government is a long-time master of the carrot and stick in keeping dissent under control not much is expected from the incident for the immediate future except increasing tension with Tehran.
The most important news of the week came in a series of announcements on Saturday. The CEO of Saudi Aramco said that the country was unlikely to expand its capacity to produce oil to 15 million b/d given that expected increases from Iraq and Brazil would be enough to fulfill demand. Aramco, however, remains committed to spending $125 billion over the next five years to maintaining production and increasing refining capacity despite the global slowdown.
The announcement by Saudi oil minister Ali Naimi on Saturday that there was no excess capacity in world oil markets and that Riyadh had unilaterally cut back production in September by 400,000 b/d came as a surprise. Recent wire service surveys were crediting the Saudis with 9.8 million b/d last month. This cutback simply adds more uncertainty over the course of oil prices over the coming months.
The recent fall in oil prices, which had the OPEC receiving less than $100 a barrel, set off a wave of concern among over-extended oil exporting governments. Oil production in Iran and Venezuela which continues to slip is leading these governments to demand production cutbacks by the Gulf States. We may be entering a period where formal OPEC quotas play less of a role and where the Saudis and their Gulf allies regulate production in camera.
To top off the week, a pipeline bombing in Iraq temporally cut oil production by about 700,000 b/d. Although the damage is expected to be repaired quickly without affecting exports, the incident again raises questions as to just how much oil the country can keep producing after US forces leave.
4. The sands of Alberta
The future of increased production from Alberta’s tar sands is raising passions and rhetoric in the US and Europe. The very-expensive-to-produce, and at least for now dirty-to-produce, tar sands oil seems to be approaching a turning point. The EU Commission is preparing to declare oil extracted from the sands as 25 percent dirtier than conventional oil production thereby discouraging its use in Europe which is more concerned about global warming than most. The Canadian government responded to this threat by saying it was unfair to stigmatize Alberta’s heavy oil when equally dirty-to-produce oil from other countries was not mentioned.
The second major issue facing the expansion of Alberta’s oil production is the approval of the Keystone pipeline expansion to the Gulf of Mexico. The Obama administration seems to have transferred authority to sign off on the project to the US State Department which says it has no problems with the project, raising all sorts of concerns among environmentalists.
While the oil industry and its allies have released a barrage of propaganda advocating for quick approval of this “essential” project, the environmental movement in equally strident in its opposition. Environmentalists see approval of the Keystone pipeline expansion as symbolic of whether or not the world is ready to confront global warming. In the words of NASA’s Jim Hansen, if we torch the tar sands, it is “essentially game over for the climate.”
Quote of the week
“In the old days, Saudi Arabia had plenty of spare capacity and could always flood the market with extra oil if supplies got pinched. But that's no longer the case. Global demand is growing too quickly, and the Saudis are running out of spare capacity. Nor will new, unconventional sources alleviate the problem entirely… However you want to define peak oil, it looks like we’re in for an uncomfortable ride.”
-- Brad Plumer, Washington Post
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)