1. Oil and the Global Economy
NY oil prices climbed steadily last week as worries about the effects of sanctions on Iran outweighed concerns about the Eurozone crisis. Starting the week at $97 a barrel, oil closed Friday just below $101. In London where prospects for the survival of the Eurozone are of more interest, prices were more volatile, climbing from $107 on Monday to a close just below $110 on Friday after touching $112 on Wednesday. NY prices were helped by the news that a major US refinery will be closing early reducing excess refining capacity in the US. News that China’s economy may be slowing added to concerns about the Eurozone in holding down prices.
The equity markets rallied last week on optimism that the Eurozone crisis could eventually be settled. There was also optimism that the employment situation in the US is improving and that eventually the demand for gasoline would increase. Closer inspection of the underlying evidence shows that these rallies were based in large part on wishful thinking and that the demand for oil in the US and EU is not likely to improve in the foreseeable future.
The UN climate change meeting opened in Durban last week amidst doubts that any real progress will be made. Despite the increasing incidents of climate-induced disasters around the world, the underlying dynamic that nothing can be done that will harm economic growth still trumps longer term dangers. The issue of global disparities in the consumption of fossil fuels and economic well-being coupled with the question of how will the poorer nations ever pay for reductions in emissions still dominates the debate. It is unlikely that there will be much movement on these concerns until the climatic conditions become so bad that hopes for more economic growth become of secondary importance.
2. Sanctioning Iran
The Iranian situation took a turn for the worse when members of the hardline Basji militia stormed and sacked the British embassy and housing quarters in Tehran last Tuesday. The vehemence of the EU’s and many other nations’ reaction to this affront shows that the hardline faction of the Iranian government initiating the move miscalculated. The affair shows how dangerous the confrontation with Iran has become and the growing risk to oil shipments from the Gulf. On Sunday Tehran claimed to have shot down a US drone over Eastern Iran.
In the wake of the sacking, a number of European countries including France, Germany, Italy, and the Netherlands withdrew their ambassadors from Tehran. The withdrawal of so many ambassadors will, at a minimum, complicate efforts to find a peaceful solution to the nuclear weapons standoff.
There are already signs of disagreement within various power blocs in Iran over what to do next. While the hardliners are seized with the notion that confrontation with the West will firm their domestic support, realists believe that that Iran’s economy may be in for such a beating that it will bring the protestors back into the streets.
On Thursday the EU foreign ministers met to consider further sanctions on Tehran. High on the list of possible sanctions was an EU embargo on Iranian oil imports. Although this move was favored by France, the UK, Germany, and Netherlands, it was rejected as the inevitable increase in the price of crude would harm the already precarious economies of southern Europe. For now the plan is to increase restrictions on those banks helping Tehran receive payments for its oil exports. It is hoped that this move will eventually narrow the numbers of countries taking Iranian crude which in turn would force Teheran to sell oil at a discount to the remaining buyers.
The major issue remains as to what this confrontation will do to the price and availability of oil in coming months. On Sunday, the Iranian Foreign Ministry opined that should Iranian oil shipments be blocked, crude would quickly soar to over $250 a barrel doing unimaginable damage to the global economy. Other analysts are not so sure that the loss of 2.5 million b/d of Iranian exports would be that devastating. They point out that Libya oil is coming back, Iraqi production is increasing, and that the Saudis and other Gulf states still have some spare capacity.
PIMCO released a study last week speculating about what would happen in oil prices given various types and durations of supply interruptions that might arise from the current confrontation. Brief interruptions in Iranian oil supplies could send prices to $130-140 a barrel before settling back to the $120 range. An interruption of Iranian oil for a month would send prices to new highs above $145 a barrel. A six month interruption would result in prices averaging $150 with higher spikes.
The Armageddon scenario, in which the 16 million b/d coming through the straits of Hormuz stops, is simply too much to set a price on. Obviously with much of the world brought to its economic knees with 16 million b/d less oil reaching refineries, the reaction of the world importers would be to use whatever military force against Tehran necessary to reopen the straits. Some notion of this must be taking hold in Tehran these days for we are seeing less of the “we will bring the world to its knees by closing the straits” rhetoric coming out of Iran in recent weeks.
3. Europe on hold
The Eurozone sovereign debt crisis, which has the potential to trigger anything from a recession in the EU to a global economic depression of unimagined depth, continues to muddle along. Once again we are faced with a decisive week as the EU holds yet another summit in Brussels on Thursday and Friday to devise a solution. This time the plan is to modify the EU agreement to allow for a closer fiscal union that would give the EU as a whole the power to impose budget discipline on those members that have been running unsustainable deficits.
Last week the equity markets rallied after European Central Bank signaled that it might be willing to turn on the printing presses to bail out faltering banks and countries, but only after a new fiscal union was in place. The whole issue now comes down to whether the politicians can put together enough of a master plan to convince the theoretically independent central bankers that profligacy among the EU members can be controlled.
If the EU is unable to come up with a definitive fiscal union before January, when a massive refinancing of Italy’s debt come due, then it may be too late. The fiscal union will be difficult to achieve for it would likely give the executive of the European Commission power to veto individual nation budgets which it deems break EU wide standards. Automatic sanctions on offending nations would be supplemented by their being taken to European Court of Justice for punishment.
Whether there would be such a surrender of sovereignty in the interests of saving the euro and the EU remains to be seen. Domestic political risks abound within the 17 sovereign nations that would have to assent to the scheme. To avoid the perils of reopening the fundamentals of the EU agreement, France and Germany are working on a simpler plan that would have the 17 Eurozone members reach a separate agreement outside of the EU treaty.
Time is running out however. The Eurozone appears to be already entering a recession and most observers are predicting that Europe’s troubles will soon spread to the rest of the OECD and the world. Europe’s banking system is already freezing up and preparations by banks and major businesses for the demise of the euro surface daily. After years of muddling along, the crisis seems to be coming to a head in the next few months.
4. Exodus from Iraq
As one of the last places on earth where one can still drill for large quantities of oil relatively cheaply, Iraq is seen by many as the key member of OPEC for the next decade or two. The problem of course is that Iraq is an artificial country patched together after World War I and is riven with internal tribal and religious conflicts. Fifty years of incessant geopolitical problems have left the country with large amounts of unexploited and yet-to-be-discovered oil.
This month, after nearly nine years of occupation, US forces will be withdrawing from Iraq leaving the nation to cope with multiple security issues on its own. Some of the numerous conflicts have been going on for over 1000 years and there is no reason the think they will be settled soon. With the Shiite majority now in charge of the country there is every reason to believe that Tehran will soon be having more influence. Given the problems the Iranians are likely to have in the next few years, it is likely some of the conflicts will spill over into Iraq.
For oil importing nations, the key issue is whether Iraq will be stable enough to increase its oil output to 5 or more million b/d even with the best foreign technical assistance. Suicide bombings are already on the rise and last week the annual oil and gas conference held at Basra had to be cancelled due to the security situation.
The standoff with the Kurds will never be truly settled until the Kurds have their own independent homeland. Exxon seems on the verge of being kicked out of Iraq for signing a contract to exploit Kurdish oil. There is always the possibility that very high oil prices will bring the nation together as there could be plenty of oil revenue for all to share. Given the history of the region, the chances are, however, that the security situation will continue to deteriorate and the major increases in oil production will be very difficult to achieve.
Quote of the week
“Saudi Arabia has been making excuses for years for their inability to produce more than 10 million barrels of oil per day. They're publicly stating — for the first time, I think — that they aren't going to keep up the pretense anymore. Their exploration and drilling program is over, and 10 million barrels is as good as it's ever going to get.”
-- Kevin Drum
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)