1. Oil and the Global Economy
Oil prices fell sharply last week as concerns about the ongoing European debt crisis outweighed unrest in the Middle East. NY oil closed out the week at $93.50 down by $6 for the month. In London crude closed the week at $103.35 after trading close to $111 on Tuesday on concerns that Iran was threatening to close the Straits of Hormuz. The price decline was aided by the US stocks report which showed an unexpectedly large decline in US gasoline consumption. NY gasoline futures which had traded as high as $2.67 a gallon on Monday closed out the week at $2.49 – a nearly 17 cents per gallon drop. The IEA joined the pessimism by forecasting a drop of at least 200,000 b/d for 2011 and 2012.
OPEC, bowing to the inevitable, gave up on country quotas and decided that the cartel as a whole would produce 30 million b/d – some 700,000 b/d below what is thought to be current OPEC output. November production was at the highest level in three years as about 400,000 b/d of Libyan oil came back into production and the Saudis raised their output to about 10 million b/d.
Much of the increase in Saudi production went to Asia, where China is believed to be filling the new strategic reserve facilities it has been building over the last few years and is trying to overcome its endemic diesel shortage. Beijing's imports in November were 5.5 million b/d, up from 4.9 million in October and 8.5 percent over November 2010. China's refining in November reached a record high of 9.22 million b/d.
It did not take long for the markets to figure out that the great EU settlement announced with much fanfare a week ago has very little relevance to the Union's current problems. Some observers are already saying the accord is on the verge of collapse. The deal reached in Brussels will take months to ratify and implement but in the meantime mountains of European debt, that can only be refinanced at unsustainable interest rates, is coming due. Last week the three big credit rating agencies issued a stream of warnings, downgrades, and threats of impending downgrades covering many of the Eurozone's members and banks.
The Fitch credit rating agency put the situation succinctly by saying that a comprehensive solution to the Eurozone's debt crisis was "beyond reach" as it put six EU countries including Italy on watch for potential near-term downgrades. Moody's downgraded Belgium and S&P has 15 of the 17 Eurozone members close to a downgrade.
There is general agreement that Europe is falling into a recession as various economic indicators are signaling contraction. The only issue is just how deep it will be. The IMF's Managing Director warned last week that the EU situation could slide into a world-wide depression similar to the 1930's. Many are warning that major financial institutions will fail in the coming year. Several major European banks have already announced retrenchment and some are pulling out of various kinds of banking such as mortgages or commodity speculation. French banks have long been the engine that financed a sizeable part of the oil industry's exploration and drilling activity. These loans are usually made in dollars which are no longer readily available to European banks. With higher interest rates and the new Basel reserve requirements cutting into funds available for lending, financing new oil production should prove to be far more difficult in the coming year.
What all this means for oil demand is unknown. For now the IEA is sticking with only small reductions in its demand forecasts while at the same time recognizing that global economic growth may not be as forecast earlier this year. So far the Agency is only talking about minimal growth holding demand steady and has not yet ventured into the realm where there is outright global economic contraction.
Crude futures jumped more than three percent in a few minutes on Tuesday as rumors circulated that Iran had closed the Straits of Hormuz. The rumor, which was officially denied by Tehran, started when a member of the Iranian Parliament said its Navy was going to practice closing the straits. This incident again illustrates how volatile the Iranian nuclear standoff has become. Last week the Iranian government released a flood of threats and bombast concerning how much damage an EU embargo of Tehran's oil would do to the global economy. To bolster morale, Tehran announced that it had just discovered 50 trillion cubic feet of natural gas in the Caspian Sea.
The Iranians said that as part of the OPEC negotiations, Tehran had extracted a promise from the Saudis that the Kingdom would not compensate for any reduction in Tehran's oil exports by raising its own production. Considering that Riyadh is now producing around 10 million b/d, the chances of a jump in exports do not seem that good. Although much attention is being placed on the possibility of cutting into Tehran's current exports through sanctions, the IEA noted that over the next few years Iranian production could fall precipitously due to lack of foreign technology to support drilling.
Reacting to the "stealth drone" incident, a senior Iranian defense official said the country may have to move its uranium enrichment to a "safer place." This announcement may be a belated recognition that frequent drone operations over its sensitive installations may be revealing more information about its nuclear programs than it had realized.
Last week the US Congress approved a defense bill sanctioning Iran's central bank. While there is no ban on Asian nations – China, Japan, Korea, and India – buying Iranian crude, the various sanctions measures make it difficult to for buyers to pay for the oil in hard currencies. For China the issue is easy as it simply pays about $20 billion in euros for the roughly 520,000 b/d it buys from Tehran. For the other major buyers, the issue is more difficult as they have extensive involvement with the US and EU banking systems and could easily fall into problems trying to circumvent the sanctions. For now all four Asian buyers that need the oil are unlikely to give it up. Should their imports contract due to a slowing global economy, purchases from Tehran would likely be among the first to go.
4. Iraq on its own
Nearly all forecasters are counting on Baghdad to count for an increasing share of global oil exports during the next five or ten years. On Thursday the US handed over its last base in Iraq and on Sunday the last few hundred of what was once a force of 170,000 troops left the country, leaving the Iraqis on their own to maintain a sufficiently stable political and security environment to support substantial increases in oil and gas exports.
So far the signs are not good. Last week an attack on the Rumaila oil pipeline temporarily reduced Iraqi exports by some 700,000 b/d.
Even more ominous were the moves by Prime Minister Maliki to consolidate power by rounding up hundreds of former Baath Party members and evicting Western companies from the fortified Green Zone. Over the weekend the Sunni politicians walked out of the Parliament, threatening to resign from the government citing Maliki's increasingly dictatorial behavior. Overshadowing all this is Iran and the nature of its relationship with the Maliki government. Tehran is currently facing a sea of troubles ranging from the civil war in Syria to increasingly tough sanctions, to internal dissent, to drones circling unseen above its military installations. Any overt move to intervene in Iraqi affairs on behalf of Shiites risks a response from Washington.
It seems a little early to start counting all those barrels that are to come from Iraq.
5. IEA's December Oil Market Report
Buried behind the press release forecasting that global oil demand next year will be 200,000 b/d lower than previously forecast is much uncertainty on the part of the IEA's analysts. The Agency is not in the business of predicting major depressions as economic contractions would not be welcome news to its sponsoring governments. The worst the Agency will admit for now is a 30 percent reduction in global economic growth which results in demand being 700,000 b/d next year.
The Agency notes that the leading macroeconomic forecasters are saying that next year could see anywhere from -.04 percent to +2.3 percent change in the global GDP next year.
The December OMR updates the IEA's medium-term outlook which forecasts out to 2016. The IEA is now saying the demand for oil products in 2016 will be 95 million b/d which is down slightly from last June's forecast. This new forecast assumes that the global GDP will not be doing so well in 2012; by 2013, however, things will be back on track with annual global GDP growth perking along at 4.6 percent. To its credit, the Agency recognizes that given recent developments in Europe, North America, and the emerging markets this "base case" rate of growth may be too optimistic. The "alternative case" for the period has global GDP falling to 3 percent for the period and global demand in 2016 ends up in the vicinity of 92.6 million b/d.
Given the depth of the economic problems that are shaping up for EU and likely much of the world, even a 3 percent annual growth rate over the next five years seems optimistic. Either world oil demand will drop more than is currently envisioned over the next five years, or economic problems and difficulty getting loans will curtail the drilling necessary to come up with 18 million b/d of new production before the end of 2016.
Quote of the week
"Much attention is paid to new energy technologies, with good reason. But it also is important to know that most of today's liquid fuels come from fields that have been producing for decades. More than 95 percent of the crude oil produced today was discovered before the year 2000. About 75 percent was discovered before 1980."
-- from Exxon Mobil's 2012 Outlook for Energy
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