1. Oil and the Global Economy
Oil prices climbed last week on increasing tensions in the Persian Gulf despite pressure from a weaker euro which tends to hold prices down. NY oil futures closed at $101.56 on Friday and London's Brent at $113.06. The spread between NY and Brent widened slightly as sanctions on Iranian oil are likely to have more impact on the EU and petroleum sales in the US fell to a 14-year low resulting in an unexpected jump in US petroleum inventories.
The news from Europe last week was not good, with the pronouncements coming from the EU's leaders taking on an increasingly pessimistic tone. Manufacturing in the Eurozone fell for the fifth consecutive month and the euro is now down to $1.27 as compared with $1.35 at the beginning of December and $1.45 last summer. The euro also hit an 11-year low against the yen last week.
Despite moderately satisfactory French and German debt auctions last week, investors continued to dump the euro. Next week will see the first major refinancing of Italian and Spanish bonds which should provide important insights into the course of the debt crisis. The EU, however, is clearly headed into a recession as austerity measures are being implemented everywhere.
Media attention is starting to focus on gasoline prices in the US. NY futures have risen 30 cents a gallon since mid-December and 10 cents a gallon in the last week. Average retail gasoline is now going for $3.37 a gallon which is the highest on record for this time of the year. Leaving aside the danger of supply interruptions which would send prices much higher, experienced observers are saying the US gasoline prices will average between $3.75 and $4.25 a gallon this year with $4 gasoline expected in the spring. As we saw in 2008, prices at this level will clearly cause serious economic damage with or without economic contagion from the EU.
2. The Iranian Confrontation
Tensions increased last week as the EU tentatively decided to slow Iranian oil imports into Europe; the US acquired Congressional authorization to sanction any foreign entity doing business with Iran, particularly its banking system; and Iranian officials unleashed a new round of threats against the US and EU. On Sunday an Iranian newspaper reported that according to a Revolutionary Guard commander, the country's leaders have decided to order the closure of the Straits of Hormuz if Iran's oil exports are blocked. Iranian spokesmen have made this threat many times in the past, but this is the first time the threat has been described as official policy. The Iranian press also reported that the country had begun enriching uranium deep underground where it was safe from air attack.
Much of the Iranian bombast is aimed at keeping up domestic morale in the face of worsening economic conditions – Iran's currency, the rial, has fallen 40 percent against the dollar in the last month making many imports prohibitively expensive. Many observers believe that the increasing flow of rhetoric from Tehran shows that the sanctions are having an effect.
Tehran is scheduled to have parliamentary elections in March, but these are likely to be boycotted by the major opposition movements as many of their leaders are under some form of arrest stemming from the crackdown following the 2009 elections.
The prospects of a EU embargo and the ability of the US to sanction countries doing business with Iran raises some interesting questions for the months ahead. Policymakers in the US and EU will have a delicate task in restricting Iranian oil exports without sending world prices to new highs. Korea, Japan, and India which next to China are major buyers of Iranian oil are already looking for alternative sources of oil. Some analysts are saying that there is sufficient spare capacity in the world with the return of Libyan oil production and stepped up production in the Persian Gulf to offset the loss of Iran's 2.5 million barrels a day of exports.
Chinese policy towards all this is the great unknown. Tehran maintains that Beijing is such a good friend that it would be willing to buy up all of Iran's production thereby nullifying the boycott. China of course would extract a toll in the form of below market prices should it decide to help out the Iranians, but it remains to be seen just how far Beijing is willing to stick its neck out to help Iran. This is a complicated situation with many twists and turns in the offing. For now, the general idea is for any embargo on Iran or sanctions on its customers to be imposed gradually so that the effect on Iran and global oil prices can be evaluated each step of the way.
Aside from the impending boycott, there is much danger implicit in this confrontation. As long as Tehran is determined to remain on its current course of refusing international inspection of its nuclear programs, this situation will continue. While the US and EU are attempting to forestall the much more serious problems that would arise from a nuclear armed Iran, the Iranian government is also deeply involved in numerous other confrontations in the region particularly the centuries old disagreements between Sunnis and Shiites. Last week Turkey's Foreign Minister warned that events in Iraq and Syria could lead to a "Cold War" between Sunnis and Shiites saying that such a development would be "suicide" for the region.
3. Problems for "Big Oil"
Last week several international oil companies ran into problems as they tried to do business around the world. Exxon took a major hit when the Paris-based International Chamber of Commerce's Arbitration Panel awarded the company $908 million, 11 percent of the $7 billion Exxon had been seeking in compensation for Venezuela's 2007 nationalization of its assets. The judgment was further reduced to $750 million due to a counterclaim by the Venezuelans. To add to the insult, Venezuela's oil company, PDVSA, announced that it will only pay Exxon $255 million on the judgment after it deducted debts that it claimed Exxon owed the company.
While the judgment was a major victory for nationalization-minded oil producers, the case which involves the nationalization of the Cerro Negro project in the Orinoco heavy crude belt, is still pending before the World Bank's arbitration tribunal so it will be some time before any money is paid. The case will likely continue for years.
Chevron suffered a setback in its ongoing dispute with Ecuador over oil pollution caused by Texaco in the rain forest more than 20 years ago. Last week an Ecuadoran appeals court upheld an $18 billion judgment against Chevron for the pollution. Chevron maintains that the case is simply evidence of corruption in Ecuador's judicial system and will seek to have the claim reversed outside the country. Chevron promptly asked a US federal appeals court to block efforts to seize Chevron's assets to satisfy the judgment, but on Friday the US appeals court rejected the request. This case too could last for years. Chevron is also facing large claims in a Chinese court for an oil spill off China's coast last fall and Shell is facing a variety of claims for oil spills in Nigeria.
Should any of these companies ultimately be forced to pay large and possibly dubious compensation for oil spills or forced to accept nationalizations without just recompense, it will likely have a dampening effect on oil production by major oil companies in less-than-stable regions of the world. Last week the heads of three major oil companies were in Alaska, where the prospects of nationalizations are zero, discussing a new natural gas pipeline that would bring north slope natural gas to markets.
The situation in Nigeria, a country with a population of 155 million and which produces some 2.5 million barrels of oil per day, is deteriorating on several fronts. Half of Nigeria's population is Muslim living in northern Nigeria where an insurrection seems to be breaking out as extremists seek to force Christians living in the area to move south so that they can form an independent Islamic state in the region. On Sunday, Nigeria's President, Goodluck Jonathan, termed the violence the worst since the civil war of 1967-1970 that killed nearly 1 million people.
Jonathan, however, may be faced with a larger problem in the form of a nationwide strike this week to roll back the highly unpopular doubling of gasoline prices to $3.50 a gallon announced last week. As with many other oil exporting states, Nigeria has long subsidized gasoline prices, but in recent years has come under increasing pressure from the IMF to drop the $8 billion subsidy, thus freeing up money for social projects and eliminating the incentive to smuggle gasoline out of the country. Most Nigerian gasoline is imported at world prices as corruption and mismanagement have largely shut down domestic oil refining.
Nigerians however have long felt that cheap gasoline was the only real benefit they got from the nation's oil patrimony and are bitterly opposed to removal of the subsidies. It is widely feared that doubling gasoline prices will lead to higher prices for many other products. Several previous governments have attempted to remove the subsidy, but have backed down in the face of widespread opposition.
For now industry sources do not believe that the strikes will disrupt much oil production. Last week the offshore Bonga field which had been shut down due to an oil leak came back online producing 250,000 b/d. Immediately following the resumption of production at Bonga, Shell announced a force majeure on export of its Bonny Light crude – likely due to damage to pipelines. The government has long banned oil companies from announcing damage to oil pipes by terrorists or oil-thieves.
The Islamic uprising in the north is hundreds of miles away from the oil producing regions along the Gulf of Guinea and is not likely to be directly affected by fighting should the unrest increase. Over the longer run 75 million Muslims in revolt is likely to be too much for the government to handle and numerous developments are possible that could curtail oil production. The strike this week is likely to be curtailed quickly with either the government or the unions backing down.
Quote of the week
"Gasoline prices are the highest ever for the start of the year, and they're on the rise, supercharged by expensive oil and changes in refinery operations."
-- Ronald White, Los Angeles Times
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)