1. Oil and the Global Economy
Oil prices were relatively steady until last Wednesday as concerns about the possibility of strike by Nigerian oil workers and the increasingly shrill rhetoric and exchange of threats between Tehran and its adversaries dominated the market. The assassination of an Iranian nuclear scientist and the revelation that Tehran was moving some of its enrichment operations to underground facilities which, in theory, would be immune from air strikes added to the tensions. On Wednesday Brent crude traded between $110 and $115 a barrel as news roiled the markets.
On Thursday, after it was revealed that the EU was likely to delay a halt to Iranian oil imports for another six months, some of the concern was taken out of the market. On Friday when it was learned that S&P was downgrading the debt of 11 EU members, the euro slipped as low as $1.26 taking oil prices down with it. The week ended with NY crude closing at $98.70 and Brent at $110.92.
NY oil prices also suffered from the weekly stocks report which showed an increase of 9.4 million barrels in US commercial crude inventories and continuing weakness in US oil consumption. The four week moving average has US consumption running 6.5 percent lower than last year. Moreover, US gasoline consumption is now down to 8.2 million b/d, the lowest since 2003. Despite the low gasoline consumption numbers and the large inventories, gasoline futures were only down a couple of cents for the week closing around $2.75 a gallon. The closure of two refineries in southeastern Pennsylvania and the potential closure of a third has raised many concerns about the supply of petroleum products to the northeastern US. With the loss of circa 45 percent of the region's refining capacity the area would become much more reliant on the import of finished products from the Gulf Coast or Europe. This raises the likelihood of higher petroleum product prices for the region as logistics of supplying these products would become more complicated and there is the possibility of severe shortages in the event of Gulf hurricanes.
Mild weather across much of the US and forecasts of more to come drove natural gas prices to a 28-month low of $2.67 per million BTUs. Natural gas futures have fallen by 13 percent in the past week and are 40 percent lower than last year. Overproduction from the shale gas drilling frenzy is behind the gas glut as drillers are forced to keep drilling new wells under contractual obligations despite massive losses. Many analysts are predicting that natural gas futures prices will fall as low as $2.40 per million in coming weeks.
Bombs continue to go off several times a week in Iraq, mainly aimed at Shiites and police facilities. Last week saw the first attack on foreign oil workers in a long time -- possibly a harbinger of things to come. Syria continues to sink into civil war as efforts by the Arab League to negotiate a settlement are making little progress. Syrian President Assad apparently has more support from his tribe than did Gadhafi and coupled with support from Iran could drag this situation out for an extended time.
2. The Iranian Confrontation
Last week started with a hard-line Iranian newspaper announcing that uranium enrichment has begun at a new underground site protected from airstrikes and having the capacity to carry on the nuclear program should things get nasty. IAEA inspectors in Vienna confirmed the Iranian announcement. This news was accompanied by various threats and establishment of "red lines" by both sides. EU negotiators continued to meet on the details of the embargo of Iranian crude that it is planning as diplomats and high officials scurried about in an effort to line up support for an embargo and discuss replacement oil supplies.
US Treasury Secretary Geithner went to Beijing and Tokyo, while China's Premier Wen visited Saudi Arabia and other Persian Gulf oil-producing states. While the headlines spoke of China snubbing Geithner's request, the situation is far more complicated. The object of the embargo is to not to cut off all of Iran's oil sales, but to restrict them just enough to force policy changes. Most Iranian oil is going to China, India, Japan, Korea and southern Europe. None of these countries are enthusiastic at the prospect of giving up Iranian imports and scrambling to do without or establish other sources of oil which are becoming increasingly hard to find.
Should the EU followed by India, Japan and Korea which are more susceptible to Western pressure cut back on purchasing Iranian oil even at a deep discount -- the issue becomes one of whether the Chinese buy up Iran's lost sales. China now gets about half of its daily oil consumption from the Middle East and clearly does not want to alienate the Saudis and their Gulf friends or Beijing could be left dependent on Tehran for its Middle Eastern crude. Should war break out in the region, China could grind to a halt. Thus it is unlikely that Beijing will embrace either side in the nuclear dispute, but will attempt to thread a course that will keep its oil flowing.
During the week, there were numerous reports that India, Japan and S. Korea were unenthusiastically looking for a way they might cut back on their Iranian oil consumption before they end up being hurt by US and EU sanctions.
On Thursday, it was revealed that the internal EU negotiations on sanctioning Iranian crude were headed towards a six month delay in order to allow time for Greece, Italy and Spain -- which are having obviously serious economic problems -- to work out alternative sources of supply. In the meantime, purchases of Iranian petrochemicals will be halted and many European economic links with Iran will be severed.
The ability of Saudi Arabia to make up for any lost Iranian production came to the fore last week with the Saudis telling foreign visitors that they could increase production. With Saudi production now around 10 million b/d vs. a theoretical capacity of 12 million, many foreign observers doubt that the Saudis could sustain production much above current levels.
The assassination of an Iranian nuclear scientist on Wednesday further raised tensions with Tehran openly blaming Israel, the UK, and the US and threatening retaliation in kind. Despite a momentary relaxation of market concerns, the situation still remains a dangerous threat to oil exports and the stability of the global economy.
3. The EU Downgrade
Friday was a bad day across Europe as S&P downgraded the credit ratings of nine Eurozone countries and the talks over restructuring Greece's debts broke down. The political and economic fallout from these developments could be considerable. By removing the AAA rating from France the ratings agency makes it more difficult for the Eurozone's bailout fund to help the troubled states of Southern Europe.
France's loss of its coveted AAA is a major blow to France's President Sarkozy just three months before his bid for re-election. In addition to downgrading two of the Eurozone's six AAA rated countries, seven other countries including Italy and Spain were downgraded. Portugal is now given "junk" status by the three main ratings agencies. In the near term it may become more difficult to roll over debt in the zone, and in the longer run various bailout plans may become more difficult to implement.
The failure of the Greek debt restructuring talks makes it likely that Athens will become the first developed country to default on its debt since the end of World War II. The problems came when private bondholders balked at taking a 50 percent write down in their holdings, preferring that governments shoulder the loss. This development is just one more step in the contagion which many fear will spread across the world causing a global depression.
In addition to the downgrade and looming default, it was announced last week that the German economy -- the powerhouse of Europe -- suffered a small but actual drop in GDP during the first quarter. This development makes it likely that the EU will be enmeshed in an official recession by the end of the first quarter.
The bad news sent the euro down last week and took oil prices down with it. In recent weeks the harsh rhetoric coming out of the Middle East has overshadowed the Eurozone crisis and kept oil prices strong. Now many analysts are starting to wonder if the threat of a major global economic setback which would reduce the demand for oil is not more imminent than the possibility of unmanageable supply disruptions for the Middle East.
The nationwide strike to reimpose the subsidy, the removal of which increased the cost of gasoline from $1.60 per gallon to $3.70, continued for five days last week, took a break over the weekend, and is due to start up again on Monday. While tens of thousands took to the streets to protest the gasoline price increase, only a few were killed and some 600 injured in clashes with police. Oil workers remained at their posts last week so oil exports were not affected. The 80 percent of its gasoline consumption which is largely imported from Europe came to a halt, shortages developed and black market operators were selling gasoline for nearly $9 a gallon. With most shops closed, Nigeria's economy largely ground to a halt.
While foreign observers see the gasoline subsidies as corrupt and wasteful with billions of dollars going to cartels that import gasoline, most Nigerians see cheap gasoline as their birthright and the only benefit from the $200 million a day Nigeria makes from exporting its crude.
President Jonathan is adamant that the subsidies must be removed so that the billions of dollars can go to other social programs and not to the benefit of those that can afford cars and the gasoline importing cartels.
The key player in all this is PENGASSAN, the oil workers union which has the power to make a big dent in the 80 percent of its revenues the government gets from oil exports. Last week PENGASSAN was threatening to start closing down oil production on Sunday, but relented as long as talks between the government and the union continue.
This, of course, provides an incentive for the government to keep negotiating with the unions who are demanding a return to the full subsidy. PENGASSAN has a long history of threatening to strike, but never really pulling out its workers. The Jonathan government is also facing an increasingly violent Islamist insurrection in the north of the country and there is clearly a limit on how much turmoil the government can handle at the same time. It seems likely that some sort of compromise will be reached before oil exports are affected.
Quote of the week
"Russia now needs oil at $110 a barrel to manage its finances. For Iraq, the number is $100. Even Saudi Arabia now needs oil to trade around $80 a barrel just to balance its budgets...Only a decade ago Saudi Arabia was able to balance its budget with oil prices averaging around $25 a barrel."
-- Fareed Zakaria
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)