1. Oil and the Global Economy
Crude prices changed little last week as the various forces moving the markets seemed to balance each other out. New York oil closed on Friday at $96.65 and London at $111.52. In contrast with the oil markets, gasoline futures and natural gas underwent substantial moves. Gasoline futures in New York closed 15 cents a gallon higher as reports of multiple refinery closures and production problems at others in the US and Europe raised concerns over the availability of gasoline in coming months.
Natural gas futures, which had been trading above $4 per million BTUs in November, fell to below $2.30 per million last Monday as warm weather and over-production in the US continued. After Chesapeake Energy and other producers announced that they were making substantial cuts in their drilling programs in the coming year, futures rebounded sharply, closing out the week at $2.67 per million.
The now familiar crises of the Iranian confrontation, the EU’s sovereign debt, employment, interest rates, economic growth and the Syrian uprising continued to make news, pulling the markets one way and then the other. In addition to the world’s multiple mega-crises, numerous smaller situations that will impact the availability of oil continued to fester. Bombs continued to go off amid increasingly unstable political and social situations in Iraq and Nigeria suggesting to some observers that civil wars in one or both of these countries might not be far away. South Sudan shut-in some 350,000 b/d of oil production claiming that Sudan was stealing its oil as it was being exported to customers. Although Libyan oil is reported to be back to 80 percent of pre-uprising production, the political situation is still highly unstable with clashes between various militia groups starting to occur.
In the US, “Election 2012” moved ahead with President Obama devoting a substantial portion of this year’s State of the Union address to energy policy and his various political opponents denouncing his positions. With higher, and possibly much higher, gasoline prices in store for the next few months, energy policy could easily come to dominate the political discourse this year.
2. The Iranian Confrontation
Developments came rapidly last week with the European Union formally establishing a phased embargo on Iranian oil imports starting on July 1st -- new contracts with Tehran are banned already. Various other economic sanctions imposed by the UN, US and EU already are starting to have an effect, with the value of Iran’s currency dropping precipitously. For the first time, senior Iranian officials have moved beyond bravado to admit to their people that the sanctions are hurting the economy.
Tehran’s response to the EU’s announcement has taken two tracks. One was to call for renewed negotiations over its nuclear program and an IAEA team is now in Tehran to explore whether the Iranians are genuinely seeking a solution to the crisis or, as many believe, are simply seeking to buy more time to develop nuclear weapons.
The second and more risky track for Tehran was the announcement that it could halt oil sales to Europe as early as this week, thereby preempting the EU’s embargo and depriving Italy, Greece, and Spain of five months’ time to line up other sources of oil. Over the weekend mixed signals came from senior Iranian officials. While debate on a bill to halt oil sales to the EU was postponed, a senior Iranian official said oil exports to the EU would be “stopped soon.” Another official warned that the IEA inspection team had better act “professionally” or suffer the consequences.
Should the negotiation track fail once again, the situation gets murkier. The Iranians are saying that stopping the 600,000 b/d that it currently sells to Europe will drive world oil prices to $150 a barrel and thereby do more harm to the EU’s economies than to Iran as Tehran will benefit from the price increase. However, Libyan oil production is recovering nicely and Saudi production is at a recent high, so that the loss of Iran’s exports may not hurt the EU as much as Tehran portrays. Whether Tehran would be able sell the 600,000 b/d to Asia, possibly at cut rate prices, or be forced to load them onto floating storage for a while remains open. Should Beijing be tempted to fill its strategic reserve cheaply with Iranian oil while the rest of the world suffers from high oil prices is an open question. It is clear that China does not want to become dependent on Iran as its major source of Middle Eastern oil and has much to lose from this confrontation.
There are numerous sub-plots to the embargo story. Some of the oil Iran ships to Europe is coming in repayment for investments that Italy, which is still owed $1.5 billion, has made in Iran. Tehran is threatening to cancel these contracts. It also seems that 95 percent of the world’s oil shipments are insured by EU companies and insurance pools subject to the sanctions. Without proper insurance many tanker owners and destination ports would be reluctant to accept Iranian oil shipments.
Although a handful of Iranian politicians continue to talk about closing the Straits of Hormuz in retaliation for the EU’s embargo, the realization that Iran would be a clear loser in any military confrontation with the West is reducing such talk. The situation remains volatile but for now the ball is in Tehran’s court. The solution to the problem most frequently mentioned is to allow the Iranians to develop their nuclear technology under strict supervision to the point where they could in theory quickly build and deploy nuclear weapons without actually doing so. Whether this solution would be acceptable to those countries who would feel most threatened by a nuclear armed Iran remains to be seen.
3. The Euro Crisis
The interminable sovereign debt crisis continues to muddle along with endless talks and new “agreements” surfacing almost daily. On Sunday yet another agreement on conditions for the next Greek bailout of $170 billion was said to have been reached. As usual, this agreement forgives a large part of Greece’s current debt, said to be as much as 70 percent, and sets strict standards for how the Greeks are to manage their fiscal affairs in the future. This time, however, there are said to be automatic penalties should Athens fail to meet its obligations. As the Greeks have a rather bad track record in meeting EU fiscal standards, there is talk that an EU commissioner, with veto power over Greek budgetary decisions will be stationed in Athens for as long as needed. On Sunday, Germany’s economics minister openly endorsed the proposal for Athens to surrender control over its national budget. A German official said the statement was aimed at other EU members struggling to gain political control over their budgets as well.
Whether the Greeks are willing to accept such a surrender of their national sovereignty to remain in the EU is an open question, as is whether the rest of the EU is willing to sign off on the new agreement and hand over yet another bailout to the Greeks. Many observers are skeptical that the new proposal will be ratified. They believe that the only solution is for Greece to be cut loose from the Eurozone while efforts are made to protect the remaining members.
4. Refining petroleum
There were a number of developments in the last few weeks that contributed to the 8 cent a gallon jump in gasoline futures on Friday. At one point during the day gasoline was trading at a five-month high of $2.96 a gallon after it was announced that Conoco was having troubles at its 238,000 b/d Bayway refinery in New Jersey. This news came after Hess Energy announced that it was considering shutting down another New Jersey refinery for maintenance. In recent months announcements have been made that five large refineries serving the US East Coast were shutting down this spring unless buyers could be found. This comes on top of the closing of two other East Coast refineries in recent years.
As in the US, European refiners are coping with overcapacity, weak demand, and tight credit. Two weeks ago Petroplus announced that it was going into bankruptcy and would shut its five refineries located in the UK, Belgium, France, Germany, and Switzerland. Three of those have already been shut down and the outlook for another is precarious. The prospects for EU refining in the wake of the Iranian oil embargo is also raising concerns. The fear is that Iran will dump its oil production on Asian refiners at cut-rate prices, where it will be refined and shipped back to Europe in a position to undercut local refiners.
The Eastern US has long benefited from refining overcapacity in Europe as refiners there could profitably ship to the US gasoline that they were unable to dispose of locally. Any reduction in EU refining capacity is likely to be felt in the form of higher prices along the US’s eastern seaboard.
The outlook already is for higher prices along the East Coast. While retail prices have not kept up with the recent gasoline price increases in the futures markets – up by over 40 cents a gallon in the last six weeks as compared to a 15 cent increase at the pump – it is only a matter of time. Gasoline prices in relatively high-tax New York and Connecticut are now only 2 cents a gallon below those in California, the traditional price leader in the lower 48. Gasoline prices in the Washington DC area, where the political impact is likely to be the greatest, are not far behind.
Given that it is only January and that we still have four or five months of traditional spring price increases to go before the 2012 peak is reached, this year is giving every indication of shaping up to be a record breaker for gasoline prices. Given that it is a presidential election year, and considering what we saw in Washington during the 2008 gasoline price spike, we can expect the political theater, histrionics, and finger pointing to begin any day now.
Quote of the week
“The approaches needed for tackling the economic impacts of resource scarcity and climate change are the same: moving away from a dependence on fossil-fuel energy sources. Whereas the implications of climate change have driven only slow policy responses, economic consequences tend to drive shorter-term action."
-- James Murray and David King
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)