1. Oil and the Global Economy
After nearly a month of steady increases, oil prices had a down week falling from circa $110 in NY and $125 in London to close out the week $2-3 a barrel lower. There was a spot of excitement on Thursday when a fire near the Saudi's massive oil export center of Ras Tanura was reported by the Iranian News service, Press-TV, as an attack on a major oil pipeline. This sent oil prices surging with London reaching a high of $128.40 a barrel, the highest since July 2008. The excitement ended when a spokesman for the Saudi Interior Ministry announced that there had been no sabotage of its oil facilities. Other sources say there was a fire, which did not affect oil production, in an industrial area of Safwa where there has been unrest among the Shiites in recent days.
The rapid price spike reflects how nervous the markets have become in wake of the ongoing Iranian confrontation and the reduction in spare capacity to produce oil. A similar price spike occurred in February 2006 after the Saudis repelled an attack on the Abqaiq oil processing facility.
A number of factors seem to have contributed to last week's price drop. The Iranian confrontation was relatively quiet as Iranians went to the polls to elect a new parliament. The euro ended an up and down week sharply lower, taking oil prices with it as disagreements over the Eurozone bailouts continue to erupt and the ECB handed out $700 billion in loans to its member banks. It now seems that the Greeks will only receive half the $170 billion bailout they were promised until they make more progress on getting their economic affairs in order. The ECB loans were seen by some as tantamount to "quantitative easing" or printing money. The price of Brent crude as expressed in euros is now at €82 -- higher, in euros, than during the 2008 price spike. Another factor keeping a lid on the price of oil is simply the high price of oil which many, including the IMF, are saying could cause more economic harm than the Eurozone debt crisis.
2. The Iranian Confrontation
The confrontation may reach a turning point this week when Israeli Prime Minister Netanyahu meets with President Obama on Monday. Netanyahu is said to be bringing an ultimatum that either the US promises to attack Iran whenever Tehran acquires the capability to build nuclear weapons, or Israel will attack unilaterally this spring. The Israelis believe they have a limited window of opportunity to undertake an effective attack on Iranian nuclear facilities by themselves after which so much of Iran's nuclear program will be moved underground where it would be invulnerable to the Israelis. At that point Israel would have to rely on Washington to stop any Iranian effort to build nuclear weapons.
The US currently holds the position that the red line is an Iranian attempt to actually build a nuclear weapon and not just acquire the capability to build one. Last week in speeches and interviews Obama laid out the case that the Israelis should be patient. The US believes the sanctions are beginning to work and that an unprovoked attack on Iran's nuclear facilities would not only swing world opinion to Tehran's side, but would also set off a chain of hostilities in the region which would probably lead to much higher oil prices as the Iranians retaliated.
Israeli public opinion, however, is said to have accepted the idea that war at this time would be better than confronting a nuclear armed Iran that could wipe out Israel with a small number of nuclear weapons, and appear ready to back their Prime Minister in confronting Washington on the matter. The situation is further complicated by the US elections with the President's opponents seeing political advantage in demanding a harder, more threatening US stance against Tehran.
For some time, the US has been assessing the likely Iranian response to an Israeli attack on its nuclear facilities. While missile attacks on Israel by Tehran or its allies in Lebanon and Gaza seem likely, it is believed that Tehran would be careful in calibrating whatever it does to attack US, EU, and Arab interests in order to avoid a major US or even NATO military riposte. Such an attack would not only be likely to destroy their nuclear facilities, but could also wreak untold damage on their military forces and economy. Tehran would therefore probably act through proxies rather than engaging in direct military confrontation with US or other western forces.
Where Middle Eastern oil exports would come out in all this is an open question, but the likelihood of a reduced flow of oil from the Gulf is high. While the Iranians have repeatedly threatened to block the Straits of Hormuz in retaliation for any attack, they have many other options such as "proxy" attacks on the extensive oil export facilities in the region.
Over the weekend, Iran held parliamentary elections. As "reform" candidates and parties opposed to the current policies were not allowed to take part, the election was between the hardline and still more hardline. Initial indications seem to be the President Ahmadinejad's followers lost badly against the even more hardline candidates, a development that most believe will reinforce the government's position against compromise.
In the meantime, the US, EU, and UN sanctions seem to be having an effect as more of the workarounds that Tehran has been using to conduct its foreign trade are being closed. With foreign ships reluctant to visit Iranian ports, Tehran has been forced to turn to its own fleet of 26 tankers to deliver some of its crude. As the war drums beat louder, more of Tehran's customers are having second thoughts about their dependence on Iranian crude and are looking for other sources.
Current indications are that the President is unlikely to give in to Israeli demands. Polling in the US indicates that close to 50 percent of Americans say the US should support Israel. However, most seem to support continuing talks and as yet no one has clearly pointed out the consequences to the US, in terms of oil prices, of an attack on Iran. The most recent bluster from Tehran, by the way, has oil going to $440 a barrel in the wake of any attack.
In addition to the confrontation with the West and Israel over nuclear weapons, Iran seems to be increasing its involvement in the Syrian uprising by providing military equipment and advisors to the Assad government -- its last true friend in the region. As the situation grows worse, Iranian meddling in the conflict is likely to lead to repercussions that further complicate the Middle Eastern situation. It looks like a dangerous year ahead which is not good for oil supplies or prices.
3. Gasoline and Election 2012
The incessant rise in gasoline prices, up 30 cents a gallon in the last month, is to show up in the US political debate. The $4 psychological barrier has already been breached in several parts of the country and with premium already averaging above $4.50 in California; $5 does not seem that far away. With the average US prices close to, or above $4 a gallon last spring and in the summer of 2008, $4 gasoline no longer comes as a shock to the motoring public. Many businesses have already factored gas prices into their plans and US gasoline consumption is down by 1.5 million barrels per day in the last five years. Nonetheless, a dollar a gallon increase in gasoline prices, if maintained over the year, takes about $100 billion out of the US economy.
Sensing a good political issue, Republican candidates have been trying to tag the Obama administration as the reason for the high prices. So far Newt Gingrich has taken the lead in blaming the President in an effort to distinguish himself from his rivals. The Gingrich plan to return gasoline prices to $2.50 a barrel involves lots of drilling in Alaska, off both coasts, in the Gulf, and in the interior. Lost in such plans is the point that the oil companies are already fully booked and that it would be 10 to 20 years before significant quantities of oil would emerge from a major increase in drilling. The President's refusal to issue an immediate permit for the Keystone pipeline is another favorite target for criticism.
Of interest is a recent analysis saying that completion of the keystone pipeline would actually increase gasoline prices in the Midwest. The reasoning is that the pipeline would drain the current glut of crude coming from Canada and the Bakken shale to the Gulf coast where it would be refined or exported. This would bring West Texas Intermediate prices back to parity with world prices and result in more expensive crude for Midwestern refiners.
The American people and many commentators seem to be catching on that there is very little any US President can do to control gasoline prices, especially in the short run. Many are starting to understand that the troubles in the Middle East, when combined with increasing demand for oil from Asia, and the lack of a significant increase in global production, is behind the higher prices. Indeed, a recent Pew Poll shows that only one in five mention the President when asked the cause of high oil prices.
A few Democrats are calling for releases from the Strategic Petroleum as a way to lower prices, but with the possibility of more troubles looming in the Middle East, the administration and most members of Congress do not think this would be a wise move.
Gasoline prices still have the potential of becoming a key issue in this fall's elections. With three months to go until the annual late-spring price peak, it seems that we are on our way to $5 gasoline in at least some parts of the country. The refinery shutdowns in Pennsylvania suggest that the highest prices will probably occur along the heavily populated coasts where they will have the most political impact. If some easily understood event such as a curtailment of Middle Eastern oil supplies should happen this year, the voters may be less inclined to blame the administration than in a situation where numerous small and not understood factors combine to drive prices higher.
We are certain to hear a lot more about this before election day in November.
4. A New EIA Report on East Coast Refining
Last week the US Energy Information Administration issued a 27 page report that delves more deeply into the problems that the closure of several refineries serving the US East Coast could cause before the year is over. The report notes that since last September two refineries in the Philadelphia area (363,000 b/d) and one refinery in the Virgin Islands (350,000 b/d), that has been supplying the East Coast, have been closed down. In addition a fourth (335,000 b/d) Philadelphia-area refinery is due to close in July unless a buyer can be found. The three Philadelphia-area refineries comprise about 50 percent of the refining capacity on the US's East Coast.
So far there has been little disruption to East Coast refined product supplies, in part due to the restarting of a Delaware City refinery (182,000 b/d) in October after being closed for two years. The EIA warns however, that should the third and larger Philadelphia refinery close in July, "petroleum markets in the Northeastern US could be significantly impacted."
The US has sufficient refinery capacity along the Gulf coast to supply the Northeast; the problem will be constraints on the transportation system. The pipelines to the northeast from the Gulf are already maxed out, and the current pipeline system in Philadelphia is designed to unload crude for refineries, not finished products for distribution to consumers. While the crude oil pipeline system can eventually be modified to take oil products from ships and send them on to refinery distribution pipelines, this will take a year or more and nobody is willing to invest in the expensive modifications until the fate of the third Philadelphia refinery is known.
The situation is further complicated by the US law, the Jones Act, which says that only US owned, flagged, and manned tankers can transport oil products from the Gulf Coast to US ports. There are only 56 tankers meeting the Jones Act standards and these usually are chartered out months in advance.
If the last Philadelphia-area refinery closes in July, replacing the lost supply of Ultra Low Sulfur Diesel (ULSD) is likely to be the major problem as it can only come from the US Gulf Coast. Additional supplies of gasoline can be imported from refineries in Europe and Asia -- provided crude is still coming out of the Middle East in sufficient quantity. Pennsylvania and Western New York are most likely to be affected by the refinery shutdowns as nearly all of their oil products come by pipeline from the Philadelphia area.
Yet another complication is the new requirement in New York State that all heating oil be switched to low sulfur beginning this July. This means that the demand for low sulfur distillates in the region could increase by 35-50 percent next winter over the base ULSD demand of 360,000 b/d for transportation fuels. The closing of the three refineries would result in a loss of 150,000 b/d in USLD production and the closing of the Virgin Islands refinery has already reduced USLD shipments to the region by 15,000 b/d.
The use of 10 percent ethanol in 1.5 million b/d of gasoline consumed in the northeast region is still another problem. As ethanol and ethanol-laced gasoline cannot be shipped by pipeline, refiners now have to prepare a blend stock which is gasoline minus its ethanol, then ship it to blending terminals where the ethanol is blended in prior to distribution by truck. The problem is further complicated by the need for two types of blend stocks, one of which meets specification for reducing ozone. About 70 percent of the gasoline sold in the Northeast is of the low-ozone variety.
Gasoline imports from overseas to the Northeastern US averaged about 560,000 b/d last year, with about 250,000 b/d coming from Europe. With Europe scheduled to lose about 600,000 b/d of Iranian crude by July and the US possibly looking to increase gasoline imports at the same time, there is a good chance that the gasoline supply in Europe will be a lot tighter and more expensive this summer.
All the foregoing suggests why gasoline prices seem on their way to record levels and why the EIA is right to be concerned about the fate of the third Philadelphia-area refinery -- which by the way is owned by Sunoco. Should the refinery be closed and shortages develop, $5 gasoline may look pretty good.
Quote of the week
"...any discussion of rising gas prices that does not include the words "China" and "India" is not a serious discussion. Though short-term fluctuations have many causes, the underlying story on gas prices is that the world has a limited supply of oil, but a growing supply of people who want to use oil. That makes prices rise."
- Ezra Klein, Washington Post
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)