1. Oil and the Global Economy
Oil prices were little changed in a holiday-shortened trading week. After climbing on Monday in response to economic news; falling on Tuesday and Wednesday after reports of an unexpectedly large build in US crude stocks; and rebounding on Thursday on what were at first thought to be good employment numbers. The decline on Wednesday was helped by bad economic news from the EU where Spanish bond sales did not do well. In addition German industrial output slackened at bit. Hints that the Federal Reserve will not be resuming quantitative easing in the near future, helped with the decline as did a drop in factory orders during February.
Unusually large crude imports the week before last helped to increase crude inventories by 9 million barrels. US consumption of oil products during March was down by 4.7 percent as compared to last year despite the nice weather which allowed many businesses to get a jump on summer activities. The job numbers out on Friday were well below expectations, suggesting that the US economy has not been doing as well during the last few months as had been thought. It remains difficult to see economic recovery underway when oil products consumption continues to run well below last year’s levels.
Gasoline prices rose less than one cent a gallon last week, but most are predicting that prices will continue to rise as the transition to more expensive summer gasoline blends gets underway. Shell is reported to be completing the construction of a $10 billion facility in Louisiana to convert cheap US natural gas into expensive diesel fuel.
Natural gas prices fell last week, closing at $2.08 per million, as inventories continued to increase faster than expected. Drilling rigs continue to be switched from drilling for natural gas only to drilling for either liquids-rich natural gas or oil.
2. The Iranian Confrontation
The situation seems to be heading towards a turning point later this week as negotiators from the big six – the five permanent members of the UN Security Council + Germany – are scheduled to sit down in Istanbul with the Iranians to discuss Tehran’s nuclear program. The confrontation is complicated by Tehran’s efforts to support the Assad government in Syria. The Iranians have been sending munitions and security advisors to Syria, and has helped Damascus market what little oil it still has to export. As thousands of refugees from Damascus’s military assaults on rebellious towns continue to flood into Turkey, Ankara has become more strident in its calls that Assad must go, thus upsetting the Iranians who are becoming more and more isolated.
After agreeing that the talks be held in Istanbul two weeks ago, last week Tehran started saying that the Turks were not impartial hosts and suggesting that China, Iraq, or even Syria would be a better location. For most observers this change of position signaled that Tehran was in the midst of an internal struggle as to just how to deal with the talks in face of the tightening web of international sanctions. On Sunday, however, Tehran announced that the talks would take place in Istanbul as previously announced.
Pressures from the sanctions continue to tighten. Last week President Obama authorized actions against banks in countries that continue to import Iranian oil and want to do business in the US. The Turks announced that they were cutting back by 20 percent on their Iranian oil imports and a major Chinese ship insurer announced that it would halt indemnity coverage for tankers carrying Iranian oil. This suggests that there may be more to Beijing’s position on the Iranian nuclear issue than has been made public.
If the negotiations actually begin this week, the US and its EU allies will open with a demand that Tehran dismantle its new underground enrichment facility, ship the 20 percent enriched uranium already made out of the country, and allow unlimited UN inspection of its nuclear facilities. Such a demand would be difficult for the Iranians to agree to as they have much invested in the program and the nation’s self-image and prestige is wrapped up in the project. Almost any concession Tehran makes on these issues could have serious domestic political repercussions.
The Europeans fear the Obama administration, which does not want to see a spike in gasoline prices before the November elections, would be willing to let the negotiations drag out for another seven months while Tehran continues to crank out enriched uranium.
There are so many irons in this fire that the outcome is impossible to foretell. In the best case, a consensus would coalesce in Tehran that the prestige and deterrence potential of being a nuclear or near-nuclear state is not worth the economic damage of the sanctions or some sort of regional hostilities. The worst case starts with much higher oil prices, and possibly oil shortages. From there it goes on to include grave damage to the global economy should Gulf oil exports be restricted for a protracted period or oil production and export facilities be damaged. The next few months seem to be shaping up into a situation that could be far more serious than most realize.
3. Iraq, the Kurds and Exxon
As nearly the last place on earth with lots of cheap-to-extract oil still in the ground, Iraq has figured prominently in most projections of future oil availability. As an ersatz country cobbled together after WW I from various tribes and ethnic groups in the Ottoman empire, Iraq has had a troubled history which has served to restrict oil production during the last 60 years. In the wake of the US invasion, the new Iraqi government embarked on a program to increase the nation’s oil production significantly. To accomplish this they invited the world’s oil companies to bid on the right to exploit Iraq’s highly attractive oil reserves. To prevent charges that foreigners were exploiting Iraqi oil, Baghdad demanded and got terms that allowed the foreign oil companies to make little profit in return for their efforts and the risks of drilling in an unstable part of the world where bombings and other attacks happen frequently.
Although, the foreign oil companies were not happy about working for returns far below normal, most participated in order to get a foot in the door should Baghdad’s policies change someday. After years of futile efforts, the Iraqi Parliament, as currently constituted, has been unable to agree on an oil production law that would specify how oil revenues would be divided between the central and regional governments. Without such a law, Kurdistan which is a semi-autonomous and trouble free province went ahead, in defiance of Baghdad, and began contracting with foreign oil companies to exploit the province’s oil – shipping it out through the northern pipeline through Turkey.
Baghdad acquiesced in this arrangement which allowed Baghdad a share of the oil revenue and bragging rights to increased Iraqi oil production so that the Kurds contracted with some 40 small oil companies to exploit their fields. In recent months, however, this has broken down. The Kurds are accusing Baghdad of withholding oil revenues which should to going to them and in retaliation have halted exports through the northern pipeline. Baghdad claims the Kurds are depriving Iraq of $6 billion in oil revenues and are smuggling oil from Kurdistan to Iran.
The situation is further complicated by the entry of ExxonMobil into the situation. Although Exxon currently has a stake in exploiting the West Qurna 1 oilfield, the unfavorable terms of the contract suggest that Exxon will never make much money from the deal. When the Kurds offered Exxon what are presumably far more attractive terms for drilling in the Kurdish fields, Exxon moved on the opportunity, signing a deal with the Kurds last October.
This left Baghdad in the awkward position whereby one of its contractors, especially a major US oil company, was defying its policies and casting its lot with the Kurds. So far Baghdad has only barred Exxon from participating in further rounds of bidding on southern Iraqi oil, but has not as yet banned the company from continuing work in southern Iraq. Shell considered joining Exxon in contracting with the Kurds in an area which offers a better working environment, increased security and better returns. In the end Shell opted to stay with Baghdad and work on a major natural gas project in the south.
On March 25th Baghdad’s North Oil Co. announced that it has signed a deal with BP to develop the northern Kirkuk oilfields which may contain one-third of Iraq’s 143 billion barrels of oil. This deal, which is seen as a response to Exxon is in an area claimed as part of Kurdistan as it was in a Kurdish province during the 400 years of Ottoman rule. The Kurds in turn appear to have retaliated for the BP contract by first reducing and then shutting off exports.
Developments in the past few weeks seem to have dimmed the prospects of Iraqi oil production. Exxon is adamant that it is sticking with the Kurds. Without the stabilizing presence of US forces, the Sunni minority are becoming restive under Maliki’s Shiite rule. The whole situation is ripe for further troubles which could easily slow development of Iraq’s oil reserves in the years ahead.
Quote of the week
"I want people to understand that all of our energy options require trade-offs, and sometimes we aren’t even aware of what those trade-offs entail."
- Robert Rapier, author of Power Plays: Energy Options in the Age of Peak Oil
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)
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