1. Oil and the Global Economy
Oil prices fell another $5 a barrel last week to close at $91.48 in New York and 107.14 in London. Again a combination of turmoil surrounding Greece’s remaining in the Eurozone, unfavorable economic news from the EU, China, and the US, weak demand and growing crude stockpiles was behind the move. Oil has now fallen some $18 a barrel since March. The spread between NY and Brent crude increased to over $15 a barrel last week as a consensus grew that the reversal of the Seaway Pipeline will not be sufficient to drain much of the glut from Cushing. Okla. until its capacity is increased to 400,000 b/d next year.
Wholesale gasoline prices fell by nearly 10 cents a gallon last week while average retail prices fell by nearly 4 cents. The gasoline situation is complicated by refining problems on both coasts which are keeping average California prices nearly 65 cents a gallon above the national average. The refining situation on the US East Coast is still uncertain. Even though Delta Airlines say they will reopen a shuttered Philadelphia area refinery in the fall, many analysts are skeptical. A second and larger Philadelphia refinery is now scheduled to be closed around the 1st of August unless negotiations with a hedge fund to purchase it are successful.
US natural gas prices continued the steady climb which began in mid-April, closing at $2.74 per million on Friday, up nearly 75 cents in the last six weeks. As fracked natural gas wells are rapidly depleted, it requires continuous widespread drilling to maintain production. The heavy losses that drilling companies have suffered in the last six months has resulted in a 35 percent drop in the numbers of rigs drilling for natural gas. There is a backlog of drilled wells, waiting to be fracked and start producing, however, so for the present natural gas production remains high. The decline in new drilling coupled with the increased use of natural gas to generate power indicates that production and inventories eventually will fall. In addition, long range weather forecasts suggest that the US will have a warm summer, increasing the demand for natural gas-powered air conditioning.
There have been a number of stories on the damage wrought by the surge of drilling in shale for tight oil and gas. The large numbers of heavy truckloads and workers required is overwhelming and damaging local roads and other infrastructure, while greatly increasing unreimbursed costs to local governments. If oil prices should fall much further, the profitability of expensive-to-drill and rapidly depleting fracked oil wells may come into question. Barclay’s analysts point out that the boom in “super light” liquids from US tight oil and gas production is leading to a global refinery mismatch as the trend has been towards building refineries to process heavy sulfur laden crudes.
The recent surge in Saudi oil production to an official 9.923 million b/d has pushed the Kingdom into first place as the world’s top oil producer, surpassing Russian production for the first time since February 2006.
2. The EU Crisis
Over the weekend, the G-8 summit at Camp David struggled with the Eurozone debt crisis to little avail. Other than agreeing that the crisis posed a serious threat to the global economy, there seemed to be little agreement on whether to continue the present path of austerity to reduce deficits or to increase deficits in hopes of stimulating economic growth. With the results of recent elections in Greece, France and Germany, the pendulum seems to be swinging towards initiatives to stimulate growth.
The failure of the Greeks to form a coalition government had set up the need for new elections next month. Polls say that anti-austerity forces are likely to increase their strength in a new election leading to the likelihood that Greece will default and leave the Eurozone later this year. Opinions are mixed on just how much damage such an event would do to the EU’s economy and the economies of its trading partners. Some foresee a financial Armageddon that will result in a global depression and sweep away many governments including that of the US, while others believe that a Greek default, although costly to the EU, would be manageable. Other than some reduction in trade with the EU they say the global economy would cope.
For now however, the perceived likelihood of a Greek default and the consequent weak euro continues to be the main factor pushing oil prices lower.
With much of the world joining in, to a greater or lesser degree, with US and EU enhanced sanctions on Tehran, the Iranian economy is starting to suffer badly. Although Iran has been sanctioned in some fashion for the last 30 years, this is the first time the sanctions have really hurt the petro-state with its large oil income. As Iran has no interest in releasing figures on just how badly they are hurting, most of the evidence of serious economic problems is anecdotal. From time to time Tehran makes optimistic pronouncements such as over the weekend when they announced the discovery of 10 billion barrels of oil in the Caspian.
Although high oil prices have been helping counteract the ever tightening oil sanctions, the recent drop in oil prices has hurt Tehran as much as anybody. The Iranians’ economic situation is due to get much worse after July 1st when the EU’s full sanctions kick in.
In contrast with the G-8 indecisiveness over what to do about Europe, there seemed to be a remarkable unanimity concerning the Iranian confrontation. For a group that included Russia and China as well as the major western powers, this may be bad news for Tehran. The meeting agreed that Iran is entitled to peaceful uses of atomic energy, but must be more open regarding activities related to developing nuclear weapons.
Moscow and Beijing now seem willing to accept the West’s program of economic sanctions on Tehran as a fait accompli and realize that a slow tightening of economic pressure on the Iranians is more in line with their interests than unleashing the Israelis which could easily lead to a major conflict.
Although there has been no definitive word as yet, the vibrations coming from working level meetings with the Iranians suggest that progress is being made. On Sunday, the head of the IAEA flew to Tehran for discussions with Iranian officials prior to the resumption of talks between the major powers and Iran in Baghdad on Wednesday. Some see this development as progress as others see it as simply part of the stalling tactics which Tehran has raised to an art.
The West is insisting that Tehran stop enriching beyond 3 percent, ship the 20 percent enriched uranium out of the country and open their nuclear programs to full inspection. The Iranian position is still in flux, but it clearly involves not losing too much face by giving in to outside, particularly Israeli, demands.
For now the West seems to be getting the upper hand. Tehran’s oil exports are sagging, the price of oil is dropping, the banking sanctions are taking a heavy toll, and things are about to get worse for the Iranians. The West’s major concern is that oil prices will increase sharply in the second half of the year as the sanctions come into full force. Whether a combination of slowing world demand, increased Gulf Arab production, and G-8 agreement to release strategic reserves, if needed, will be enough to offset still lower Iranian exports remains to be seen.
Most observers see the negotiations as a long drawn-out process with small confidence-building concessions being made by both sides one step at a time. The West has made it clear, however, that lifting of the sanctions will not happen until Tehran has taken verified steps to assure the IAEA that they are not developing nuclear weapons.
Quote of the week
"So many of us watched this slow train wreck happening and asked: Why are all these smart people running these smart companies consciously producing more gas than the market needs..."
- ASPO-USA Board Member Art Berman, on the CBS Evening News
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)