1. Oil and the Global Economy
After holding steady on Monday and Tuesday last week, oil prices plunged for three days on a plethora of bad economic news. By week's end, oil prices were down by some $9 a barrel from the Tuesday highs with London closing the week at $98.43 -- the lowest closing since January 2011. The drop was precipitated by a perfect storm of weak US employment numbers, slumping manufacturing in the EU and China, growing US crude inventories and weak demand nearly everywhere.
The burgeoning EU debt crisis with more bad news from Spain, Italy, and Greece did not help the situation. Even recalcitrance on the part of Tehran regarding their nuclear programs, making the outlook for a negotiated settlement more remote, was not enough to support prices. The general thinking now seems to be that if the sanctions go into full force on July 1 and a million b/d or so of exports are taken off the market, a combination of falling demand and increased OPEC production will be enough to offset the lost Iranian oil without major price increases.
US gasoline futures slumped along with oil. From a high of circa $3.50 a gallon in March, gasoline futures closed at $2.65 on Friday. US retail gasoline prices continue to fall slowly, currently averaging $3.59 a gallon and still have another 30 cents or so to fall in order to catch up with falling futures prices. West coast prices remain stubbornly high, in the vicinity of $4.25 a gallon, due to refining problems.
US natural gas prices, which had made it all the way from $2 per million BTUs in April to nearly $2.85 in mid-May, fell steadily last week to close at $2.32. Forecasts of milder weather and the likelihood that there will be lower demand from utilities as falling coal prices once again became competitive with natural gas were behind the drop.
The Iranians said last week that they will continue to stockpile highly enriched uranium and are refusing access to the suspect Parchin nuclear site. At this point it does not look as if much will happen at the next round of negotiations with Iran in Moscow on June 18th, and that the EU sanctions will go into effect on July 1st. The Iranian nuclear negotiations also are becoming ensnared with the deteriorating Syrian situation, with Moscow, Tehran, and to a lessor extent Beijing still supporting the Assad government. With the death toll rising and the fighting spreading into Lebanon, pressures for outside military intervention continue to grow.
With every passing week, the chances of widespread hostilities, with serious implications for Middle Eastern oil exports, seem to grow.
Despite lower oil prices and growing stockpiles, reports of retail gasoline and diesel shortages continue. Last week they came in from India, Egypt, and Nigeria. Most of these shortages are due to inability to pay for the oil products or other local problems rather than short supplies. In Nigeria, the problem now is money for subsidies. As nearly all retail oil products must be imported and sell for well below world prices, the state subsidy fund, which is out of money, is key to keeping imports flowing. In Egypt, the problem seems to be letters of credit, which have become difficult to get amidst the political and economic turmoil.
Looking ahead, Colorado State University researchers increased their forecast for Atlantic Storms last week based on the lack of signs that an El Nino is forming in the Pacific. If the El Nino does form, it usually generates winds that tear apart hurricanes before they get too big. Some forecasters are still looking for a mild hurricane season in the Caribbean this year.
2. The EU Crisis
It is starting to look as if the course of the EU's debt crisis will be the major event of 2012. Last week there was hardly any good news anywhere. It now is looking more likely that either the Eurozone will break up or that the Europeans will get together and form some sort of highly unpalatable fiscal union that will allow Brussels a say in sovereign monetary policies. These outcomes could have major implications for the global economy and the demand for oil in the months ahead.
There is little time left. The next Greek election which is coming up on June 17th, seems likely to lead to more turmoil and possibly a disorderly Greek exit from the Eurozone. Last week the Spanish banking crisis deepened further with a bailout clearly called for. The problem is that Spain's economy is so large that existing bailout funds are not adequate to the task.
In the last four years nearly every major freely-elected government, but the one in Germany, has been tossed from power as voters searched in vain for someone who could solve the endemic economic problems and return to economic growth. Now even the German government seems to be having problems and could be defeated in the next election.
The IEA continues to forecast that the global demand for oil will increase by some 900,000 b/d this year, based largely on the expectation that Asia will continue to grow and that the OECD's oil consumption will remain level. Such forecasts are beginning to look uncertain as economic growth in India and China is slowing. While the EU's oil consumption is still holding fast, reports of increasing unemployment and lower manufacturing suggest that demand will be falling in the months ahead. It is difficult to imagine any way out of what looks like a very difficult period ahead with slowing economies, perhaps worldwide, and lower demand for oil.
3. Falling prices
In 2008, when oil prices plunged from $140 to $34 per barrel, a number of reactions took place. The swift drop in prices was a major economic stimulus that quickly put cash into the pockets of many consumers thereby preventing the crisis form getting worse. Another major effect was a widespread reduction in new commitments for oil exploration and drilling as the returns from selling crude quickly fell well below costs of production.
We now have oil trading at $83 in NY and $98 in London with many observers predicting that nothing, short of war in the Middle East, will prevent prices from going lower. There is no question that lower gasoline prices will help reduce pressures on consumers, but there is a question as to what will happen to production should prices continue to fall this summer.
There were two major developments during the past four years that have a bearing on this question. The first was Arab Spring and the second the growth in production of very high cost "tight" oil from shale beds and from deep beneath the sea. In some cases falling oil prices are already approaching what is believed to be the cost of production.
The question may come first with the high-cost drilling that is going on in the US's Bakken and Eagle Ford shales. Drilling and fracking these wells is now running above $10 million each and the depletion rate is so fast that replacements must be drilled every year or two if production is to be maintained. If oil prices rebound quickly as they did four years ago, it will make little difference; however, if it looks like a prolonged period of lower prices ahead, drilling in tight shales may start to slow as it has done for natural gas.
Deep sea drilling is another proposition. As it takes years to build the platforms and drill the wells, there are unlikely to be cutbacks unless the economic situation deteriorates so much that capital becomes hard to get.
Another interesting question is just what OPEC, meaning the Saudis, will do if prices fall much below their announced goal of maintaining oil circa $100 a barrel as the ideal price. It is generally thought that most oil producers require on the order of $75-105 a barrel to make their annual budgets. In 2008 OPEC reacted to the price decline at the $65 dollar level, cutting production sharply and driving prices higher again. Last week the Saudi Finance Minister said that his country would probably react if oil were to drop below $80 a barrel, which is a good bit higher than four years ago and only some $18 below current levels. Considering that Brent has dropped some $18 in the past month and that speculative overshoots work on the downside as well, OPEC production cuts are a possibility before the summer is out.
Quote of the week
"To ensure mission sustainability when supplies are not assured, the Defense Department should incorporate an additional pillar into its operational energy security strategy ¡X that of energy resilience."
- David Kerner and Scott Thomas
The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)