1. Oil and the Global Economy
NY crude closed out the year quietly at $98.83 a barrel, eight percent higher than where it opened 12 months earlier. For 2011, NY crude averaged $95 a barrel as compared with $79 in 2010 and $62 in 2009. Brent crude averaged $111 for the year, $11 a barrel more than the previous high set in 2008. Last week's excitement came on Tuesday when a senior Iranian official started talking about closing the Straits of Hormuz to all shipping in retaliation for sanctions on Iranian oil. Prices climbed about $2 a barrel for a day or so until traders realized that this threat was likely just more bluster for domestic consumption.

Natural gas prices in NY closed at $2.98 per million BTU, the first time gas has closed below $3 during the winter months in more than a decade. Overproduction of shale gas and mild weather in the northeastern US were behind the decline. At $3 per million most shale gas is unprofitable to produce, but drillers are locked into contracts which require them to keep drilling and either lose leases or violate partnership agreements. Drilling for shale gas in the US has been slowly declining in recent weeks as rigs are moved to the more profitable oil drilling sites. Unless prices rise markedly in the years ahead, many drillers, including Exxon and Chesapeake Energy, are going to suffer large losses on their natural gas projects.

As we enter 2012, the major issues that affected oil prices in 2011 – the potential for a global recession and more upheavals across the Middle East – still seem destined to remain the major issues affecting oil prices. It is hard to find anyone, outside of government spokesmen, who does not believe that the EU will suffer an economic setback, perhaps a major one, in the near future. Optimists say these problems will be muddled through or confined to Europe, but pessimists hold that the slowdown will spread across the globe and will keep a cap on oil prices in the coming months.

Despite endless talk of the recovery that is supposed to be going on in the US, there is little evidence that a turnaround is actually talking place. Last week the EIA reported that US consumption of oil products over the previous four weeks was down 7.8 percent as compared to December 2010. A decline of this magnitude is not indicative of any economic rebound.

The EIA is warning that recently announced plans to shutter three large refineries in Pennsylvania --more than half of the refining capacity in the northeastern US -- is likely to affect the availability and prices of oil products in the region. To make up for the loss, more refined products will have to be imported or transported from refineries on the Gulf coast – adding to the costs and logistical difficulties of keeping adequate supplies in stock.

There is no end in sight to the assorted ongoing confrontations in the Middle East - Syria, Iran, Egypt and Yemen. The Egyptian uprising has already cut off natural gas supplies to Israel, Jordan, and Lebanon; Syrian and Yemeni oil production has been reduced substantially. The western powers are attempting to slow Iran's exports. While Libyan oil exports are returning, it is likely to be some time before pre-uprising levels are attained. A new factor in recent weeks is reports of troubles in Kazakhstan which is currently producing about 1.6 million barrels of crude per day.

In short, the year ahead is shaping up to be a race between faltering economies that will cut demand for oil, and numerous political confrontations that could curtail supplies. In the background is the continued growth of China, India and several other large oil consumers that may be growing more slowly in the future, but are still likely to continue increasing their oil consumption.

2. The Iranian Confrontation
The threat by Iran's Vice President last week to block the Straits of Hormuz in retaliation for EU sanctions against Iranian oil exports reminds us that the confrontation over Tehran's alleged efforts to acquire nuclear weapons is still with us. Despite Moscow's and Beijing's refusal to let the UN impose meaningful sanctions on Iran, the combined economic power of the US and its NATO allies is starting to worry the Iranians.

Over the weekend President Obama signed a bill giving him authority to impose new sanctions on companies doing business with Tehran. The EU has already imposed numerous sanctions and seems ready to slow purchases of Iranian crude in an effort to increase the pressure on Tehran while keeping oil prices under control.

There is some evidence that the increased pressures are paying off. Iran's currency has fallen by 50 percent in relation to the dollar and oil production is starting to slip. Many foreign companies are pulling out of contracts with the Iranians or refusing to write new ones. In short, the Iranian economy is starting to be hurt by the sanctions. The political disarray in Tehran seems to be increasing. The uncertainty following the attack on the British embassy a few weeks back shows that there is much disagreement within Tehran's ruling circles. When you have to lock up your major opposition politicians and keep anti-government demonstrations suppressed by military force, all is not well. On top of all this the situation in Syria continues to deteriorate raising the possibility that Iran will lose one of its best friends in the Middle East and much political influence at the same time.

So far Tehran has responded with threats and predictions that oil prices will climb to $200 a barrel should serious efforts be taken to restrict Iran's exports. Over the weekend the Iranians indicated that they are willing to enter fresh talks on their nuclear program, but Tehran has done this many times before in an effort to buy time and the West will need to see significant concessions by the Iranians before opening another round of talks.

In the meantime the situation seems destined to fester into the indefinite future. Hostilities or blockades are not in anybody's interest especially Iran's which is certain to be hurt the worst in any kind of military confrontation with countries dependent on oil from the Gulf. The more serious threat to global oil supplies would seem to be miscalculation either by the West which results in oil prices increasing more than intended or by some Iranian faction that does something to provoke hostilities.

3. Trouble in Baghdad
The news out of Baghdad last week was not good for those hoping to see a major increase in the production of "cheap" crude from the easy-to-produce Iraqi oil fields in the next few years. Events in Baghdad suggest that the carefully crafted coalition that Washington left behind when it withdrew its remaining combat forces is breaking down rapidly. Last week started with a suicide bomber attack on the Iraqi Interior Ministry, likely in retaliation for the arrest warrant issued by the Shiite Prime Minister against the country's Sunni Vice President who currently is seeking sanctuary in Kurdistan. Last week's bombing followed a series of bombings across the country the previous week.

With the Sunnis and their allies the Kurds no longer participating in the government, the chaos was joined by the Shiite followers of the anti-American cleric Moktada al-Sadr who called for the al-Maliki government to be dissolved and new elections held. New elections would take months to organize and would likely result in the same sort of stalemate that arose after the elections in March 2010 which took nine months to resolve. It is possible that visions of Saudi-class wealth that would come to Iraq should oil production increase by millions of barrels per day could keep age-old animosities in check.

Alternatively, it is possible that the situation could devolve into so much anarchy that it will become impossible to increase oil production.

Quote of the week
"The United States, alone or with Canada, will never produce a sustained volume of 19 million barrels of oil a day."
-- Steve LeVine

The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)

• For three decades, the U.S. government sought to protect American corn farmers and ethanol makers from a feared flood of Brazilian imports by imposing a tariff. But as the contentious tax finally expires at year-end, American farmers' fears of being swamped by sugar-based tropical biofuel seem unfounded. (12/31, #10)
• Brazil's national petroleum agency says it had imposed a new fine on Chevron for allegedly failing to comply with its development plan for the appraisal well that caused a leak last month. (12/31, #11)
• For the first time, the top export of the United States is fuel. Measured in dollars, the nation is on pace this year to ship more gasoline, diesel, and jet fuel than any other single export, according to US Census data going back to 1990. (12/31, #14)
• Authorities in Islamabad said Pakistan, despite U.S. reservations, needs to consider a natural gas pipeline from Iran to cope with energy shortages. (12/29, #12) (12/30, #5)
• Chinese manufacturing activity declined for the second consecutive month in December but showed tentative signs of stabilizing. (12/30, #10)
• A Chinese court accepted a lawsuit that claims that leaks from offshore oil production facilities operated by ConocoPhillips caused $78 million in damages to local fishermen. (12/30, #13)
• California's low-carbon fuel standard was blocked by a federal judge who found that it discriminates against out-of-state corn ethanol and crude oil and violates the Commerce Clause of the U.S. Constitution. (12/30, #14)
• Nebraskan environmental regulators said they outlined a map for pipeline company TransCanada delineating areas the Keystone XL oil pipeline should avoid. (12/30, #15)
• Turkey this week gave a boost to plans by Russia's Gazprom by issuing permits for its South Stream natural gas pipeline to be built under Turkish territorial waters. (12/28, #19) (12/30, #17)
• Four international companies were invited to submit bids for the first liquefied natural gas terminal for Bangladesh. Bangladesh produces around 630 billion cubic feet of natural gas each year. Proven reserves, located in the east of the country, total an estimated 1.4 trillion cubic feet of natural gas. (12/29, #15)
• U.S. prosecutors are preparing what would be the first criminal charges against BP employees stemming from the 2010 Deepwater Horizon accident, which killed 11 workers and caused the worst offshore oil spill in U.S. history. (12/29, #17)
• Gasoline prices may rise above $4 a gallon next summer as refineries along the US East Coast close, reducing fuel supply. (12/28, #15) (12/29, #19)
• Turkey and Azerbaijan signed an agreement for a new "Trans-Anatolian" natural gas pipeline stretching from Turkey's eastern to western borders. (12/28, #20)
• Israel's Energy and Water Ministry has ordered the setting up of a team to deal with a gas shortage in the country which is likely to peak mid-2012. (12/27, #9)
• The worst Nigeria offshore oil spill in more than a decade has been contained before reaching the West African nation's coast, officials with Royal Dutch Shell said. (12/26, #11) (12/27, #10)
• Afghanistan's cabinet cleared the way to sign a contract with China's state-owned oil giant China National Petroleum Corp (CNPC) for the development of oil blocks in the Amu Darya basin. (12/26, #5)