1. Oil and the Global Economy



It was another week in which ever-growing US crude stockpiles balanced off an ever-deteriorating Ukrainian situation. Crude prices fell gradually for most of the week on generally bad economic news and expectations of another inventory increase. On Thursday NY futures touched a five-week low. The markets reversed on Friday as fighting intensified in eastern Ukraine and somewhat better US employment numbers sent prices higher. New York futures closed at $99.76 and in London, which is more vulnerable to the Ukrainian situation, at $108.59. The premium for Brent over WTI crude increased on Friday to $8.83 a barrel.



The US crude inventory is now just shy of 400 million barrels which is the highest since 1931, according to data going back to 1920. With so much oil around, the Department of Energy decided to establish a million gallon stockpile of gasoline in New York and New England and eventually in other locations in case hurricanes disrupt supplies. The EIA noted that US crude imports the week before last were down by 313,000 b/d from the 7.7 million b/d that was averaged during the preceding month. As nobody wants to slow production of the cheaper US crude production, short of a jump in domestic consumption and product exports, lower imports will be necessary in coming months.



The EIA reported an 8,000 b/d drop in US crude production the week before last. Some analysts are suspicious that the Administration has simply been estimating a steady increase in domestic oil production week after week rather than reporting actual production figures obtained from the states. Increases in US shale oil and gas production were disrupted by the harsh winter and it may take a while before we get a complete picture of US production so far this year.



With the possible exception of the new fields being developed in Iraq, the cost of drilling for oil has been climbing rapidly in recent years leading many companies to cut budgets for exploration. The prime example of this is the Kashagan project in Kazakhstan where a consortium of western companies has invested some $50 billion with almost zero oil production. Last week it was announced that the project will be delayed for another two years while 200 km of pipeline is replaced — adding considerably to the costs of the project.



It is generally recognized that the pace of global oil production in the last ten years has been maintained by the phenomenal growth in US shale/tight oil production. While some expect this growth to continue until the end of the decade, many analysts are expecting that US shale oil production will stop growing significantly in two-three years. The US has made little progress in increasing deepwater offshore production in recent years and given the cutbacks in major oil company spending, this can be expected to start declining in the next few years.



The EIA reports that due to better weather the US was able to stockpile 82 billion cubic feet of natural gas the week before last which is 30 percent more than normal for the week. Natural gas prices now are down some 20 cents per million BTU’s from the highs seen at the beginning of last week. The Director of the EIA recently told the National Gas Roundtable that predicting natural gas inventories is becoming more difficult due to aberrant weather and what the EIA says are recent improvements in hydraulic fracturing that are enabling the industry to produce more gas with fewer rigs. Although the winter heating season is over, parts of the country are already being subjected to higher than normal temperatures which also increase gas consumption.

2. The Middle East & North Africa



Iran : Most of the news from Tehran last week was linked to the Ukrainian crisis and Moscow’s efforts to undercut the Western sanctions on Iran by establishing its own bi-lateral energy deals. At the top of the list is a $10 billion deal under which Russia would help Iran upgrade its electrical system and possibly even supply power directly to the Iranian grid. Iran’s state media are reporting that a possible food for oil swap could be in the works. Russia, which produces about 10 million b/d and exports about 7.5 million, could easily bypass the complex currency sanctions by simply bartering food for oil, which would make life for Tehran somewhat more bearable under the sanctions.



China seems to be over-reaching in its unending quest for oil anywhere it can find it. Last week the Iranians cancelled a $2.5 billion contract with the China’s National Petroleum Corp to develop the South Azadegan oil field. Tehran says that Beijing is using the international sanctions as an excuse for not pressing ahead with development of the field. After many warnings Tehran pulled the plug on the contract which was signed four years ago saying there had been no significant progress.



Iraq : Although the parliamentary elections are over, it is likely to be many weeks or perhaps months before a post-election government is in place. Most observers expect there will be little change in the status quo and believe that the country is collapsing around the al-Maliki government. Iraq’s armed forces clearly cannot cope with the growing strength of the Sunni insurgency in Anbar province, which already has a hold on much of the country’s water supply. While Election Day was relatively peaceful, only 14 killed due to bans on vehicular traffic and increased security, bombings and killings continue across much of the country.



Maneuvering to form a new government in Baghdad may have resulted in a deal which lets the Kurds begin exporting their oil directly to Turkey at the rate of 100,000 b/d with the central government’s blessing. It is unclear as how much cut of the exports Baghdad will get but al Maliki may need the Kurds’ help in forming a coalition.



The increased fighting in Anbar province is forcing many local residents to flee to Kurdistan which is the only relatively safe place for Iraqi Sunnis to flee these days. It won’t be long before the presence of large numbers of Arab Iraqis in Kurdistan sets off another round of problems. It is hard to see how Iraq can hold together and keep increasing its oil exports much longer.



Libya : The second of two smaller oil ports with a combined capacity of 140,000 b/d is supposed to open this week. The opening of this second oil port, however, will add little to the country’s oil production which was 1.4 million b/d before the troubles began last summer and recently has been in the neighborhood of 250,000 b/d or less. Libyan tribesmen have ended the blockade of the 340,000 b/d El Sharara oil field in the east, but a separate protest group is still blocking the pipeline to the coast.



Turmoil continues in the country. Efforts by the General Assembly to elect a new prime minister have been blocked twice by militiamen who stormed the Assembly hall during the voting. Another prime minister was “elected” over the weekend, but there is much confusion as to whether the vote was valid. Meanwhile, the missing 1.2 million b/d of Libyan oil production is still adding a premium to world oil prices.



Egypt : Warnings are increasing about the perilous state of the Egyptian economy and particularly the deteriorating energy situation. BG, the British company which is one of the largest natural gas producers in Egypt, warned that its business there is about to collapse. Cairo owes BG $1.4 billion and the energy industry as a whole $5.4 billion in back payments. In the first quarter, the government took all the natural gas that BG produced to make electricity so that the company could not export a single shipment of LNG from which it derives its revenue. Cairo has been surviving in recent months on payments from the Gulf Arab states that are delighted with the suppression of the Muslim Brotherhood in Egypt but may be tired of the expense. Most analysts expect this support to continue indefinitely, but some are starting to warn that simply sending money and some oil may not be enough.



BG says that its production in the first quarter was down 30 percent from the previous one. Electricity shortages are already starting to appear and extensive blackouts are expected during the hot summer months. The government’s currency reserves are currently holding at about $17 billion, but a devastating devaluation would occur if it actually paid its energy and food import bills. Tourist revenues are down two-thirds since 2010 and are now only about $5 billion a year. Without gas exports and tourists, the government is reliant on Suez Canal tolls which are insufficient to support its need for oil and food imports and subsidies.



A low level insurgency is already going on in the Sinai and the occasional terrorist bomb going off in Cairo. While the impact of all this on oil and gas exports from the region is minimal, a collapse into turmoil of the area’s largest country would likely have serious percussions across the Arab world.



3. Ukraine



The fighting and the body count increased across eastern and southern Ukraine last week as government forces moved to recapture key buildings that had been seized by pro-Russian militants. The rhetoric coming out of Moscow has been increasing as Russian-speaking Ukrainians started to be killed by government forces. In Odessa some 40 pro-Russian protestors died in a fire after the building in which they had taken shelter caught on fire. Moscow continues to threaten that it will intervene with the large forces it has built up along the border to protect Russian-speaking Ukrainians, but so far there has been no movement.



The threats and counter threats related to this situation have rattled the energy markets and have supported oil prices – particularly in Europe. Although the EU has been very cautious not to harm its economic relations with Moscow in imposing sanctions, the situation is becoming increasingly dangerous.



4. China



After extensive research the World Bank has concluded that China is already the world’s largest economy as money goes further in poorer economies than previously thought. Most economists had thought this seminal event in world history was still five to ten years away. When Beijing found out the World Bank report, it did its best to stop its publication and still maintains the conclusion that China is the world’s largest economy is based on faulty analysis. By surpassing the US in economic power, China takes on the responsibility of being the country which should hand out the most foreign aid and make the biggest contribution in international endeavors – something it would rather leave to the US.

A new survey shows that Chinese industrial production increased marginally in April, but exports orders fell sharply. This news continues the concerns about whether Beijing will meet its growth target of 7.5 percent for 2014. The occasional concern still surfaces that China’s housing bubble is about to collapse.



Concerns are also increasing about just where China’s efforts to improve its dangerous air quality are leading us. Beijing’s chief concern is naturally to get rid of the particulate matter in the air of major cities and the government really cares very little as yet about the carbon emissions thought to be responsible for global warming. Beijing still maintains that it has a right to be as rich per capita as anybody else before it worries about carbon emissions. China is pumping some 10 gigatons of CO 2 into the air each year, about a third of the world total and more than the US and EU put together.



While China is making good progress in at least slowing the pace of its increasing air pollution — some 60 percent of the 94 gigawatts of new generating capacity installed last year was renewable – the country is still expected to install 248 gigawatts of new coal-fired generators in the next six years. This is equivalent to three new coal-fired generating stations a month. Clean air is not going to come soon if coal consumption continues to increase.



Of more concern to the world however, is Beijing’s decision to undertake a massive program of converting low grade coal into methane which can be burned with almost no particulate emissions in cities. The downside to this process of converting coal to gas is that it results in 82 percent more carbon emissions going into the atmosphere than if the coal were simply burned to produce power. So far 18 new coal-to-gas conversion plants have been approved for construction which is likely to increase China’s carbon emissions by seven percent when they come into operation.

5. Quote of the Week

“Deepwater spending has had growth at a 12 percent+ compounded rate over the past five years and has been the best and most secular growth sector in oilfield services. But while spending has increased, production hasn’t, and today, we think that deepwater is now the second-highest marginal costs per barrel of oil produced behind Canadian oil sands. So the oil companies have decided what to do: they are going to focus on growing returns rather than production.”

— James Wicklund, Credit Suisse LLC, managing director of energy research



6. The Briefs