1. Oil and the Global Economy



A new era in global oil production began on Thursday when the Saudis and allied oil producers announced that, in effect, they would not be the swing oil producer and would allow prices to follow the dictates of global supply and demand. As had been widely predicted, the announcement brought about a major plunge in oil prices exceeding even the gloomy forecasts that had been around before the announcement. At Friday’s close, New York oil futures were down to $66.15, the lowest settlement since September 2009, and London was down to $70.15, the lowest since May of 2010.



Most observers expect that prices will continue to fall as increases in shale oil and Gulf of Mexico production continues from wells that will open next year, and demand remains weak. By the second half of 2015, however, production is expected to decline as capital spending slows in response to lower prices. Many are interpreting the Saudi decision as a direct challenge to US shale oil producers that have been eating into Saudi markets in recent years. Perhaps the Saudis came to believe the shale industry hype that shale oil production will continue to grow and grow for the foreseeable future and that US production will climb by additional millions of barrels per day. There are, of course, many who doubt that this will be the case and some who already see signs that that the growth of US shale oil production has started to slow.



The financial press is awash with dire predictions of what could happen to oil prices in the coming year. Some are saying that prices will not stabilize until they reach $60 a barrel; however, considering that New York futures have declined from $93 to $64 in the last two months, this does not seem like a particularly bold forecast. A more pessimistic outlook comes from Tom Kloza, founder of the Oil Price Information Service, who says we could see $35 oil next year unless there are substantial production cuts. Kloza believes the problem will come when there is no place to store excess crude production which some are saying could be as high as one or two million barrels per day.



The impact of the sudden drop in oil prices is the subject of endless commentary. All agree that the consumers in oil consuming countries such as the US, Japan, and Europe are going to do better for now, while the oil producers and exporters are going to be hurting – several of them, such as Venezuela, Iran, and Russia, really hurting. Refiners with large stocks of expensive crude in inventory will have profitability problems as they will have to sell their oil products at a loss. Russia’s ruble fell to a new lows last week and the currencies of several major exporters such as Canada and Mexico are already suffering. On the good news side, forecasters expect US gasoline prices to fall another 30 cents per gallon to $2.50 per gallon shortly with pump prices below $2 in a few of the low-price states.



The future of the US shale oil industry, however, is coming into question. The Vice President of Russia’s OAO Lukoil made headlines by saying that uneconomic prices will reduce US shale oil production so much in 2015 that oil prices will recover in the following year. So far prices have fallen so rapidly that there has been little time for the shale oil industry to react to prices that in some cases are well below production costs. The industry’s problem is that it must continue to borrow large amounts of money to keep drilling and that Wall Street is bound to become more skeptical as prices fall.



Shale industry apologists continue to proclaim loudly that US shale oil production remains economically viable. IHS Energy consultants put out a report last week saying that most shale oil plays are still economic and that 80 percent of planned drilling can still take place with oil at $70 a barrel. There are already scattered reports of cutbacks in drilling, but the situation is moving quickly. Obviously, if oil falls to $60 or lower and stays there for some months, the shale oil industry is in trouble.



US natural gas prices had a wild ride last week bouncing around between a high of $4.66 per million and a close of $4.08. By week’s end a combination of not particularly cold weather and ever-increasing natural gas production won out, sending prices lower.



2. The Middle East & North Africa



Iraq : The OPEC decision and subsequent drop in oil prices will in the long run hurt Iraq’s oil industry wiping out most of the economic gains Baghdad was hoping to make from increased production. After the decision was announced, Iraq’s Oil Minister termed it “terrible.” According to the IMF, oil prices are now 29 percent below what Baghdad needs to balance its budget.



In the wake of their forced withdrawal from positions surrounding Iraq’s Baiji refinery two weeks ago, ISIL forces destroyed the pipeline which used to bring crude to the refinery from the northern oil fields currently occupied by the Kurds. This action makes the refinery useless until a means of supplying it with crude can be found.



ISIL bombs continue to go off in Baghdad while US and allied aircraft continue to bomb selected ISIL targets across Iraq and Syria. Refugees continue to leave both countries with Palestine being the latest place for sanctuary. If any conclusion can be drawn, it is that the whole region continues to sink into ever-increasing anarchy which will eventually impact oil exports.



Libya : The situation is just as bad in Libya, where the country is slowly destroying itself. With two governments – the Islamists in Tripoli and the internationally recognized government in Tobruk – vying for power and the oil revenues, it is nearly impossible to know what is going on. The Tobruk government which showed up at the OPEC meeting (the Tripoli government said it could not get an invitation or visas) says that oil production is currently around 700,000 b/d. This number is duly accepted by the financial press. If large quantities of crude are actually making it out of the country, it is not being reported in any detail – perhaps to avoid provoking the Islamists in Tripoli.



This control situation came to a head last week when the government in Tobruk appointed a new oil minister to replace the one that seems to have been recognized by both sides. As the Tobruk government is 1000 km away from the oil company’s headquarters in Tripoli, which currently occupied by Islamist militias, this appointment is clearly impossible to enforce. International oil traders are faced with the dilemma of which government they should be dealing with. Many expect a separate “Eastern Oil Company” will be formed soon to sell the oil controlled by the Tobruk government. In the meantime, rogue general Haftar, who is loyal to Tobruk, says he will drive the Islamists from Tripoli after he is through with them in Benghazi which has been the scene of heavy fighting in the last few weeks. The Turks, who have large economic interests in Libya, are trying to mediate the situation.



Iran : To maintain OPEC solidarity, Tehran refrained from protesting the OPEC decision to maintain production levels last week, despite the fact that they were among the hardest hit members. Although private discussion within OPEC focused on driving US shale oil producers out of business, many believed that the Saudis were just as interested in hurting Iran, their arch-rivals in the Muslim world. Where Iranian oil exports go from here is hard to say. With western sanctions cutting oil exports and falling oil prices, Tehran’s revenues are sinking rapidly.



Iran has attempted to compensate by finding new outlets for their natural gas. Tehran says the new natural gas pipeline to Iraq is nearly operational, but with ISIL still active in the area, it is doubtful that reliable natural gas exports to Iraq will be established in the near future. Likewise, Pakistan has withdrawn from its piece of the new natural gas pipeline from Iran, saying it cannot afford the construction costs.



The seven-month extension of the nuclear talks until next July has many observers saying that nothing will ever come of them. Iran has had many years and many opportunities to come to a reasonable agreement, but so far the factions in their government that value national prestige and their own self image as a powerful bulwark against the West and Israel have won out. The new Congress in Washington is likely to pass another round of feel-good sanctions on Tehran which will further complicate the chances of reaching an agreement in the coming year.



For the immediate future, Iran’s only prospects are the pending barter deal with Moscow. Under this deal the Russians would take Iranian oil to sell as their own in exchange for something of value for Tehran such as new nuclear power plants. Given the expectations that there will be millions of barrels of unsold oil sloshing around in the world market next year, all this is a very dubious proposition.



3. China



Newly released data shows that Beijing is taking advantage of low oil prices to fill its strategic reserve at double the planned pace. China now has a 30-day reserve to cover its crude import requirements should they be cut to zero. Imports from Iran in October were up 36 percent to 340,000 b/d over October 2013. No doubt Iran gave the Chinese a very good price.



China’s economy is still struggling as housing values came down again in November. Reuters reports the Central Bank is preparing for a second interest rate cut. As, however, a major importer of crude, China’s economy should be benefitting from lower oil prices much as the US economy is being helped.



Deadly smog returned to eastern China last week with the US Embassy’s pollution detector in Beijing reporting “hazardous” air conditions. Concerns are rising about Beijing’s plans to build many massive facilities in western China to covert coal into gas and then pipe the gas to eastern cities. While this plan would lower the particulate matter in city air, it is believe that the process would emit far more carbon to the atmosphere than by simply burning the coal.



4. Russia/Ukraine



Most of the news last week concerned the perilous state of Russia’s economy and its poor prospects for the coming year. The combination of Western sanctions over the Ukrainian situation and plummeting oil prices have set in motion a train of events that many economists believe will lead to a serious recession next year.

Russia’s economy minister says Moscow is preparing for the coming drop in oil prices. The irony is that as the ruble falls against the dollar, the government is ending up with increasing ruble income to compensate for delcline in oil prices The government gets about 50 percent of its annual revenues from oil and gas sales. Moscow was initially expecting to receive about $100 a barrel for its crude in 2015, but is now budgeting for $80 and keeping in mind the possibility that prices may go even lower.



Russian largest energy company, OAO Rosneft, owes about $60 billion to foreign banks and bondholders after spending $55 billion to buy its competitor TNK-BP in 2013. Since the Ukrainian incursions and beginning of sanctions, its financial difficulties have been increasing. It has already applied for government assistance to pay off some $30 billion in foreign debt coming due next year. While the company may be able to scrape by with oil selling at $70-75 a barrel, some believe there will be almost nothing left to finance expensive new drilling ventures without which Russia’s oil production is likely to fall in the next five years. Despite the troubles, Russia’s Energy Minister Alexandrov says Moscow is planning to maintain production at about 10.5 million b/d next year.



5. Quote of the Week

[During a week when OPEC’s meeting and falling oil prices dominated world energy news, here’s an energy note that flew under the radar screen.]

“On November 20, 2014, ten bids for the 100 megawatt PV IPP tender issued by Dubai’s state utility DEWA were opened. Saudi Arabia’s Acwa Power bid an unprecedented 5.98 USD cents/kWh, with a consortium of Spain’s Fotowatio Renewables and Saudi Arabia’s ALJ Energy coming a close second with 6.13 cents/kWh. The low tariffs, bid in a fully commercial, unsubsidized setting, disprove persisting misconceptions in the region about the allegedly high cost of PV and should provide a boost to other governmental procurement programs in the Gulf, in particular, in Saudi Arabia.

Dr. Moritz Borgmann, partner, Apricum – The Cleantech Advisory



6. The Briefs