Quote of the Week

"It’s disappointing that American Petroleum Institute continues to look for reasons not to engage in improving safety of oil transported by rail."

–Suzanne Emmerling, spokesperson for the Federal Department of Transportation



1. Oil and the Global Economy

One of the most active weeks for oil futures in recent months began with prices climbing steadily for three days as the US dollar showed weakness after many weeks of climbing against most foreign currencies. Prices then spiked on Thursday as Saudi Arabia began bombing Houthi rebels in Yemen as they advanced southwards towards Aden. Many traders feared that the fighting could threaten oil shipments through the Strait of Bab el Mandeb. By Thursday’s close, NY oil had advanced by 4.5 percent for the day and was close to achieving the biggest weekly gain in more than four years.



On Friday, however, cooler heads prevailed. The markets realized that Thursday’s gains were an overreaction as there was really little threat to oil shipments from the fighting in Yemen; US crude inventories were still growing rapidly; and the pace of the continuing drop in the US rig count was beginning to slow. There also were reports of weakness in the US and Chinese economies and optimistic reports concerning progress in the Iranian nuclear negotiations were coming out of Lausanne. All this was too much for the oil markets which fell 5 percent on Friday afternoon and then extended losses in after hours trading to finish out the week at $48.28 a barrel. Likewise, London oil futures fell 4.7 percent to close at $56.41 after having flirted with $60 a barrel on Thursday. Despite the price collapse on Friday, New York oil still had a good weekly gain, up 4.9 percent, largely on dollar weakness.



The US Commerce Department announced on Thursday that GDP increased at an annual rate of 2.2 percent in the fourth quarter as compared with 5 percent in the third. US corporate profits fell 1.6 percent in the fourth quarter, including an 8.8 percent decline in profits earned outside the US. Part of this decline in GDP comes from reduced government spending as sequestering of federal expenditures takes hold.



The weekly stocks report showed US crude inventories up by 8.2 million barrels which was more than analysts had expected. Crude stocks at Cushing increased by 1.9 million barrels to a record 56.3 million. Talk in the financial press that a shortage of storage capacity could drive oil prices lower seems to be receding. Most outside analysts do not see a shortage of storage capacity as a real possibility as US oil production will soon be dropping and demand increasing as the summer driving season approaches.



The EIA also reported last week that capital expenditures for exploration and oil field development were down 12 percent year over year in the fourth quarter. While this will have little immediate impact on production, it suggests that production will be falling substantially in the years ahead. Some even see these numbers as a harbinger of peak oil.



Natural gas prices fell last week as the winter heating season draws to a close and the possibility of another spike in demand recedes. Prices on Friday closed down 8.2 percent to $2.59 per million BTU’s which is close to the lowest we have seen in recent months. Some analysts fear that a plunge in natural gas prices, similar to the one which took place in the oil markets, is in the offing due to overproduction. Wellhead prices for natural gas have fallen below $1.50 per million due to limited transport for the gas and saturation of local demand. While the natural gas rig count has fallen of late it has only decreased by half as much as rigs drilling for shale oil, suggesting that there are still too many active rigs.



2. The Middle East & North Africa

From the perspective of oil exports, the Middle Eastern situation took a turn for the worse last week when the Saudis responded to the Houthi offensive into southern Yemen by launching air strikes and forming a coalition of like-minded Sunni states to force the Iranian-backed Houthis from power. Thus we seem to have started yet another of those interminable Middle Eastern civil wars to join the four major and numerous minor conflicts that are underway in the region. While Yemen was only a small oil exporter whose 130,000 b/d will not be missed, the further hardening of the lines between Sunnis and Shiites will not be good for the future of the region. The direct involvement in the fighting by the region’s major oil exporter is even more troubling as prolonged Saudi participation in the region’s turmoil is likely to have unhappy consequences for the Kingdom in the years ahead. Saudi oil exports become an obvious target for numerous malcontents waging Jihad in the region.



Yemen : Heavy fighting continued in Aden over the weekend as an Arab summit declared that the military intervention would continue until the Houthis were vanquished. The military intervention is being seen by many as a “proxy war” to constrain further Iranian involvement and influence in the Arab world. Tehran is already playing a major role Syria, Iraq, Lebanon, Palestine and Gaza, so Yemen just adds another conflict to the list that Iran must support. The impromptu alliance between Tehran/Baghdad and Washington to drive ISIL from Tikrit is leading to concern amongst the Sunni Arab countries about the US commitment to their defense against Iran, further complicating the Middle Eastern mess.



Iran : The nuclear talks continued over the weekend with the two sides still apart on what it take to ensure that it would take at least a year for Tehran to build a bomb and how soon the sanctions would be lifted following an agreement. The latter is the issue dear to the Iranians’ heart as they are currently involved in several expensive proxy wars at a time when their oil revenues are at a nadir. Both sides are expressing some optimism that an agreement will be found in the next few days or at least enough progress can be made to justify an extension.



The closer we get to an agreement the more Israelis and their friends in the US howl that a terrible agreement is being negotiated that will only lead to a nuclear armed Iran or military conflict. Some note that a traditional Iranian negotiating tactic is to wait until the last possible minute before making concessions — so the next few days may be important.



Concerns are rising that Tehran may be facing a leadership crisis soon which could derail any agreement that is reached this year. While the Iranians still elect a President in a more or less democratic manner, the Supreme Leader, an Ayatollah, is selected through a power struggle among the various factions close to the center of power in Tehran. Given the poor state of Iran’s economy, the numerous military conflicts that the country is involved with across the region, and its confrontation with the US and much of the West – the selection of a new Supreme Leader could become contentious with numerous possible outcomes.



Some observers are concerned that Iran could flood the markets with up to 37 million barrels of oil they could have in floating storage. Others discount this idea and hold that it will take several months to Tehran to ramp up oil production that has been shut-in for the last two years.



Iraq/Syria : North of Baghdad, the battle to recapture Tikrit continues, with US airpower now being employed to help the government’s ground forces, largely Shiite militia, drive ISIL from the town. In a new wrinkle to this bizarre situation, some Shiite militias are threatening to go home as they do not like US involvement in what they regard as their holy war despite the benefits that US airpower brings to their position. In Syria, anti-government Islamist forces, but not those of ISIL, which is busy keeping out of the way of coalition air strikes, overran the key city of Idlib on the highway between Damascus and Aleppo. This development could prove to be a major setback for the government in its long-running struggle to maintain power with Iranian and Russian help.



In Iraq, the Kurds received a second payment from Baghdad, this time of $408 million, as part of the new agreement to share oil revenues between the government and Erbil. As the fighting continues and more and more Iraqis become refugees, talk of a three-way partition as the only possible solution is on the rise. A key issue in coming weeks is how the Tehran-sponsored Shiite militias treat the Sunni civilians they overrun in recaptured towns. So far the record is not good and more atrocities would likely lead to a fight-to-the-death mentality that would last for many years.



Libya : The three-way fight amongst the Tripoli government, the Tobruk government and the Islamic state continues with the two governments occasionally diverting forces to fight against the Islamic state insurgents as needed. The UN passed resolutions calling for a ceasefire and a partial lifting of the arms embargo to help fight the Islamic State which is thought to be getting help from the outside. Italy has deployed naval forces along the Libyan coast to protect shipping and oil platforms; to deter the Islamic state from attacks on Italy; and to slow the flood of refugee boats arriving on Italian shores from Libya.



There was little news on Libyan oil production last week. It probably remains in the vicinity of 300,000 b/d. Efforts by the recognized government in Tobruk to divert the oil revenues from Tripoli to banks in eastern Libya will likely fail as the Libyan Oil Company which manages the money will not cooperate.