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Tom Whipple, Editor

1.  Oil and the Global Economy
2.  The Middle East & North Africa
3.  China
4. Ukraine
5.  The Briefs

1.  Oil and the Global Economy

Despite the volatility engendered by the Islamic State’s move against Kurdistan and the US’s reentry into active participation in Iraq’s civil war, oil prices were little changed for the week with New York futures closing at $97.65 a barrel and London at $105.02. For now the markets seem to believe that US airpower will keep the IS out of Kurdistan’s and Iraq’s southern oilfields so that oil production will remain stable or even grow. Likewise, the markets seem to believe that current oil and gas sales are exempt from any sanctions resulting from whatever Moscow does in response to Ukraine’s successes against the separatists. The markets continue to move in response to normal supply and demand developments with a wary eye to the risks that may stem from the political chaos.

The global supply and demand picture is mixed with OPEC reporting that production in July was at the highest level in five months; however much of this was due to a jump in Libyan production which is a murky story at best.  Chinese imports were up by 2 percent from June to July, but still 9 percent lower than last July. Last week’s US stocks report provided little guidance to the markets as changes were in line with recent trends and seasonal expectations.

US natural gas prices continued to climb slowly last week as forecasters are back to talking about warmer weather for the rest of August.  Prices are up at 10 cents per million BTU’s in the last ten days, closing Friday at $3.97.

Perhaps the key question for the future of world oil supplies and prices is just how long before US shale oilproduction peaks and starts what will likely be a rapid decline. As the financial press and even government agencies have to been loath to address this issue except in optimistic terms, outside analysts using different techniques have been providing estimates as to how long what is termed the “shale oil bubble” will last. The most pessimistic of these estimates have been running around 2016-2017 giving the shale or light tight oil industry another two or three years to grow. The government has production growing for most of this decade but then declining only gradually

Last week a new study based on Hubbert linearization was released. This study crunched the last seven years of US tight oil production and concluded that the US shale industry will ultimately produce a total of 7.7 billion barrels of oil with peak production reaching 3.9 million b/d in mid-2015. If these projections turn out to be reasonably correct, then US tight oil production could be down to circa 1 million b/d by the end of the decade which is considerably less than the EIA and the financial press has been projecting. Although some quarrel with the numbers in the new study, the general idea that we should be seeing significant declines in US production within the next three years is the same.

2.  The Middle East & North Africa

Iraq:  After weeks of stalemate, the Iraqi military situation flared last week when Islamic State forces and their Sunni allies went on the offensive capturing numerous towns and coming to within 20 miles of Erbil, the capital of Kurdistan. Armed with heavy military equipment captured during the June rout of the Iraqi army, the IS forces — which are now more of an army than an insurgency — easily drove back the Kurd’s Peshmerga militia. The combination of the threat to US diplomats and military personnel and numerous expatriates in Erbil and the IS’s policy of killing or driving into the desert tens of thousands of minorities that do not adhere to their version of Islam was too much for Washington.  President Obama overcame his reluctance to get involved and ordered the dropping of humanitarian aid to refugees and air strikes on IS forces threatening Erbil.  The President indicated that these threats will continue as long as the IS threat to the Kurds, Baghdad, and innocent refugees continues. In addition to capturing many small towns in northern Iraq, the IS captured two small oilfields and the Mosel dam which supplies electricity to Mosel and much of the north and controls  much of the water flowing into southern Iraq.

As we have seen in numerous Middle Eastern wars, local armies and insurgent forces can hold their own when taking cover in towns and dispersing themselves among the civil population but are highly vulnerable to current military technology when they attempt to move in vehicles across flat open deserts or take up fixed military positions outside of towns. If current US policy that US ground forces will not be involved continues, and that only US air power will be used, the IS offensive is unlikely to make much more progress into Kurdistan or towards Baghdad and the southern Iraqi oilfield.

Last week several oil companies drilling in Kurdistan announced that their expatriates were being evacuated which will likely slow progress on increasing oil exports. Given the tens of thousands that are seeking refuge in Kurdistan the country and its economy are likely to be seriously disrupted no matter how much foreign assistance they receive.

Over the longer term much depends on what sort of political settlement can be worked out with Baghdad and whether the Sunnis that are supporting the IS can be brought back into a coalition government. There is no reason for complacency about Iraqi oil exports even with the return of US air power. While the IS can no longer move as freely or support large forces in the field, they are masters of terrorism and suicide bombings. A campaign against foreigners working in the southern and Kurdish oilfields would quickly result in a mass exodus of foreign workers and a reduction in exports. This story has a long way to go and will continue to represent a major threat to the globaloil supply.

Libya:  The situation deteriorated further last week with heavy fighting continuing in Tripoli. Most foreign embassies have withdrawn to Tunisia as have most NGOs, exacerbating the humanitarian crisis. As much of the country’s medical staff were expatriates, there is a growing shortage of medical services and almost everything else.

The new parliament continues to meet in Tobruk near the Egyptian border but seems to have little influence on what is happening as various militias, tribes and religious groups fight it out. The latest concern is for the Egyptian border which is nearly unguarded now. There are calls in Cairo to send army units to the border before the whole Islamist/secular mess ends up in the Nile valley.

OPEC and the financial press keep saying that oil production in Libya is up to 450,000 b/d leaving about 200,000 b/d to be exported. Although a tanker or two may have been loaded last week, there is no indication that significant exports are about to resume.  The more likely scenario is that, except for the offshore fields, production will fall as storage tanks fill and the turmoil grows.

Iran:  Given the turmoil in Iraq, Gaza and Ukraine, Tehran is not getting much attention these days; however, the country is much involved in nearly all the turmoil going on, and its own nuclear power confrontation with the West. The nuclear talks resumed in Geneva last week after having failed to reach an agreement prior to last month’s deadline.

Last week Tehran and Moscow signed a five-year, $20 billion oil marketing agreement. Under the agreement, Moscow would receive 500,000 b/d of Iranian oil in exchange for Russian equipment and goods – thereby undercutting the Western sanctions on Tehran. The US says such a deal would be inconsistent with the interim treaty with Iran.  The agreement would also bypass the dollar-based western monetary system which is a goal Moscow and Tehran have sought for some time. In addition the deal strengthens Tehran’s position in the nuclear negotiations.

Should a nuclear agreement be reached and the sanctions lifted. Iran would be in a good position to begin exporting large quantities of oil to the EU. In addition, within a decade, it could start supplying large quantities of natural gas to the EU, undercutting Moscow’s sales.

4. Russia/Ukraine

The Ukrainian army continued to push forward against the remaining cities held by separatist forces last week. Donetsk now appears to be surrounded by the Ukrainian army. The humanitarian crisis is growing with some 300,000 forced from their homes in Donetsk alone. Moscow keeps offering to send humanitarian assistance, but Kyiv and the West objects, fearing any Russian intervention would be a cover for a military invasion in support of the separatists.

The exchange of sanctions between Russia and the West continues with Moscow banning imports of food from the US and EU and several other western countries. Most think this ban will hurt Russia worse than the US or EU as Moscow is dependent on imports for many popular consumer foods which will undoubtedly increase in price.  Threats of more serious sanctions are starting to arise, however. Ukraine warned that it might cut Russian oil and gas flows across its territory and ban Russian aircraft from its airspace. Ukraine has not received Russian gas since June 16th when it was cut off during a payment dispute.

Moscow is talking about banning EU and US flights through its airspace, a sanction which would certainly prompt retaliation. Russia’s tourist industry is collapsing as its economy falters and as Moscow warns that any Russian caught abroad could be arrested and sent to the US for trial. Most of Russia’s commercial airliners are leased from US and EU leasing companies. One Russian company has already had its leases cancelled for flying into the Crimea. There is talk that the West could destroy Moscow’s air travel industry by taking back its leased aircraft.  In this age of globalization, it is very difficult for major powers to conduct trade wars with each other. So far Moscow’s seizure of the Crimea and intervention in Ukraine in generally popular in Russia, but the sanctions have not yet taken hold. Most observers believe that Moscow has more to lose in these exchanges than does the West.

Despite the sanctions, Exxon began drilling in Russia’s arctic over the weekend. Although Exxon’s move does not technically break the sanctions, it certainly violates their general idea which is to slow Russia’s efforts to find new sources of oil using western technology. Moscow hailed Exxon’s adherence to the contract.

5.  The Briefs

  • The world’s oil prices have stayed high since 2010 — bouncing around $100 per barrel — for two reasons. Oil demand keeps rising, and production is struggling to keep up. Wars, unrest, and sabotage have increasingly plagued oil producers like Iraq, Libya, Sudan, Yemen and Syria since 2011. The sanctions on Iran have also removed a lot of oil from global markets. Altogether some 3.3 million b/d — equivalent to nearly 4 percent of global supply — are offline due to “unplanned outages.” (8/7)
  • In Brazil, output from the “pre-salt” fields has passed 500,000 barrels of oil a day, nearly triple that of 2012, and now accounts for nearly a quarter of the company’s total production of two million b/d. It is a quick ramp-up for Petrobras, and is taking place in one of the most challenging oil patches in the world. (8/8)
  • Brazil’s Petrobras posted an unexpected profit decline in the second quarter after its fuel imports surged 56 percent to 407,000 b/d and crude exports fell 14 percent to 308,000 b/d.  Domestic demand for gasoline and diesel is rising because the government, which controls Petrobras with a majority of voting shares, has kept prices between 10% and 20% below international prices. The fuel subsidy policies have weighed on the shares, making it the worst performer of the 20 most valuable major oilproducers (8/9)
  • Petroleos de Venezuela said the US oil refining and marketing assets it’s seeking to sell are worth more than $10 billion. Citgo owns three refineries capable of handling about 749,000 barrels a day in Louisiana, Texas, and Illinois. It also operates the sixth-largest U.S. retail gasoline chain through about 5,900 branded stations. (8/7)
  • Nigerian convergence: The US now gets less than 2 percent of its oil from Nigeria, compared with 7 percent in 2011, Energy Department data show. Yet Nigeria imported more than half of its fuels from America at times in 2013, up from less than a fifth three years ago. (8/4)
  • Shell said Wednesday it started oil production from the first well at its deepwater Nigerian Bonga North West development. At its peak, the facility is expected to process as much as 40,000 b/d. (8/7)
  • Oil of DRCongo, owned by Israeli billionaire Dan Gertler, said it has discovered around 3 billion barrels of oil within the Democratic Republic of Congo. The crude was discovered around Lake Albert on Congo’s eastern border with Uganda. (8/8)
  • Norway’s Statoil decided to end a campaign in the arctic waters of the Barents Sea. The company said it ended its campaign in the frontier Hoop area. Small volumes of hydrocarbons were encountered, but nothing in the way of a commercial discovery. (8/9)
  • PetroChina plans to pay the more than $1 billion it needs to complete a takeover of the Dover oil sands project from Canadian firm Athabasca Oil Corp by the end of September. An internal review showed the geological structure of the project is more complicated than previous estimates, which would increase development costs, but the acquisition will go ahead. (8/5)
  • Deepwater: Energy companies are drilling in waters deeper than ever before, though the industry still could tap even deeper, a Danish drilling engineer with Maersk Drilling said. Maersk is trying to breathe new life into an industry working with a fleet of offshore rigs in need of replacement. (8/5)
  • Europe’s major oil companies are starting to pay their own way. The sector has beaten the market so far this year in the hope that spending cuts and improving operations would mean companies could cover their investment and dividends from operating cash flow. Covering its out-goings should shore up investors’ faith in the sector’s ability to make payouts to shareholders, after years where funds were shoveled into grandiose capital projects, depressing returns. (8/5)
  • US rigs targeting oil surged by 15 to a record 1,588 as drillers ventured outside the nation’s biggest basins to search for crude in developing plays such as the South-Central Oklahoma Oil Province.  It was the most rigs targeting oil since Baker Hughes separated the oil and gas rig counts in 1987. Rigs targeting crude outside the major plays jumped by 19 to a record 399. The total U.S. rig count has increased by 151 this year to 1908, 53% of the world’s total rig count. Worldwide rigs for July totaled 3,608, a 163-unit gain from June and a 246-unit gain from July 2013. (8/9)
  • Companies mining sand for fracking are growing, though there’s been a backlash against their operations. Last week, the Minnesota Department of Natural Resources ordered a mine operator to shut down because of environmental concerns. Frackers are expected to use nearly 95 billion pounds of sand this year, up nearly 30 percent from 2013.  (8/7, 8/4)
  • Concho Resources is facing delays of several hours to get sand for fracking in the Permian Basin as a drilling boom in West Texas drives up demand and creates delivery bottlenecks. The use of sand for fracking in the U.S. and Canada is expected to increase 17 percent a year, reaching 130 billion pounds (59 billion kilograms) in 2016 from 80 billion last year. (8/8)
  • In Colorado, Gov. John Hickenlooper said he made a deal with the environmental advocacy community and those in the energy industry that would ward off initiatives that would have curtailed oil and gas drilling in the state. Instead, the governor said he created a task force that would oversee the issue in a way that would benefit residents and the state’s economy. (8/7)
  • An oil shale industry in Colorado, Utah and Wyoming is likely to be about one-third the size it had been envisioned. Instead of a 1.5-million b/d industry, the more likely scenario is 500,000 b/d according to estimates by the National Oil Shale Association. The estimates were dramatically reduced “in light of a more pragmatic view of what an industry might look like in 50 years or so. The new estimate is based on production of 225,000 b/d from in-situ (heating shale deep below the surface); 200,000 b/d from retorting shale on the surface; and 75,000 b/d from modified techniques. (8/4)
  • China has halved the amount of shale gas it expects to produce by 2020 after early exploration efforts proved challenging. China is believed to hold the world’s largest technically recoverable shale resources, but so far drilling has yielded only one large find, the Fuling field in Sichuan. Experts say the Fuling success is hard to repeat elsewhere due to complex geology and high cost of production. (8/8)
  • Violence trumps: Egypt, Iraq and Jordan have called off talks regarding construction of a gas pipeline as a result of violence, instability and insecurity. The goal of the proposed pipeline was to carry Iraqi fuel to Jordan and Egypt. (8/7)
  • Trouble in Ireland:  An energy company planning to drill for shale natural gas in Northern Ireland said the home of one of its workers was the target of a fire bomb. The drilling company said its workers have been the target of threats from groups worried the drilling campaign would lead to hydraulic fracturing. (8/6)
  • US LNG: GDF Suez became a partner with Cameron LNG for the new plant planned for Hackberry, La. The plant is designed to produce and export up to 12 million tons of LNG per year. Production of the facility should be completed in 2019 at a cost of $10 billion. (8/8)
  • Natural gas production from the Marcellus shale has surpassed 15 billion cf/d and now represents 40% of US shale gas production, making it the largest producing shale gas basin in the country. While the region’s rig count has leveled off at around 100 rigs over the past 10 months, improvements in drilling productivity have enabled operators to more efficiently drill new wells. Marcellus production in recent years has shot up to record levels after accounting for just 2 billion cf/d in 2010, resulting in record gas storage injections, multiple pipeline expansion projects to remedy bottlenecks, and stabilized or decreased prices.  (8/6)
  • High rates of natural gas flaring in the Bakken shale formation are symptomatic of infrastructure limitations that prevent this gas from reaching a market. Although various technical options could reduce flaring from high-output well sites, none matches the benefits of developing large-scale outlets for the gas. State data from North Dakota indicate 10.3 billion cubic feet of gas were flared there during April 2014–30% of total gas production in the state for the month. (8/5)
  • In Denton (TX) there are more than 270 active wells within city limits, and alarmed locals have taken things into their own hands. In November, a proposal to ban fracking will go to a vote. If it passes, this would be the first town in oil and gas-loving Texas to say not in our backyard. (8/8)
  • Europe’s energy dilemma — burning the dirtiest coal while meeting pollution targets — is crystallizing into opposition to a plan that would uproot 700-year-old villages and dig two pits the size of Manhattan. Polish Prime Minister Donald Tusk sees coal, used to generate 90 percent of his nation’s power, as a way for Europe to depend less on Russian natural gas. (8/6)
  • China’s smog-plagued capital has announced plans to ban the use of coal by the end of 2020 as the country fights deadly levels of pollution, especially in major cities. Beijing’s Municipal Environmental Protection Bureau posted the plan on its website Monday, saying the city would instead prioritize electricity and natural gas for heating. (8/5)
  • India’s reliance on domestic coal has left many of its power stations starved for fuel, forcing electricity cuts throughout the country. Despite having the world’s third-largest coal reserves, a quarter of India’s 100 coal-fired power stations are short of supply with stocks of less than four days. A prolonged summer and below-normal monsoon rains have exacerbated the situation by raising electricity demand. (8/4)
  • Egypt last week announced plans for a ‘new’ Suez Canal that will run in parallel to the current waterway, which provides a vital shipping link between Europe and Asia. The Egyptian plan, part of an $8.4 billion project to upgrade the canal, could raise its capacity to 97 passing ships a day by 2023, up from 49 currently. The President stated the military will take the lead on the project and that it can be completed in one year.  Many are skeptical.  (8/9)
  • Volkswagen and Audi are launching sustainability programs as they deliver their ultra-low-carbon cars. To go along with Volkswagon’s introduction of the e-Golf, it is developing carbon offsets and partnering with Chargepoint to provide access to charging stations nationwide.  Both manufacturers are working with SunPower to provide qualified US Volkswagen e-Golf customers in all 50 states the opportunity to install a solar electric system at their residences. (8/6)
  • Federal forecasters on Thursday downgraded their outlook for the 2014 Atlantic hurricane season, predicting “below normal” activity with seven to 12 named storms, no more than two of which are expected to reach major hurricane status. (8/9)
  • Western drought: Lake Mead is the largest reservoir in the United States.  At full capacity, it holds two years of the Colorado River’s flow.  But due to the drought conditions since 2000, when the lake was just about full, today Lake Mead holds about 9 months of Colorado River flow.  Just as worrisome, groundwater has been tapped at such a fast rate that NASA satellite data shows a withdrawal of 77 million acre-feet of water, or one and a half Lake Meads during the last nine years.  The West’s water security is in serious jeopardy. (8/6)
  • CA’s drought: One of the worst North American droughts in history is getting worse. More than 58 percent of California is in an “exceptional drought” stage–up a staggering 22 percent from last week’s report. Officials noted that California is short more than one year’s worth of reservoir water, or 11.6 million acre-feet, for this time of year. (8/6)