Quote of the Week

“Credit rating agency Fitch says defaults for oil and gas companies are already at the highest since 1999. Since the start of the third quarter, at least 12 oil and gas companies have defaulted on their debt. The ‘zombies’ bet that by shifting into survival mode they can hang on until oil prices recover, but the outlook is grim.”

Anna Driver and Tracy Rucinski, Reuters, “Zombies Appear in U.S. Oil Fields”

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

1.  Oil and the Global Economy

Oil prices tumbled for six straight sessions following the OPEC decision to maintain production levels the week before last. At the close Friday prices were down 11 percent for the week with New York futures closing at $35.62 a barrel and London at $37.93. This is the lowest close for oil futures since the 2008-2009 recession. Adjusting for inflation, oil prices this low were last seen in 2002. A pessimistic IEA report on Friday contributed to the price drop by forecasting that the oil glut will continue well into next year as the demand for oil falls and additional Iranian oil comes onto the market. The IEA now says that the increase in global demand in 2016 will be only 1.2 million b/d as compared to 1.8 million this year.  The only good news for oil prices was a 21 unit drop in the US rig count last week, but as the markets know by now, drops in the rig count do not immediately translate into lower production even in the rapidly depleting shale oil fields.

US natural gas prices also took a major hit last week closing below $2 per million BTU’s as weather forecasts are calling for above-average temperatures for much of the US at least through January. Spot prices for natural gas at the Henry Hub fell as low as $1.77 last week, the lowest since November 2001. Given the wave of unusually warm weather there is no end to the price slump in sight.

Global oil supplies crept up to 96.9 million b/d in November as record production from Iraq and higher Kuwaiti production offset a drop by African producers. The IEA forecasts that non-OPEC (mostly US shale oil) production will fall by 600,000 b/d next year, but this will be offset by increased Iranian production which should be 500,000 b/d or higher by the end of next year. The Agency says there will likely be enough new and existing storage capacity to hold the 300 million or so additional barrels that will accumulate in 2016. There has been much discussion of late as to how little impact the drop in oil prices during the last 18 months has had on economic growth in the US and other countries.

Nearly everybody foresees a bad year ahead for the oil industry. Hedge funds are short. Distant futures are not doing well, foreclosing on the opportunities of storing oil aboard tankers for a year or two with a guaranteed profit at contract expiration.

The world’s oil companies need to replace the 34 billion barrels of oil that are consumed globally each year. In 2015 capital spending on exploration and production fell by $250 billion leaving enough spending to produce about 8 billion barrels from this year’s investment.  Capital spending by large oil companies is seen as falling by $70 billion next year making the situation still worse. It is numbers like these that have some people asking whether we are seeing the all-time peak in world oil production this year or whether a rebound in oil prices will be matched by sufficient investment to offset depletion in coming years.

For the smaller oil companies that have been producing mostly shale oil in the US, many foresee big troubles in the coming year with numerous bankruptcies and mergers. Last week the junk-bond market which has been financing much of the shale oil boom took a hit with the sudden closure of a high-profile junk-bond mutual fund. Many fear investors will see that the risk of default by companies with high debts is increasing and that money to continue oil drilling operations will dry up in the coming year.

Some pessimists see the recent breaking of the $40 oil price barrier which came last week as a harbinger of the deflation that will soon trigger another severe recession even in the US.  Japan, Canada, Brazil, and Russia are already in recession.  The US economy has been bumping along for the last seven or eight years by printing money. Near-zero interest rates have made it possible to service oil industry debt that will never be repaid. Next year will be a very interesting one which could determine much of the oil industry’s future.

2.  The Middle East & North Africa

Iran: Tehran’s Minister of Petroleum announced on Sunday that the sanctions on its oil exports and banking will be lifted within a “few days” and that the country is about to have an economic boom with much new investment flowing into its industries.  Washington is not this optimistic but seems to be aiming for January as the time to lift the sanctions. Despite some muttering from the Israelis and Republicans in Congress that the Iranians are sure to cheat under the new agreement, all the requirements that Iran must meet seem to be completed or underway. The US is helping with an arrangement to send part of Tehran’s enriched uranium stockpile to Kazakhstan for safekeeping.

Iran and Russia are considering a gas swap deal that would have Tehran supply natural gas to Armenia in place of Russia, thereby relieving Moscow from paying the transit fees for moving the gas through Georgia. Iran would be compensated in some other way such as selling an equivalent amount of gas in the EU that comes from Russia. Iran says it wants to increase its oil sales by 1 million b/d as soon as possible, but this could become a problem in the coming year. Given the world oil glut, the Iranians are going to have to make some major price concessions to take away market share from other exporters.

Tehran still continues its love-hate relationship with the US. It loves the technical goodies that America can produce and sell it, but fears that too close a relationship could undermine the ideological underpinnings of its theocratic government.  The government has already issued a ban on importing American goods despite the universal desire of its citizens for IPhones and the need for US technology to increase oil production.

Syria/Iraq:  Changes are clearly underway in the nature of Moscow’s and Tehran’s intervention in the Syrian civil war on behalf of the Assad government. Last week there were reports that Iran has started withdrawing the troops that were leading the ground offensive against the moderate rebels that were threatening to overrun northwestern Syria. This was said to be due to the unacceptable level of casualties that Iran’s forces were suffering while engaging in offensive action against the rebels. In response to the Russian/Iranian intervention, military aid to the more moderate rebels was said to have been stepped up.

Moscow has begun shipping its new T-90 main battle tank to the Syrians. The 500 T-72 tanks have been highly vulnerable to the US TOW anti-tank missiles which have been supplied to the moderate rebel forces in large quantities and are thought to be responsible for the progress the rebels were making against the Syrian Army last summer. The T-90 has more advanced armor and anti-missile systems that could prove to more effective against anti-tank missiles.

There seems to be some change in the nature of the Russian efforts on behalf of Assad. Despite Moscow’s rhetoric about fighting ISIL terrorists, most of its bombing campaign was directed against more moderate and threatening rebel groups that were being supported by the Gulf Arabs and the West.

Some are now saying that after three months of attacks this plan has failed and that Moscow is turning more of its air power against ISIL and is even giving air support to more moderate rebel groups that it had been bombing. Moscow’s ability to add much to this war is coming into question. Last week it managed to bomb an Assad government base by mistake, while claiming that it was the Americans that carried out the strike. Moscow has few precision weapons so that the bulk of its attacks consist of blowing up towns that stand in the way of government forces – causing large numbers of civilian casualties.

Moscow and Washington are working on ways to bring about a negotiated settlement, but so far the Assad government refuses to participate despite the heavy dependence on Moscow. Given the rapid deterioration of Moscow’s economy, this war is one that Russia can ill afford.

The air war against the various ISIL targets continues with strikes now being made by US, Russian, British, and French aircraft. The token participation by the Gulf Arab air forces seems to be on the wane. A major effort is underway to reduce the revenue that ISIL has been getting from oil sales to the Assad government and Turkish buyers by increased attacks on oil production and transportation equipment under ISIL’s control.

The increase in air attacks on ISIL in the last few weeks may be taking toll on its ability to hold territory and conduct offensive action. The terrorist attacks on Russian, French, and American targets has led to more weapon systems and military assets being turned against a rather small group that only exists due to their ability to hide themselves among the civilian population.

In Iraq, government forces are reported to be making progress in the campaign to retake Ramadi from ISIL.  Some 350 of the 600-1,000 ISIL fighters holding the city are reported to have been killed by US airstrikes. Despite continuous statements from the Shiite government in Baghdad that they do not need foreign help in their fight against ISIL, addition deployments of US force including attack helicopters seems to be in the works.

Baghdad is reorganizing the South Oil Company which is responsible for the bulk of the country’s oil production, oil exports, and revenue. While the restructuring is said to be for “better decision making,” there have been reports that the people in southern Iraq are demanding a greater share of the oil money and that the move is intended to strengthen Baghdad’s control over the company.

3.  China

Parts of Beijing’s economy did better than expected in November, but a decline in imports suggests that the weakness in manufacturing is still ongoing. China’s foreign reserves fell by $87 billion in November.  These reserves have fallen nine of eleven months this year and now stand at $3.4 trillion. Much of the decline comes from government efforts in support its currency in the face of economic weakness. The country’s farmers had a good year with the grain harvest up 2.4 percent over last year.  Over the longer run, China’s working age population is due to fall by 10 percent by 2040 as the effects of the one child policy continue to be felt.

The major news of the week was another round of hazardous smog which settled in on northern China driving pollution meters off the scale in some cities and forcing the first “red alert” in Beijing’s history. The Chinese are still of two minds about air pollution and global warming. They realize the dangers of the heavily polluted air, mostly from coal smoke, that engulfs many cities several times each winter and which is causing considerable harm to vulnerable segments of their population. They are doing their best to reduce this pollution without upsetting the economic apple cart which is the underlying justification for one-party rule in China.

Beijing’s rulers also realize that carbon emissions leads to global warming which eventually will flood their coastal cities, lower their water supplies and disrupt agriculture.  However, they still maintain that they must continue to keep their economy growing and that the rest of the world should not expect to see reductions in their carbon emission for another 15 years.  Concern about doing serious harm to economic growth still trumps the threat of climate change today, but worsening climatic conditions will eventually become the primary concern

China’s crude oil processing climbed to a record 10.73 million b/d last month – a 3.3 percent year-over-year increase – as several large refineries finished their annual fall maintenance cycles.  The increased processing came as November crude imports were 77 percent higher than in October. As China’s economy shows little sign of increased demand for oil products, we can expect ever increasing product exports and surpluses in coming months.

4. Russia/Ukraine

Moscow has been having problems maintaining the electricity supply to Crimea after unknown Ukrainian nationalists blew up the four power lines supplying it. Although one of the lines has been restored, Ukrainian officials are showing no urgency in restoring the remaining three lines. Russia has responded by announcing that it will install underwater cables that will bring power from southern Russia to the peninsula. Russia does not make the proper type of cable and, as it is under sanctions, cannot import them from Japan or Europe, so has had to go to the Chinese to get the cables. Installing the cables and rebuilding Crimea’s electric grid to run from east to west rather than north to south would normally take several years while the Crimean people are cold, hungry and for the most part without much electricity. Another solution is to build several new coal-fired power stations in Crimea, but this also will take several years.

The drop in oil prices last week with the ruble down to 70 to the dollar is not helping Moscow’s situation. Last week Russian Economy Minister Ulyukayev said that Russia’s economic rebound would stall if oil prices stay at $40 a barrel, but that it will rebound to $50 shortly. The minister expects that Russia’s GDP will fall by 3.7 percent in 2015.  He has also warned that there is no assurance of any economic growth in Russia for another five to ten years.

5. Climate Talks

As a statement of goals, the agreement reached at the COP21 climate summit over the weekend was admirable, but as an effective plan to stop global warming, most environmental specialists are skeptical that any real plan has been agreed upon. In the real world, expecting that some 200 sovereign nations with some 200 differing perceptions as to the seriousness of climate change when weighed against other national priorities, is simply too much.

For now, we have an explicit goal of keeping the increase in average atmospheric temperature below 2oC or perhaps 1.5o. In many cases, progress towards reducing carbon emissions is moving rapidly, but so far the goal in many developing countries is to lower the amount of toxic particles in the air rather than reduce global warming.  Countries such as China may be doing right for another reason. A recent study shows that some 87 percent of the world’s population now lives in areas exceeding safe levels of air pollution.

It is interesting to note that while Beijing is receiving much praise for its efforts to clean up its own emissions, at the same time its companies are building 92 coal-fired power stations having a combined capacity of 107 gigawatts in countries around the world. This is enough to offset the planned closure of numerous coal fired plants in the US during the next five years.

Looked at realistically, so long as extracting energy from the combustion of fossil fuels is cheaper or easier than from non-polluting sources, the fossil fuels will be used until the effects of global warming become unbearable. A heavy carbon tax which reflect the true costs of burning fossil fuels would likely slow the use of these fuels and make green sources of power more competitive. This is unlikely to happen on a large scale in the foreseeable future due to the economic dislocations it would cause.

In the meantime, all the world can do is watch the costs of renewable energy fall and hope that there are new sources of non-polluting energy waiting to be discovered that will be so cheap that a rapid movement away from fossil fuels can be accomplished before it is too late.

6.  The Briefs

[NOTE: This week’s Briefs are heavily weighted towards the financial aspects of the oil industry, in the wake of the previous week’s OPEC meeting which maintained the status quo, resulting in ever-lower prices and the media focus on financial performance.  Additionally, it’s that time of year when companies announce capital investment plans for 2016.]

In the U.K., BP said it started sea trials for a floating production platform that will serve as a hub for developments west of the Shetland Islands that are meant to extend the life of the regional Schiehallion and Loyal fields. (12/12)

In Israel, companies working in the energy sector said they’re still pursuing commercial deals in Egypt despite reports of a breakdown in talks. (12/9)

Iran has agreed to a $3 billion contract with a consortium of Indian companies to develop the Farzad B gas field in the Persian Gulf. The lifting of sanctions means the consortium can resume development. (12/7)

In northeastern Bangladesh, Chevron has started production from two new onshore wells in the Jalalabad gas field.  A third well will be added during 2016, with total production from the three at 130,000 million cubic ft. per day. (12/7)

In Nigeria, the fuel crisis took a dramatic turn for the worse as massive queues were seen in almost all the petrol stations selling products in Abuja. Also, some oil marketers blamed the prolonged scarcity on the insincerity of the Federal Government and called on Nigerians to expect a further worsening of the situation in the days ahead. (12/9)

Brazilian tailspin:  Moody’s cut its rating on state-controlled oil producer Petróleo Brasileiro SA one step to Ba3, citing the difficulty the company may face in refinancing its debt amid slumping crude prices, investor pessimism on Brazil and negative free cash flow. It put the rating on review for further cuts. Because of internal rules, some institutional investors such as pension funds can’t invest in securities labeled junk—the next step below Ba3.  (12/10)

Mexico’s monthly exports to the US during September this year totaled 0.6 million b/d, the lowest level since 1990, and a decrease of about 50% since January 2011. Meanwhile, Mexico’s exports of heavy crude oil to Asia and light crude oil to Europe rose. (12/12)

The U.S. total rig count declined by 28 to 709, according to Baker Hughes Inc. The number of rigs drilling for oil was 524, down 21 units, and gas rigs were at 185, a decline of 7. (12/12)

US natural gas surge: on Tuesday the EIA said domestic natural gas production in 2015 is expected to reach 79.58 billion cubic feet per day. By a large margin, that figure would top 2014’s record high of 74.89 bcfd and would be the fifth consecutive annual record high for U.S. gas production.  U.S. consumption is also scheduled to rise for the sixth consecutive year. (12/9)

Emissions low-balled: A new scientific study from the National Academy of Sciences reports findings from the most comprehensive examination of regional methane emissions completed to date. Focused on Texas’ Barnett Shale the study reports that methane emissions there are 90 percent higher than EPA’s inventory data would suggest. This is just one of several recent studies showing a pattern of underestimating methane emissions in locations across the country. (12/10)

US oil exports: The 40-year-old ban on most U.S. crude exports will “very likely” be lifted in the government spending bill, and talks on the final budget deal are likely to continue through the weekend, a Senate aide said on Friday. (12/12)

Sinking feeling: Executives at the world’s biggest oil companies are wondering how much worse the news can get. This week crude prices slid to their lowest levels since the 2008-09 financial crisis — triggered by a rancorous OPEC meeting that failed to tackle a global supply glut. The fall has revived investor fears that dividends could be shelved or cut.  The suggestion is that “Big Oil” could follow the path of the mining industry, which is dealing with the worst commodities downturn in a decade. (12/9)

2016 capex: ConocoPhillips will reduce capital spending by 25 percent next year to $7.7 billion to protect the highest dividend yield among major U.S. oil producers. Chevron Corp. disclosed a 2016 budget 24 percent smaller than this year’s plan. Together, the cuts by both companies totaled $10.9 billion, enough to rent 10 deepwater drilling rigs every day for more than half a decade. (12/11)

Master limited partnerships hurt: The oil selloff has hurt energy investments across the board, including one that has attracted billions through its reputation as a haven from big drops in the price of crude. Shares of energy pipeline and storage companies have fallen sharply in the past couple of weeks, accelerating a recent rout for master-limited partnerships, which have seen strong demand for their shares in recent years as investors sought ways to profit from the natural gas and energy infrastructure boom in the U.S.

A US mega-deal in 2016? Oil’s messy reckoning is inviting one. If current conditions persist, something like Royal Dutch Shell’s takeover of BG, originally valued at $70 billion, should look ever more appealing. (12/11)

Chesapeake down: Half of the 10 worst-performing junk bonds over the past week were issued by Chesapeake, the Oklahoma City company that is the second-largest US natural gas producer behind Exxon Mobil Corp. (12/11)

Halliburton/Baker Hughes? Plunging oil prices have reduced demand for drilling, complicating the oilfield-service giants’ efforts to find buyers for assets they would need to sell for the deal to pass regulatory muster. (12/11)

Chemical giants DuPont and Dow Chemical Co agreed to merge in an all-stock deal valuing the combined company at $130 billion in a win for activist investors that could spark further consolidation in the farm chemicals industry. (12/12)

Exxon Mobil promoted Darren Woods to president, putting him on a path to succeed Chairman and CEO Rex Tillerson as leader of the world’s largest energy producer by market value, sometime between now and March 2017. (12/12)

Venezuelan electoral authorities have confirmed that the opposition has won a key two-thirds majority, enabling it to challenge President Nicolas Maduro. The opposition said it would work to release jailed opposition leaders and address the country’s economic crisis.  Maduro has announced a cabinet reshuffle but vowed to veto any amnesty law for jailed politicians. (12/9)

New Zealand’s government joined a global geothermal energy group, saying the move was emblematic of a shift toward a low-carbon economy. (12/9)

South Korea on Tuesday unveiled a five-year plan to drastically increase the number of environmentally-friendly cars on its streets, as auto makers’ emissions come under intensifying scrutiny globally. The government aims to ensure that hybrids, electric vehicles and hydrogen fuel-cell cars account for 20% of all new cars sold in the country by 2020, up sharply from the current 2%. (12/8)

The Philippines is set to open 23 coal-fired power plants over the next five years to meet rising electricity demand, illustrating the challenge climate-talk negotiators face in crafting a deal that reduces carbon emissions. In the Philippines and in dozens of other developing countries, coal remains an essential fuel for building more prosperous societies. (12/10)

First commercial offshore U.S. wind farm: Deepwater Wind, one of the developers behind the Block Island wind farm off the coast of Rhode Island, said five steel platforms are now installed. The project should yield 30 megawatts of electric power, powering the 17,000 homes on Block Island, 12 miles from the mainland, that currently use diesel fuel for electricity. Excess electricity will be carried to the mainland by cable. The turbines will be 589 feet above sea level, making them among the tallest in the world. (12/10)