Quote of the Week

Due to the oil price crash and the industry’s crushing debt load, “The oil industry will be permanently damaged.”

Steven H. Pruett, CEO of Elevation Resources, an oil company based in Midland (TX)

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

1.  Oil and the Global Economy

Oil prices plunged for four days last week, settling at a recent low of $26.21 in New York, a drop of nearly 30 percent since the start of the year, and $30.06 in London a 20 percent drop this year.  The inevitable rebound came on Friday with a vigorous jump for the day of $3.23 or 12.3 percent in New York to close at $29.44, and $3.30 or 11 percent to $33.36 in London. This time the rebound was started by rumors out of the UAE that OPEC, while not considering a production cut, might be willing to consider halting further increases in production.  This rumor was seen by traders as a willingness on the part of OPEC to take charge of the oil supply situation for the first time since the crisis began. Another factor contributing to the decline was the long weekend in the US and the unwillingness of traders to be caught in short positions with prices so low. As one analyst said, “every time someone in OPEC comes out and says we are willing to cooperate, there is always a knee-jerk reaction on the part of oil traders.” “No one wants to be caught selling futures at the bottom of the move.”

Except for the OPEC rumor, all of the other news last week pointed to still more oversupply, rapidly filling storage capacity, and still lower prices. At a major oil industry conference in London, several executives cautioned that oil prices would stay low until 2017. The IEA warned again last week that the oversupply situation is getting worse and that oil prices could fall further. The Agency noted that increased production from OPEC is offsetting declines in non-OPEC output so that the world is still oversupplied. The IEA opined that a Russia-OPEC deal to cut production is unlikely so long as the Iranian-Saudi confrontation remains in place.

Concerns about storage capacity for all the excess crude and oil products continue.  The tanks at Cushing, Okla. are approaching 90 percent of capacity which is one reason the spread between WTI and Brent is increasing again. There is talk about placing crude aboard supertankers for permanent storage until prices rise again as happened in 2008-2009.

Some US shale oil producers are saying that it will take more than a rally in oil prices for them to bring rigs out of storage and start drilling again as happened last year. At least one executive says he wants to see oil staying above $60 a barrel before he increases production.

In the meantime, bad news from nearly every corner of the oil industry continues to pour in. Some companies are maxing out their revolving credit lines; others are selling off assets; and some are declaring bankruptcy. With half of global oil production now going to emerging markets, the troubles in China, whose imports have been responsible for much of the increase in oil demand from China’s trading partners in recent years, suggest that drops in demand may soon be adding to the oversupply problem.  IHS Inc. says that while a group of 44 North American oil companies plan to cut capital expenditures from $101 billion last year to $78 billion in 2016, it will take another $24 billion in cuts to bring their spending into the historical ratio of capital spending and cash flow.  In recent months, drillers have been relying on an exotic form of hedging known as a “three-way collar.” While this form of hedging is cheaper than traditional futures hedges, it leaves the drillers unprotected at the unexpectedly low prices we have seen in the last week or so.

The EIA is forecasting that US shale oil production will decline by 92,000 b/d from February to March due to the continuing drop in operational drilling rigs and fewer well completions. However, the EIA’s forecasting record has not been good of late — the administration had to add 184,000 b/d to their previous US production estimates in a new report issued last week.

Environmentalists are very concerned about the hold the US Supreme Court placed on the new emissions regulations on coal plants that the government has recently imposed. The fear is if the regulations are eventually overturned, the US would have little chance of meeting the emission goals agreed to at the Paris global warming conference. Should the US be forced out of the agreement by the Supreme Court, many other nations would follow, endangering worldwide efforts to stem global warming.

2.  The Middle East & North Africa

Iran: Tehran is continuing its battle for market share with the Saudis by cutting its price for heavy crude going to Mediterranean customers by more than a recent Saudi cut. The selling price for Iranian Heavy crude is now set at $6.40 below the Brent Weighted Average. For Northwest Europe and South Africa the price is now $6.30 below the Brent Average as compared to $6.00 for Arab crude.  This may only be the beginning of price wars between Iran and the Gulf Arabs as Tehran battles to regain the market share it held before the sanctions were imposed.

The postponement of a conference in London at which Tehran was to announce its terms for foreign oil companies wanting to invest in developing Iranian oil shows that there is considerable infighting within the Iranian ruling class. Although the Iranians tried to blame the postponement on troubles getting visas for all the Iranians who wanted to attend, the delay likely was forced by hardline opponents of the Rouhani government who say the proposed agreements violate Iran’s constitution which decrees that none of Iran’s oil reserves can be owned for foreigners.  Iran is seeking some $200 billion in foreign investment to increase its production to 4-5 million b/d. Given the low oil prices, Iran is unlikely to be capable of accumulating the capital to make major increases in its oil production.  Some believe the domestic political situation will become worse after the elections when the hardliners make an effort to gain take more control over the oil industry away from moderate President Rouhani and his government.

The lifting of the sanctions my not turn out to be as much of a boom for Iran’s economy as many Iranians had hoped. It is doubtful that in these tough times for the oil industry many international oil companies will be interested in deals in which they supply the money and take the risks while allowing the Iranians all the control and most of the benefits from the projects.

In the meantime, Iran is demanding payment for its oil in euros rather than dollars in order to stick it to Washington. The problems of insuring cargoes of Iranian oil, however, seem to be easing. Washington will now allow non-US persons to insure crude and oil products coming from or going to Iran.

Syria/Iraq:  The situation in Syria continues to get worse — a harbinger of troubles for years or perhaps decades to come. As Syrian government and its allied ground forces, supported by heavy and some say indiscriminate Russian bombing, close in on Aleppo, tens of thousands of Syrians are fleeing for their lives to escape what the UN calls “extermination by government.” Efforts by the US to broker a ceasefire do not seem to be going anywhere as Moscow intends to keep bombing until what it calls “terrorists” are defeated and those being bombed have no intention of ceasing fire so long as they are being bombed. The Turks are beginning to shell Kurdish militia in Syria and the Saudis are offering to send ground forces to Turkey as part of an effort to defeat ISIL.

The world’s press is unanimous in its opinion that the Russian intervention has been a success in that it is enabling Assad and his allies to militarily defeat the more moderate rebel forces who will no longer pose a threat to the Assad government. Moscow is supposed to have the upper hand in dictating a settlement that would keep Assad in power permanently. A side benefit for Moscow is that the millions of refugees trying to get into Europe are making endless headaches for the European governments. Just to add to the contretemps, Moscow is now accusing the US and NATO of reviving the cold war. Considering that Russia was an economic basket case 20 years ago, it is amazing what a few years of $100 oil will do for a country’s self image and ambitions.

The downside of this for Moscow and Damascus, however, is that they are regaining little more than piles of rubble and a populace seething with hatred for Assad and his minority rule. Syria no longer has an economy and will be dependent on Moscow and Tehran for financial support for years to come.  The end of this story is nowhere in sight. Should the Saudis become involved with ground forces – and they are already moving aircraft to a Turkish airfield – the multi-faceted struggle amongst dozens of players with differing agendas could eventually bring trouble to the Gulf Arabs and their circa 20 million b/d of oil production.

Down in Iraq things are not going well either. As oil revenues sink, Baghdad is trying to impose higher import duties on goods coming into the country. This has not only slowed the importation of foreign goods, it has led to weeks of demonstrations in Basra by merchants hurt by the new tariffs. Prime Minister Abadi is overhauling his government to deal with the worsening economic situation.

While US airpower and military advice was enough to drive ISIL forces out of Ramadi, the latest word is that the assault to retake Mosel will not come this year. While ISIL no longer has the military power to undertake major offensives, it is spending its time digging its men and facilities into tunnels in the parts of the country it controls. As this takes place, airpower becomes less relevant and ISIL’s staying power and the effort it will take to dislodge them from cities increases.

Libya: The two rival Libyan governments are still feuding over who can sell oil and collect the revenue. UN   efforts continue to try to form a unity government. It is generally believed that a new government will ask for and likely receive some sort of military intervention against ISIL by US and EU forces.

EU warships are now patrolling the Libyan coast in an effort to cut down human trafficking into Europe and there are reports that EU military aircraft are already flying patrols over Libya. The Pentagon is seeking $200 million in the 2017 budget for counterterrorism operations in Libya.

Saudi Arabia/Yemen: Saudi involvement in the various Middle Eastern wars increased last week with the deployment of Saudi warplanes to Turkey’s Incirlik air base. The planes are to conduct air strikes against ISIL targets in Syria with the US, British, and French aircraft already based there. Riyadh also announced that plans are underway to send Saudi ground forces to Turkey to take part in operations against ISIL in Syria. Damascus and Moscow have already denounced this plan saying than any Saudi or Turkish troops entering Syria would “amount to aggression and would be resisted.”

An interesting sidelight to this development is that the Turks seem more interested in attacking Kurdish militias operating in Syria along the Turkish border and are using the fight against ISIL as cover or pretense for these attacks. This seems rather similar to Russian claims that its airstrikes are against ISIL terrorists while the most of the bombing is being directed against moderate rebel groups that had been close to overrunning the Assad government.

All this raises questions as to whether a joint Saudi/Turkish military force would be used against ISIL, the Kurds, or perhaps even to protect and support the moderate rebels that are trying to overthrow the Assad government. These forces are currently under threat of destruction by Russian airpower, and a combination of Assad’s remaining ground forces, Hezbollah, and possibly some Iranian “volunteers.” This whole situation is becoming dangerous and could easily morph into a much wider war involving the US, Russia, Turkey and several European states, not to mention the direct Middle Eastern protagonists.

Nearly everyone dealing with Saudi affairs recognizes the need to reform the country away its current state that functions mostly by handing out oil revenues to keep the populace docile, to one with a more diversified economy. The new deputy crown prince is hard at work on these plans. The trouble is that the necessary changes necessary to build a more diversified economy may destabilize the delicate balance between the royal family and the 30 million citizens.  This is a dangerous time for the kingdom and the recent decision to get involved in external wars with greatly reduced oil revenues could easily lead to all sorts of unforeseen consequences which might someday reduce oil exports.

3.  China

In the last 18 months individuals and companies have moved some $1 trillion out of China, having lost faith in the future of the Chinese economy. Much of this has taken place via various subterfuges as Beijing has numerous controls in place to prevent unauthorized capital outflows. This situation alone should be sufficient to raise questions about the outlook for China’s economy and its demand for oil in the next few years. The massive debt which has accumulated in the last decade along with shrinking growth in the manufacturing sector and in the overall GDP should add to the concerns.

The use of natural gas, which Beijing plans to grow rapidly as a substitute for coal, grew by only 3.7 percent during the first 11 months of last year. The growth rate did increase to 5.7 percent in December after the government cut prices by 25 percent to stimulate demand. Although the government is projecting 8-11 percent annual growth in demand during the next four years, competition with $30 oil and cheap coal will be a problem. Heavy government emphasis on renewable and nuclear energy will also be a problem for the gas industry.

China, which has recently been producing above 4 million barrels of oil per day, is one of the world’s top five oil producers.  However, its oil fields are aging and the cost of drilling new wells has become increasingly expensive, especially when compared to the under $30 a barrel oil that can now be imported. Some specialists are saying that Chinese oil production will be lower in 2016 than in 2015 which could turn out to be the all-time peak for China’s oil production. The good news is that this drop in production may help ease the global oil glut.

4. Russia/Ukraine

The apparent success of Moscow’s intervention against the rebel forces threatening to overthrow the Assad government was the top international news story last week.  An international conference in Munich to settle the crisis, or at least launch a ceasefire, announced that there had been some agreement late last week, but whether a ceasefire comes to pass remains to be seen. Moscow and Washington exchanged harsh words during the conference with the US accusing Russia of targeting mainly rebel groups trying to unseat the Assad government. Moscow replied that the US and NATO were trying to restart the cold war. For now, Russia is basking in the position as an influential power broker in the Middle East, but the Syrian civil war still has a long way to go. Bombing defenseless rebel-held villages into rubble in order to keep a friendly dictator representing a minority of what is left of his country’s population is not statesmanship. Russia’s day as a major Middle Eastern power may be short lived.

In the meantime, Igor Sechin, the head of Rosneft and the most powerful figure in Russia’s oil industry, reaffirmed that Moscow is unlikely to combine with OPEC to make coordinated cuts in oil production. He suggested, however, that if OPEC by itself cut its production by a million barrels per day prices could start to recover.  Sechin also said that it is possible that Rosneft, the state-owned oil company, could go private as the government seeks new sources of revenue to offset low oil prices in a time of increasing international tensions.

The swift fall in oil prices last week prompted the Bank of Russia to warn that it may be forced to raise interest rates to stem inflation.  Moscow is still trying to sell Eurobonds to foreign banks as a way to raise money.  The Ukrainians are hopeful that the low oil prices and a deteriorating economy will eventually lead to a more conciliatory Russia, which at the minute is throwing its weight around after a decade of selling its oil at undreamed of prices.

5. Venezuela

All indications say Caracas is heading for an economic or political collapse in the next year or so. The government is badly split between a President clinging to power and a newly elected legislature seeking to oust him. The financial markets are expecting that Venezuela will default on its debt which is now on the order of $120 billion. The credit-default-swap markets are saying that there is 97 percent chance that Venezuela will default on its debt within the next five years.

In the meantime, citizens of Venezuela are suffering from shortages of nearly everything as there is no money in the country to import raw materials or finished products. Foreign companies are pulling out as they cannot import raw materials. Inflation is expected to hit 720 percent this year and the government is flying in planeloads of freshly printed money to keep the economy functioning.

It is unclear how a collapse might come. There could be a default, riots, a military coup, an assassination or simply a withering away of economic activity.  A key question is how much of the oil industry could keep functioning. A quick fix would be for Venezuela to swallow its national pride and invite foreign oil companies and capital back into the country, but this would likely take a while to negotiate given the country’s debt problems.

Oil production has been running about 2.7 million b/d of late with domestic consumption at about 700,000, leaving exports at about 2 million b/d.  US imports from Venezuela have recently been running around 725,000 b/d down from a peak of 1.8 million b/d in 1997. Much of the rest has been going to China at low prices to pay off the billions that the Chavez borrowed from Beijing during his battles with the international oil companies.  Loss of all or a substantial part of the country’s oil production would certainly eliminate much of the global overproduction of oil, but would come at a terrible cost to the Venezuelan people.

6. The Briefs

European banks face potential loan losses from energy firms of $27 billion, or about 6 percent of their pretax profit over three years, according to analysts at Bank of America Corp. The $27 billion estimate is “potentially a smaller figure than is implied in the share prices of a number of banks,” and lenders’ potential losses aren’t a threat to the capitalization of the banking system or its ability to provide credit to the economy, they wrote. (2/10)

Floating storage: The world is so awash with crude that oil traders are eyeing a potentially profitable opportunity: turning supertankers into temporary floating storage facilities.  Trading houses collectively made billions of dollars from 2008 to 2009 stockpiling crude at sea. (2/11)

BP is planning for oil prices to stay low for the first six months of the year and expects surplus production to only start diminishing when storage tanks fill up in the second half. (2/11)

U.K. gas mini-boom: Laggan Tormore, one of the last big North Sea projects sanctioned under high oil prices, has begun pumping natural gas, highlighting an unexpected boom in U.K. energy production that analysts say is unsustainable. French oil company Total said that the deep-water natural-gas project west of the Shetland Islands will add the equivalent of 8% of current UK oil and gas production. It is part of $50 billion of U.K. offshore projects that were commissioned in recent years when oil prices were $80 a barrel or more. (2/9)

Brent problem: Oil pricing agency Platts is taking new technical steps to protect the Brent benchmark from declining North Sea output, in what could be a first step in radically overhauling the product to eventually include grades from outside the region. (2/10)

In Europe, the lowest oil prices in a decade have yet to fully trickle down and benefit Europeans, where fuel taxes are among the highest in the world. From Belgium to Poland, Europeans are mostly driving less and buying smaller vehicles, even though gasoline prices have fallen more than 20% in some countries. (2/11)

Russia’s CEO of Rosneft Igor Sechin said U.S. shale oil production will peak by 2020 and will decline in the long-term.  “Shale oil production has its limitations in scope and time,” said Sechin at the International Petroleum Week conference. (2/10)

Kuwait plans to increase its crude production by 150,000 barrels a day by the third quarter of this year despite the current slump in oil prices. Kuwait currently produces around 3 million b/d of oil. This suggests Kuwait is planning to stick to the OPEC strategy of increasing production to maintain market share. (2/10)

Nigeria’s export earnings in 2015 from the sale of oil declined by 50 per cent. A contributing factor was the 57% drop in petroleum gas/natural gas liquids. (2/10)

In Nigeria, record government spending — and having to borrow to fund almost half of it — spells trouble for investors in the bonds of Africa’s biggest oil producer. President Muhammadu Buhari is attempting to counter an economic slowdown as crude prices plunged to 12-year lows by increasing government spending about 20 percent in 2016 to $31 billion. (2/11)

The Nigerian government accused oil majors operating in the country of not being sincere in their plans to downsize their workforce, stating that profit motive is the main aim in their quest to fire workers. (2/13)

Africa-focused Tullow Oil said the challenge for 2016 was to navigate the weakened market with key offshore priorities intact while cutting investments. Tullow said revenues were down 27 percent for the year. Net debt rose to $4.0 billion for the year, compared with $3.1 billion for the previous year. (2/11)

Venezuela’s PDVSA cut 2015 capital spending by roughly $2.5 billion or 15%, as the state oil company grappled with crude prices that last month extended a decline to the lowest in almost 13 years.  (2/10)

Cuba has total undiscovered technically recoverable reserves of 4.6 billion barrels of crude oil, 9.8 trillion cubic feet of natural gas and 900 million barrels of natural gas liquids, based on 2004 estimates by the United States Geological Survey. But even after the end of the 54-year US trade embargo, it’s not all about the reserves. It’s about past failures, an anticipated investor-unfriendly environment, and a lack of oil and gas infrastructure projects. (2/13)

Mexico’s president Enrique Peña Nieto has replaced the chief executive at Pemex, the state oil company that is bleeding cash because of the oil price slump, with instructions that all its units must become more profitable. (2/9)

The US drilling rig count plunged 30 units to 541 during the week ended Feb. 12, continuing another interval of steep declines amid a drilling slump that stretches back to late 2014. The count the previous week dived 48 units, the largest in nearly 11 months. The nadir of the 1998-99 downturn was 488 units on Apr. 23, 1999.  U.S. rigs targeting oil dropped by 28 to 439, while the gas rig count declined by 2 to 102. (2/13)

Tight oil production in the U.S. increased from 2007 through April 2015, based on estimates in EIA’s Drilling Productivity Report, and accounted for more than half of total US oil production in 2015. Tight oil growth has been driven by increasing average initial production rates from tight wells for nine consecutive years. (2/12)

For Oklahoma, EIA raised the estimated daily oil production by 100,000 barrels for 2014-2015. Oklahoma is one of the top 5 oil production states in the nation, accounting for an average of between 3 percent and 4 percent of the total output. (2/13)

US shale oil production will double from 4 million b/d to over 8 million during the next 20 years as drillers that became more efficient amid a slump in oil prices unlock new resources, BP said in its industry benchmark 2035 Energy Outlook. BP forecast global demand for energy to increase by 34 percent, driven by growth in the world population and economy. (2/11)

The US shale boom was built on high oil prices and low-cost financing, which enabled drillers to spend more than they earned while making up the difference with debt. (2/10)

Anadarko slashed its quarterly dividend 81% to conserve cash. Anadarko, one of the largest independent oil and gas producers in the U.S., reported a fourth-quarter loss as revenue dropped 35%. (2/10)

Loews Corp. CEO Jim Tisch said “chaos continues to reign over the energy market” after the slump in commodity prices fueled a fourth-quarter loss and stock decline. “If these pricing levels persist over the next two years, we’ll be in a drastically under-supplied oil market,” he said. (2/9)

Paragon Offshore is filing for bankruptcy.  Its bondholders have agreed to accept $345 million in cash and 35% equity in the restructured company in exchange for forgiving $984 million in debt. (2/13)

Chesapeake Energy, the No. 2 U.S. natural gas producer, said on Monday it had no plans to file for bankruptcy, after sources told Reuters the company had asked its counsel to look at restructuring options. (2/9)

U.S. oil and gas pipeline companies including Williams Companies and Kinder Morgan have contracts worth billions of dollars that might be at risk as Chesapeake Energy Corp aims to slash its debts amid collapsing energy prices. (2/9)

Refineries in the middle of the US are curtailing crude processing as profits shrink, leaving behind crude that’s adding to a supply glut and pushing prices to the lowest since 2003. (2/12)

The Obama administration is preparing to make a major offshore drilling regulation somewhat more favorable to the oil and natural gas industry, compared to a preliminary proposal issued last year. The regulations are aimed at preventing the kind of explosion that erupted more than five years ago on BP Deepwater Horizon rig. (2/10)

Two recent drinking water investigations in Texas show dangerous levels of contamination. The larger study tested 550 water samples collected from public and private water wells in the north Texas Barnett Shale region over a three-year period and found that the closer a water well is to a fracked gas well, the higher the concentration of contaminants including arsenic, selenium, strontium, and barium. (2/12)

The startup of US LNG exports, some of which will be headed for Europe, will shift market dynamics, creating a much more competitive European gas market, a senior official from US LNG pioneer Cheniere Energy said Wednesday. He said the US is going to create increasing competition, create abundance and create lower prices. (2/11)

Southern California Gas Company got control of a leaking well that spewed natural gas for nearly four months and uprooted thousands of Los Angeles residents.  Steps remain before the well will be considered permanently sealed off. (2/13)

The insurance industry is becoming the latest casualty of the oil price slump, with postponements and cancellations of energy projects forcing down premium rates and income in a market that was already crowded. Insurers forecast income could dive by 20 percent or more, possibly forcing some players to quit the energy part of a business that has attracted new entrants hoping for better returns during the era of ultra-low interest rates. (2/11)

U.S. retail gasoline price movements may buck historic trends and not move up dramatically on seasonal pressures, motor club AAA reports. Retail gasoline prices are at $1.73 nationally for a gallon of regular unleaded. The price is 25 cents less than one month ago and 45 cents lower than this date in 2015. (2/10)

Climate support: BP’s CEO Bob Dudley called on governments Wednesday to do more to encourage a shift to lower-carbon fuels, warning that the world is on course to see global temperatures rise to dangerous levels. Mr. Dudley was joined in his call for climate-change action by other energy-industry officials at International Petroleum Week, the first major western oil-sector conference since global leaders met in Paris in December. (2/11)

In China, carbon sequestration, the long-term storage of carbon dioxide through natural or artificial means, is seen as one of the best ways to mitigate global warming. Recent research shows that China can store another 3 billion tons of carbon through development of major projects covering 21 percent of its landmass. (2/11)

Short of water: Alarming new research has found that 4 billion people around the globe — including close to 2 billion in India and China — live in conditions of extreme water scarcity at least one month during the year. Half a billion, meanwhile, experience it throughout the entire year. (2/13)