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Tom Whipple, Editor

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

1.  Oil and the Global Economy

The week’s news was dominated by the Sunni extremists’ offensive against government-held cities in northern Iraq. By week’s end insurgent forces were within 60 miles from Baghdad and oil prices were up some $4 a barrel on fears that Iraq’s oil production of 3.3 million b/d could be disrupted.  New York futures closed Friday at $106.91 and London at $113.41 after topping $114 during the day.

The OPEC meeting in Vienna agreed to leave the cartel’s production quota unchanged at 30 million b/d. The decision was largely symbolic as most members are pumping as much as they can given their individual circumstances.  Around the world some 3.5 million b/d have been taken off the market in the past year or so due to various geopolitical upsets in oil-exporting countries. Recent increases in US shale oil production have been enough to make up for some of this loss but not enough to keep prices from rising. In its monthly report, the IEA notes that there has been an apparent increase in China’s strategic crude reserve averaging 1.2 million b/d which has also been contributing to the higher prices. The Agency expects global oil demand in 2014 will increase from 91.4 million b/d in the 1st quarter to 94 million in the 4th quarter. It is this forecast which has the IEA calling for increased OPEC oil production or the world will see higher prices before the year is out.

US natural gas prices were unusually volatile last week. After falling for three days on the theory that there will be enough surplus produced this summer to refill the storage caverns before winter, prices took a 25 cent per million jump on Thursday after the weekly injections report did not show as much gas had been stored away as analysts had been expecting. By Friday, however, prices were weaker again as revised weather reports forecast that the rest of June will enjoy normal temperatures for the time of year across most of the country.

So far there has been little reaction at the gas pump to the surge in crude prices brought on by the Iraqi and Ukrainian crises. The US retail price for regular is currently $3.65 per gallon – the same as last week and only up a couple of cents in the past month. Just prior to the new Iraqi crisis the EIA was expecting that US gasoline prices would only be up about 4 cents per gallon this summer over last year.  Given the dangers of a supply disruption implicit in the Iraqi situation, gasoline is likely to be higher before the summer is out.

2.  The Middle East & North Africa

Iraq: The suddenness of the Sunni insurgent offensive which captured Mosel and then drove some 200 miles south to the outskirts of Baghdad came as a complete shock. Four Iraqi army divisions were routed with little resistance and large stocks of US-supplied military equipment were captured by the insurgents. The week’s event showed how weak the Maliki government’s control over the Sunni controlled areas of the country really was and likely has opened a new chapter in the modern history of the Middle East.

Currently the Sunni offensive is halted a few dozen miles outside of Baghdad along the line where Sunni-majority towns and cities turn into Shiite majorities. The Maliki government, which seems unlikely to remain in office much longer, talks of driving back the insurgent forces, but considering how little success it has had in Anbar province in the last six months, this seems unlikely without foreign intervention. The Sunni extremists’ talk of driving into Baghdad, turning out the Maliki government and then moving south to destroy the hated Shiite shrines which are located south of Baghdad seems a stretch.

Thus further movement south by the extremists seems unlikely for now. The remaining ten divisions of the Iraqi Army consist of better led and motivated troops who would be fighting Sunni extremists for their lives and would be unlikely to run as they did in the north. Any move to capture Baghdad or to bypass it to move against southern cities would likely be met by foreign intervention in the form of US airpower and Iranian troops, some of which may already be in the country.

The Sunni surge resulted in other developments that are important to the future of Iraq and its oil production. When the Iraqi Army abandoned the oil center of Kirkuk just outside the border to Kurdistan, Kurdish forces moved in and seized the city while skirmishing with the Sunni insurgents.  While this move was ostensibly to keep the Sunni extremists at bay, in reality it fulfilled a decades-old goal of the Kurdish people to incorporate their historic capital into the Kurdish semi-autonomous province. This of course would leave a larger, if not a preponderant, share of the oil in northern Iraq in the hands of the Kurds. Another important result of the Sunni surge was the capture of the Baiji oil refinery north of Baghdad which is the source of the fuel for much of Iraq including for its electricity generation. For now the refinery continues to function, but if the Sunni extremists continue to hold the facility Baghdad would be in a lot of trouble.

What does all this mean for Iraq’s oil production? For the immediate future, the southern oil fields which produce the bulk of the exports remain safe from the Sunni extremists – at least this is what the IEA and the Iraqi government are telling us. The thinking is that there are simply too many Shiites, the bulk of the Iraqi Army, US airpower, the Iranian Army, and a growing force of highly motivated Shiite militiamen between the Sunni extremists and the oilfields for an attack into the region to be successful. This does not rule out increased sabotage and bombings however.

In the longer run, there are numerous problems which do not bode well for Iraqi oil exports. The country is now effectively partitioned into Sunni, Kurd, and Shiite sectors.  While the Shiites have the capitol and the bulk of the oil, the Sunnis have some important assets including control of much of the country’s water and oil refining capacity. Baghdad is between governments at the minute and the task of forming a new one became much more difficult last week.

The most likely course seems to be an indefinite standoff between the Shiite government and the newly strengthened Sunni extremists. Even if the southern oilfields remain in Shiite hands, it would not take much to drive the foreign oil companies from the country, seriously damaging Iraq’s oil production and its potential to increase production in coming years. Beyond this, what looks like the beginning of a major Sunni-Shiite conflict with a well-defined front has implications for much of the region including the Gulf Arab States that produce so much of the world’s oil.

Iran:  The offensive in Iraq has changed the tone of the US-Iranian relationship markedly in the past week as both share an interest in seeing that the Sunni extremists do not succeed in overrunning Baghdad and destroying sacred Shiite shrines in southern Iraq. Some are already saying that Iranian boots on the ground and US airpower would be the combination that could stop and reverse the extremist threat to southern Iraq. Such a development would have many profound, but unpredictable consequences for relationships in the Middle East.

The nuclear talks resume this week with mixed reports as to their progress. Tehran remains optimistic that an agreement can be reached before the 20 July deadline, but others talk of “obstacles” to an agreement,

Libya: Oil production has now fallen to the vicinity of the 120,000 b/d or so that is consumed domestically and it is doubtful that much will be exported in the near term. Over the weekend the Libyan oil ministry announced that the 80,000 b/d El Feel oilfield was back in production after being shut down by protestors with various grievances against the government.  The renegade general, Haftar, launched an offensive against Islamist forces in Benghazi on Sunday. Heavy fighting is taking place there and residents are fleeing to the deserts. No end to the turmoil and resumption of exports is anywhere in sight.

3.  China

Beijing may be anticipating a jump in world oil prices for it has been importing an additional 1.2 million b/d for the last two months to build its strategic reserves. Many, including the IEA, are attributing this new source of demand as a major factor in increasing world oil prices.

China’s May exports were up by 7 percent over last May, but imports fell 1.6 percent suggesting that the economy still has troubles. Electricity consumption, which is a good indicator of economic growth, was up by 5.2 percent in the first five months of 2014.

Chinese President Xi stressed the need for the country to revolutionize energy supply and consumption as the country faces growing environmental problems and a changing global energy market.

The controversy with Japan and Vietnam over oil rights in the South China Sea continued last week. Chinese fighter planes buzzed a Japanese patrol plane, while Beijing has taken the fight with Vietnam over its oil rig to the UN. Beijing says Vietnamese ships have rammed its vessels near an oil rig more than 1,000 times.

4. Ukraine

Fighting continues in the eastern Ukraine as Kyiv moves to drive the separatists out of the government installations they have been occupying. Evidence of Moscow’s involvement in the fighting increased when the separatists used an advanced surface to air missile to shoot down a Ukrainian military transport plane killing 49 military personnel. Three unmarked T-64 tanks showed up in separatist hands in the Ukraine and Washington verified that they came from inside Russia.

Gazprom reduced the flow of natural gas to Ukraine on Monday after the failure of last minute negotiations over the weekend. Moscow raised its price for gas from $326 per 1000 cubic meters to $485 in April in order to pressure the Ukrainians into joining a customs union with Belarus and itself. Ukraine is willing to pay the lower price, but Moscow insists that it must be paid $1.9 billion for gas already delivered immediately. The impact of less gas flowing into Ukraine is not clear. Since the opening of the Nordstream pipeline under the Baltic, Ukraine has become less significant as a transfer point for Russian gas going to Europe.

5.  Quote of the Week

  • “Shale will not take off in Mexico like it did in Texas in the near future. Unless the security situation along the northeastern border improves significantly, smaller companies will probably take their time before jumping in.”

— Dwight Dyer, a senior analyst at the consulting company Control Risks

6.  The Briefs

  • OPEC said Thursday it expects the global economy in 2014 will need 29.7 of its crude oil per day, 400,000 less of its crude oil than it did last year. (6/13)
  • Saudi Arabia expects to boost its crude output in the second half of this year, an oil official with the Kingdom said Monday. The remarks are the clearest signal to date that the OPEC kingpin will respond to rising demand as the group prepares to meet in Vienna on Wednesday. OPEC sees demand for its oil rising by about 1 million barrels a day in the second half of 2014, compared with the preceding six months. (6/10)
  • In Iraq, Russia’s Lukoil said it has fulfilled its contractual obligations for the West Qurna-2 field and production is above 200,000 b/d. (6/11)
  • In Iran, China’s Sinopec has doubled production at its Yadvaran oil project, from 25,000 b/d to 50,000 b/d, a rare success as the country struggles to revive its flagging oil output. The push is part of a broader attempt by China and Iran to mend fences after the cancellation of a $2.5 billion oil-field deal with a different Chinese state-owned giant. (6/11)
  • In Saudi Arabia frequent protests by the Shia minority have gone largely unreported. But a co-production headed by a BBC reporter investigated how three years of civil unrest have continued in the eastern province in spite of a violent government crackdown. (6/11)
  • Kazakhstan’s giant Kashagan oil field, one of the world’s largest industrial projects, won’t produce any oil until at least 2016. The project’s partners have concluded they must entirely replace two 55-mile pipelines, at a cost of “a few billion dollars,” before they can restart production. (6/11)
  • In Pakistan, Hungarian energy company MOL said Tuesday it made an oil discovery close to estimated reserves of 22 million barrels. With a test-well flow rate of 5,500 b/d, oil production from the site could come on stream as early as this month. Pakistan, with a population of 188 million, had total oil production from 2012-13 just over 70,000 b/d. (6/11)
  • In Chad, Chevron sold its interest in oil producing assets for about $1.3 billion to the national government. The oil and gas company had a 25 percent interest in the properties. (6/14)
  • Kenya, Uganda and Tanzania plan to allocate money in their annual budgets to spur investment in infrastructure to exploit oil and natural gas from deposits discovered since 2006 that companies including Tullow Oil are developing.  (6/11)
  • Circle Oil, an Irish exploration company with a focus on the Middle East, said it started an offshore drilling campaign in Tunisia. The company said it estimates there may be as much as 46 million barrels of oil in the prospect, above its commercial threshold of 10 million barrels of oil. Tunisian oil production has declined steadily since reaching a peak of 120,000 b/d in 1980. (6/11)
  • A Vietnamese surveillance agency said Wednesday an oil rig stationed by China in disputed waters has moved under guard by six warships. The External Relations Committee at the Vietnamese National Assembly sent a letter to lawmakers saying China’s actions were provocative. (6/11)
  • China told the United Nations that Vietnam is the aggressor in the countries’ month-long standoff over a Chinese oil rig in disputed waters, defending Beijing’s conduct and positioning itself as the victim in the conflict. (6/11)
  • Mexico:  While oil shale drillers in Texas have had to contend with environmental opposition and soaring costs, a few miles south of the border in Mexico workers preparing to drill oil shale there have to duck gunfire sprayed from drug traffickers. (6/13)
  • In Canada, more than 98,000 oil sands construction, maintenance and operations jobs will be generated over the next decade, according to a new report “the Oil Sands Construction, Maintenance and Operations Labour Demand Outlook to 2023”. (6/13)
  • In Canada, a Vancouver-based company said on Tuesday it was planning to build a $10 billion oil refinery on the north-west coast of British Columbia that could eventually process up to 1 million b/d of oil sands bitumen. (6/11)
  • Approving Canada’s planned Northern Gateway oil pipeline will be an outrage to the aboriginal community, a tribal leader said. Canadian company Enbridge Energy aims to build its 550,000 b/d Northern Gateway pipeline to the coast of British Columbia. The pipeline received conditional approval from the National Energy Board, the country’s independent regulator, and a final decision is expected before the end of the month. (6/11)
  • Canadian oil and gas trade group on Monday lowered its long-term outlook for oil-sands production by 400,000 b/d, or 7.7 percent, to 4.8 million b/d, citing higher costs and deferment of projects. The group also said overall oil production in Canada will likely rise from 3.5 million b/d in 2013 to 6.4 million b/d by 2030, which is 300,000 b/d below its forecast a year ago. (6/10)
  • Total US crude oil production in 2015 will reach its highest level since 1972, the US Energy Information Administration forecasts in its Short-Term Energy Outlook. Production, which averaged 7.4 million b/d in 2013, is expected to average 8.4 million b/d in 2014 and 9.3 million b/d in 2015.
  • The US oil and natural gas rig count fell by six to 1,854 rigs last week, but is up 83 rigs from the 1,771 total posted in the comparable week a year ago, Baker Hughes said. US gas rigs declined 10 to 310 while the oil rig count rose by six to 1,542. (6/14)
  • A four-decade-old US ban on crude exports should remain until a “saturation” point when domestic refining capacity becomes insufficient to absorb increased oil production, according to Goldman Sachs. Maintaining the statutory curb on shipments overseas will deliver the “highest value” to the U.S. economy, the bank said. (6/11)
  • The Senate Energy and Natural Resources Committee will vote on legislation Wednesday that would approve the Keystone XL oil pipeline. It is expected that the committee will approve the bill. (6/14)
  • Oil and natural gas disruptions from hurricane activity in the Gulf of Mexico may be three to four times higher than last year. (6/13)
  • Oklahoma is poised to become the third-largest oil producing state following a strong surge in oil production in 2013 and 2014. The rise in production began when tax incentives for horizontal drilling were started. Total oil production in the state in March, 2014 was up 17 percent over year-earlier figures, averaging 388,000 b/d. (6/10) [NOTE:  Oklahoma is currently in 6th place, well behind Alaska’s 500,000+ b/d rate.]
  • American Energy Partners, the company started by Aubrey McClendon after he was pushed out as CEO of Chesapeake Energy Corp, said it would acquire shale oil and gas assets in Texas, Ohio and West Virginia for $4.25 billion. (6/10)
  • UK-focused shale gas firm Cuadrilla Resources is a step closer to beginning fracking operations in the northwest of England after Lancashire County Council formerly validated and accepted an application to drill four shale gas exploration wells in the county. (6/11)
  • Last week the head of Russia’s state-owned Gazprom, which supplies Europe with 30 percent of its natural gas, announced the oil company would shift “nine out of 10” payment contracts from dollars to euros, with the ultimate goal of transitioning those contracts to rubles or renminbi. Undercutting the dominance of the US dollar as international reserve currency has long been an ambition of the world’s emerging economies, spearheaded by the BRICS nations — Brazil, Russia, India, China and South Africa. (6/9)
  • LNG exports: The United States and Canada will account for about 8 percent of the global liquefied natural gas market by 2019, the International Energy Agency said. “While demand growth is driven by the Asia-Pacific region, and especially China, supply growth for the international gas trade is dominated by private investments in LNG in Australia and North America. (6/11)
  • LNG exports: a proposed change in way the US Department of Energy approves application for permission to export LNG will streamline the process by focusing on the projects that have the greatest chance of being built, a DOE official said in Houston Monday. (6/10)
  • In India, scorching summer heat caused power outages and triggered protests in the capital, underscoring the challenges the country’s new government faces as it strives to improve dilapidated energy infrastructure and restore India’s appeal as an investment destination. (6/11)
  • In China, despite being based in one of the world’s biggest and most polluted car markets, electric-car maker BYD until recently sold few of its hybrid or battery-powered electric cars outside of its home province of Guangdong, thanks to a system of local subsidies. Those rules are now changing under a new effort by China’s central government to push local authorities to treat equally all Chinese car makers when granting green subsidies.  (6/9)
  • Americans are willing to bear the costs of combating climate change, and most are more likely to support a candidate seeking to address the issue. By an almost two-to-one margin, 62 percent to 33 percent, Americans say they would pay more for energy if it would mean a reduction in pollution from carbon emissions. (6/11)
  • The Scottish government said it has reduced its greenhouse gas emissions by 26.4 percent since 1990 and is on pace to hit 42 percent by 2020. The government aims to generate the equivalent of 100 percent of its annual electricity consumption through community and locally-owned renewable energy resources by 2020. (6/11)