Quotes of the Week

“Oil prices simply aren’t going to rise fast enough to keep oil and energy companies from defaulting. Then there is a real contagion risk to financial companies and from there to the rest of the economy.”

Jason Schenker, president and chief economist at Prestige Economics

“Put bluntly, the standard claim that the world has proved conventional oil reserves of nearly 1.7 trillion barrels is overstated by about 875 billion barrels. Thus, despite the fall in crude oil prices from a new peak in June 2014, after that of July 2008, the ‘peak oil’ issue remains with us.”

Professor Michael Jefferson of the ESCP Europe Business School, a former chief economist at oil major Royal Dutch/Shell Group, former Deputy Secretary-General of the World Energy Council

1.  Oil and the Global Economy

Analysts are starting to wonder as whether 2016 could turn out to be similar to 2015 when oil prices rose sharply in the first five months of the year on hopes that the oil surplus would soon be over, and then collapsed in May when it became apparent that there was going to be more oil around than necessary. Last week the price surge which began in February continued throughThursday and then slowed on Friday leaving London futures at $48.13 at the close and New York at $45.92. The impetus for the surge is that that hedge funds and other speculators are convinced that the two-year price slump is over and that higher prices are ahead. This forecast is supported by the steady decline in the US rig count, which continued last week; a continuing drop in US crude production which the EIA projects will continue into next year; a weaker dollar due to the Federal Reserve’s failure to increase interest rates; increased consumption of gasoline in the US due to low prices; market technical analysis showing prices breaking various “ceilings;” and news of a string of production outages across the globe due to insurgencies and unsettled economic conditions.

Most analysts and financial institutions are saying that the recent price increase of more than 70 percent since January has been too much too soon and that the fundamentals do not support such a rapid increase. They cite the increasing global crude stockpiles, both on shore and at sea, and the recent increases in oil production by Iran and the Saudis which is offsetting the drop in US shale oil production. While there are several geopolitical situations around the world which have reduced oil exports in recent months, most of these are of a temporary nature and are likely to be reversed shortly.

The US economy and that of the EU are growing rather slowly which is keeping the demand for distillates low.   The price of gasoline in the US has been rising in the last few weeks which will make it less attractive for discretionary travel. Chinese refiners are producing more diesel and gasoline than their country can consume, so the surplus is being dumped on the world market. Some see a gasoline glut currently developing.  While the massive cutbacks of capital expenditures on exploring for and drilling new oil wells will eventually have a major impact on the supply and price of oil, it is likely to be another year or two before the full impact is felt.

There are, however, at least three geopolitical developments that could drive prices sharply higher in the near term. These are the political/economic upheavals going on in Venezuela, Nigeria, and Iraq. Evidence is mounting that one or more of these countries could be engulfed by so much political turmoil in next few weeks or months that their combined oil production of nearly 7 million b/d would be affected. Oil stoppages on the order of millions of barrels a day would almost certainly drive oil prices much higher. As with most efforts to forecast oil prices, there are simply too many forces at work to come to a conclusion as to which just which forces will prevail, even in the short run. Over the next two years or so, oil prices will almost certainly be higher due the drop in investment and contraction of the industry. It is the timing of this increase where the uncertainty lies.

Last week saw much bad news from across the oil industry with profits plunging, credit ratings being reduced and workers let go. Particularly hard hit has been the oil services industry that makes its money supporting exploring and drilling operations which have been sharply curtailed. The economies of those states that have been benefiting from the shale oil bonanza are reporting souring economic conditions with loan delinquencies and bank losses on the rise. Offshore drillers are being hit particularly hard as the cost of producing deepwater oil in now well over $100 a barrel making the economics of starting new projects prohibitive. Last week, however, a new well was started off Uruguay in 11,000 feet of water setting a new record, but it is unlikely that many new deepwater wells will be started until prices recover back into the $100s. The IMF reports that Middle Eastern oil exporters are on track to receive some $500 billion less for their oil this year as compared to 2014.

2.  The Middle East & North Africa

Iran: Tehran’s oil production in April is estimated to have increased by 300,000 b/d to 3.5 million. This jump was a major contributor to the 484,000 b/d climb in OPEC production to 33.2 million b/d during April. An Iraqi increase of 160,000 b/d and a Saudi increase of 80,000 b/d offset the drop in production of 100,000 b/d in Kuwait due to a short-lived strike. The Iranian production increase is somewhat of a surprise as analysts were predicting that it would take many months to get back close to pre-sanctions levels.

An expo will be held in Tehran this week to highlight opportunities to participate in expanding Iran’s oil and gas industries. There are indications that the number of foreign companies attending this event will be less than the Iranians had hoped for. This suggests that doing business with Tehran and the opportunities it will offer are still an object of suspicion as hardliners in the government are reluctant to see foreigners earn much profit from exploiting Iranian oil.

Tehran is very upset over the court-ordered seizure of $2 billion worth of Iranian assets to compensate victims of terrorist attacks that were allegedly perpetrated by or with the aid of the Iranian government. Naturally, Iran denies any involvement in terrorist activities abroad and sees anything less than a full protest and retaliation as a tacit admission of participation in terrorist activities abroad.

Syria/Iraq:  The situation in both countries deteriorated markedly last week. The battle for Aleppo in Syria is destroying large parts of the city, while in Baghdad mobs have stormed the parliament building inside the fortified Green Zone to protest the endless delay in forming a new government. The attack on the Green Zone, which was led by supporters of the cleric Moqtada Sadr, has sparked the worst political crisis since the US invasion in 2003.  The survival of Prime Minister al-Abadi is in doubt.

The problem comes from the balancing of political parties, tribal affiliation and the distribution of power inside the government.  If Prime Minister al-Abadi does not survive the current crisis, a prolonged period of turmoil is likely. This will probably delay efforts to dislodge ISIL from Mosel and raises issues as the future of the oil industry which for now continues to increase production. The crisis is raising the issue as to whether it is time to consider partitioning Iraq into independent states though just how this can be done with ISIL occupying a large part of the country is debatable. Obviously, the distribution of the oil fields and revenues will be a major stumbling block in developing a workable partition plan.

Last year Iraq was the fastest growing OPEC exporter and seems likely to continue to increase its exports this year unless the political turmoil overwhelms the country. Exports from the north are not going well, however, as there are increased ethnic problems in Kirkuk. In Iraqi Kurdistan, the government is intensifying negotiations with Tehran to build a new pipeline that would export oil through Iran to bypass the political problems of exporting through Turkey. Turkish air raids on Kurdish separatist camps in Iraq continue.

In Syria, heavy fighting continues in and around Aleppo. Casualties from government airstrikes on the city are mounting.  The food crisis is growing worse as the fighting is interfering with farming in many parts of the country and is destroying much of the infrastructure which supports agriculture.  This is only going to add the the ever-growing humanitarian/refugee crisis which is engulfing the region.

Libya: The key issue at the minute is the status of the rumored EU intervention with sufficient ground forces to stabilize the situation; halt refugee flow across the Mediterranean; eliminate the Islamic State hold on several cities; and hopefully to restore oil production to pre-uprising levels.

Last week the National Oil Company outlined an ambitious plan to restore oil production in the country although full recovery to 1.6 million b/d will take several years due to the damage that has been inflicted on facilities by militia groups and the Islamic State attacks. The first phase of the recovery, which could be implemented in a couple of months, if the political situation is settled, however, would bring some 430,000 b/d back into production. The remainder of Libya’s production would be implemented slowly over several of years as much damage has to be repaired requiring considerable investment.

Last week a shipment of 650,000 barrels of crude left the eastern port of Hariga. This shipment was negotiated by the Tobruk government representing the old parliament and was vigorously protested by the new UN-backed unity government in Tripoli. In the past, such “illegal” shipments have been halted by force. There are still issues of who is willing to buy oil subjected to UN sanctions.

Saudi Arabia/Yemen: There is general agreement that the new Saudi plan to transition its economy from reliance on oil exports to a major financial center controlling much industry will not get very far. Most are wondering where the $2 trillion that the Saudis will need to accumulate to establish an investment fund will come from. Selling off 5 percent or less of Saudi Aramco will not do it. Many are questioning whether Saudi Arabia, where most of the real work and technical expertise is done by foreigners, has the human and fiscal resources to do much more than pump oil and keep a lid on society. There are also concerns as to whether the “reforms” that are coming will tear the social fabric that has been maintained for decades by oil-financed subsidies.

For now, however, things are going well. Oil prices are up and oil production was slightly higher in April.  Cuts in government spending have slowed the pace at which net foreign assets were being depleted to only 1 percent in March. The new reforms mostly involved cutting subsidies for the wealthy, and cuts in new government projects. The Saudis also intend to increase oil production in the next few months in order to meet the demand for summer air conditioning without cutting back on exports significantly.

The war in Yemen continues. Last week during the ceasefire between the Saudi coalition and the Houthis, coalition forces pushed al Qaeda out of the port city of Mulkalla. The Saudis say some 800 al Qaeda fighters were killed in the operation. Over the weekend, however, Houthi forces attacked a military base north of Sanaa that was held by an army unit that had declared its neutrality and never took part in the fighting. The Houthi attack brought the ceasefire to at least a temporary end so the war continues.

3.  China

Business remains lackluster despite government efforts to spur the economy. Government data for April shows almost no growth in the manufacturing sector and a slight improvement in the “services” sector. Bad loans are increasing and South Korea reports an 18 percent year on year drop in its exports to China. While sales for many Chinese firms are holding up, customers are not paying their bills as promptly as they used to and receivables are increasing along with other forms of debt. The conclusion that China’s economy is barely expanding seems to remain valid.

The number of crude oil tankers headed for China continues to increase. Oil currently arriving in China was likely purchased last winter at very low prices and is just now reaching Chinese ports. Bloomberg says that China is stockpiling oil at the fastest pace in at least a decade with some 800,000 barrels going into inventory during the first quarter.

Like many of its Western counterparts, the China National Petroleum Corp. reported that its profits in 2015 fell — by 52 percent– due to lower oil prices and that revenues fell by 26 percent. With the state owning the largest oil companies, however, the government can manipulate profits. Sinopec, which is a major refiner, was able to earn large profits on its refining operations as government regulations set gasoline prices artificially high while crude prices were unusually low.

4. Russia

Rising oil prices are giving Moscow’s economy a much-needed boost as the ruble has risen only 2.8 percent in the past month while the price of oil is up nearly 20 percent. This improvement comes as the government contends with its biggest deficit as a percentage of economic output in the last six years.  Moscow is studying the possibility of selling off some of its stake in Russia’s largest oil companies as a means of increasing revenue. During the banner years of $100+ oil prices, the government moved to gain control over much of the industry.

The bad news for Moscow is that its manufacturing declined to an 8-month low in April, missing forecasts as demand deteriorated. A combination of low oil prices and the EU sanctions imposed over the Ukraine led to a 1.4 percent contraction in Russia’s economy in the first quarter.

The government is making an effort to entice oil traders to buy and sell oil futures in rubles on its own commodity exchange. It is hoped that this will increase the revenue it gets for its Urals crude by disassociating it from the Brent benchmark.  For decades, Moscow has had to sell its lower quality crude at a discount to the Brent price which is assessed by the Platts Agency. There is concern that with the Kremlin so heavily involved in Russia’s oil industry that it has many opportunities to manipulate the price of crude. The exchange was started in 2008 and Moscow decreed that Russian producers sell between 5 and 10 percent of their domestic transport fuel through the exchange. Foreign traders are still skeptical.

5. Venezuela

By every measure, Venezuela is a country on the verge of collapse. Some see the state degenerating into a Somalia-like situation with armed gangs running various parts of the country and trying to make deals to export oil. The workweek is down to two days a week for many if not most workers. Imports soon will be down by close to 60 percent. Foreign companies are not being paid and are pulling out.  The government no longer reveals information about the Guri dam which now is providing some 70 percent or more of the country’s electricity.  Nationwide blackouts of at least 4 and probably more hours a day are in place. Medicines and other vital supplies are no longer available. Should the dam have to close in the next few weeks to avoid damage to its turbines, it is difficult to see how much longer the country can keep exporting oil.

To cope with the 700 percent inflation, the country has been importing plane loads of new currency. However, this has now stopped as the currency printers were not being paid.

Schlumberger and Halliburton are cutting back their activity as Venezuela’s principal oil service contractors due to lack of payments for their services.  This alone will likely cut into the country’s oil exports. The failure of the electric power grid will be a more serious issue, but likely to be short lived as rains sufficient to restore some level of electric power are certain to return at some point. The economic crisis is more of a problem, for the low-quality, heavy Venezuelan oil has been yielding well below world prices when exported. There is simply not enough money left to jump-start economic growth in the immediate future.

The opposition has garnered 600,000 signatures on a recall petition, but to oust the current President in a referendum will require a vote of 7.6 million — the number that President Maduro received in the 2013 election. Even if he is ousted, the constitution provides that the vice-president takes over so little change in government policies could be expected.

This situation currently is the leading candidate to force oil prices higher in the next six months.

5.  The Briefs

The European Union released data on Friday showing that the overall economy of the 19 countries that use the euro advanced 0.6 percent over the first three months of the year, compared with the previous quarter. That gain, equivalent to an annual rate of 2.2 percent, brought the Eurozone’s gross domestic product for the period to slightly above the previous peak reached in the early months of 2008—an underwhelming milestone.  Eurozone unemployment still hovers around 10%. (4/30)

Russian President Vladimir Putin is on the verge of realizing a decade-old dream: Russian oil priced in Russia. The nation’s largest commodity exchange is courting international oil traders to join its emerging futures market. The goal is to increase revenue from Urals crude by disconnecting the price-setting mechanism from the world’s most-used Brent oil benchmark. Another aim is to move away from quoting petroleum in U.S. dollars. (4/28)

Norway’s Statoil reported its worst-ever adjusted earnings as crude prices fell the lowest in almost 12 years. Still, the company beat estimates for a loss as cost savings are having an effect. (4/28)

Italian oil company Eni plunged to a net loss in the first quarter, hurt by accounting changes related to disposals and low crude oil prices. It posted a net loss for the quarter of €792 million ($897.8 million) compared with a net profit of €832 million in the same period a year earlier. (4/29)

BP said it could cut capital spending further after reporting an 80 percent drop in profits in the first quarter of the year, when oil prices touched a near 13-year low. The British oil company lowered its 2016 spending target to $17 billion, from $17-19 billion, and said the marker could fall to $15-$17 billion next year if oil prices remain weak. (4/27)

Uganda and Tanzania will in the coming days meet to fine-tune the work plan for the development of the proposed 1,400 km crude oil export pipeline that will run from Hoima District in Uganda to the Indian Ocean port of Tanga in Tanzania. The target date for completion will be 2020. (4/30)

In Nigeria, a conference of political parties has issued a seven-day ultimatum to the Ministry of Petroleum Resources to end fuel queues cross the country or face mass protests from organized labor, civil society groups and the general public. (4/30)

Petroleos Mexicanos posted a loss for the 14th consecutive quarter as massive spending cuts diminish the state oil producer’s ability to arrest years of declining production. (4/29)

The US oil rig count fell to a fresh six-year low this week, by 11 to 332, down almost 80 percent from the peak of 1,609* oil rigs in October 2014.  The tally of gas rigs dropped by 1 to 87, taking the total rig count to 420. The previous low of 488 total rigs set in 1999 was eclipsed March 11 and has continued to plunge. (4/30)

(*NOTE: recently, including this week, several news stories have been erroneously using the 1,609 rig figure as the total rig count at the peak during the fall of 2014, instead of the 2014 oil rig count at that 2014 peak.)

Defaulting: Ratings agency Standard & Poor (S&P) reported this week that 46 companies have defaulted on their debt this year—the highest levels since the depths of the financial crisis in 2009. The total quantity in defaults so far is $50 billion. Half this year’s defaults are from the oil and gas industry, according to S&P, followed by the metals, mining, and the steel sector. Among them was coal giant Peabody Energy. (4/25)

Big Oil bummer: BP reported an 80 percent decline in earnings, and ExxonMobil lost its coveted AAA credit rating from Standard & Poor’s Ratings Services, which Exxon has held uninterrupted for more than eight decades. Low oil prices are still wreaking havoc on the industry, hollowing out profits and forcing companies to cut back on spending and personnel. (4/28)

Exxon Mobil saw its profit plunge 63% to the lowest level since 1999, a year when it nearly doubled in size by acquiring rival Mobil in an $80 billion deal. The sharp decline came amid a loss from its business producing oil and natural gas, one that largely came from operations in US shale basins. (4/30)

Chevron Corp. on Friday said it would cut another 1,000 jobs as it reported a wider-than-expected loss as oil prices continued to languish during the first quarter. The newly announced layoffs, which will happen later this year, will bring Chevron’s job cuts to 8,000 employees, or 12% of its workforce. (4/30)

ConocoPhillips is reducing spending further as it posted the fourth straight quarterly loss amid an oil rout that continues to strain independent producers. The 2016 capital budget was lowered by 11 percent to $5.7 billion, primarily driven by cuts to deep-water exploration activity, deferrals and lower costs across the portfolio. (4/29)

Hess Corp. said it was producing more from its US assets than in late 2015, even as it reported a loss for the first quarter of the year. Hess reported net production from the Bakken shale reserve area in North Dakota in Montana was up 2.7 percent from the fourth quarter to 110,000 barrels of oil equivalent per day. (4/28)

Chesapeake Corp. has had little refuge from both oil and gas market chaos in recent quarters. CHK reported a $2.2 billion loss in its most recent quarter, reflecting the market carnage. After a collapse of 90 percent in the 12 months ending in February, the company’ stock price has recovered over one-quarter of its losses. (4/27)

Otto Energy, an Australian company, said it made an oil discovery in the Gulf of Mexico that was productive enough to keep drilling to ensure the entire targeted region will be evaluated. (4/28)

Seattle activists who took on Shell offshore Alaska turned their eye to Exxon, while opponents on the east coast raised objections to ongoing energy work there. Activists from 350 Seattle said they’re set to deliver more than 10,000 signatures to state officials calling for the state of Washington to divest from Exxon Mobil. (4/30)

Fracking =’s quakes? Pennsylvania environmental regulators want to determine whether a series of minor earthquakes in the state this week were caused by nearby fracking operations by an oil and gas company. (4/30)

Pipeline blocked: The New York State Department of Environmental Conservation (DEC) denied a key permit to companies seeking to build a 124-mile pipeline. The Constitution Pipeline Project was proposed to transport fracked natural gas from Susquehanna County in Pennsylvania through three counties in New York to existing interstate pipelines. Using the power granted under the Clean Water Act, DEC officials rejected the companies’ permit application, citing damage the project would do to water supplies along the pipeline route. (4/27)

Mortgage problems: The slump in crude prices is starting to show up as missed payments by consumers in the oil patch. In states from Oklahoma and Texas to North Dakota and Wyoming, rising unemployment in the energy sector is pushing up loan delinquencies and raising the risk of new losses for banks.  Over the last two quarters, 119,600 of the nation’s oil and gas jobs—22% of the total—were laid off, making it very difficult to cover mortgage payments. (4/28)

Ford Motor Co. reaped the benefits of its costly F-150 truck revamp, doubling income in its first quarter and posting a North American operating margin rivaling those returned by luxury brands. Ford is among auto makers benefiting from record US light-vehicle demand and low gasoline prices. (4/29)

U.S. natural gas companies are laying steel pipes, some beneath the Rio Grande riverbed, to export billions of cubic feet more US shale gas to markets in Nuevo León, Guanajuato, and other Mexican states. The shipments could quietly uncork a glutted US market, rivaling volumes of much-hailed new liquefied natural gas (LNG) exports from the coasts. Bigger gas sales to Mexico could not come soon enough for energy producers. The warmest winter on record left 2.5tn cubic feet of gas in US storage, the most ever for the end of the heating season. (4/26)

Chernobyl tomb: A workforce of around 2,500 people is finishing a massive steel enclosure that will cover Chernobyl’s reactor 4, where the radioactive innards of the nuclear plant are encased in a concrete sarcophagus hastily built after the disaster. If all goes to plan, the new structure—an arch more than 350 feet high and 500 feet long—will be slid into place late next year over the damaged reactor. (4/25)

The American Wind Energy Association said it expects wind’s contribution to America’s electricity supply to double over the next five years. A quarterly report from the AWEA said more than 500 megawatts of new wind energy were added to the U.S. grid during the first quarter and construction started on another 2,000 MW. (4/30)