By Tom Whipple

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

1.  Oil and the Global Economy

Several factors combined last week to send oil prices to their biggest weekly drop in nearly two years. At week’s end, New York futures were down to $94.25 after having traded above $100 the week before last. London prices fell about $5 a barrel last week to close at $107 after Libya announced that a 350,000 b/d oil field that has been closed by protestors for the past two months may open this week.

The drop in NY prices was aided by a stronger dollar and the weekly stocks report which showed the demand for distillates fell sharply the week before last. A 7 million barrel drop in the US crude inventory was dismissed by traders as the normal year-end tax avoidance manipulation of inventories by refiners. US oil production in the lower 48 was flat the week before last, but did creep up by 10,000 b/d in Alaska where production has been gradually declining for years.

Record cold weather is currently engulfing much of the northern US. This is certain to increase the demand for heating oil in the next week or so and to slow shale oil production in North Dakota where temperatures are expected to fall as low as 25oF below zero.

Natural gas futures, which have been falling from recent highs above $4.50 per million for the last two weeks, were volatile on Friday as traders weighed an EIA report showing a much smaller than expected inventory drawdown against the prospects of much colder weather in the week ahead. Natural gas closed Friday at $4.30.

2.  The Middle East & North Africa

Iraq:  The long anticipated civil war in Iraq seems to be coming to fruition as heavy fighting broke out in Sunni majority Anbar Province last week among Shiite dominated government forces, local Sunni tribesmen, and the Iraqi version of Al-Qaeda who engaged in a three way brawl to control the cities of Falluja and Ramadi. The troubles began two weeks ago when a party of government security officials was ambushed in the region and 15 senior officers were killed. In retaliation the Maliki government decided to close the camp that Sunni protestors have occupied for many months only the road to Jordan.. Al Qaeda and other Sunni tribal forces rushed to repel the government assault and heavy fighting began.

At week’s end Al Qaeda with the aid of local Sunni tribal militia seems to have driven central government officials and troops from Fallujah and raised the Al Qaeda flag over the town, declaring it an independent Islamic state. In Ramada, the local Sunni tribes apparently dislike Al Qaeda worse than the Shiite government, so they ended up helping the government at least temporarily maintain  control of the town. Washington is obviously concerned about Al Qaeda taking over an Iraqi city but says it will deal with the issue through military aid to the Iraqi government and will not send US troops.

So far the Sunni-Shiite-Kurd conflicts have only resulted in a modest reduction of Iraqi oil exports but if the fighting increases, it is only a matter of time before Al Qaeda and other Sunni militants go after the major source of government strength which is the oil exports. Two weeks ago Sunni militants slaughtered a crew who were building a pipeline to bring Iranian natural gas into Iraq to power its electric stations. If this sort of thing continues, Baghdad will have to spend substantial resources protecting oil workers or see foreigners depart the country;

Iraqi oil exports for 2013 averaged about 2.3 million b/d as storms, construction on the export facilities, and periodic attacks on the northern export pipeline slowed shipments. During the next two years, Baghdad hopes to increase its exports by some 3 million b/d as new oil production and improved exports facilities come on line.  Given the political and security situation in the country the chances that these plans will come to fruition seem dim.

The UN reports that circa 9,000 Iraqis died in bombings and other forms of violence last year, the highest in five years. Given that hundreds will likely be killed in the current round of fighting in Anbar province, this toll will likely increase in 2014.

The Iraqi Kurds got their new 300,000 b/d pipeline to Turkey working last week. The Turks say the crude will be moved by pipeline to the oil export port of Ceyhan, Turkey and held there until an agreement is reached with Baghdad to sell the oil on the world markets. Although Baghdad is loath to let the Kurds sell their oil independently, given the troubles the Maliki government is facing at the minute, it may be willing to let the Kurds do their own thing in return for a piece of the pie.

Syria/Lebanon: The situation continues to deteriorate on many fronts which is resulting in more human suffering in the region. The government continues to drop bombs on civilians in Aleppo in hopes of retaking what is left of the city someday. The rebels have blown the main natural gas pipelines supplying fuel to Western Syrian power stations including those supplying Damascus. Although this has happened before, the explosion on Friday was unusually large so that it may be a while before power is restored. Prior to the blast, Syria’s Electricity Minister reported that electricity production in the country was already down by 50 percent due to insurgent attacks.

Fighting between radical and more moderate insurgents is being reported more frequently in Northern Syria as Al Qaeda tries to take over the uprising. The Syrian insurgents launched an offensive last week to drive Hezbollah fighters from towns near the Lebanese border resulting in a deployment of the Lebanese Army to the region.

Hezbollah is reported to be taking advantage of the turmoil to smuggle long range missiles into Lebanon in order to threaten Israel. As we have seen many times in the past this is one of the best ways to get Israeli forces involved in the Syria/Lebanon situation. As Hezbollah is now the backbone of the Syrian government’s offensive capability, it is in a position to blackmail the Syrians into handing over anything in their arsenal.

Hezbollah’s intervention in the Syrian uprising in order to insure that they will continue to have an open supply line to Iran is starting to have serious repercussions back home in Lebanon. Hezbollah and Lebanese Sunnis have started to assassinate each other’s leaders and Al Qaeda has started to bomb Hezbollah dominated neighborhoods in Beirut.

The most important impact of the Syrian uprising on oil exports is likely to come through the Sunni-Shiite confrontation in Iraq. Already Al Qaeda fighters are moving freely across the border between eastern Syria and Iraq with Baghdad and Damascus powerless to stop the flow of men and weapons. The whole region seems on the verge of becoming a bunch of failed states with local and tribal leaders and warlords controlling the remains of Syria, Lebanon, and Iraq.

Libya: The government announced Monday that the local tribes who shut down the 300,000 b/d Al Sharara oil field have agreed to reopen the field this week. A spokesman for the protesters, however, said that the plant will be shuttered again unless Tripoli agrees to meet their demands, including increased services for the city, within two weeks. The announcement pushed down Brent oil prices that have been climbing in recent weeks due to the virtual elimination of Libyan oil exports. The situation in Libya is inherently unstable so that any agreements are likely to be short lived.

3. Shale oil

The large deficits being run by the US shale oil and gas industry are starting to be reported in the financial press. Last week the Wall Street Journal ran a story that large foreign investments in US shale oil and gas leases are drying up rapidly. In 2013, foreign companies spent only $3.4 billion on stakes in US shale formations which was less than half 2012 investments and a tenth of what they spent in 2011.

The reason for this decline is that while some wells may be profitable, overall drilling and producing shale oil and gas is simply not. In 2012, 80 big energy companies in the US spent a combined $50.6 billion more than they brought in from energy operations. This was twice as high as in 2011 and four times as high as 2010. For 2013, the deficit is on track to reach roughly $25 billion.

With losses like these it is no wonder that foreign investors are bailing and staying out of the US shale market. Exxon says it has lost in shirt in shale gas, Shell has written down the value of its US shale properties by $2 billion, and BHP has written down its US properties by $2.8 billion.

With foreign investment, which has been the backbone of the US shale oil and gas boom, drying up, US drillers are turning to Wall Street to finance the thousands of new wells that they need to drill and frack annually to maintain and increase production. In the past, foreign investors were less interested in whether oil wells were profitable, but were more interested in gaining access to US oil reserves and fracking technology.

US investors, however, will only be interested in whether the wells are profitable. As the “sweet spots” for drilling in US shales shrink, money for drilling new wells may shrink even faster than the availability of good places to drill.

To top off the shale industry’s problems, the recent explosion of tank cars carrying Bakken crude, which is clearly far more volatile than conventional crude, has caused the US government to warn that stricter regulations of crude carrying railroad trains is ahead.

While it is too early to declare an end to the great US shale oil boom, there are clear signs of troubles just ahead.

4. Quote of the Week

  • “Since 2008, deep-pocketed foreign investors have subsidized the U.S. energy boom, as oil and gas companies spent far more money on leasing and drilling than they made selling crude and natural gas. But the rivers of foreign cash are running dry for U.S. drillers. In 2013, international companies spent $3.4 billion for stakes in U.S. shale-rock formations, less than half of what they invested in 2012 and a tenth of their spending in 2011, according to data from IHS Herold, a research and consulting firm. It is a sign of leaner times for the cash-hungry companies that have revived American energy output. The value of deals involving U.S. energy producers plunged 48% this year from 2012, to $47 billion, the first annual decline since 2008. So U.S. oil and gas producers have started to slash spending.”

— (The Wall Street Journal, Jan 2)

5. The Briefs

  • Russian oil output rose by 1.3 percent to 10.5 million b/d during 2013, the nation’s fifth annual increase in a row. They reached a record high for the post-Soviet era, driven by continuing strength in global oil prices. (Jan 2)
  • Russia’s record 2013 oil output allowed the Kremlin to maintain record spending from an overstretched budget. Energy has been the engine of Russia’s growth during the last a decade, with oil and gas accounting for more than half of budget revenues. But the government has been increasingly overstretching its finances due to social spending as well as a swelling $50 billion budget for the 2014 Winter Olympics. (Jan 3)
  • Exxon Mobil and Russia’s Rosneft are set to start their first Arctic well this year, targeting a deposit that may hold 9 billion barrels. It will kick off a series of landmark projects and cement an alliance begun in 2011. They also plan to frack shale fields in Siberia, sink a deep-water well in the Black Sea and build a natural-gas export terminal in Russia’s Far East. (Jan 2)
  • Trouble around the tar sands: scientists have found a nearly 7,500-square-mile ring of land and water contaminated by mercury surrounding the tar sands in Alberta. Government scientists are preparing to publish a report that found levels of mercury are up to 16 times higher around the tar sand operations. (Dec 30)
  • US crude-oil imports fell to the lowest level in almost 16 years as domestic output rose, the US EIA reported. Shipments of foreign crude fell 1.1 percent to 7.41 million barrels a day, the fewest since January 1998. (Jan 4)
  • The US drilling rig count fell 6 units to settle at 1,751 rigs working last week, Baker Hughes reported. Oil rigs lost 4 units to 1,378 and gas rigs dropped 2 to 372. Meanwhile in Canada, the oil rig count shot up 21 units to 152, with gas rigs down 2 rigs to 130, giving the country 282 total units. Canada has 24 more rigs compared to a year ago. (Jan 4)
  •  A steep fall in oil prices would choke off production at some US fields and quickly tighten supplies. Harold Hamm, CEO of Continental Resources, the largest producer in the Bakken shale of North Dakota, said if an oversupply of oil drove the price down to $70 a barrel, it would hurt the US industry, but would quickly correct itself because it would make marginal production uneconomic. His assessment suggests that oil prices are likely to remain at around Friday’s level of about $100 a barrel for benchmark US West Texas Intermediate crude. (Dec 30)
  • Safety rules for oil shipped by rail will probably be tightened on crude shipments from North Dakota following a string of railway explosions. The type of oil pumped from the shale formations of North Dakota may be more flammable and therefore more dangerous to ship by rail than crude from other areas. (Jan 4)
  • US gasoline prices will probably be 5 cents a gallon less in 2014 than in 2013 as refineries produce more fuel, AAA said. The price of regular gasoline averaged $3.49 a gallon in 2013, $3.60 in 2012 and $3.51 in 2011. (Jan 1)