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1. Oil and the Global Economy

Oil traded between $88-89 a barrel for most of last week with a quick excursion to a two-year high of $90.76 on Tuesday and a dip on Friday to close at $87.79. As has become usual in recent weeks, the state of China’s economy and the nature of the measures Beijing will impose to stem inflation was the oil markets’ major concern. In London, Brent crude continues to trade above $90 a barrel.

On Friday Beijing announced that it will increase its banks’ reserve requirements, leading oil traders to worry that an increase in interest rates is coming shortly. It is generally believed that higher interest rates would slow China’s growth more than simply increasing reserve requirements for banks.

The OPEC meeting in Quito ended without a decision to increase production. The leading “price hawks, ” Venezuela and Iran, who are already pumping as much as they can, do not want to see a production increase. They say that higher production costs and the falling dollar are eating into their real revenue. The Saudis reaffirmed their commitment to $70-80 oil and as usual suggested that current prices are due to speculation rather than inadequate supply. Some believe that if prices go much higher, the Saudis will quietly increase shipments rather than formally changing the nearly meaningless quotas and risking confrontation with other OPEC members.

China’s diesel shortage, which has been a major factor in the recent price run-up, may be easing a bit. Beijing’s crude imports jumped by 26 percent in November over October to support the increased diesel production. In addition, the Chinese halted diesel exports and imported at least 480,000 tons in the last two months. Lack of sufficient imports in October forced the Chinese to draw down on crude and product stockpiles. The completion of the autumn harvest and the start of the new year, which will bring a relaxation in restrictions on electricity production, should contribute to lower demand next month. Unusually cold winter weather and trouble supplying sufficient coal to coastal power plants could keep demand for imported oil higher than normal. Moreover, the recent drawdown in China’s stockpiles of crude and finished products likely will result in an increase of imports by 300,000 b/d for the next year or so as stockpiles are rebuilt.

Other factors contributing to the recent price increase are colder-than-usual weather across the northern hemisphere and increasing speculative interest by hedge funds. US crude inventories continue to decline. A better than expected report on Japan’s GDP and some hints that unemployment in the US might be easing a bit were also cited as factors supporting oil prices. As usual the European debt crisis continues to be of concern to oil traders.

Expectations of a major winter storm in the US sent natural gas prices higher last week. In the meantime the natural-gas glut has analysts forecasting that drilling will have to decline next year to keep supply and demand in balance and support prices.

The IEA says that the BP oil spill and the ensuing tougher regulations will set back development of new oil fields in the Gulf of Mexico by 12 to 18 months. The full impact of these delays will not be felt for another two or three years, however.

As the preliminary numbers come in, it is starting to look as if the 3rd quarter may have set a new record for global oil demand. A British energy consultant says that demand hit 88.3 million b/d, breaking the old record of 88 million set in the 4th quarter of 2007. Preliminary numbers are always suspect and revisions are to be expected. The IEA, however, is saying global oil consumption will be up on the order of 2.5 million b/d to an average of 87.4 million b/d this year.

2. The IEA’s Oil Market Report

In this month’s Oil Market Report, the IEA once again pushes its estimates for global oil demand higher with the increase for 2010 up by 130,000 b/d and for 2011 up by 260,000 b/d to an annual average of 88.8 million b/d. While the increase in demand this year will be 2.5 million b/d, next year’s increase in demand is forecast to fall to 1.3 million b/d as consumption in China slackens. The 2.5 million b/d increase in demand which will occur this year is the largest annual increase in at least 30 years.

The Agency says that November oil production increased by 400,000 b/d, largely due to increased output from Canada, Kazakhstan and Brazil. The IEA says that OPEC production in November increased by 45,000 b/d, while Platts says that OPEC production fell by 70,000 b/d last month. OPEC’s production capacity, however, is due to fall in 2011 due to depletion from existing fields and then increase between 2012 and 2015 as new projects come online. Much of this increase, however, is supposed to come from Iraq which is still very much of an open question.

The IEA’s monthly report notes that in retrospect demand for oil in the 3rd quarter was exceptional. Price increases were due mainly to market fundamentals rather than speculation. In making forecasts for 2011 and beyond, the Agency is faced with the problem of feedback from higher prices slowing growth or possibly even driving demand lower as happened two years ago. Last week OPEC released its monthly forecast for future demand. The cartel is forecasting that demand will increase by only 1.18 million b/d to an annual average of 87.1 million b/d next year – well below the 88.8 million b/d forecast by the IEA. While the lower OPEC forecast supports the cartel’s decision not to increase production at this time, it is also based on expectations that the global GDP increase in 2011 will not be as robust as some suggest.

3. Forecasts

Hardly a week goes by without some prestigious organization or analyst forecasting higher oil prices next year and in 2012. So far the most pessimistic forecast comes from Goldman Sachs which is talking about an average oil price of $100 a barrel in 2011. Considering that oil is currently only around $90, we are going to have to see oil prices at $110+ for a considerable part of next year for the $100 average in 2011 to prove out.

As we learned two years ago, at those prices the US and other economies start to come unstuck. Gasoline goes up about 25 cents a gallon for each $10 increase in oil so we are talking about $3.50 or higher gasoline for a considerable part of next year.

Another question is whether prices spike into triple digits as we saw in 2008, or just slowly drift upwards. The latter case presumably allows for more time to adjust and might be less damaging to the economy. We are already consuming oil at more than 4X the cost that it was a decade ago without what many see as undue consequences. Others ascribe much of the OECD’s current economic difficulties to energy prices.

The Wall Street Journal recently made the case that a spike is unlikely next year, citing such factors as larger OECD stockpiles, more spare OPEC production capacity, a weaker euro, and higher unemployment that will force people to cut back driving sooner rather than paying higher prices. There are so many cross currents and feedback loops in all this that there is no clear answer as to whether the global economy will be driven into another dip by rising oil prices.

4. US gasoline prices

With national average gasoline prices just a hair short of $3 a gallon and crude flirting with $90 a barrel, the main stream media, which has been focused on economic “recovery” for the past two years, is starting to take notice. Most papers start with facts of the price increase: gasoline up 34 cents a gallon in the last 12 months and the hardships it will cause to some consumers. From there, the papers vary with the point they are trying to make.

If a paper is trying to say that there may be an apocalypse just over the horizon, then it points out, as several have done, that IEA says oil peaked four years ago; the Fed’s quantitative easing policies will drive down the dollar and oil prices higher; and that the Chinese, Indians, Latin Americans and Arabs are increasing their demand for oil at a prodigious rate.

If, however, a paper wants to calm its readers’ fears, then it cites more transient events such as a cold snap, or a few new refineries opening in China, or perhaps the Fed’s plan to stimulate the economy by buying some Treasury bonds. The writer will trot out an expert who will assure readers that there is plenty of oil, refining capacity and transportation so the present price increase will not lead to serious dislocations; there is not an oil price bubble in the offing.

The more optimistic journalists point out that China’s economy is overheating and that it will soon have to rein in its demand for oil. They mention all that spare capacity in Saudi Arabia and that there will soon be torrents of oil coming from Iraq, Africa and Brazil. Their readers are left with the impression that $90 oil is really nothing to worry about. It depends on your point of view.

5. Managing China’s economy

Over the weekend, the Chinese held their annual economic policy setting conference and reaffirmed the shift to a more “prudent” monetary policy that was announced last week. Beijing also announced that its inflation during November which at 5.1 percent was at a 28-month high. Analysts note that China’s inflation is showing signs of spreading beyond food prices. On Friday the central bank raised reserve requirements for the third time, but the newly announced jump in inflation suggests that stronger measures such as an interest-rate increase feared by the oil traders may be in the offing.

China’s economy, however, has built up considerable momentum with exports increasing by 35 percent in November and imports increasing 38 percent, both year over year. The trade figures released Friday show that in November imports of many key commodities such as copper, crude oil, iron ore, and soybeans surged. Oil imports were up to 5.09 million b/d from an unusual 13-month low of 3.86 million in October. Some analysts say that import numbers like this suggest that China’s economy is in better shape than many believe. They add that there are no signs of economic slowdown that the markets have feared in recent weeks. The 4th quarter GDP numbers should give some insight into all this.

Last week the IEA warned that China’s “astonishing” 12.6 percent apparent increase in oil consumption during October was symptomatic of an economy overheating. The agency is forecasting a drop in consumption next year. The Chinese themselves however are expecting that economic growth as they define it will continue at something over 8 percent next year. Unless there is some sort of economic meltdown in the works that is not yet apparent, China’s demand for oil in the next six months could be higher than forecast.

Quote of the week

“The mistake is to read the market from London or New York; where there is a temptation to assume that the weakness of the local economies is the global reality. The reality however is that growth in China, India, Brazil or the Middle East is very strong.”

— Anonymous oil trading executive

Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)

  • China and India have resisted legally binding cuts in heat-trapping gases but want Kyoto Protocol signatories to commit to a new round of cuts from 2012. India has said for the first time that it will eventually consider a binding treaty. (12/10, #10; 12/11, #8)
  • UN climate conference participants have agreed to design a Green Climate Fund; to protect tropical forests; to share clean energy technologies; to raise an annual $100 billion for poor countries by 2020; to aim to limit the temperature rise to 3.6°F; and to take another year to decide whether to extend the Kyoto Protocol. (12/11, #9, 10)
  • Oil prices may soar to $200 a barrel if the world doesn’t move more rapidly to a clean-energy economy, says Virgin founder Branson. The billionaire predicts an “unbelievably painful” economic slump if governments don’t do more to encourage alternative fuels. (12/6, #15)
  • Deutsche Bank has raised coal price forecasts by up to 17 percent, saying export prices at Richards Bay, South Africa, will average $118 a ton next year and $140 in 2012. Demand will outpace supply by 28 million tons in 2011 and by 30 million tons the year after. (12/11, #11)
  • India will miss its target for installing additional electrical generation capacity for the five years through March 2012, due to weather and topography effects on some hydroelectric projects. (12/9, #17)
  • India doesn’t expect to deregulate diesel because global crude prices are rising. (12/6, #14)
  • Iraq’s oil exports will increase next year when two of four offshore mooring facilities start to operate. Iraq plans to start work soon on offshore facilities in the south where export capacity is due to increase to 4.5 million b/d by mid-2012 from current 1.8 million b/d. (12/6, #9)
  • Iran says it plans to boost domestic gasoline production by 62,000 b/d. (12/9, #8)
  • The Iranian government says warm weather allowed pollution to reach a “critical” level during the last four weeks. Tehran residents say sanctions and the government’s sale of low-quality gasoline produced in petrochemical plants have caused pollution blamed for an unofficial 2,500 deaths. (12/9, #9; 12/11, #13)
  • Talks between Iran and world powers on Tehran’s disputed nuclear program have ended in Geneva. No substantial breakthrough appears to have been achieved. Iran says another round has been agreed for Istanbul in January. (12/7, #10)
  • The Obama administration says the US and its allies have planned new sanctions to test “Iran’s pain threshold.” (12/11, #14)
  • In Nigeria, NNPC says that none of the nation’s four refineries are operating because of vandalism to crude supply pipelines. The petroleum minister says Nigeria must import all of its petroleum products in the next 18-24 months, until pipes are repaired. (12/9, #11)
  • A top Shell official bragged to US diplomats that her company infiltrated “all relevant ministries” involved in its Nigerian business, according to a leaked State Department cable. The official also discussed fears about militants in Nigeria’s southern delta. (12/9, #12)
  • Shell said last year if Nigeria’s oil reforms went ahead as planned the company could lose 80 percent of its offshore oilfield acreage, according to a leaked State Department cable. (12/11, #15)
  • Ugandan officials were likely bribed to support a bid by ENI for control of half of the country’s crude deposits, according to a leaked State Department cable. (12/11, #18)
  • Ecuador may seek investments in new oil fields from other OPEC nations after seizing licenses from Petrobras, Noble and other companies. (12/11, #19)
  • Venezuela has ordered foreign oil companies to develop plans to increase production at over 20 joint ventures within a month. Several companies want another month. (12/9, #18)
  • Venezuela President Chávez has had to make deals with foreign corporations to avoid the socialist revolution going broke, according to a leaked State Department cable. The memos suggest Chávez allies Argentina, Brazil and Cuba are gravely concerned at Venezuela’s direction. (12/11, #20)
  • The Delaware River Basin Commission has proposed uniform standards for regulations for combined horizontal drilling and fracking in the watershed. Despite objections from NY State, which is working on its own regulations, Pennsylvania, New Jersey, Delaware and the Corps of Engineers agree that three public hearings will be held on the standards by mid-March. (12/11, #26)
  • A Halliburton technician missed signals that BP’s Macondo well was about to blow out because he was on a smoking break, the technician has told investigators. (12/8, #14)
  • A university scientist and the federal government say they have found persuasive evidence that oil from the Gulf spill is settling on the ocean floor. (12/9, #18)
  • The Obama administration is retreating on long-delayed environmental regulations on smog and toxic emissions from industrial boilers, leaving in place Bush policies. (12/11, #24)
  • A Republican leadership panel has endorsed Rep. Upton to head the House Energy and Commerce Committee. He was chosen over Reps. Barton, Shimkus and Stearns. (12/8, #12)
  • Coal’s share of the US electricity market will plummet from 49 percent today to 25 percent by 2035 as supplies of natural gas expand and new pollution controls come into effect, says Black & Veatch. By 2035 gas’s share will rise from 21 percent to 40; renewables will spike from four percent to 11; and nuclear will increase slightly from 20 percent to 21. (12/7, #18)
  • YPF has discovered an estimated 4.5 trillion cu. ft. of non-conventional natural gas reserves off Argentina, which could supply the country for 50 years, according to the AP. (12/8, #11)
  • Sinopec will buy Occidental’s operations in Argentina for $2.45 billion. (12/10, #14)
  • Kuwait will invest $794.6 million, and France half that amount, in French nuclear engineering firm Areva. (12/10, #12)
  • Mexico’s Supreme Court has approved Pemex’s plans to award incentive-based service contracts to private companies that would receive a per-barrel fee to drill for oil. (12/9, #14)
  • Pemex is likely to post a seventh straight year of output declines in 2011: 2.55 million b/d next year, down from 2.58 million in 2010. (12/9, #13)
  • Upstream capital and operating costs rose in the 6 months ending in the third quarter of 2010, according to IHS CERA. The Capital Cost Index, which had fallen since 2008, rose 3 percent. The Operating Cost Index rose 1 percent. (12/10, #23)
  • Russia says it will supply all necessary natural gas to Europe this winter. (12/7, #21)
  • Gasoline shipments to the US from Europe are poised to drop this month after the profit from the trade tumbled to a six-week low. US gasoline was 1.1 cents a gallon cheaper than Europe’s on Dec. 6, the biggest discount since Oct. 21. (12/9, #4)
  • Natural gas prices may rebound next year as producers cut output for the first time in six years, the US Energy Department says. A 20 percent price drop this year will lead a decline in drilling for the fuel sold to factories, power plants and homeowners. Output will average 62.01 billion cu. ft. a day in 2011, down from a record of 62.09 billion this year. (12/10, #22)
  • BP is weighing the sale of North Sea assets that may raise up to $1 billion. (12/7, #22)
  • BP’s plans to sell two gas fields in Algeria to Russian partner OAO TNK-BP for $3 billion are being held up by Algeria’s refusal to release data on the fields to TNK-BP. (12/6, #15)
  • Desire, the UK energy explorer, has plunged after saying the Rachel North well off the Falkland Islands won’t produce oil. The news reversed the company’s Dec. 2 report that the well may have made a commercially viable find. (12/6, #11)
  • China’s boom in nuclear power plant construction is rekindling demand for uranium, leading to higher prices. In November Beijing announced plans to spend $511 billion to build 245 reactors in the next two decades, double previous plans. (12/9, #22)
  • B9 Energy, Britain’s largest wind-farm operator, has designed wind-powered sail ships to cut carbon emissions. (12/11, #30)
  • Konarka of Lowell, Mass., says its “Power Plastic” has set a new record for organic solar technology, with an 8.3 percent efficiency in converting sunlight into electricity. (12/10, #28)