Category Archives: Energy

WSJ Sounds The Alarm: “There’s No Getting Over” Gas at $4 a Gallon

Consumers, who are already being squeezed by rising interest rates (even as the return on their cash deposits remains anchored near zero), are facing another potential constraint on their already limited purchasing power. And that constraint is  rising gasoline prices, which, as we pointed out last month, could erode the stimulative impact of President Trump’s tax plan as rising prices sop up what little money the middle class is saving.

As prices rise and banks scramble to update their forecasts, the Wall Street Journal has become the latest publication to sound the alarm over what is, in our view, one of the biggest threats facing the US economy in the ninth year of its post-crisis expansion. 

In its story warning about $3 a gallon gas (of course, we’re already seeing $4 a gallon in parts of California and other high-tax states), WSJ cited Morgan Stanley’s latest projection that rising gas prices could wipe out about a third of the annual take-home pay generated by the tax cuts.

Rising fuel costs can also feed inflation and pressure interest rates. Even though the Federal Reserve typically looks past volatile energy prices in the short term, higher energy costs help shape consumer confidence. And with the central bank poised to be more active this year, rising energy costs pose an additional risk to the economy.

Morgan Stanley estimates that if gas averages $2.96 this year, it would take an annualized $38 billion from spending elsewhere, an upward revision from the bank’s $20 billion estimate in January. That would wipe out about a third of the additional take-home pay coming from tax cuts this year, the analysts said.

Patrick DeHaan, petroleum analyst at GasBuddy”Three dollars is like a small fence. You can get through it, you can get over it,” said Patrick DeHaan, petroleum analyst at GasBuddy, a fuel-tracking app. “But $4 is like the electric fence in Jurassic Park. There’s no getting over that.”

Of course, MS’s take appears downright pollyannaish when compared with a Brookings Center report that we highlighted last month.

The left-of-center think tank, which of course has every reason to hope that the next recession will materialize on President Trump’s watch, projected that consumers would soon spend about half of the money saved from tax cuts on fuel costs.

And in a report published in April, Deutsche Bank illustrated how rising fuel costs will disproportionately squeeze the most vulnerable among us – a cohort of consumers who already shoulder an outsize share of the country’s household debt.

https://www.zerohedge.com/sites/default/files/inline-images/2018.05.15db.jpg?itok=H0g5_RQa

The FT put it another way…

https://www.zerohedge.com/sites/default/files/inline-images/2018.05.15ft.jpg?itok=HdnzBFje

As the chart above shows, middle-income families – aka the engine of consumption – will be the hardest hit by rising gas prices.

Indeed, small business owners in California, where gas prices are the fifth highest in the nation thanks to taxes and stringent emissions standards, say they’ve seen their energy bills shoot higher in the past few months. Car salesmen say consumers are asking more questions about mileage, according to WSJ.

Robert Lozano, a car salesman in Los Angeles where some gas prices are already above $4, said the dealership’s gas bill has climbed from about $9,000 to about $12,000 a month recently.

Customers are inquiring more about electric vehicles, he said.

“It’s more in the consumer’s mind as to what the most efficient vehicle is.”

With oil already at $70 a barrel, early indicators imply that the summer driving season could see an unusually large spike in demand for gas…

https://www.zerohedge.com/sites/default/files/inline-images/2018.05.15vacations.png?itok=oOyR1nG8

…As the number of Americans intending to take vacations in the next six months climbs to its highest level in decades.

Heightened vacation intentions suggest the number of vehicle miles driven will also climb (because people tend to travel greater distances when they go on vacation). As the chart below shows, fluctuations in miles driven – a close proxy for gas demand – are quickly reflected in prices at the pump.

https://www.zerohedge.com/sites/default/files/inline-images/2018.05.14gascorrelation.png?itok=Q3j2fPOJ

While the US’s increasing prominence in the oil-export market could soften some of the economic blow as the energy business booms, other large business from airlines to shipping companies would feel the pinch at a time when costs are already rising.

But some economists say the growing importance of energy to the U.S. economy could blunt some of the impact from rising oil prices.

The country has become a more prominent supplier of crude oil and fuel. Domestic production has reached record weekly levels of 10.7 million barrels per day and a lot of it is being exported.

[…]

“People don’t understand how we could double crude oil production” and see higher gas prices, said Tom Kloza, global head of energy analysis at the Oil Price Information Service. “The answer lies in the balance of payment. We are an exporting power right now.”

[…]

Airlines and shipping companies will also be paying more for jet fuel and diesel – costs that may be passed along to consumers. Even companies such as Whirlpool Corp. have noted that higher oil prices have boosted the cost of materials.

Refiner Valero Energy Corp. said it wouldn’t expect consumer demand to drop off until oil prices are at $80 to $100.

But demand is only one factor driving up oil prices. Supply issues have also weighed on oil traders’ minds. Traders pushed oil prices higher as the US pulled out of the Iran deal as some worried that it could impact global supplies (though, as we’ve pointed out, there are plenty of other buyers waiting to step in and buy Iranian crude). Even if the Iranian crude trade isn’t impacted by sanctions, plummeting production capacity in Venezuela could ultimately have a bigger impact on global supply.

Conflicts in other oil producing regions could also impact supplies, pushing prices higher.

Last week, Bank of America became the first Wall Street bank to call $100/bbl for Brent crude (at the time, it was trading around $77/bbl) in 2019. That could send prices to highs not seen since 2008. Other banks have been scrambling to raise their forecasts as well. 

With the Fed changing its language in its latest policy statement to reflect rising inflation expectations, rising oil prices could also inspire the Fed to hike interest rates more quickly for fear that the economy might overheat. That could result in four – or perhaps five – rate hikes this year.

The resulting effect would be like economic kudzu strangling the buying power of consumers and possibly forcing a long-overdue debt reckoning as millennials, who are already drowning in debt, are forced to put off home ownership and family formation until they’re in their late 30s or even their 40s.

Source: ZeroHedge

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In Unprecedented Move, China Plans To Pay For Oil Imports With Yuan Instead Of Dollars

Just days after Beijing officially launched Yuan-denominated crude oil futures (with a bang, as shown in the chart below, surpassing Brent trading volume) which are expected to quickly become the third global price benchmark along Brent and WTI, China took the next major step in challenging the Dollar’s supremacy as global reserve currency (and internationalizing the Yuan) when on Thursday Reuters reported that China took the first steps to paying for crude oil imports in its own currency instead of US Dollars.

https://www.zerohedge.com/sites/default/files/inline-images/2018-03-26_5-47-22.jpg

A pilot program for yuan payments could be launched as soon as the second half of the year and regulators have already asked some financial institutions to “prepare for pricing crude imports in the yuan“, Reuters sources reveal.

According to the proposed plan, Beijing would start with purchases from Russia and Angola, two nations which, like China, are keen to break the dollar’s global dominance. They are also two of the top suppliers of crude oil to China, along with Saudi Arabia.

A change in the default crude oil transactional currency – which for decades has been the “Petrodollar“, blessing the US with global reserve currency status – would have monumental consequences for capital allocations and trade flows, not to mention geopolitics: as Reuters notes, a shift in just a small part of global oil trade into the yuan is potentially huge. “Oil is the world’s most traded commodity, with an annual trade value of around $14 trillion, roughly equivalent to China’s gross domestic product last year.” Currently, virtually all global crude oil trading is in dollars, barring an estimated 1 per cent in other currencies. This is the basis of US dominance in the world economy.

However, as shown in the chart below which follows the first few days of Chinese oil futures trading, this status quo may be changing fast.

https://www.zerohedge.com/sites/default/files/inline-images/china%20oil%20trading.jpg?itok=qPyOsjfZ

Superficially, for China it would be a matter of nationalistic pride to see oil trade transact in Yuan: “Being the biggest buyer of oil, it’s only natural for China to push for the usage of yuan for payment settlement. This will also improve the yuan liquidity in the global market,” said one of the people briefed on the matter by Chinese authorities.

There are other considerations behind the launch of the Yuan-denominated oil contract as Goldman explains:

  • A commercial benchmark and hedging tool. Until now, Chinese oil imports were based on FOB benchmarks, with long-term procurement contracts settling off Platts Oman/Dubai or Dated Brent. The INE contract has therefore the potential to become the pricing reference for CIF China crude oil, enabling corporate financial hedging. Its warehouse structure is however likely to limit its use for physical crude delivery and may in fact at times reduce its hedge efficiency.
  • A new investment vehicle for onshore investors. The majority of China commodity futures trading volumes are from retail investors, yet these had until now little ability to trade oil futures. China’s capital control was the main bottleneck  to trading contracts like Brent as authorities only allow $50,000 outflow a year per person. While several petrochemical and bitumen contracts already trade in China, INE will be the first contract for crude oil, likely drawing significant interest.
  • Direct access to China’s commodity markets for offshore investors. China offers deep and liquid commodity markets to its onshore investors. Due to China’s tight capital controls, however, foreign investors have so far only been able to trade these through qualified onshore subsidiaries. The INE contract opens up the first channel for offshore investors to trade in its onshore commodity market, with both the USD deposit and capital gains transferable back to offshore accounts. The government further announced last week that it would waive income taxes for foreign investors trading these new contracts for the first three years. The obligation to trade in Yuan will also add a currency risk exposure to offshore investors. We illustrate in Exhibit 6 a likely template (amongst others) of how overseas investors will be able to access INE liquidity.

https://www.zerohedge.com/sites/default/files/inline-images/China%20petrodollar%20gs%201.jpg?itok=9RV49Cj0(Click to enlarge)

The danger, of course, is that such a shift would also boost the value of the Yuan, hardly what China needs considering it was just two a half years ago that Beijing launched a controversial Yuan devaluation to boost its exports and economy.

Still, in light of the relative global economic stability, Beijing may be willing to take the gamble on a stronger Yuan if it means greater geopolitical clout and further acceptance of the renminbi.

https://www.zerohedge.com/sites/default/files/inline-images/China%20oil%20imports%20gs.jpg?itok=jERHtMYK

Which is why restructuring oil fund flows may be the best first step: as of this moment, China is the world’s second-largest oil consumer and in 2017 overtook the United States as the biggest importer of crude oil; its demand is a key determinant of global oil prices.

https://www.zerohedge.com/sites/default/files/inline-images/petroyuan-1024x587_0.png?itok=KbUyMQWr

If China’s plan to push the Petroyuan’s acceptance proves successful, it will result in greater momentum across all commodities, and could trigger the shift of other product payments to the yuan, including metals and mining raw materials.

Besides the potential of giving China more power over global oil prices, “this will help the Chinese government in its efforts to internationalize yuan,” said Sushant Gupta, research director at energy consultancy Wood Mackenzie. In a Wednesday note, Goldman Sachs said that the success of Shanghai’s crude futures was “indirectly promoting the use of the Chinese currency (which, however as noted above, has negative trade offs as it would also result in a stronger Yuan, something the PBOC may not be too excited about).

Meanwhile, China is wasting no time, and Unipec, the trading arm of Asia’s largest refiner Sinopec already signed a deal to import Middle East crude priced against the newly-launched Shanghai crude futures contract, which incidentally is traded in Yuan.

The bottom line here is whether Beijing is indeed prepared and ready to challenge the US Dollar for the title of global currency hegemon. As Rueters notes, China’s plan to use yuan to pay for oil comes amid a more than year-long gradual strengthening of the currency, which looks set to post a fifth straight quarterly gain, its longest winning streak since 2013.

In a sign that China’s recent Draconian capital control crackdowns have sapped market confidence in a freely-traded Yuan, the currency retained its No.5 ranking as a domestic and global payment currency in January this year, unmoved from a year ago, but its share among other currencies fell to 1.7 percent from 2.5 percent, according to industry tracker SWIFT.

A slew of measures put in place in the last 1-1/2 years to rein in capital flowing out of the country amid a slide in yuan value has taken off some its shine as a global payment currency.

But the yuan has now appreciated 3.4 percent against the dollar so far this year, with solid gains in recent sessions.

“For PBOC and other regulators, internationalization of the yuan is clearly one of the priorities now, and if this plan goes off smoothly then they can start thinking about replicating this model for other commodities purchases,” said a Reuters source.

Still, it will be a long and difficult climb before the Yuan can challenge the dollar and for Beijing to shift the bulk of its commodity purchases to the yuan because of the currency’s illiquidity in forex markets. According to the latest BIS Triennial Survey, nearly 90% of all transactions in the $5 trillion-a-day FX markets involved the dollar on one side of a trade, while only 4% use the yuan.

* * *

Still, not everyone is convinced that the new Yuan-denominated contract will create a “petro-yuan” as the following take from Goldman highlights:

The launch of the INE contract is not just about oil, as it will also be the first Yuan denominated commodity contract tradable by offshore investors. Such a set-up meets the PBOC’s monetary policy committee goal to raise the profile of its currency in the pricing of commodities. It has raised however the question of whether the INE contract is an incremental step in achieving the currency reserve status for the Yuan. We do not believe so.

While the INE launch does represent an additional step in the CNY internationalization, the CNY denomination of the INE contract does not in itself imply CNY investments. The INE contract does not represent an opening of China’s capital accounts since foreign deposits operate in a closed circuit, deposited in designated accounts and not to be used to purchase other domestic assets. In practice, the collateral deposit and any capital gains can be transferred back to offshore accounts. The potential for greater foreign ownership of Chinese assets is therefore not impacted by CNY oil invoicing and would require instead oil exporters to recycle their proceeds in local assets, for example. The incentive to do this has not changed with the introduction of the INE contracts. In particular, most Middle East oil producers still have currencies pegged to the dollar and limited ability to hedge CNY exposure.

Whether or not Goldman is right remains to be seen, however it is undeniable that a monumental change is afoot in global capital flows, where the US – whether Beijing wants to or not – will soon be forced to defend its currency status as oil exporters (and investors in this highly financialized market) will now have a choice: go with US hegemony, or start accepting Yuan in exchange for the world’s most important commodity.

https://www.corbettreport.com/update-china-to-start-paying-yuan-for-oil/

Source: ZeroHedge

 

Venezuela Just Stopped Accepting US Dollars for Oil As Countries Join Forces to Kill US Petrodollar

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In what is the latest move to undermine the imperial world order maintained by the United States, which is underpinned through use of the petrodollar as the world reserve currency, the Wall Street Journal reports that Venezuelan President Maduro has officially followed through on his threat to stop accepting US Dollars as payment for crude oil exports in the wake of recent US sanctions.

Last Thursday, President Nicolas Maduro said that if the US went ahead with the sanction, Venezuela would “free” itself from the US Dollar.

According to Reuters:

“Venezuela is going to implement a new system of international payments and will create a basket of currencies to free us from the dollar,” Maduro said in a multi-hour address to a new legislative “superbody.”

Unsurprisingly, Maduro noted that his country would look to the BRICS countries, and begin using the Chinese yuan and Russian ruble instead — along with other currencies — to bypass the US Dollar stranglehold.

Rather than work diplomatically with other nations, the United States often uses sanctions to force compliance. Due to the dollar being accepted as the world’s reserve currency, almost all financial transactions are denominated in dollars. This phenomenon gives the US a powerful weapon to wield against states that refuse to follow US directives, and underpins the unipolar model of global domination exercised by the US.

Interestingly, the decision by Venezuela – the nation with the world’s largest proven oil reserves – comes just days after China and Russia unveiled an Oil/Yuan/Gold plan at the recent annual BRICS conference. This plan would strongly undermine the hegemonic control the US enjoys over the global financial system.

During the BRICS conference, Putin unveiled a geopolitical/geoeconomic bombshell as he forwarded the notion of a “fair multipolar world.” He emphasized a stance “against protectionism and new barriers in global trade” — a reference to the manner in which US operates its empire to maintain primacy.

 

Russia shares the BRICS countries’ concerns over the unfairness of the global financial and economic architecture, which does not give due regard to the growing weight of the emerging economies. We are ready to work together with our partners to promote international financial regulation reforms and to overcome the excessive domination of the limited number of reserve currencies.

“To overcome the excessive domination of the limited number of reserve currencies” is simply a nice way of saying that the BRICS will create a system to bypass the US dollar, as well as the petrodollar, in an effort to undermine the unipolar paradigm embraced by the United States.

As we previously reported, China will soon launch a crude oil futures contract priced in yuan that is fully convertible into gold.

What this means is that countries who refuse to bend to the imperial will of the United States, i.e. Russia, Iran, etc., will now be able to bypass US sanctions by making energy trades in their own currencies, or in Chinese yuan – with the knowledge that they can convert the yuan into gold as added incentive/insurance/security.

The yuan will be fully convertible into gold on both the Shanghai and Hong Kong exchanges. Typically, crude oil is priced in relation to Brent or West Texas Intermediate futures, both denominated in U.S. dollars.

“The rules of the global oil game may begin to change enormously,” said Luke Gromen, founder of U.S.-based macroeconomic research company FFTT.

This new paradigm of oil, yuan, and gold is, without question, an international game changer. The key takeaway here is that the US dollar can now be bypassed without so much as a second thought.

Russia and China – via the Russian Central Bank and the People’s Bank of China – have been steadily working on ruble-yuan swaps as a means of hedging against US hegemony.

There is a strategic movement to take these actions beyond the BRICS, first allowing aspiring “BRICS Plus” members, then entire Global South to divest themselves from dependence on the US dollar.

Essentially, Russia and China are working together to usher in a new paradigm of Eurasian integration, something that goes directly against US strategic doctrine – which dictates that Russia and China, the United States’ two main geopolitical rivals, should never be allowed to dominate Eurasia.

“In 2014 Russia and China signed two mammoth 30-year contracts for Russian gas to China. The contracts specified that the exchange would be done in Renminbi [yuan] and Russian rubles, not in dollars. That was the beginning of an accelerating process of de-dollarization that is underway today,” according to strategic risk consultant F. William Engdahl.

Russia and China are now creating a new paradigm for the world economy and paving the way for a global de-dollarization, and Venezuela is just the beginning.

“A Russian-Chinese alternative to the dollar in the form of a gold-backed ruble and gold-backed Renminbi or yuan, could start a snowball exit from the US dollar, and with it, a severe decline in America’s ability to use the reserve dollar role to finance her wars with other peoples’ money,” Engdahl concludes.

Make no mistake that the BRICS are not only working to integrate Eurasia, but to geo-economically integrate the entire Global South under a new multipolar framework that treats states as equals, regardless of their power stature globally.

The Neolibcons in Washington – bent on eventual regime change in Russia and China – are in for an extremely rude awakening. Although the BRICS have their own structural economic problems, they have created a long-term plan that will change the face of geopolitics/geo-economics and degrade the imperialist will of those that wish to dictate and order the world as they see fit.

The DC War Party’s petrodollar imperialism, which funds the US war machine and allows for a constant war footing, is quickly running out of allies to maintain its global hegemony.

Video Commentary:

By Jay Syrmopoulos | Activist Post

De-Dollarization Accelerates: China Readies Yuan-Priced Crude Oil Benchmark Backed By Gold

The world’s top oil importer, China, is preparing to launch a crude oil futures contract denominated in Chinese yuan and convertible into gold, potentially creating the most important Asian oil benchmark and allowing oil exporters to bypass U.S.-dollar denominated benchmarks by trading in yuan, Nikkei Asian Review reports.

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The crude oil futures will be the first commodity contract in China open to foreign investment funds, trading houses, and oil firms. The circumvention of U.S. dollar trade could allow oil exporters such as Russia and Iran, for example, to bypass U.S. sanctions by trading in yuan, according to Nikkei Asian Review.

To make the yuan-denominated contract more attractive, China plans the yuan to be fully convertible in gold on the Shanghai and Hong Kong exchanges.

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Last month, the Shanghai Futures Exchange and its subsidiary Shanghai International Energy Exchange, INE, successfully completed four tests in production environment for the crude oil futures, and the exchange continues with preparatory works for the listing of crude oil futures, aiming for the launch by the end of this year.

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Source: ZeroHedge

Oil Rally Not Sustainable Says Russian Central Bank

Summary

  • The Russian central bank sees several catalysts that could stop the oil rally in its tracks.
  • Bearish rig count report from Baker Hughes could signal a reverse in direction.
  • Supply will continue to increase rather than slow down in 2016 – even if there is a decline in shale production.
  • Battle for market share is one of the major catalysts not being considered.

I believe it’s very clear this oil rally is running on fumes and was never the result of an improvement in fundamentals. That means to me this rally is going to quickly run out of steam if it isn’t able to run up quicker on existing momentum. I don’t see that happening, and it could pull back dramatically, catching a lot of investors by surprise. The Russian central bank agrees, saying it doesn’t believe the price of oil is sustainable under existing market conditions.

Cited by CNBC, the Russian central bank said, “the current oil market still features a continued oversupply, on the backdrop of a slowdown in the Chinese economy, more supplies originating from Iran and tighter competition for market share.”

In other words, most things in the market that should be improving to support the price of oil aren’t. That can only mean one thing: a violent pullback that could easily push the price of oil back down to the $30 to $32 range. If the price starts to fall quickly, we could see panic selling driving the price down even further.

I think most investors understand this is not a legitimate rally when looking at the lack of change in fundamentals. I’ll be glad when the production freeze hoax is seen for what it is: a manipulation of the price of oil by staggered press releases meant to pull investors along for the ride. The purpose is to buy some time to give the market more time to rebalance. Once this is seen for what it really is, oil will plummet. It could happen at any time in my opinion.

 

Rig count increases for first time in three months

For the first time in three months, the U.S. rig count was up, increasing by one to 387. By itself this isn’t that important, but when combined with the probability that more shale supply may be coming to the market in 2016, it definitely could be an early sign of the process beginning.

EOG Resources (NYSE:EOG) has stated it plans on starting up to 270 wells in 2016. We don’t know yet how much additional supply it represents, but it’s going to offset some of the decline from other companies that can’t continue to produce at these price levels. There are other low-cost shale producers that may be doing the same, although I think the price of oil will have to climb further to make it profitable for them, probably around $45 per barrel.

It’s impossible to know at this time if the increase in the price of oil was a catalyst, or we’ve seen the bottom of the drop in rig counts. The next round of earnings reports will give a glimpse into that.

Fundamentals remain weak

Most of the recent strength of the price of oil has been the continual reporting on the proposed production freeze from OPEC and Russia. This is light of the fact there really won’t be a freeze, even if a piece of paper is signed saying there is.

We know Iran isn’t going to agree to a freeze, and with Russia producing at post-Soviet highs and Iraq producing at record levels, what would a freeze mean anyway? It would simply lock in output levels the countries were going to operate at with or without an agreement.

The idea is the freeze is having an effect on the market and this will lead to a production cut. That simply isn’t going to happen. There is zero chance of that being the outcome of a freeze, if that ever comes about.

And a freeze without Iran isn’t a freeze. To even call it that defies reality. How can there be a freeze when the one country that would make a difference isn’t part of it? If Iran doesn’t freeze production, it means more supply will be added to the market until it reaches pre-sanction levels. At that time, all Iran has promised is it may consider the idea.

 

What does that have to do with fundamentals? Absolutely nothing. That’s the point.

Analysis and decisions need to be based on supply and demand. Right now that doesn’t look good. The other major catalyst pushing up oil prices has been the belief that U.S. shale production will decline significantly in 2016, which would help support oil. The truth is we have no idea to what level production will drop. It seems every time a report comes out it’s revised in a way that points to shale production remaining more resilient than believed.

I have no doubt there will be some production loss in the U.S., but to what degree there will be a decline, when considering new supply from low-cost shale companies, has yet to be determined. I believe it’s not going to be near to what was originally estimated, and that will be another element weakening support over the next year.

Competing for market share

One part of the oil market that has been largely ignored has been the competition for market share itself. When U.S. shale supply flooded the market, the response from Saudi Arabia was to not cede market share in any way. That is the primary reason for the plunge in oil prices.

There has been no declaration by the Saudis that they are going to change their strategy in relationship to market share and have said numerous times they are going to let the market sort it out, as far as finding a balance between supply and demand. So the idea they are now heading in a different direction is a fiction created by those trying to find anything to push up the price of oil.

It is apparent some of the reason for increased U.S. imports comes from Saudi Arabia in particular lowering its prices to nudge out domestic supply. It’s also why the idea of inventory being reduced in conjunction with lower U.S. production can’t be counted on. It looks like imports will continue to climb while shale production declines.

More competition means lower prices, although in this case, Saudi Arabia is selling its oil at different price points to different markets. It’s the average that matters there, and we simply don’t have the data available to know what that is.

 

In the midst of all of this, Russia is battling the Saudis for share in China, while the two also battle it out in parts of Europe, with Saudi Arabia looking to take share away from Russia. Some of Europe has opened up to competitors because it doesn’t want to rely too much on Russia as its major energy source.

For this and other competitive reasons, I could never trust a production freeze agreement if it ever came to fruition. They haven’t been adhered to in the past, and they won’t be if it happens again. Saudi Arabia has stated several times that it feels the same way.

Conclusion

To me the Russian central bank is spot on in saying the chance of a sustainable oil rally is slim. It also accurately pointed out the reasons for that: it’s about the lack of the fundamentals changing.

With U.S. inventory increasing, rig counts probably at or near a bottom, no end in sight to oversupply continuing, and competition for a low-demand market heating up, there is nothing I see that can justify an ongoing upward price move. I don’t even see it being able to hold.

A weaker U.S. dollar has legitimately helped some, but it can’t support the price of oil on its own. When all the other factors come together in the minds of investors, and the price of oil starts to reverse direction, there is a very strong chance a lot of bullish investors are going to get crushed hard. It is probably time to take some profits and run for the exit if you’re in the oil market for the short term.

by Gary Bourgeault


Irrational Oil Optimists About To Experience Some Panic Selling Pain

Summary

  • Short-term positions in oil getting more risky.
  • U.S. production will outperform estimates as shale producers add supply to the market.
  • Inventory will come under more strain as key U.S. storage facilities approach full capacity.
  • Dollar weakness isn’t enough to maintain oil price momentum.

The longer the price of oil has upward momentum, and the higher it goes, the more risky it becomes for investors because there is nothing outside of a weakening U.S. dollar to justify any kind of move we’ve seen the price of oil make recently.

The falling dollar isn’t enough to keep the oil price from falling to where it belongs, and that means when the selloff begins, it’s likely to gravitate into full-panic mode, with sellers running for the exits before they get burned.

This is especially risky for those looking to make a quick windfall from the upward movement of oil. I’m not concerned about those taking long-term positions in quality energy companies with significant oil exposure, since they’ve probably enjoyed some great entry points. There is, of course, dividend risk, along with the strong probability of further share erosion before there is a real recovery that has legs to stand on because it’s based on fundamentals.

For that reason, investors should seriously consider taking profits off the table and wait for better conditions to re-enter.

Oil has become a fear play. Not the fear of losing money, but the fear of not getting in on the fast-moving action associated with the quick-rising price of oil. Whenever there is a fear play, it is ruled by emotion, and no amount of data will convince investors to abandon their giddy profits until they lose much, if not all, of what they gained. Don’t be one of them.

 

Having been a financial adviser in the past, I know what a lot of people are thinking at this time in response to what I just said. I’ve heard it many times before. It usually goes something like this: “What if the price of oil continues to rise and I lose a lot of money because of leaving the market too soon?” That’s a question arising from a fear mentality. The better question is this: “What if the oil price plunges and panic selling sets in?”

Oil is quickly becoming a casino play on the upside, and the longer investors stay in, the higher the probability they’ll lose the gains they’ve enjoyed. Worse, too much optimism could result in losses if preventative action isn’t taken quickly enough.

What needs to be considered is why one should stay in this market. What is so convincing it warrants this type of increasing risk, which offers much less in the way of reward than even a week ago? What fundamentals are in place that suggest a sustainable upward movement in the price of oil? The answer to those questions will determine how oil investors fare in the near future.

U.S. shale production

The more I think on the estimates associated with U.S. shale production in 2016, measured against the statements made by stronger producers that they’re going to boost supply from premium wells this year, the more I’m convinced it isn’t going to fall as much as expected. New supply will offset a lot of the less productive and higher cost wells being shuttered. I do believe there will be some loss of production from that, but not as much as is being suggested.

There are various predictions on how much production is going to be lost, but the general consensus is from 300,000 bpd to 600,000 bpd. It could come in on the lower side of that estimate, but I don’t think it’ll be close to the upper end of the estimate.

What is unknown because we don’t have an historical guideline to go by is, the amount of oil these premium wells will add to supply. We also don’t know if the stated goals will be followed up on. I think they will, but we won’t know for certain until the next couple of earnings reports give a clearer picture.

 

When combined with the added supply coming from Iran, and the ongoing high levels of production from Saudi Arabia, Russia and Iraq, I don’t see how the current support for the price of oil can continue on for any length of time.

There is no way of knowing exactly when the price of oil will once again collapse, but the longer it stays high without a change in the fundamentals, the higher the risk becomes, and the more chance it could swing the other way on momentum, even if it isn’t warranted. It could easily test the $30 mark again under those conditions.

Inventory challenges

What many investors don’t understand about storage and inventory is it definitely matters where the challenges are located. That’s why Cushing being over 90 percent capacity and Gulf storage only a little under 90 percent capacity means more than if other facilities were under similar pressure. Together, they account for over 60 percent of U.S. storage.

With the imbalance of supply and demand driving storage capacity levels, the idea of oil staying above $40 per barrel for any period of time is highly unlikely. A lower U.S. dollar and the highly irrelevant proposed production freeze talks can’t balance it off.

Once the market digests this, which could happen at any time, we’ll quickly enter bear mode again. The problem is the price of oil is straining against its upper limits, and if momentum starts to deflate, the race to sell positions will become a sprint and not a marathon.

Uncertainty about shale is the wild card

As already mentioned, U.S. shale production continues to be the major catalyst to watch. The problem is we have no way of knowing what has already been unfolding in the first quarter. If investors start to abandon their positions, and we find shale supply is stronger than projected, it’ll put further downward pressure on oil after it has already corrected.

What I mean by that is we should experience some fleeing from oil before the next earnings reports from shale producers are released. If the industry continues to surprise on the upside of supply, it’ll cause the price of oil to further deteriorate, making the outlook over the next couple of months potentially ominous.

 

This isn’t just something that has a small chance of happening; it’s something that has a very strong probability of happening. Agencies like IEA have already upwardly revised their outlook for shale supply in 2016, and if that’s how it plays out, the entire expected performance for the year will have to be adjusted.

Conclusion

Taking into account the more important variables surrounding what will move the price of oil, shale production remains the most important information to follow. Not much else will matter if supply continues to exceed expectations. It will obliterate all the models and force analysts to admit this has little to do with prior supply cycles and everything to do with a complete market disruption. Many are still in denial of this. They’ll learn the reality soon enough.

That doesn’t mean there won’t eventually be a time when demand finally catches up with supply, but within the parameters of this weak global economy and oil supply that continues to grow, it’s going to take a lot longer to realize than many thought.

For several months, it has been understood that the market underestimated the expertise and efficiency of U.S. shale producers, and to this day they continue to do so. We will find out if that remains in play in the first half of 2016, and by then, whether it’ll extend further into 2017.

As for how it will impact the price of oil now, if we start to have some panic selling before the earnings reports, and the earnings reports of the important shale producers exceed expectations on the supply side, with it being reflected in an increase in the overall output estimates for the year, it will put more downward pressure on oil.

The other scenario is oil lingers around $40 per barrel until the earnings reports come out. There will still be a decline in the price of oil, the level of which would depend on how much more supply shale producers brought to the market in the first quarter than expected.

My thought is we’re going to experience a drop in the price of oil before earnings reports, which then could trigger a secondary exodus from investors in it for short-term gains.

 

For those having already generated some decent returns, it may be time to take it off the table. I don’t see how the shrinking reward can justify the growing risk.

by Gary Bourgeault

The Mosul Dam – OPEC’s Unavoidable Supply Cut

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Summary

The Mosul Dam in Iraq could collapse at any time, causing massive flooding across the country.

Iraq produces over four million barrels of oil per day, a number which will drop immediately when this event occurs.

The destruction of oil production in Iraq will immediately decrease world supply, lifting oil prices.

The Oil Situation: Since 2014, the oil market has been in a tailspin due to a multitude of global factors. As of March 2016, prices seem to have stabilized, although the persistence of crude oversupply continues to hang over the market. For months, declining US production and a potential output freeze by OPEC have been putting a potential floor in place. However, I believe an event is on the horizon which will change the equilibrium of oil prices immediately… the collapse of the Mosul Dam.

The Mosul Dam: The Mosul Dam is the largest dam in Iraq. It is located on the Tigris River in the western governance of Ninawa, upstream of the city of Mosul. Constructed in 1981, the dam has had a history of structural issues, requiring perpetual maintenance in order to maintain its integrity. Since 1984, this consisted of 300 man crews, working 24 hours a day across three shifts, filling holes in the bedrock through a process called grouting. For 30 years, this process worked, although it was always considered to be a ticking time bomb, dubbed “the most dangerous dam in the world” by the US Army Corps of Engineers.

In August 2014, the Islamic State of Iraq and the Levant took control of the dam, halting the maintenance process until it was retaken by Iraqi, Kurdish and US Forces two weeks later. Unfortunately, the damage was already done… since then, the maintenance crews have been limited to 30 personnel or less, and the equipment is inadequate to continue patching holes. Per the dam’s former chief engineer, Nasrat Adamo, “The machines for grouting have been looted. There is no cement supply. They can do nothing. It is going from bad to worse, and it is urgent. All we can do is hold our hearts.” As winter snows melt, the water levels will rise to unsustainable levels, and while it has two pressure release gates to avoid this scenario, one has been non-functioning for years, and using the second one alone risks the stability of the structure.

The Iraqis have been working on a solution with an Italian firm, the Trevi Group, known for fixing 150 dams worldwide. This case is special, however, as it will require a cut off wall 800 feet below the dam, the construction of which may affect the dam’s integrity. Additionally, the continued presence of ISIS poses a risk to any contractors in the area, which will require a security force of 450 personnel. Until Mosul (still held by ISIS) is retaken by Coalition forces, full repairs cannot commence. While the Iraqi forces believe this can happen in months, the US Defense Intelligence Agency head, Lt Gen. Vincent Stewart, is not optimistic that it will occur this year.

My personal opinion, knowing the effectiveness of Iraqi Forces (who dropped their guns and fled during the initial ISIL invasion), is that the Mosul Dam will fail. Without significant US assistance, the retaking of Mosul will not occur fast enough to begin construction, and as long as it is in ISIS’ hands, safe repairs cannot commence. Although the US has not said the event is guaranteed, warnings are coming at an increasing pace, and the State Department has warned US citizens to prepare for evacuation in the event of failure.

The Event: When the Mosul Dam collapses (and without reconstruction measures being implemented quickly, this is considered a ‘when’, not an ‘if’), a wave 45-65 feet high is expected to flood the country, drowning Mosul in four hours and reaching Baghdad within two to four days.

Estimates range from 500,000 to 1,500,000 lives lost. In addition to flooding, there will be secondary and tertiary effects… as demonstrated in America during Hurricane Katrina, panic and lawlessness can be equally as dangerous as the flooding itself, but even worse, diseases such as malaria and West Nile fever will follow. A catastrophic event of this magnitude will immediately push the entire country into chaos, and Iraq does not have the capability to respond without global support. The closest comparison to make is Haiti, which with billions in global assistance has not returned to normalcy in five years. Overall, I anticipate this catastrophe will take years to overcome… in the meantime, it will have a significant effect on the world’s supply of oil today.

The Effects: As of winter 2015, Iraq was producing 4.3M barrels per day, with the southern fields producing 3.3M barrels and the remaining 1M coming from the north. The graphic below (left) is from 2014, but gives a picture of the oil field placements. To the right is a topographical map, which gives us an idea of how the floodwaters will progress. Based on the elevation of where the flood would initiate, everything between Mosul and Baghdad will be completely covered, and while the wave will dissipate over time, the fields between Baghdad and Basra will see enough water (and everything that comes with it, to include bodies, disease and unexploded ordinance) to temporarily disable operations. Additionally, the pipeline between Kirkuk and Ramadi will be underwater, and there is a potential for damage to the Iraq Strategic Pipeline, which runs parallel to the direction of the water’s progression.

The world’s oversupply of oil is estimated around one million barrels per day. Assume that the above happens, and in a best-case scenario, only northern production is affected. What would occur immediately is the elimination of one quarter of Iraq’s oil output, rapidly pushing supply and demand into equilibrium. In a worst-case scenario, where all of Iraq’s oil is temporarily eliminated, it will move the supply deficit to three million barrels per day, leading to large ramifications on the world’s crude oil surplus within weeks.

While the true answer lies somewhere between these possibilities, what is undeniable is that a catastrophe of this magnitude will immediately move the price of crude oil up, and depending on the timeline to return to today’s production levels, that move could be enormous. In late 2015, the world produced 97M barrels per day, causing the price to collapse to $26.00 per barrel. In 2014, while producing 93M barrels per day, the price averaged near $110.00 prior to its fall. Although the above is simple extrapolation, demand continues to grow, so I think we can all agree that the price shift north will be significant.

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Conclusion: The subject of this article is admittedly morbid. The true fallout of this event is the loss of hundreds of thousands of Iraqi lives, and damage that would take years to erase. However, as informed investors, it would be irresponsible to not consider global events, and this has the potential to re-balance the oil market in a matter of days. When this occurs, over four million barrels per day can disappear from production, immediately shifting the direction of oil prices. Based on the above information, I believe a production cut decision by OPEC is irrelevant, as natural forces are preparing to address the oil oversupply on their own.

by Middle East Medium in Seeking Alpha

West Texas Bust – “We Never Expected The Good Times To End”

The residents of West Texas are accustomed to a life dependent on hydrocarbons. As Bloomberg reports, the small communities built into the flat West Texas desert are dotted with oil pumps and rigs, and the chemical smell of an oil field hangs in the air.

Here the economy rises and falls on drilling.

When the drilling is good, everyone in the town benefits. When it’s bad, most of West Texas feels the pinch.

Oil prices have plunged as much as 75 percent since June 2014. That drop has dismal consequences for residents, and not just the ones working in oil fields. Bloomberg spoke with some of the people trying to endure the historic dip in oil prices. This video tells some of their stories….

In sharp contrast, click the following to enjoy this bitter sweet October, 2013 oil boom report by (CNN Money) titled ‘Moving in droves’ to Midland, Texas