Persian Pain with No Western Gain

“The two most common elements in the universe are hydrogen and stupidity.”
― Harlan Ellison

February 22, 2012, crude oil futures for April gained 3 cents to reach $106.28 per barrel on the New York Mercantile Exchange, thereby marking the highest gain since May 2011.  While some attribute the price hike to the growing demand in Asia, the bigger blame is placed on Iran.  Tehran appears to be posturing with threats to block the Strait of Hormuz or cut oil supplies to U.K. and France, which have not imported as much oil as other European countries (e.g. Greece, Italy and Spain), but the growing tension over Iran’s reported nuclear enrichment program is largely behind the nearly 5-percent fresh spike in crude prices in the U.S. and Europe.  With a sense of inevitability of war, as the recent visit to Iran by the International Atomic Energy Agency proved unsuccessful, could anyone not expect that the crisis would trigger high oil prices?  While some naturally blame speculators for capitalizing on the anxiety over Iran’s saber-rattling with the West and potential supply disruptions, there seems to be little focus on how the West could be shooting itself on its foot by waging an unnecessary war at the wrong time. 

My January 5 blog piece examined the West’s misplaced euphoria about the pain its sanctions it believed to be creating for Iran and inevitable certainty of harm on fragile economies of the West from looming warmongering.  If it is not already obvious, the danger lies in stratospheric oil prices that would go beyond the Persian Gulf and derail the West’s economic recovery before the pain of any bloodshed.  Fearing a backlash at the presidential polls this November, the administration of Barack Obama is worried about the effect of crude prices on the economy, as it should be.  At $4 per gallon, with expected further rise, oil prices are starting to seriously bite U.S. consumers, even though the demand is low.

The problem is that even though the U.S. has reduced its dependence on foreign oil, specially from the Middle East, and it boasts highest domestic oil production in eight years as well as increased efficiency of the average U.S. passenger vehicle, changes in global oil prices inexorably reverberate through inter-connected markets laden with intricate speculative mechanisms.  With current high risk premiums attached primarily to the crisis in the Persian Gulf, the oil market is unlikely to bring prices down.  That would be damaging to recession-ridden economies whether high oil prices are short or long-term possibilities.

Kazakhstan on Crude Expansion Trajectory

With a 50-percent stake in a Tengizchevroil joint venture to produce crude in Kazakhstan’s Tengiz oil field, Chevron announced this week that it planned to enter a front-end engineering design (FEED) phase to increase production in the country from 250,000 to 300,000 barrels per day (bpd).  However, Chevron’s numbers were higher than those provided by Tengiz, Kazakhstan’s major crude producer, which estimated the expansion to reach 260,000 bpd by 2017.  The Tengiz oil field, situated along the shore of the northern Caspian Sea, is the deepest producing major oil field in the world.  Under a new $25 billion investment plan, Chevron and other stakeholders in Tengiz will also “build a new crude-processing plant, a separate pressurizing unit that will make the new and existing plants work more efficiently, and drilling about 20 new wells.”  The plan, which is contingent upon the Kazakh government’s approval, will be a boost to the country’s annual oil output.

Despite the unprecedented political unrest in Kazakhstan’s oil town of Zhanaozen in December 2011, which resulted in the deaths of 15 oil workers from clashes with security forces over poor living conditions, the threat to oil production in the country was minimal, if any.  Allaying the concerns of some energy analysts that a halt to crude output in this Central Asian country would have an analogous effect on global oil prices as the violence in Libya, Kazakhstan’s central bank issued a statement on February 7, 2012, that “commodity exports grew by 46.1 percent [in 2011] compared to 2010.” 

The country’s leadership appears to be confident that the production level would not only be maintained, but it will increase.  According to the Kazakh State Statistical Agency, the country’s oil production increased by 2.6 mm in January.  The U.S. Energy Information Agency estimates that crude output is set to rise in Kazakhstan as its vast Kashagan oil field comes online in 2013 and add an average of 125,000 bpd each year.  With parliamentary elections behind, which re-asserted the victory of the current government in January 2012, Kazakhstan expects to reach a deal with international companies on expanding the production in the Kashagan oil field. 

Meanwhile Nursultan Nazarbaev’s long-standing regime has squashed the unrest in Zhanaozen, it is unclear whether this is an end to it.  Imprisoned then freed opposition leaders of a recent rally in Almaty planned to hold another peaceful protest on February 25.  The Kazakh leadership sees a solution to dissent in providing economic and social stability, which may not be enough for a politically suppressed society.  While implications of the tragedy in Zhanaozen on the near to long term stability of Nazarbaev’s regime are uncertain, it appears that the current leadership of twenty years has tightened its control on the country and will predictably rely on increasing exports of hydrocarbons to maintain economic strength.

U.S. Ushering in an Era of Nuclear Renaissance… or Maybe Not

On February 9, 2012, the U.S. Nuclear Regulatory Commission (NRC) approved a license for the Atlanta-based Southern Company, in a vote of 4 to 1, to build two new nuclear reactors at the Plant Vogtle nuclear power station near Augusta, Georgia.  This $14 billion project (with $8.3 billion in federal loan guarantees) is the country’s first nuclear reactor approved since the 1979 partial meltdown of the Three Mile Island plant’s reactor core.  This accident bumped up construction costs of nuclear plants and halted many planned reactors. 

Built by Westinghouse Electric, the two new reactors would be designed “to withstand earthquakes and plane crashes and to be less vulnerable to a cutoff of electricity, which set off the triple meltdown at Fukushima in 2011.”  The only vote against the approval of the project came from NRC’s chairman, Gregory Jaczko, who was not convinced that the project would ensure all safety improvements before reactors start operating in 2017. 

Mr. Jaczko’s concern with nuclear safety may have some grounds in the post-Fukushima era.  In fact, NRC faces a challenge not only to apply lessons from last year’s disaster in Japan, but also to decide what do with America’s all 104 old nuclear reactors, which will need to be phased out and replaced in the next 20 years.  Meeting 20 percent of the U.S. electricity needs, the future of nuclear power maybe at a crossroads where a decision must be made to build new reactors and to find viable alternatives.  Some predict that nuclear power production would shrink in the U.S. before growing.  According to Marvin Fertel, president of Nuclear Energy Institute that lobbies for the nuclear industry, not many new nuclear plants were to be built in the near term.  The reasons are depressed electricity demand, cheap natural gas that can be burned to produce electricity, lack of funding and ambiguity in the wake of the Fukushima Daiichi meltdown. 

While the future of nuclear power in the U.S. is largely undecided, the preparedness of the existing fleet of 104 reactors for potential earthquakes, floods, hurricanes, tornadoes, fires, and potential terrorist attacks is questionable, according to the January 17, 2012, PBS investigative film “Nuclear Aftershocks.”  Nearly 29 nuclear reactors across the country “were identified in the 1990s as seismically under-designed, but the NRC required no corrective action,” and 47 reactors failed to meet new fire protection standards.  Some nuclear plants avoided accidents caused by natural disasters, such as the recent flooding in Nebraska and earthquake in Virginia, only because they managed to boost their defenses and upgraded seismic protection in a timely manner.  Given its mixed track record, NRC is up against its own known weaknesses as much as against unforeseen disasters.

Revised U.S. Shale Gas Estimates Came at No Surprise

According to new information from the U.S. Department of Energy, estimates of shale gas in the country were lower than predicted earlier.  The Energy Information Administration (EIA), Energy Department’s collector of data, reported that there were 482 trillion cubic feet (tcf)of available shale gas in the U.S., which is 40 percent lower from the 2011 estimate that maintained 827 tcf.  New estimates of shale gas in the Marcellus region, which spans from New York to West Virginia, were at 141 tcf from previous estimates of 410 tcf.  Attributing the new projections to the availability of better information, the industry considers its accomplishments a huge step forward for the U.S. energy supply security, despite the latest estimates of lower amount of shale gas, noting how far it has come in the past few years. 

While natural gas prices have been record low in recent times, primarily due to the explosion of the shale gas supplies, influx of new producers, economic slowdown and warm winters, it is yet to be seen whether the fresh projections will have any implications on the price.  Despite the lowered estimates of shale gas in the U.S., natural gas is likely to bring down electricity prices in the next few years and surpass coal in electricity production.  According to EIA, increase in gas output will cut U.S. dependence on energy imports by almost half by 2035.  All in all, the role of natural gas will remain important in the U.S. energy mix.

The changes in the estimates of shale gas reserves are not shocking, given that the industry is still relatively brand new.  The technology and information collection on it improves with time.  As the industry evolves and changes, it is also worth keeping an eye on the rate of return of shale gas wells.  As experience shows, there were rapid declines in several fractured shale gas wells from 50 up to 80 percent or more during the first year.  Emphasizing my earlier views expressed on shale gas and oil in this blog, the novelty of the industry warrants sufficient experience and time to establish recoverability of reserves, decline rates and production lifespan of shale gas and oil wells. 

No Keystone Pipeline. For Now

Despite the U.S. State Department’s rejection of the heavily contentious Keystone XL pipeline on January 18, 2012, industry observers believe that it may not be an end of it.   Demand for oil and jobs in the U.S. are likely to prompt TransCanada Corporation, Keystone XL’s sponsor, to look for other ways to bring Canadian crude oil to the U.S.  The fact of the matter is Canadian oil will be increasingly important to the U.S. with time, as refineries of the latter have been feeling the crunch from dropping production levels in Venezuela and Mexico.  American demand for Canadian oil is estimated to be at 2.7 million barrels a day by 2015.  As the U.S. economy is picking up pace, oil demand is expected to rise. 

TransCanada seems to be determined not to give up on the project.  It may re-apply for permit later or build the pipeline in pieces.  Even some Democratic Senators favor the project and hold the belief the pipeline is not shelved for good.  According to Senator Kent Conrad, D – N.D., “it is clear that Canada is going to develop this resource, and I believe it is better for our country to have it go here rather than Asian markets.”  If the Republican-imposed timeframe to review the pipeline's safety was the major reason for the Obama administration to turn down the pipeline, it is likely that Keystone will reemerge through alternative routes, perhaps after the 2012 elections.

U.S. Shale Gas: In for More Game Change

2012 kicked off with major developments in the U.S. natural gas sector: huge foreign acquisitions of its shale gas plays and the lowest natural gas prices in a decade.  Within the first week of January, China’s state-run Sinopec acquired a 30-percent stake in Devon Energy’s five shale plays; French oil giant Total planned to invest in Chesapeake Energy’s Utica shale; and a Japanese trading house, Marubeni, acquired a minority interest in the Eagle Ford Shale play.  Racing to take advantage of the shale gas boom in the U.S. and to transfer technological know-how to other countries, these foreign companies and others, which have already entered the market last year, pay a premium price for an acre of shale play in America. 

At the same time, the plummeting natural gas prices in the U.S., due to the glut topped by mild winter thus far, have not stopped the production.  Gas futures dropped 17 cents, closing the day at $2.77 per thousand cubic feet on January 11, 2012, which is the lowest since 2002.  There are concerns that the U.S. will run out of places to store gas.  At the end of the day, the news is good to consumers’ heating bills.  Despite the excess supply, new producers are entering this crowded sector in anticipation that the market will pick up pace, given the popular push for cleaner energy sources. 

At this point, U.S. is ready to export its natural gas and it makes economic sense.  Several companies began looking into building liquefied natural gas (LNG) export terminals, which would be expensive, but the costs could be recouped and, ultimately, create huge profits for the U.S.  Natural gas prices in Asian markets, for example, would be nearly four times more than they are in the U.S.  Some American lawmakers questioned the advantage of exporting U.S. natural gas.  Rep. Ed Markey, D-Mass., asked Energy Secretary Steven Chu to explain the effect of gas exports on prices for consumers and producers, noting that he was “worried that exporting America’s natural gas would reduce the global competitiveness of U.S. businesses, make us more dependent on foreign sources of energy, and slow our transition away from dirtier fuels.”  While U.S. should seek diverse sources of energy, not taking advantage of the gas export opportunity makes no economic sense. 

The more important questions that should be posed to the Energy Secretary are why the U.S. still lacks a cohesive energy policy, what it could be like and when it can emerge.  Rejecting the production of low cost traditional energy sources and pushing for expensive alternative sources with no clear vision on their economies of scale is not a real solution.  The shale gas revolution in the U.S. may be a timely push to a debate on a long-term energy policy.

The Costs of Playing Chicken with Iran

The West is pleased at the thought that the pain of tightening economic sanctions on Iran to punish for its reported development of atomic weapons appears to be bearing fruit.  Otherwise, how to explain Tehran’s increasingly aggressive statements to close the strategically important oil chokepoint Strait of Hormuz, which transited nearly 17 million barrels of oil per day in 2011, and threats against US ships in the Persian Gulf. 

But tightening the noose around Iran’s petroleum sector may ultimately miss the West's main goal, and worse, backfire on its fragile economies, beginning of which was already felt at the gas pumps.  As the second largest OPEC oil producer, Iran’s daily supply of 450,000 barrels to the European Union (EU) would clearly find its market in Asian customers, China and India.  A response of oil markets to the possible supply disruption from Iran was a jump in prices on January 4, 2012.  Brent crude reached $113.97 on January 4, 2012, highest since November 14, 2011, with a prospect to rise further as EU draws closer to implementing the sanctions. 

In the given situation, Western countries seem to be as irrational as the Iranian government (further proof of uselessness of the rational actor theory), as their choices of action are hardly rational at the time of delicate domestic economic recovery and a multitude of colossal debt crises.  While stable (read - low) oil prices are not necessarily guarantors of economic growth, economists caution that a sudden rise in oil prices had preceded nine out of previous 10 recessions in America.  According to a 2000 report by the International Monetary Fund, “a $5 permanent increase in oil prices cuts world GDP growth by 0.25 percent over the first four years. But the impact on the U.S. was a larger 0.3 percent, reflecting this country’s high per-capita energy use.”  Given a possible economic backlash from sanctions on Iran, can the US afford to bite the bullet and survive the high oil prices?  It does not look like it can afford it right now.

Further, the West’s reliance of Saudi Arabia’s excess capacity and growing production from Libya and Iraq to salvage the situation is a hard bet.  Recovery of production capacities of post-war Libya and Iraq are inevitably subject to existential domestic political and security threats, raising the specter of their uncertainty as reliable suppliers in the short to medium-term.  Meanwhile, an OPEC swing producer, Saudi Arabia, faces close to 7 percent growth per year in domestic demand for oil and gas.  The Joint Organizations Data Initiative (JODI), which provides official oil output numbers from its 90 member-countries, shows that Saudi Arabia “produced 9.4 million barrels a day of oil (mbd) in October 2011 and consumed 2.0 mbd.”  Although the Kingdom indicated it could produce up to 12.5 mbd, it is unlikely that it can maintain this production level for a long time. 

Lastly, economic sanctions to punish an enemy can yield some results, but often are less than effective.  According to a 1992 study of the US Government Accountability Office (GAO) on 27 cases of post-World War I economic sanctions “the measures are more successful in achieving the less ambitious and often unarticulated goals [...] however they are usually less successful in achieving the most prominently stated goal of making the target country comply with the sanctioning nation’s stated wishes.”  Given that the sanctions by the United Nations and Western countries have been directly aimed at forcing Iran to suspend its nuclear enrichment program, it is unlikely that falling short of that goal would be acceptable to the West, while Iran is increasingly defiant and provocative.  But it is also not likely that an escalation of the conflict to a point of war or risking the economic recovery with high oil prices would be acceptable and economically affordable to the West either.