U.S.: Avoid Oil Speculation Overkill?

President Barack Obama’s latest policy initiative to take a more aggressive stance against manipulation of oil markets received mixed reactions. The proponents of the measure, including Chairman of the Commodity Futures Trading Commission (CFTC), Gary Gensler, welcomed Obama’s proposal, noting that it “build[s] on progress the CFTC has made in making the unregulated swaps market more transparent and implementing new anti-fraud and anti-manipulation reforms.”  Other federal agencies, including the Energy Information Agency, pointed out the role of oil supply disruptions from unstable parts of the Arab world as well as temporary interruptions from Canada, China and Brazil due to technical problems were key factors in elevated crude and gasoline prices. 

A bigger argument against Obama’s policy initiative appears to be that high oil and gasoline prices are not because of the presence of financial investors in the oil futures markets and “there is no evidence that the bulk of the financial investors taking positions in oil futures markets since 2003 have engaged in such activities.” According to the Chicago Mercantile Exchange (CME) Group, which sets margins for the benchmark U.S. crude oil contract, “speculation should not be confused with manipulation.”  Still, it is interesting that “speculators tend to buy crude when there is a strong underlying reason to do so such as the loss of Libyan crude last year or sanctions and possible military action against Iran” this year.  In fact, higher oil price bets by speculators at times of an anticipated supply crunch from Libya and Iran increased prices by $15-$20 a barrel. 

At this point, a prudent approach for the Obama administration to understand the oil futures market may be to monitoring it better, particularly since it plans to increase access to CFTC’s data, before setting trading margins on the market.  The latter may carry unintended consequences, such as making prices more susceptible to swings by squeezing out smaller investors out of the market and giving more influence to bigger hedge funds and banks.

New Federal Emission Caps on Fracking: To Be or Not to Be?

The Environmental Protection Agency’s (EPA) new cap on emissions in drilling natural gas this week is the first federal ruling to tackle air pollution tied to hydraulic fracturing.  According to EPA, the new standards would reduce the release of toxic and carcinogenic chemicals such as benzene, hexane and methane.  Natural gas producers would have two years to comply with the new standards.  Although the American Petroleum Institute (API), which represents 500 oil and gas companies, argued that the new standards would slow down the production of domestic natural gas and cost hundreds of millions of dollars, some gas drillers did not think the costs would slow down the gas boom in the U.S.   Gas producers, such as Southwestern Energy Co. and Devon Energy Corporation, stressed that they already have technology in place to capture fugitive methane, an important greenhouse gas. 

Pollution related to drilling natural gas does remain a source of concern.  For example, emissions from gas wells in Wyoming attributed to the increase in ozone levels to the degree that the government may need to “declare parts of the state as an ozone non-attainment area.”  But drilling for gas has not been delayed in Wyoming or Colorado, “where technology to capture emissions has been required by state since 2009 and 2010.”  Development of shale gas in Arkansas’ Fayetteville Shale by Southwestern has been also relatively successful due to cutting costs of emission capturing from $20,000 per well to zero.

While EPA’s new environmental measure is a step towards improving environmental standards of the booming shale gas industry in the U.S., there is a potential for over-regulation of the industry or duplication of efforts already undertaken by the industry to control emissions.  Shale gas has completely transformed the U.S. energy landscape, making the country self-sufficient in natural gas.  The low cost natural gas is reviving the manufacturing and chemical industries in the U.S., shifting the heavily coal-based utility sector to gas, and bringing down the prices of heating and electricity to consumers.  Regulatory slowdown of the industry would have unintended consequences to the economy. 

At this point, addressing casing and cementing of shale gas wells as well as usage and treatment of the flowback water appear to be the most important environmental challenges facing the industry.  But before slapping a one-size fits all regulation to appease environmental groups, it is also crucial to look at functioning state regulations that already exist as well as voluntary self-regulation practiced by some gas producers to avoid major accidents.

U.S. Energy Independence: Optimism with Caution

A recent announcement by the White House that onshore drilling permit application reviews would be cut by 80 percent is good news of the month. According to the Secretary of the Interior, Ken Salazar, the measure will “make oil and gas permitting and production on public lands a reality [and] the automated permit application process, which is expected to be in place in early 2013, would be similar to a program already in place for offshore drilling permits.” The new automated processing of applications would reduce the permit review process from 298 days to about 60 days. With gasoline prices highest since 2008, Republicans criticized the Obama administration for foot dragging in issuing drilling permits and obstructing exploration and drilling in public lands. Simplification of the review procedure will further help usher the development of energy in the U.S., which has seen a renaissance over the past five years thanks to shale gas and oil supplies.

As access to federal lands for oil and gas exploration expands, some analysts optimistically predict that the U.S. is bound to significantly increase domestic oil production and reduce its dependence on foreign oil. According to Raymond James and Citigroup, U.S. oil imports will fall from 9.8 million barrels per day (mbpd) in 2011 to 4.5 mbpd by 2015 and reach zero net imports by 2020. Analysts in these companies believe that ramped up deepwater production from under the Gulf of Mexico and natural gas liquids output will account for such a dramatic change in the U.S. energy landscape.

This forecast seems to be overly optimistic. While increased domestic oil production is an important factor behind the growing U.S. energy independence, changes in the country’s hobbling economy, weak oil demand, increased physical supply, or the above average increase in crude inventories may carry implications on how the U.S. energy market would evolve. In other words, it may be too ambitious and misleading to put definitive timeframes by which the U.S. would be a zero net importer of oil. Another important factor that continues to impact oil prices is the role of energy market speculators, an interesting perspective on which is given by Forbes:

The U.S. oil production increased since 2008 from 4.95 mbpd up to 5.59 mbpd [but] is so small that U.S. supply increases have no discernible impact on the price. If oil prices were determined solely by supply and demand for oil, U.S. production might matter more to the price. But what matters most to the price of oil is the positions that speculators — who do not take delivery of oil – take. When oil hit $147 a barrel [in 2008], investigators found that those speculators accounted for 81% of the trading volume in the oil markets. There’s an easy way to take those speculators out of the oil price equation: raise the amount of capital they need to invest in their bets on the direction of the price of oil. And when the commodities exchanges require the speculators to increase the amount of their own capital — dubbed margin — into their bets, the price of oil seems to go down.

It is hard to imagine the U.S. energy market not to continue being impacted by global oil prices and by speculators in the future, given that it is already happenning at a time when the country has reduced dependence on foreign oil and boasts highest domestic oil production in eight years. Do correct if I am wrong.

Trans – Caspian Gas Pipeline Still a Pipe Dream?

Potential major developments in the Caspian energy landscape may be underway, but laden with more doubt than certainty. Negotiations between the European Union (EU), Azerbaijan and Turkmenistan on building a much debated Trans-Caspian Gas Pipeline (TCGP) has led to an agreement in principle in March 2012. A key point is that under such an agreement, Azerbaijan and Turkmenistan would also overcome disputes over the ownership of the Kapaz/Serdar oil fields in the Caspian for the TCGP project to move forward. But TCGP’s imminence may be unrealistic for a number of reasons.

First, Azerbaijan and Turkmenistan continue to hold differing views on the sectoral demarcation of the Caspian Sea. Unless both countries reach an agreement on the disputed Kapaz/Serdar hydrocarbon deposits, there will be no TCGP. Second, while some analysts argue that legally there would not be problems if both countries sign a bilateral deal on the status of the Caspian Sea, its other littoral states are bound to disagree and protest it. Namely, Russia and Iran are against TCGP because it does not serve their commercial or geopolitical interests. They have invoked at various times the unresolved legal status of the Caspian and environmental threats in building an undersea infrastructure. Iran sent troops to the Caspian area when an attempt to begin development of a field in the so-called 'gray zone' was made in the late 1990s – early 2000s.

Meanwhile, Moscow continues to insist that only the Caspian littoral states have the right to decide on any pipeline traversing the sea. EU’s invitation of Kazakhstan to join TCGP and talks between the Austrian President Heinz Fischer and the Turkmen president Gurbanguly Berdymukhammedov in October 2012 on creating a legal framework for supplies of Turkmen gas to EU caused a bitter reaction from Russia. It is not ruled out that Russia may threaten to cut off gas supplies to the growing domestic consumption in Azerbaijan or exert pressure on Baku not to participate in the TCGP on the grounds of creating an unnecessary rival if Turkmenistan winds up supplying cheap gas to the Turkish market. In the long run, Turkmenistan and EU could agree to ship compressed natural gas via tankers, but it will depend on the availability of a pipeline to send the gas onward to European markets.

Lastly, the funding sources of TCGP are still unclear. As Rovshan Ibrahimov, head of the foreign policy department at Azerbaijan’s Centre for Strategic Studies, aptly pointed out, neither his country nor Turkmenistan would handle the risk of financing and running the project on their own. And it is doubtful that the EU would sponsor the project due to its lack of supranational mechanisms to implement a comprehensive energy agreement across several countries. It is uncertain who is willing to and can provide the guarantees to justify the risk.

Eastern Mediterranean: Horn of Plenty or Pandora’s Box

As the world watches the Arab Spring continue its struggle for freedom, an additional factor of instability (or an economic boon in the best case scenario) maybe unfolding before its eyes.  According to the US Geological Survey, the continental shelf in the eastern Mediterranean, which includes Cypriot, Lebanese, Israeli and Syrian waters, has an estimated 122 trillion cubic feet of gas and nearly 4 billion barrels of oil.  This relatively recent discovery has a potential to secure energy independence of its littoral states.

But because Lebanon is still in a state of war with Israel, Turkish and Greek Cypriots (including Turkey and Greece) are in a long-standing dispute over Cyprus, and the relations between Israel and Turkey are strained, exploitation of offshore natural gas is likely to open a fresh can of worms, if it is hijacked by politics.  With global majors scrambling to snatch up exploitation licenses in Cyprus and Israel, it is a crucial moment for each littoral state to define its exclusive economic zone (EEZ) before any offshore exploration and drilling activity begins.  As Nizar Abdel-Kader aptly points out, apart from establishing EEZ, “there may be a need for a regional conference sponsored by the UN with the main task of facilitating negotiations between Lebanon and Israel and between the Turks and Greek Cypriots […] to avoid future military conflict.” 

The tensions already heightened last fall in the eastern Mediterranean, when Turkey threatened to send its navy to prevent Greek Cypriots from drilling gas and to stop Israel’s unilateral exploitation of its offshore hydrocarbons.  In the wake of Israel’s gas discovery, Hezbollah issued a warning that it would defend Lebanon’s natural resources, which elicited a similar response from Israel.  It is the most opportune moment for UN’s assistance to address the maritime boundaries in the Levant Basin before a source of energy supply security turns to a source of another conflict.

How Thomas Friedman Got It All Flatly Wrong on Energy

Bumping into Thomas Friedman’s visible omniscience on basically all global problems, a lingering question is whether or not his readers feel they know more about an issue thanks to him, and if so, by how much.  Personally, after being forced to read his “The Lexus and The Olive Tree” as part of a graduate school class, I swore to never waste time on his books with bumper-sticker style writing and less than deep and meaningful ideas.  It remains a mystery why New York Times keeps putting out Friedman’s mostly senseless and sloppy columns, which any moderately educated American should be able to quickly grasp.  While it is too easy to mock him, I see some friends quoting him or posting his columns on various social media sites.  Noticing his recent pieces on energy, one would hope that nobody is taking his writing on this subject matter to heart.  Here is why.

Friedman argues in his February 29, 2012, column that the U.S. should consider joining the Organization of Petroleum Exporting Countries (OPEC) because the country's oil and gas output are highest for the first time in eight years and “this transformation could make the U.S. the world's top energy producer by 2020, raise more tax revenue, free us from worrying about the Middle East, and, if we're smart, build a bridge to a much cleaner energy future.”  According to Friedman, it should be in the U.S. interests to join OPEC to sustain high oil prices.  Lobbying for high oil prices for years now, he believes that a $4 per gallon of gasoline should be a constant to “reduce our addiction to oil.”  In his April 30, 2008 column he was upset that “oil and gas kept all their credits, but those for wind and solar have been left to expire this [2008] December.” 

Based just on these points, if Friedman was in charge of energy, the U.S. would not have a functioning economy.  For the first time in two decades, the country is moving towards more energy self-sufficiency not because of a revolution in green energy, but thanks to the development of gas and oil from shale formations.  At the same time, U.S. continues to import nearly 9 million barrels per day of oil and refined petroleum products.  But for Friedman that still makes the country a very suitable to candidate for OPEC.  Moreover, it is uncertain whether the levels of production of shale gas would be maintained at the current rate.  According to Energy Information Administration’s (EIA) revised estimates of reserves, 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.  Given that there were rapid declines in several fractured shale gas wells from 50 up to 80 percent or more during the first year, there may be changes in the rates of return of shale gas wells. 

Second, as I noted in my previous blog entry, economists caution against a sudden rise in oil prices that were followed by nine out of previous 10 recessions in America. A 2000 report by the International Monetary Fund shows “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.”  Friedman overlooks this factor.  Oil addiction will not disappear until another cheap energy source is widely available across the economy.  A cursory review of publicly available data shows that traditional sources of energy, such as oil (36%), natural gas (25%), coal (20%) and nuclear (8%), still constitute a backbone of the economy and will remain so for years to come.  Transportation takes up about 93% of the petroleum use in the U.S. due to its outspread landscape of rural and urban areas that require driving.  Friedman fails to provide an answer how this could change and how and when these energy sources can be replaced by green energy and achieve economies of scale. 

Third, dispelling the common perception that the U.S. is so much dependent on Middle Eastern oil, the EIA data show that 52% of U.S. crude oil and petroleum products come from the Western Hemisphere, about 22% from the Persian Gulf, and 20% from Africa.  Canada (29%), followed by Saudi Arabia (14%), Venezuela (11%), Nigeria (10%), and Mexico (8%), remains the top exporter of oil to the U.S., the role of which is growing and will continue to grow in the U.S. energy market.  The concern about the Middle East is not (or at least should not be) necessarily about reducing addiction to Saudi oil, but how global markets are much more closely inter-connected and various events, such as wars, natural disasters, or rising oil demand, invariably affect the price of crude oil. 

Lastly, while Friedman was troubled in 2008 that the U.S. government was cutting support to wind and solar industries, the Obama administration in fact has bumped up subsidies to renewables, spending over $13 billion of taxpayer money by now.  But renewables still stand at only about 9% at this point.  While the oil industry has received subsidies from the government as well, the sheer economies of scale of the traditional sources of energy are incomparable to the renewables.  In short, the U.S. will be able to maintain its economic stability and growth with affordable and widely available traditional sources of energy for decades to come.  Denying it is misleading, delusional and utopian.

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.