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6 March, 2018 00:00 00 AM
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Oil market fears: War, default and nuclear weapons

Nick Cunningham
Oil market fears: War, default and nuclear weapons

The U.S. is one of the few areas of the world in which there is an energy investment boom underway, a development that could smooth out the uncertainties of geopolitical events around the world. At the same time, outside of the U.S., there is a deterioration of stability in many oil-producing regions, aggravating risks for both oil companies and the oil market, according to a new report.

Financial risk firm Verisk Maplecroft explores these two trends as they play out simultaneously. The U.S. shale sector has emerged from years of low oil prices, damaged but still intact. Importantly, the shale industry “can ride out price dips and respond quickly to upticks, weakening OPEC in the process,” James Lockhart-Smith, director of financial sector risk at Verisk Maplecroft, wrote in the report. Combined with deregulation at the federal level, the oil industry is in the midst of an investment boom in the U.S.

Meanwhile, things are not so rosy elsewhere. Verisk Maplecroft surveyed a long list of countries, and produced its Government Stability Index (GSI), which uses some predictive data and analysts forecasts to take stock of geopolitical risk in various countries over the next few years.

The results are not encouraging. The number of countries expected to see a deterioration of stability “significantly outnumber those we see becoming more stable,” the firm said. The reasons are multiple, including low oil prices, but also the erosion of democratic institutions.

“We don’t see increasing instability necessarily ending in coups or significant political upheaval, but a less predictable above-ground-risk environment is likely to emerge,” Verisk Maplecroft’s Lockhart-Smith said. “Arbitrary decision making, possible measures to buy off key stakeholders or an inability to pass regulatory reforms will be the main risks to projects in these countries, as their governments seek to stabilize and maintain their influence.”

Not all of the countries expected to suffer from a decline in stability are that important for the oil market, such as Romania or Kenya. Also, some countries might be on an improving path, but at the same time present a downside risk that, while unlikely, could be huge. In this case, Iraq stands out. Verisk Maplecroft says that Iraq “has a business-friendly upstream environment” and the forecast is for stability to improve. However, even if it seems somewhat reasonable that things could trend in the right direction, the downside risk is massive. And there are is no shortage of potential catalysts: The report points to elections in May, plus the “deep ethno-sectarian divisions and weak institutions.”

Venezuela is another obvious flashpoint. The deterioration of the country’s economy and oil sector have been profound. But Venezuela also illustrates a different problem – that disruption need not come from a coup, a civil war or some other obvious geopolitical development. Verisk Maplecroft points to the purge of state-owned PDVSA following the unsuccessful coup in 2002 as a poignant example. The country’s oil production has steadily eroded over the past decade and a half since the Venezuelan state sacked experienced professionals at PDVSA and used revenues for other purposes while failing to invest in existing oil assets.

Verisk Maplecroft argues that Egypt is a potential contemporary example of that phenomenon. The increasingly authoritarian government in Cairo could roll back the policies that attracted investment from oil and gas companies in the first place over fears of a popular uprising.

Now, more oil could flow from Iraq, although a lot of specifics need to be ironed out. "We don't know the details. We don't know whether the deal is contingent on restarting the disputed fields. But this could be the first signs of a breakthrough," an oil analyst told S&P Global Platts. "It remains to be seen whether production from the two Kirkuk fields can come online very soon. There are some reports that [Kurdish firm KAR Group] met with [Iraq’s National Oil Company] recently to talk technical equipment on Kirkuk.”

Meanwhile, the Iraqi government is seeking guarantees from Turkey that once the oil is transported out of Iraq and across Turkey to the port of Ceyhan, that the oil would be delivered into the hands of the Iraqi state-owned oil marketing company, SOMO. Still, that issue will take time to get sorted out. Over the longer-term, Iraq wants to fix and restart its damaged pipeline to Turkey, which could eventually handle 250,000 to 400,000 bpd of exports, Iraqi oil minister Jabbar al-Luaibi said, according to S&P Global Platts.

But those are longer-term issues. The more immediate question is whether output will increase from Kurdistan, and at this moment, it is still unclear. There are lingering questions about the latest deal between Iraq and the KRG, and whether it will lead to a lasting breakthrough.Related: Something Unexpected Just Happened In LNG Markets

In the meantime, Iraq is still party to the OPEC cuts, and it has agree to limit output to 4.351 million barrels per day. Iraq seems to be producing in excess of that amount by about 84,000 bpd, according to OPEC’s secondary sources in January. The Iraqi government insists output is a little less than that. Either way, Iraq is doing a decent job of sticking with the rest of OPEC to maintain high levels of compliance. Any negotiation with Kurdistan would need to be interpreted in that context.

A top official from Iraq’s oil minister told the Wall Street Journal that the country would delay its goal of reaching 5 million barrels per day of production capacity by a year, in an effort to maintain good standing with the OPEC agreement. Instead of hitting that target this year, Abdulmahdy al-Ameedi, director general of oil contracts and licensing at Iraq’s oil ministry said that Iraq would reach that level in 2019. With an eye on the future, Iraq’s oil minister is in Berlin this week, trying to drum up investment in Iraq’s oil sector as it seeks to rebound after years of war with ISIS militants

But there’s one item that barely gets a mention in the EIA’s Annual Energy Outlook. It is something I witnessed firsthand when I was recently in the Permian Basin. Oil production can expand only as quickly as infrastructure can keep up. And it is struggling to keep up.

It’s not just crude oil pipelines that are an issue. Along with oil comes associated natural gas. In some cases, producers have no outlet for this gas, so they flare it. But there are various legal limits to flaring. This week, I heard about a producer who is having to reduce production because they are bumping up against their permitted limits for flaring.

In addition to potential infrastructure constraints, higher oil prices also lead to greater demand for oilfield services providers. That leads to higher costs for the oil producers and higher profits for drilling and fracking services providers.

At present, one of the bottlenecks in the Permian Basin is with the fracking service providers, and that is leading to a growing backlog of drilled-but-uncompleted wells (DUCs). This is helping to constrain production in the Permian Basin but was not a risk identified in the EIA’s production projections.

Conclusions

The latest Annual Energy Outlook from the EIA models the future potential of tight oil production under several scenarios. Some scenarios project tight oil production growth for another three to four years, but these scenarios apparently don’t consider supply risks posed by insufficient infrastructure, oilfield services or manpower. These factors could slow tight oil growth over the next few years and could potentially shift the timing of peak tight oil.

Finally, one of the more intriguing cases is that of Russia, the largest oil producer in the world. Verisk Maplecroft sees little risk of political upheaval as Russian President Vladimir Putin seeks another six-year term in March, but a battle could ensue in the upcoming years over his succession when his term is up in 2024, and “factional struggles between liberals and statist former security officials are already ramping up in anticipation of his exit,” the report says.

Verisk Maplecroft puts the odds of a general deterioration of political stability in Russia through 2021 at 90 percent, and the “oil sector will be a strategic prize in this battle, not least because Rosneft CEO Igor Sechin is a central protagonist.”

In the near-term, there are two huge geopolitical threats to the oil market, but neither seem all that likely. Verisk Maplecroft says a potential war on the Korean Peninsula or a war between Iran and Saudi Arabia are the largest threats to the oil market, but both situations, while tense, will probably stop short of outright military conflict. Still, the mere threat of conflict, could add to the risk premium for crude oil prices.

    Eurasia Review

 

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Editor : M. Shamsur Rahman
Published by the Editor on behalf of Independent Publications Limited at Media Printers, 446/H, Tejgaon I/A, Dhaka-1215.
Editorial, News & Commercial Offices : Beximco Media Complex, 149-150 Tejgaon I/A, Dhaka-1208, Bangladesh. GPO Box No. 934, Dhaka-1000.

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