IEA Lowers Demand Forecast

Jim Brown
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Crude prices were trading back over $93 on Sunday night on expectations that China will dramatically change monetary policy to stimulate its slowing economy.

China's economic reports last week showed an economy that was accelerating to the downside and analysts believe the government will react quickly and make significant changes to monetary policy. China's reports showed that exports to Europe declined -16% in July.

Another factor supporting oil this weekend is the Iranian earthquakes. I don't know of any impact to Iranian production and with the embargo cutting exports in half I seriously doubt any actual impact would be felt outside Iran.

While on the topic of Iran, Tanzania said a Dubai based shipping agent had reflagged 36 Iranian oil tankers as Tanzanian without the country's knowledge and approval. Tanzania said it was in the process of de-registering the vessels after an investigation concluded they were originally from Iran. Reflagging ships masks their ownership and makes it easier for Iran to obtain insurance and financing for cargoes. It took a while for the Tanzanian government to react since I have been reporting on this for nearly two months now.

Goldman Sachs said exports from Iran have declined -1.4 mbpd and that "substantially exceeds" the bank's estimates.

Also supporting oil prices is the escalating violence in Syria. Reports out this weekend suggest the U.S. and a group of nations are moving closer to imposing a no fly zone over Syria. The imposition of a no fly zone is grounds for expanding the violence with retaliation against Israel according to Syrian officials. They claim Israel started the fighting in Syria and is supporting the rebels. Syria has the capability to damage oil facilities in neighboring countries in retaliation. Syria only produces about 400,000 bpd and because of the embargo against them they have not been able to export any since early this year.

Syria was implicated in a terror plot last week where they pressured a former Lebanese cabinet member, Michael Samaha, to hire mercenaries in Lebanon to plant explosives in Lebanon in an attempt to assassinate political figures. The plot was also aimed at igniting sectarian conflicts between the Sunnis and the Alawites or the Sunnis and the Christians. Samaha was reportedly a consultant to Bashar Assad. A man in Lebanon who was contacted by Samaha in an effort to find someone to transport the explosives went to the police and they implemented a sting operation to catch Samaha in the act. Apparently Syria wanted to create similar civil strife in Lebanon in order to take the focus off Syria.

There were also skirmishes between Syrian troops and Jordanian troops along the common border. For Syrian troops to be instigating attacks on Jordanians outside the border also suggests they are trying to broaden the violence to other countries.

These new events as well as the 20,000+ already killed in Syria, including some press members this weekend, is ratcheting up the chances the U.S. and others are finally going to get involved. The problem is not Syria. The problem will be Iran and Russia, allies of Syria, if a coalition is formed to implement a no fly zone. They have warned repeatedly to stay out of the conflict.

Crude prices are rising on the anticipation of a broader conflict in the weeks ahead.

Also helping support prices was news that Saudi Arabia cut production in July by -300,000 bpd to 9.8 mbpd. Saudi is reacting to the surplus of oil in the market and the lower prices in June when crude traded under $80.

Also supporting prices was news of a collision between a U.S. Navy guided missile destroyer and an oil tanker collided just outside the Strait of Hormuz. The collision had nothing to do with Iran or any combat operations. It was just an accident and nobody was injured. The destroyer received a ten foot gash in its side and there is no word on what happened to the tanker. It was a VLCC capable of carrying two million barrels of oil and it was empty at the time. This would be a collision between a mouse and an elephant in relative terms so the destroyer would always come out the loser. I am sure some navy officers are going to lose their jobs over this mistake. Why a $1.8 billion, 500 ft destroyer with more than 300 sailors and 90 cruise missiles would allow itself to be hit by a slow moving 1000 ft Japanese oil tanker is going to be a major inquiry by Navy brass. While this had nothing to do with Iran it emphasizes the tensions in the Persian Gulf and any event will produce headlines.

Damage to USS Porter

Otowasan Oil Tanker

I wrote about the deepwater drilling boom last weekend. I have some additional numbers of interest this week. A total of 88 new deepwater rigs are scheduled to be delivered between 2013-2019. That is the biggest backlog since offshore drilling began back in the 1970s. In the period 2003-2009 there were only 39 rigs built.

The acquisition announcement last week by National Oilwell (NOV) of Robbins & Meyers (RBN) for $2.5 billion solidifies NOV as the largest supplier of blow out preventers (BOP). NOV already had a 44% share of deepwater BOPs and Robbins & Meyers was the fourth largest supplier. Many of the new rigs will carry two BOPs with one as a backup. When there is a problem with a BOP it has to be lifted off the ocean floor so maintenance can be performed on the rig floor. If a rig has a spare BOP there is minimal time lost drilling because they can swap the broken one for the backup and keep going. Exploration companies are paying extra in some cases for the backup BOP capability. When rigs lease for more than $500,000 a day a loss of several days for a BOP repair is expensive.

HIS Petrodata claims manufacturers are about half way through a two year surge in orders worth about $4.5 billion for BOPs and other machinery needed on rigs after the safety rules were changed post Horizon. $1.5 billion of those orders were for backup BOPs.

Cooper Cameron (CAM) is expected to see earnings rise +54% this year and National Oilwell is expected to grow by +26%. The new requirement for third party certification of BOPs prior to use and then routinely thereafter is producing a new revenue stream for the builders. (NOV, CAM) The Horizon disaster also pointed out that Transocean and BP had modified the BOP repeatedly and those modifications meant more liability to those companies. In the current environment rig owners are turning to NOV and CAM for maintenance, modifications and certification. This is becoming a major revenue stream for those companies with CAM expected to see an additional $1 billion a year in revenue according to Barclays. Cameron has a 31% share of the BOP market.

I am really surprised oil prices are still up after the IEA lowered their demand estimates for 2012 and 2013. The IEA cut demand estimates for 2012 by -250,000 barrels to 89.6 mbpd. They cut 2013 demand estimates from 90.9 mbpd to 90.5 mbpd. They also lowered their global GDP estimates for 2013 from 2.8% to 3.6%.

The IEA also said exports from the Sudans should average 60,000 bpd in Q4 and 130,000 bpd in 2013. That is down significantly from the 450,000 bpd last year. The conflict between the Sudans forced production to be halted and some equipment was sabotaged or destroyed. It will take a year or more for the Sudans to return to prior production levels.

China reported imports declined to 5.1 mbpd in July and that is the lowest level since December. China is the second largest consumer of crude behind the USA at 9.76 mbpd in 2011.

Also helping support prices was news that Saudi Arabia cut production in July by -300,000 bpd to 9.8 mbpd. Saudi is reacting to the surplus of oil in the market and the lower prices in June when crude traded under $80.

Late Sunday we found out that Japan's GDP for Q2 rose by only +1.4% compared to a +2.3% consensus from a Bloomberg survey and +5.5% growth in Q1. The rapidly slowing economy in Japan is just one more symptom of the global economic decline. Crude prices rose on the news because of expectations for massive government stimulus from Japan.

On Sunday Bank of England Governor Mervyn King that the "euro area crisis has no obvious end in sight. The BOE raised its bond purchase target to 375 billion pounds in July and that increase in purchases will run through November. There is a report due out on Monday that may show the eurozone contracted in Q2.

These constant headlines about slowing economic conditions will eventually push oil prices lower. The central banks will print more money or announce some other form of stimulus but that will only lift prices temporarily. Demand is the main driver of prices long term. Until the global economy begins to rebound the spikes in crude prices will be currency related only. Inventories are very high and the driving season is almost over. Refining margins will begin to decline in about two weeks and that normally means a lower price for oil.

That suggests crude prices are going to remain locked into a range from $80 to $105 until the global economy begins to recover.

Jim Brown

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