White House Back on SPR Kick Again

Jim Brown
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The price of crude has been locked in a very tight $95-$97.50 and $112.50-$115 for three weeks on hurricane worries, Iranian tensions and expectations for QE programs by the central banks. That stalemate is about to change.

The tensions over Iran appear to be easing as various countries are pressuring Israel to stand down on their threat to attack Iran. The U.S. State Dept has been working behind the scenes to talk Israel off the proverbial cliff. Since an Israeli attack without help by the U.S. would be a potential disaster and open Israel up to major retaliation by Iran the potential for an Israeli strike seems to be fading.

First Israel has lost the element of surprise. The months of threats have given Iran plenty of time to harden its facilities, add defensive missile batteries and rotate planes to forward bases in order to defend against an Israeli attack.

Israel can still proceed with the attack but Iran is at the extreme range of possibilities for the Israeli air force. They will have to either get permission from some country between Israel and Iran to stage planes/tankers, etc closer to Iran or at the very least to get over flight permission for the attack. Neither of those options are likely to happen. That means Israel will have to violate airspace over one or more countries that have already warned against that course of action.

If Israel decides to go it alone their planes will only be able to carry a limited amount of ordnance because pounds in the air equate to fuel consumed. They will have to prelaunch tankers hours ahead of the main force and there will be no element of surprise. You can bet that Iran will know within 30 min that the attack is in progress and be able to put up a wall of defensive measures making any material damage to Iranian nuclear facilities less likely.

This is why Israel needs the U.S. to support and participate in the attack. Israel has no stealth bombers and they do not have the gigantic bunker buster bombs that would be needed to attack the hardened facilities. The U.S. could launch B2 stealth bombers from the U.S. loaded with these bombs and attack Iran without those on the ground having any clue the attack was coming. The difference in capability between Israel and the U.S. is night and day.

The real threat to Iran would be an Israeli missile from submarines in the Persian Gulf. Yes, Israel has missile submarines. Secondly, as I have discussed before, Israel has been rumored to be considering an EMP attack. That would involve only one missile to explode a low yield nuclear weapon high in the atmosphere over Iran. It would immediately destroy all electronic components inside Iran and knock them back to the late 1800s in terms of technology. There would be no causalities on the ground and the Iranian people would only see a flash way up in the sky. This is the only way Israel can be sure of slowing their nuclear development for a long time.

Obviously the negative feedback Israel would receive for exploding a nuclear weapon over a Muslim country would be very bad. Israel will have to decide if it is worth the risk compared to launching a conventional military strike and killing thousands of civilians, causing extensive damage on the ground, losing dozens of planes in the process and opening themselves up to retaliation. Using the EMP option would immobilize all of Iran's air force and missile force and render Iran incapable of retaliation.

I believe Israel has weighed the options and they are backing off their attack plans. That is just my opinion based on the various news stories of late. However, Israel has a long history of deception surrounding military operations. Multiple times in recent history Israel has managed government publicity to suggest nothing was happening. In the days just before the Gaza blitz, defense minister Ehud Barak, made an unannounced appearance on the Israeli equivalent of the Tonight Show where he was the butt of the jokes and he gave the impression that starting a war could not be further from his mind. On another occasion Israeli generals were all invited to a family retreat at a countryside spa. On Saturday morning the generals were awakened early and sent back to their garrisons with combat to begin within hours.

The downplaying of the Iran attack potential could be just another deception to lull Iran into a lower state of readiness.

Another factor is the Netanyahu speech at the U.N. in late September. The odds are good he will not attack before that speech. Also, the Iranian president, Mahmoud Ahmadinejad, will leave office in August 2013 and there is the possibility he will be replaced by a more moderate person. While he is very vocal against Israel he does not actually control the military or the nuclear policy. The Supreme Leader is in charge and he has strongly denounced nuclear weapons multiple times in recent weeks.

For whatever reason the tensions over Israel and Iran seem to be easing and that will have a negative impact on oil prices in the month ahead.

On the U.S. front the restart from Hurricane Isaac is proceeding normally. As of 11:30 today only six production platforms out of 596 are still evacuated. Only one of the 76 rigs remains evacuated. Only 13.45% of oil, 185,592 bpd, and 8.8% of gas, 397 mmcf, remains offline. These amounts are insignificant relative to the amount of oil and gas in inventory.

There are no storms within 10 days of the Gulf so the restart should continue and full production restored over the next several days.

The inventory report on Wednesday is sure to show another decline since the cutoff for last week's report and the prior week was in the middle of Hurricane Isaac. The next week, Sept 19th, should show a significant rebound in inventory levels as all the pent up production surges into storage.

The storm restart and the surge in inventory levels will not impact prices negatively for another week although some traders will almost surely begin to close longs and initiate short positions once we are past the FOMC meeting on Thursday.

The most significant impact on oil prices will be the FOMC meeting. Analysts tell us the Fed is almost surely to announce QE3. Those expectations along with the ECB have push prices to the current level. At this point I am not confident that a Fed announcement of QE3 will push oil prices even higher since the expectations are baked into the cake.

However, the Fed could elect to simply change the end date on their interest rate policy to late 2015 instead of 2014 and consider that sufficient in the current economy. The Fed does have to be election aware and avoid any semblance of politics. The next meeting is on October 23rd.

Since the economy did add some jobs the Fed could elect to change the date to 2015 and wait for the October meeting and September jobs report before adding further stimulus.

If by chance the Fed does not announce QE3 the price of oil should decline sharply. Even if the Fed announces QE3 it may not be a large program. It would probably be open ended but small monthly purchases of just enough to keep mortgage rates low. That may not be enough to stimulate higher commodity prices. QE1 was announced in Nov 2008 $500 billion in mortgage backed securities (MBS), $100 billion in Fannie and Freddie debt and $300 billion in longer term Treasuries. It was extended in March 2009 by another $750 billion in MBS. QE2 was announced in November 2010 as a $600 billion program. There is almost no way the Fed will announce another program of the same magnitude as QE1 and QE2 so the impact would be less.

Lastly, the White House met with a handful of oil experts on Thursday to discuss the merits of another release of oil from the Strategic Petroleum Reserve. The experts recommend "go big" and said the release could potentially be several times larger than the last release. A UK oil consultant, Petroleum Policy Intelligence, issued a report saying an injection of SPR supplies could occur "within days." However, two people attending the White House meeting said it would not happen that soon.

One proposal put forth to the administration was to do a much longer, more prolonged release of between 100 to 180 million barrels. The last release of 60 million occurred when the civil war in Libya shutdown their production. That release lowered prices for only a couple weeks.

The problem appears to be gaining support for the release. The White House does not want to be seen doing a unilateral release that could be viewed as political as an attempt to lower gasoline prices just before the election. Currently the UK and France have agreed to support it but Germany, Italy and Japan oppose it.

The SPR currently holds 696 million barrels and the White House is talking about reducing it to 500 million "because domestic production has reduced our daily import requirements to 8.0 mbpd."

Another option being discussed would be to give drivers a holiday from federal gasoline taxes but that idea has faded because those taxes amount to tens of billions of dollars and set a dangerous precedent.

As often as the SPR release has come up in the news over the last couple of weeks it appears to have legs and we could see an announcement at any time. The official reason would be to reduce the impact of high fuel prices on the global economy in this time of stress as well as improving the impact of the sanctions on Iran. Lower oil prices overall would reduce the amount Iran is getting for the oil they are still selling. It would seem to me the right thing to do would be to clamp down on the 30 or so countries that received exemptions from the President. Why impose sanctions if the 30 biggest purchasers are exempt from the sanctions?

For all the reasons above plus the normal seasonal demand cycles I believe oil prices are going to decline over the next several weeks.

The Deepwater Horizon oil spill is the gift that keeps on giving. Laboratory tests of large globs of oil that were found on two Louisiana beaches after Hurricane Isaac showed the oil came from the Horizon disaster. LSU said the oil matched the biological fingerprint of the Horizon oil and BP said it would begin work immediately to clean it up. Experts expected the churning of the water by Isaac would lift oil from the bottom and bring it ashore. On Tuesday they found a "large tar mat" on the beaches of Elmer's Island and they were forced to close 13 miles of beaches and restrict fishing in the area. Officials said every storm for years to come will likely stir up oil that could be up to three feet deep on the ocean bottom in low spots and depressions.

Oil Mats on Elmer's Island

Shell was given permission by the administration to begin drilling activity in the Arctic but they did not give them permission to drill. You have to love politics. They said "certain limited preparatory activities" could be started including work related to the installation of a blowout preventer. Ken Salazar said "We have not yet given the final permits to Shell. We don't know if it will occur, and if it does occur, it will be the most watched program in the history of the United States." The problem here is that the liberals are very against anything that might damage the environment. President Obama needs those votes so as long as no permits are issued before the election he can say he has not authorized any Arctic drilling.

The well site is in the Chukchi Sea about 90 miles off the Alaskan North Slope and 700 miles north of Anchorage. Some analysts believe there could be more than 90 billion barrels of recoverable oil and 1,700 Tcf of gas. Obviously if Shell can find a way to produce this oil it would be a game changer.

If they find oil the next step will be to design a production platform that can withstand the sea ice during the winter. The prototype of the platform has a concave base so that ice pushing against it will push upward and then fall back on itself and be unable to develop crushing pressure on the platform. It will include hovercraft that can travel over both ice and water as escape vehicles in case of disaster. My question is what happens if the entire ice sheet moves? I may be na?ve but it would seem that the platform could be pushed around as the entire ice sheet moved due to ocean currents and weather.

Shell Production Platform Concept

Platform ice concept

Saudi Arabia has 98 active land rigs drilling for oil and gas according to Shoaibi Group, a well service company. Saudi Aramco does not publish the number of active rigs. The Shoaibi Group mentioned that number in an email announcing a joint venture with a UK rig company. Saudi had a total of 121 rigs in 2011 including onshore and offshore and they are expected to increase that number by 12% this year to 145 rigs. They are trying to boost natural gas production for electricity generation and increase oil output from the Manifa field.

Saudi needs more rigs because their consumption of oil is rising at more than 9% per year. A 150 page report by Heidy Rehman last week said that Saudi Arabia could no longer be an oil exporter by 2030. Saudi already consumes about 25% of its current production of 11.1 mbpd. Most of their consumption comes from electrical power generation and water desalination. Saudi already consumes all of its natural gas and Kuwait is importing LNG from Russia. Saudi uses more oil per capita than the U.S. and that is a lot.

Oil Use Per Capita

Baker Hughes said the U.S. rig count declined by 30 last week to total 1,864. This compares to 1,958 in the same week in 2011. Land rigs suffered all the losses with Texas losing 20 rigs. Overall oil rigs declined by 10 to 1,406 and gas rigs by 21 to 452. Three rigs were unclassified.

FBR said last week that record high levels of natural gas in storage was masking a "fundamentally balanced" gas market this year and it will be under supplied in 2013 and 2014. FBR estimates the gas market will be under supplied by 1.5 Bcf/d in 2013. The company said if gas rig counts don't increase we could see a record low for gas in storage in 2014. Without an increase in rigs the gas shortage in 2014 could be 3.2 Bcf/d. The company said producers are slow to react to changes in price because they don't believe the week to week changes. Producers lag prices changes by 6-9 months.

Net imports are set to decline to 4 Bcf/d in 2012 from 5 Bcf/d last year. That is expected to decline further to 2.8 Bcf/d in 2013 and 1.8 Bcf/d in 2014. Gas sells for 3-4 times the U.S. price overseas. U.S. gas prices are not reflecting the data in the FBR report and have already begun to move lower after hurricane outages are restarted.

Natural Gas Chart

I believe the chance for lower oil prices in the weeks ahead mean we should not add any new plays until after the FOMC meeting next week. There are far more factors suggesting a future price drop than factors suggesting a price rise.

Jim Brown

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