New Direction for Iran

Jim Brown
 
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Iranian citizens swarmed the streets in Tehran cheering for the new president, Hasan Rowhani, as he pledged to end the soaring 30% inflation and end the crippling sanctions. Meanwhile U.S. lawmakers are considering new legislation that would cut Iranian exports to less than 500,000 bpd.

The election of a moderate reformist could not have come at a better time for Iran. It will take months if not years to turn the country around but every journey begins with a single step. The Iranian stock market rebounded +1,194 points or +2.5% on Sunday and the rial currency soared +9% against the dollar.

The new president has a tough job ahead. In the Iranian government the president is in charge of the economy while the nuclear program, military and foreign affairs is controlled by the Supreme Leader and the ruling council. While Rowhani has called for ending the nuclear standoff he really has little control over the nuclear activities that are tied to the sanctions. Rowhani does not take office until August.

It will be interesting to see what happens to oil prices this week. In theory they should decline on expectations for a more rational Iranian government but as I pointed out above that may not be the case. Prices could also rise because of the new legislation seeking to cut exports further but that could take weeks to pass and months to implement. Then there is the task of getting India and China to cooperate. They are still the biggest buyers of Iranian oil.

Those points suggest we could get a bit of headline volatility in oil prices but the longer term view is still a further cut in Iranian exports.

The Syrian situation is more important to oil prices. It is not that Syria's shutdown in production can get any worse with a measly 20,000 bpd trickling out. It is the risk of violence spreading to other countries. The Obama decision to arm the rebels means more of a direct confrontation with Iran and Russia, both strong supporters of Syria. If the U.S. ramps up the war by arming the rebels with higher technology weapons it could turn into a way by proxy with Russia. The rebels already have more small arms than they can use because of weapons captured from the government.

Analysts are afraid that Syria's Assad will attempt to spread the conflict to neighboring countries to take the focus away from Syria. Instead of one big war it could turn into many small ones.

The civil war in Syria is becoming a serious Sunni-Shiite war. Sunni extremists, aided by al-Qaeda, blew up a Shiite mosque in eastern Syria on Friday. Earlier in the week more than 60 Shiite fighters and civilians were killed in the village of Hatla. Most of the armed rebels are from the country's Sunni majority. Assad belongs to the Alawite sect, an offshoot of Shiite Islam. Sunni and Shiite fighters from other countries have been joining the fight in large numbers.

On Saturday Egypt announced it was severing ties with Syria and closing its embassy. Morsi's decision followed calls from hard-line Sunni clerics in Egypt and elsewhere in the region to launch a holy war against Assad's regime.

This Sunni-Shiite confrontation is the bigger issue. Many of the Middle Eastern nations are predominately one or the other and the ruling party is in the minority in several cases. This creates a powder keg situation for those countries if the sectarian violence spreads. This is why oil prices are rising.

The U.N. raised the official death toll to 93,000 and said the actual toll could be significantly higher but there was no way to tell until the war is over and refugees return home. Several million people have fled Syria to neighboring countries creating serious support problems for those countries and creating large imbalances of Sunni-Shiite populations in those countries as well.

This war is not going to be over quickly and has a better than 50% chance of spreading. Syrian oil production has already plunged from 380,000 bpd to only 20,000. If the sectarian violence spreads to other oil producing nations the supply of oil from those nations could also decline sharply. More than 40% of the world's global oil supply comes from the Persian Gulf and northern Africa nations so there is a real concern over supplies if the violence spreads.

In Nigeria the MEND rebels blew up two gasoline tanker trucks and promised to ramp up attacks on the petroleum industry. "From today, every tanker vehicle we find distributing petroleum products including propane gas has become a legitimate target in our war against injustice, corruption and oppression." Shell, Exxon, Chevron, Total and ENI produce oil in Nigeria and they constantly have to halt deliveries because of pipeline sabotage and attacks on wells and pumping stations. Between 2006-2009 the MEND rebels cut production by more than 28%. Violence subsided after the government offered thousands fo fighters amnesty and payments to turn in their weapons. The violence resumed after some key MEND players were arrested for bombings in 2010. This problem is not going away and Chevron and Shell are trying to sell their assets in Nigeria to escape the constant drain on the business.

Oil prices are expected to fluctuate next week as a result of various economic events. The HSBC Flash PMI for China on Wednesday is likely to show a further decline and that will weigh on demand expectations. The outcome of the FOMC meeting will drive the dollar and that will impact oil. The Philly Fed Survey on Thursday is likely to show contraction in manufacturing in that area and project a further decline in demand.

Oil hit a nine-month high on Friday at $98.25 on the security concerns despite some negative economic news in the USA.

Crude Oil Chart

A new weather system is forming in the Caribbean but has not yet reached the point to become a named storm. If it does intensify it is on track towards the west-central Gulf of Mexico and could be a problem for the oil patch. It will be a couple days before we know and it still has to cross over Venezuela intact to be any danger.

Natural gas prices declined to $3.73 on Friday after a strong +95 Bcf increase in gas in storage compared to a 63 Bcf build in the year ago period and a weak weather forecast. The weather is expected to be mild in the gas consuming regions with no extreme heat forecast for at least the next two weeks.

Natural Gas Chart

Drilling permits rose sharply last month in Ohio with 98 approved. Wyoming saw 91 approved and Kentucky approved 44. This is part of a spring push by producers to increase rig counts thanks to the higher gas prices. Clearly permits issued today will not see gas produced for months but producers are encouraged by the lack of a price swoon this spring. Prices have been relatively firm and with consumption increasing and LNG export licenses being approved the long term forecast for gas prices is improving.

The battle over LNG export licenses is heating up with the Exxon CEO making the case last week that higher gas prices as a result of increased exports are actually good for the economy because it will stimulate a much larger drilling boom with hundreds of thousands of long term jobs that will put money back into the economy. It is a tough sell since low gas prices are the reason many businesses are bringing manufacturing jobs back to the USA. When gas prices were so high in 2006-2008 jobs were moving offshore to locations with cheaper gas. The shale gas revival and the explosion of demand in the developing countries has reversed that trend and now the U.S. has the lowest gas prices. Gas in Asia can sell for as much as $17 per mcf compared to $3.75 in the USA. Energy secretary Ernest Moniz said last week he would like to "expeditiously" begin evaluating the more than a dozen applications waiting for approval to export LNG. The DOE ended a two-year freeze on reviewing applications when it approved the Freeport LNG terminal in Texas last month. CEO Tillerson said companies don't want to begin construction on $5-$10 billion facilities until their applications are approved. Tillerson said Exxon was not going to begin construction on the $10 billion Golden Pass LNG project until he had an approval.

Baker Hughes, Schlumberger and Halliburton have all said recently they are seeing preparations for a sharp increase in active rigs over the rest of 2013. Let's hope this trend continues. The number of active gas rigs declined to only 353 last week. That is only 3 above an 18-year low.

Walter Energy (WLT) was halted for trading at 2:PM on Friday. They announced after the close they were cancelling a $1.55 billion refinancing project due to "market conditions." They just announced the project two weeks ago to refinance some of their debt. Before shares were halted they declined -17% on three times average volume. Shares closed at $12.15 and the lowest level since 2008.

Walter Energy Chart

Coal stocks are getting hammered on demand concerns. The manufacturing slowdown in China is expected to reduce demand and several brokers in the U.S. have lowered demand and price estimates for 2013 and 2014. Peabody is the lone standout in the crowd predicting an increase in demand and higher prices but their voice is being ignored as the stocks dive. Even India, the fourth biggest coal importer in the world said thermal coal demand rose +48% in April. Nobody seems to care. The coal ETF (KOL) which contains mining stocks and equipment makers like Joy Global is absolutely imploding.

KOL ETF Chart

Another factor weighing on coal was a sneak attack by the Obama administration. The administration issued a little-noticed rule for efficiency of microwave ovens last week. I know, who cares if the government wants to save a few watts on the next generation of microwaves? Hidden in the report's complicated calculations was an increase in the cost of carbon emissions from $23.80 to $38 a ton. The government uses the number to calculate the costs and benefits of proposed regulations. The calculation is used to approximate losses from global warming such as flood damage and diminished crops.

The key point here is they raised the cost metric from $23.80 to $38 by hiding it in the microwave oven regulations. Future regulations covering everything from coal fired plants, diesel locomotives, flat screen TVs, lawn mowers and anything that consumes electricity or fossil fuels will have to use the higher $38 number. Things like the XL Pipeline, new coal plants or new cars will be viewed as more costly and therefore more damaging to the environment. That means they will have a harder time getting approved.

You know it was an important and controversial change in the administration's stance because of the way it was disseminated. It was hidden in the microwave regulations and released late on Friday May 31st without any notice or public comment period. If you want to hide something from the market they release it after the market closes on a Friday afternoon. One analyst said it appeared they wanted to get something on record containing the new number before the Keystone pipeline came up for final approval in a couple months. By increasing the carbon cost the administration can kill the pipeline again on environmental reasons.

When confronted a spokesman for the administration tried to backdate the change saying "the administration first arrived at this calculation in 2010 using leading expert models and updated it applying the same methods and assumptions." That was OMB spokeswoman Ari Isaacman Astles. That is pretty sneaky for the White House and appears to be follow through on Obama's State of the Union speech where he pledged to tackle global warming despite opposition from Congress. I guess if you don't tell them you changed the rules it makes it difficult for them to protest after the fact.

Market

The market declined last week with the Dow losing -177 points. The S&P and Dow both decline to the support of their 50-day averages and another technical rebound appeared. The market is going to be focused on FOMC meeting on Wednesday and the Bernanke press conference. There is a good chance we will end the week significantly higher or lower than the 1,626 close on the S&P on Friday. Bernanke is expected to try and calm the taper talk volatility and that could send the market significantly higher if he does a good job. If the Fed persists on warning they are about to taper the market could end the week significantly lower.

S&P-500 Chart

Energy stocks have declined about -2% last week despite the rising oil prices. If the market continues lower on negative economic news I expect that decline in energy to continue.

We are heading into the summer doldrums where traders are absent from the market and spending time with their families. Be patient and we will use any declines as a buying opportunity.

Jim Brown

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