Headlines Push Crude Higher

Jim Brown
 
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The headlines from Egypt just keep getting worse and multiple countries are now calling for intervention into the crisis. More than 149 people were killed and 1,403 were injured when the military finally moved against the two pro Morsi demonstration sites.

Qatar condemned the use of force in dispersing the demonstrators. Britain called for the military to use restraint in dealing with the problems. Turkey urged the international community to act immediately over what it said was an "unacceptable" response to the protests. Iran called the deaths a "massacre of the population" and warned of serious consequences. France and Germany issued calls for calm on both sides and for the military to return to negotiations. The EU also condemned the violence saying "confrontation and violence are not the way forward." The U.S. State Dept spokesman urged the Egyptian military to allow Morsi supports to protest freely but did not condemn the violence.

As evidence the problem is not going away Egypt appointed 19 generals as provincial governors on Wednesday. The military is increasing their control of the country despite the government moving to hold new elections in the near future.

Apache (APA) gets 20% of its production from Egypt and owns more than three million acres of oil leases declined -2% on the headlines. Apache, the largest landowner in Egypt, claims oil exploration and production has not been affected. However, if Egypt falls into a civil war their production could be at risk.

Antigovernment groups in Bahrain tried to execute a major protest on Wednesday but tight security thwarted their efforts. The activists were inspired by the events in Egypt and they had scheduled and advertised a nationwide protest march through Manama's city center. To counter the demonstrations Bahrain placed a heavy security cordon around Manama and warned in news broadcasts they would "forcibly confront" protestors. Most businesses closed ahead of the event for security reasons. More than 60 localized protests occurred around the city.

The Bahrain protests are just another example of the conflict between Sunni and Shiite sects. Bahrain is primarily Shiite but the ruling family is Sunni. The Arab Spring has fired up the age old conflicts between these sects and several countries are facing the same problems. This is going to continue to cause unrest as long as the Egyptian and Syrian conflicts exist to fan the flames.

Saudi Arabia stifled the protests in that country by ruling with an iron fist and zero tolerance policy and announcing tens of billions of dollars in spending to provide housing and jobs. Despite the outwardly calm appearance there is still unrest in Saudi Arabia.

Sunni-Shia sectarian violence has not been this high since the sack of Najaf and Kerbala in 1806. Hundreds of Iraqis are being killed each week by bombs and the country is set to fall back into a civil war.

With the entire Middle East on slow boil there is continued support for crude prices. Brent rallied to $110 on Wednesday ahead of expiration on Thursday. In addition to headlines from Egypt and Syria we are seeing supply constraints in Libya, Iraq and the North Sea.

Brent Crude Chart

In Libya the two biggest export terminals were closed again on Tuesday due to strikes by workers. Exports have fallen by -50% in July and -70% in August because of protests by workers, policemen and border guards for raises and back pay. Output of light crude has fallen from 1.2 mbpd to 400,000 bpd. This is a primary reason for the high prices for Brent crude.

Militants bombed a major pipeline carrying oil from Iraq to Turkey and halting exports from Northern Iraq. Militants in Nigeria have also slowed production and exports in July and August and forcing exporters to claim force majeure on Bonny light deliveries.

The IEA expects exports from Iraq to decline by -500,000 bpd for 4-6 months because of a heavy maintenance schedule at the southern export terminals. Iraq's largest state owned oil firm, the South oil Co, told the WSJ the maintenance would only reduce exports by a small amount. Production and exports are very important for OPEC countries. It is how they are ranked in the cartel and admitting they are going to cut exports by -500,000 bpd would be a black eye for Iraq. We won't know the actual amount until after the maintenance is completed and maybe never know the true numbers because Iraq will want to keep them secret. The bottom line is that exports will slow over the next 4-6 months.

Output from the North Sea has slowed as a result of a heavy maintenance schedule in August and is expected to decline further in September. The Forties pipeline has been shut down twice over the last two weeks. After the last shutdown forced Britain's biggest field, the Buzzard field, to halt production the restart was slower than expected.

European refiners are expected to cut production by 500,000 bpd next week to 70% of capacity due to the high price of crude and the lack of availability of Russian Urals crude. Russian exports of Urals crude have slowed significantly creating a shortage of that grade and forcing refiners to switch to other waterborne grades and pay higher prices.

The higher prices for Brent have reduced the European crack spreads to an average of $2.11 per barrel. That is down -60% from the June highs.

In the U.S. the EIA reported that crude inventories fell by -2.8 million barrels to 360.5 million and the lowest level since January. Imports were flat and refinery demand for crude declined by -282,000 bpd. Inventories at Cushing fell from 39.9 million to 38.5 million barrels and the lowest level since March 2012. U.S. crude production rose to a new 18-year high at 7.57 mbpd. Crude inventories remain at the top of their five-year range.

Gasoline inventories declined by -1.2 million barrels to 222.4 million barrels. Gasoline production fell off a cliff with a drop of -480,000 bpd and imports fell by -122,000 bpd. It was a miracle we did not see a much bigger decline given the -4.2 million barrel drop for the week in those two numbers. Gasoline demand fell -56,000 bpd. Gasoline inventories remain at the top of their five-year range.

Distillate inventories rose for the second week with a gain of +2.0 million barrels. As the summer driving season ends we should expect to see a spike in distillates as refineries ramp up heating oil production. Distillate demand declined -263,000 bpd. Distillate inventories remain at the bottom of their five-year range.

(Inventory Snapshot guide: Green squares are multiyear highs. Yellow is multiyear low. Orange is multi month high. Pink is multi-week highs. The number of active gas rigs at 350 is an 18 year low. Oil rigs at 1,412 is an eight-month high. Crude oil at 397.6 mb is the highest since 1931.)

Inventory Snapshot

Crude Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

Mexico Changes Laws to Allow Private Exploration

Mexico is taking a major step to increase oil production after a decade of declines. In 1938 Mexico outlawed ownership of oil by private companies. This prevented companies like Exxon, Conoco and Chevron from buying leases and exploring for oil in Mexico. The president of Mexico is attempting to change that law and induce private companies to compete for Mexican oil.

Under the proposal Mexico would continue to own the oil but would pay a percentage of the revenue to the oil companies in lieu of the actual oil. Basically it would be a contract drilling arrangement where the producer receives so much per barrel produced. The second part of that change is that private companies would be able to "register" the reserves they found as though they actually owned them. This would allow companies to "book" reserves even though they will not actually own the oil. They will own the revenues from the oil and that is the key point.

Mexico has the largest proved reserves in Latin America after Venezuela and Brazil with 13.87 billion barrels. Shale gas reserves could be as high as 460 Tcf. Pemex believes another 27 billion barrels of deepwater reserves could be added if companies were allowed to explore and develop properties in the Gulf. Pemex believes the changes in the law could add $50 billion a year in capex spending in Mexico and boost the Mexican GDP by +2%.

Exxon, Shell and Repsol have already expressed an interest in exploring Mexican oil fields. With the decline in Mexican production the revenue from oil has fallen from 50% of the Mexican budget to 30%. The problem is the quality of the existing fields. Because of budgetary limitations and lack of new technology Mexico has only been able to produce from the easiest fields and those are decades old and in steep decline. They need the technology currently in use by the major oil companies to open new fields and find new oil.

Storm Season Approaching

The Atlantic hurricane season is about to enter the most active part of the season. The season runs from June 1st to November 30th but the most active period is August-October. September 10th is the statistical peak in the season. Heat and weather patterns become conducive to tropical storm formation and multiple storms can form at the same time. According to NOAA there are six to seven storm fronts moving west across Africa that could eventually become tropical storms. There are two fronts already over the ocean with a 70% chance of tropical storm formation. The closest is already moving towards the Yucatan and could be in the Gulf of Mexico in the next several days.

Only four named storms have appeared so far in 2013. The 30-year average is 12 storms and the outlook for this season is 13-19 storms with five major hurricanes. The two red areas in the map below have a 70% chance of becoming named storms.


Market

The Dow closed at a four week low on Wednesday as investors began to worry about the headlines over the next six-weeks. We are just entering the typical August-September period where the markets normally decline. In addition to the normal seasonal declines we are facing a debt ceiling battle and the mid September FOMC meeting where they may decide to taper QE. I continue to believe we will see weaker markets over the next six weeks and we will have a buying opportunity in September. Be patient!

Dow Chart

Crude prices typically decline in August-September and then rebound in the fall as winter heating oil demand increases. The events in the Middle East are preventing that normal end of summer decline but once inventory levels begin to rise I think we will see a significant dip in prices.

Jim Brown

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