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This Week In Energy: Geopolitical Triggers Could Spur More Price Volatility

This Week In Energy: Geopolitical Triggers Could Spur More Price Volatility

Tensions heated up in the Persian Gulf this week after Iran fired upon and seized a cargo ship near the Straits of Hormuz. Considered to be the most strategic and vital chokepoint for global oil trade, the narrow stretch of water is regularly patrolled by the U.S. Navy. Oil prices briefly surged before it was known who was on board the ship. Once it became known that the ship was carrying a Marshall Islands flag and had no Americans on board, tensions calmed a bit. Still, the U.S. Navy sent a destroyer to the Straits in order to try to force the Iranians to back down. “At first appearance, this does seem to be provocative behavior, but we don’t have all the facts yet,” Col. Steve Warren, a Pentagon spokesman, said amid all the confusion. Iran insists the incident was a commercial dispute over unpaid debt, but there are fears that Iran thought it was targeting a U.S. ship. In any case, the incident will surely not be welcomed by U.S. President Barack Obama, who is seeking to reach a historic agreement with Iran over its nuclear program.

In another maritime dispute, the war of words between China and its neighbors over sovereignty in the South China Sea heated up this week as well. First came a statement from the Association of Southeast Asian Nations (ASEAN), which said that China’s reclamation work in the South China Sea “eroded trust and confidence and may undermine peace, security and stability in the South China Sea.” China’s Foreign Ministry followed up with a terse response, saying it was “extremely concerned” over ASEAN’s statement because the conflict was not one between China and ASEAN, but rather a dispute that should be resolved between China and individual nations. China is building artificial islands in disputed territory in the South China Sea, which its neighbors fear could be used for military purposes. China claims 90 percent of the South China Sea, territory that is also claimed by its neighbors – the Philippines, Vietnam, Indonesia, and Malaysia. The dispute may seem bizarre, but the underlying issue is the vast oil and gas potential that the South China Sea holds. Nobody thinks this will erupt into hot war – for now – but there are few reasons to think that the standoff will be resolved anytime soon. Related: We Are Witnessing A Fundamental Change In The Oil Sector

China, meanwhile, is taking on a bigger role in the oil trade. China’s state-owned companies are sending traders to the Middle East to gain insight and influence over the trading business. Where it used to rely on third parties to buy oil cargoes, Chinese traders have bought a near record level of oil on their own in the month of April. Unipec, a division of state-owned Sinopec, bought Oman and Dubai cargoes and sold it to other Chinese companies. The increasingly active role played by Chinese traders is pushing up prices. “Chinese firms are increasingly the price makers in the regional crude oil markets,” Owain Johnson, a top official at the Dubai Mercantile Exchange, told the Financial Times. “This month shows just how much firepower they have at their disposal.” China’s oil demand continues to rise, and it has taken advantage of low global prices, buying up crude for its strategic petroleum reserve.

Saudi Arabia’s King announced a historic change in its line of succession, paving the way for a smooth transition in the future for successive monarchs. King Salman named his nephew, Interior Minister Mohammed bin Nayef, as the new Crown Prince. He also made his son, Mohammed bin Salman, as the Deputy Crown Prince. Nayef, 55, and bin Salman, 30, are both young and would become the first monarchs that are not sons of the founding King Abdulaziz. The reshuffling does make succession clearer in the coming decades, but the move was widely seen as a way of dealing with the ongoing war in Yemen. The two younger princes that were effectively promoted are also associated with the air campaign in Yemen. As a result, the change in succession could mean King Salman is moving towards a more confrontational and aggressive foreign policy. Related: How The Majors Are Playing The Oil Price Slump

Tensions are also heightening in Eastern Europe. Ukraine is worried that Russia is planning a ground offensive as a new bout of violence erupted in Eastern Ukraine. Meanwhile, Baltic nations are stepping up their military readiness in preparation for a hypothetical Russian invasion. Baltic and Scandinavian states are increasing military spending and retrofitting military hardware to bolster defenses. Russia has raised fears of an incursion because of numerous territorial violations, as Russian planes strafe into foreign air space and submarines secretly travel in neighboring waters. Some analysts think Russia is merely concerned over the security of its oil shipment route through the Baltic Sea, but the small Baltic States are not taking any chances.

Offshore oil rig suppliers are facing very rocky times. The Wall Street Journal reported that oil producers are increasingly trying to break their contracts with rig suppliers due to a lack of interest in drilling. Breaking contracts often comes with hefty fees, but companies like BP (NYSE: BP) are willing to pay them. BP announced on April 28 that it would pay $375 million in order to cancel two offshore rig contracts for the Gulf of Mexico. Others are following suit. That is bad news for oil field service companies like Diamond Offshore Drilling Inc. (NYSE: DO), which could see six of its contracts cancelled. Even if rigs are not cancelled, the lack of demand and the mere threat of a cancellation will force rig suppliers to renegotiate prices. All of this points to a very bad near to medium term for oil field service companies, even if oil prices rise. Related: Health Risks From Fukushima Disaster Greatly Exaggerated

Meanwhile, problems continue to mount for Venezuela. Already suffering under a collapse in revenue from falling oil prices, the government of Nicolas Maduro now has to deal with a shortage in electricity. Venezuela gets a large portion of its electricity supply from hydropower, but has a history of coming up short when demand surges. To make matters worse, heavy subsidies incentivize profligate use of energy. Temperatures are rising in the South American country, and as consumers crank up the air conditioning, the government has been forced to institute a system of rationing. There are reports of blackouts in at least 10 of Venezuela’s 24 states. President Maduro, as he often does, has blamed “sabotage” for the electricity shortage.

Canada’s oil exports hit a record high in January, even as surging U.S. oil production and falling prices battered the industry. Canada exported 3.11 million barrels per day, 12% higher than a year earlier. Most of that traveled by pipeline and rail to the United States, especially to the Midwest. Canada’s oil sands, suffering under low prices, are still expected to see production rise this year.

By Evan Kelly of Oilprice.com

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