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Middle East Tension Won’t Rescue Oil Prices

Middle East Tension Won’t Rescue Oil Prices

First of all, we will take a quick look at some of the critical figures and data in the energy markets this week. Last year ended on a sour note, with oil prices hitting 11-year lows. Aside from a fleeting price rally, 2016 doesn’t look much better, at least for the first half of the year.

We will then look at some of the key market movers early this week before providing you with the latest analysis of the top news events taking place in the global energy complex over the past few days. 

(Click to enlarge) Related: Saudi-Iran Dispute Won’t Cause Lasting Oil Price Rally

Chart of the Week

• 2015 was a historically bad year for oil. The energy portion of the S&P Goldman Sachs Commodity Index (GSCI) fell 41 percent over the course of 2015.

• But last year was also an annus horribilis for other commodities. Every one of the 16 commodities tracked in the GSCI saw major losses. Nickel had the worst year, with a more than 40 percent decline in value. Grains fared a little better, based on tighter market conditions in the first half of 2015.
• Readers by now have likely become familiar with the causes of the commodity crash: boom-bust cycles, a strengthening dollar, slowing global economic demand, debt, and deflationary pressure in many parts of the world. The big question is when any of these trends start to reverse. For the next few months at least, the bearish sentiment will persist. Related: $1 Billion Copper Mine Deal In The Making Here

Market Movers

Swift Energy Company, an independent oil and gas producer focusing on the Eagle Ford, became the 40th company to declare bankruptcy since the beginning of the oil price downturn. The company had already slashed spending by 60 percent and laid off a fifth of its workforce, but persistently low prices overwhelmed the company. It filed for Chapter 11 protection on December 31.

Canadian Oil Sands (TSE: COS) continues to resist the takeover bid from Suncor Energy (NYSE: SU), and there are only a few days left before the C$4.3 billion bid expires. Canadian Oil Sands, with its stake in the Syncrude project, wants to remain independent. Suncor is hoping to increase its holdings of the Syncrude asset. On Monday, executives at Canadian Oil Sands told its shareholders that it should remain independent, while Suncor argued the shareholders should accept the hostile takeover. January 8 is the deadline.

Chesapeake Energy (NYSE: CHK), the second largest natural gas producer in the U.S., was downgraded by Raymond James due to low natural gas prices. The company has lost more than 75 percent of its value over the past year, although its share price jumped 10 percent on Monday after natural gas prices staged a small rally. There is a growing consensus among ratings analysts that Chesapeake could struggle to meet payments on billions of dollars in its outstanding debt.

Tuesday January 5, 2016

Happy New Year! 2016 kicked off with a ban in the energy markets. Oil prices rallied more than 4 percent in the opening hours of trading, as the markets weighed the consequences of a sudden outbreak in tensions between Saudi Arabia and Iran.

The events are complex and fluid, but the short version goes like this: Saudi Arabia executed 47 prisoners over the weekend, one of which was a notable Shiite cleric. Iran (and many other countries around the world) expressed outraged. Iranian protestors torched the Saudi embassy in Tehran, causing Saudi Arabia to cut off diplomatic relations with Iran.

Middle East tensions often cause a spike in oil prices, so a sudden conflict between OPEC’s first and third largest oil producer unsurprisingly affected crude on January 4. At the same time, markets tend to react first, only to come to more realistic conclusions later. For now, the conflict has no real tangible effect on oil markets – there is little chance of a supply disruption, absent a more catastrophic escalation in the conflict. As such, oil prices quickly retraced their gains on January 4, closing out the day mostly back where they started. Related: Panic In Chinese Markets Has Commodity Traders On Edge

The conflict between Saudi Arabia and Iran almost certainly won’t erupt into a direct military confrontation. Instead, the conflict could play out in the world of oil. As a result, the effect on oil prices is, if anything, negative not positive. For example, Saudi Arabia just slashed its price for oil shipments heading to Europe, the region where Iran held significant market share before 2012 sanctions forced it out. Saudi Arabia is likely trying to box out Iran as it ramps up oil exports in the coming weeks and months when sanctions are removed. Saudi Aramco announced on January 5 that it would discount oil exports to Northwest Europe by $0.60 per barrel and by $0.20 for oil destined for the Mediterranean. The market share strategy also serves to outcompete Russia for the European market. Competition for market share will push down prices as more discounted crude floods the market.

Moreover, as the markets shove aside worries over geopolitical tension, the bearish case for oil once again stands out. It even got some more supporting evidence as we started the New Year. Manufacturing data from China painted a worrisome picture for the world’s second largest economy, which continues to slow. China’s major stock indices crashed by 7 percent.

The instability in China adds to the growing body of evidence that the global economy is not faring well. Yet another way of looking at the problem is through trade activity. In 2015, container traffic at some of the busiest ports in the world grew at its slowest rate in a half decade. In fact, container traffic at the 30 largest ports actually shrank by 0.9 percent in the third quarter, a time of year that normally sees an uptick in activity. That was the first decline since 2009. Part of the problem is the strengthening U.S. dollar, depressing demand for Chinese goods because of the yuan link to the dollar. But tepid economic growth is raising concerns about the stability of the global economy.


Meanwhile, another geopolitical crisis to keep an eye on is in Libya. Militants associated with the Islamic State attacked Libyan security forces at the country’s largest oil export terminal, Es Sider. Together with the Ras Lanuf port nearby, the two terminals have the capacity to export 560,000 barrels per day, but both are closed at the moment.

The attacks resulted in the explosion of an oil storage tank after it was hit by a shell. The port has been closed since 2014, so the attacks won’t necessarily affect export levels. But the events are illustrative of the terrible violence plaguing the war torn country, fomenting instability that will prevent a return to pre-war export levels. The attacks come even as the political situation is starting to improve. The two rival governments, controlling east and west portions of the country, respectively, have signed onto a power-sharing agreement. It remains to be seen how that can help Libya return to some semblance of stability.

Raymond James expects that oilfield service companies will experience a rough year in 2016, as rig counts continue to fall and drilling activity remains subdued. At the same time, analysts say that the second half of the year could rebound. “Look for a roller coaster ride in early 2016 for oil field services, followed by outsize gains in the second half,” Raymond James recently concluded. They project the rig count to fall by another 150 over the next six months, which will result in “a much uglier fundamental year than current consensus estimates.” But drilling activity could come back quickly if prices rebound, and all of the job losses and sidelining of equipment could create a supply constraint for rig services. “Labor and service availability likely becomes a major constraint on the ability to meet activity demand,” Raymond James analysts wrote. “This should be compounded by oil field service pricing increases as the market for services gets tighter.” In short, things will get worse for oilfield service companies, but once the market turns, fortunes could come back relatively swiftly.

In Oklahoma, the number of earthquakes surged by 50 percent in 2015 compared to a year earlier, hitting a total of 881 with a magnitude of 3 or greater. That set another record for seismic activity in the state, and many scientists and state regulators are increasingly confident that wastewater disposal from hydraulic fracturing is a main contributor. Regulators have issued voluntary guidelines for drillers to reduce disposal injections, but after one company rebuffed the requests, the state is looking at mandatory directives. Action could also come from the state legislature. New regulations could affect drilling operations for companies in the state.

By Evan Kelly of Oilprice.com

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