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Evan Kelly

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This Week In Energy: The Growing Threat From China

This Week In Energy: The Growing Threat From China

Oil prices dropped to new six-year lows this week as WTI dipped below $42 per barrel. The big piece of news this week was the currency depreciation in China. It seems we are talking more and more these days about the warning signs coming from China’s economy and how the trouble there is depressing oil prices. In June and July, it was the stock market crash, and this week it is the currency depreciation. The yuan dropped 3 percent by the end of the week after stabilizing at 6.3975 per dollar.

The move to devalue the yuan was aimed at providing a jolt to Chinese exports. But a more pessimistic take on the move is that China’s economy is starting to raise some red flags. The grip that the central government has had on the economy appears to be slipping. The Chinese government has carefully crafted a reputation of control, backed up by two decades of phenomenal growth.

Presiding over such a period of unprecedented economic expansion has created an aura of invincibility and inevitability. But the economy is starting to appear fragile, with high levels of provincial debt, an inflated stock market, and growing unease about environmental pollution that could force the government to pullback on growth. To make matters worse, the port city of Tianjin suffered a massive explosion this week that killed dozens of people and spewed toxic chemicals into the air. The incident is emblematic of China’s growth-at-all-costs model, which is starting to run its course as people become fed up. Related: Energy Investors May Have A Long Wait Ahead

That is the backdrop for the currency move this week, and the devaluation sent a shock through the oil markets. Oil demand has been growing, but not quick enough to soak up extra crude supplies. A weaker Chinese currency will make oil comparatively more expensive, so could knock Chinese oil demand down a bit, a bearish development for oil.

In the U.S., low oil prices could be exacerbated by an outage at a major U.S. refinery. The Whiting refinery, based in Indiana right outside of Chicago, was taken offline by its owner BP (NYSE: BP) for unplanned repairs. The refinery’s total output is 410,000 barrels per day, and one of the units (with a 240,000 barrel-per-day throughput capacity) could be offline for a month or two.

The refinery is the largest in the Midwest and could divert quite a bit of crude to Cushing, Oklahoma for storage. Of course, storage levels at Cushing are closely watched as a gauge for oil markets in general. The outage at Whiting could lead to inventory builds of about 1 million barrels every four days. Such a build could start to test the capacity at Cushing, and push down oil prices as a result. Moreover, the crude that the Whiting refinery uses comes from Canada. Canada’s oil producers already sell oil at a discount, and the refinery outage could force deeper discounts. Meanwhile, gasoline prices could shoot up in the Chicago area as refined products run lower than normal. Related: Better Times Ahead For Oil, If You Can Believe It

The oil bust has claimed another casualty. Hercules Offshore (NASDAQ: HERO) plans on filing for Chapter 11 bankruptcy protection. The Houston-based shallow water rig supplier saw its business dry up and will be forced to hand over its assets to creditors. The company has over $1.3 billion in debt and just $546 million in assets. Hercules operates a fleet of 27 jackup rigs that are used in shallow water. But the industry has moved on to prefer more modern, higher-specification rigs, which has taken away business from Hercules. The problem became too hard to deal with after oil prices collapsed and demand disappeared.

Other indebted companies are increasingly turning to private equity to keep their doors open. Traditional lending and equity markets are no longer willing to fund marginal companies, but private equity is still on the hunt. In the past, exploration and production companies have dismissed solicitations from private equity, but with few options left for companies sitting on $44 billion in estimated high-yield debt, private equity is becoming a last resort. The cash injection from private equity can come with steep interest rates and onerous terms for the operator.

Optimists that believe in an oil price rebound are becoming harder and harder to find. Forecasts should always be taken with a grain of salt, but a survey of 10 investment banks shows a growing pessimism among market analysts. The survey, conducted by the Wall Street Journal, finds that the average among the 10 banks predicts that oil prices will remain below $70 until late 2016. “The heart of the matter is simple: There is too much oil,” the global head of oil research at Société Générale SA told the WSJ. “We are now forecasting significantly more global oversupply than previously, in both 2015 and 2016, which will continue to weigh on prices.” Related: Could This Be The Next Great Renewable Energy Source?

Backing up that survey was new data from the IEA. The monthly report from the Paris-based agency estimates that global supplies will exceed demand by about 1.4 million barrels per day for the rest of this year. That is bad news for oil prices. On the other hand, the silver lining in the IEA report was the upward revision of expected oil demand. With low prices, more oil is being consumed around the world. The IEA expects demand to grow by 1.6 million barrels per day in 2015, a jump of about 0.2 million barrels per day from its last report.

Finally, a deal has been reached between the Israeli government and Noble Energy (NYSE: NBL) over the development of offshore gas reserves in the Eastern Mediterranean. Noble Energy and its partner Delek Group (TLV: DLEKG) have discovered massive gas plays in the Mediterranean, including the Tamar and Leviathan fields. However, the companies had effectively suspended their development plans after Israeli antitrust regulators sought to break up their holdings, for fear that the companies had too much of a monopoly grip on Israeli gas. The sides have reached an accord that caps the price that Israeli companies will have to pay for gas, and requires the development of the Leviathan by 2020.

By Evan Kelly Of Oilprice.com

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