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1. Oil and the Global Economy

After falling steadily since May 1st on increasing economic troubles in Europe, oil prices climbed for most of last week and closed just below $74 a barrel. For the month, oil was down $12 a barrel. As has been the case for many weeks now, oil prices continue to move largely in reaction to the Euro/Dollar ratio and the twists and turns in the EU sovereign debt crisis. On Thursday oil advanced over $3 a barrel as Spain agreed to budget cuts and China reiterated its commitment to European bonds.

Bloomberg reports that OPEC increased its production in May by 187,000 b/d to a 17-month high of 29.3 million b/d. US crude stockpiles continue to rise while US gasoline consumption, which had been rising in recent weeks, was down a bit last week according to MasterCard. Average US gasoline prices fell from $2.88 to $2.73 during May.

Prospects for lower consumption in the EU, flat consumption in the US and growing Chinese consumption continue as the major fundamental factors affecting the markets.

A new factor on the world scene is increasing tensions on the Korean peninsula following the sinking of a South Korean patrol boat. So far, however, there have been no obvious effects on the oil markets. As North Korea’s major trading partner with military ties going back to the Korean War, a handful of senior decision-makers in Beijing will play a major role in determining how the crisis will be resolved.

2. Deepwater Horizon

With the announcement on Saturday that the Top Kill effort that involved pumping 30,000 barrels of drilling mud into the well had failed, efforts are now directed towards a plan called the “Lower Marine Riser Package” or LMRP. This effort involves cutting off the bent and twisted riser pipe that continues to spew at least 12,000 to 19,000 b/d into the Gulf and placing a new cap on top of the existing blowout preventer that is supposed to capture at least some of the oil and pipe it to a ship on the surface. BP says it will take four to seven days to install the new cap.

BP then plans to install a second blowout preventer on top of the existing one and use it to stop the flow of oil until a relief well is completed in early August. A senior BP official said Sunday that there is no certainty that the LMRP effort will work. If this turns out to be the case, oil will likely continue spewing into the Gulf for at least another two months. Some observers are warning that by cutting off the existing riser pipe, the oil flow could be increased.

The Environment

Last Thursday, the Flow Rate Technical Group, a panel of scientists, said that the run-away well has been releasing 12,000 to 19,000 b/d into the Gulf, far more that previously estimated. Some members of the group said that is merely the minimum amount spewing out – not the upper limit. BP continues to maintain that the original 5,000 b/d estimate made several weeks ago was estimated by the government and not BP.

As increasing amounts of oil continue to wash up along the Louisiana coast, and with no end to the crisis in sight, local residents and state officials are clamoring for the US government to do more to protect the fragile coastline. The state wants the government to create a giant sand barrier off the Louisiana Coast by dredging sand that would build up and join outlying sandbanks and islets.

There is now general agreement that this blowout is the greatest environmental disaster in US history and is likely to get worse. Twenty-five percent of the Gulf is now closed to commercial and recreational fishing and tourism along the coast is down as people see images of oil washing ashore.

Scientists have discovered a giant plume of dissolved oil that is six miles wide, 20 miles long and extends down to a depth of 3,200 feet below the water. While the oil plume of oil and dispersants is transparent, there is concern that it could be toxic to marine life.

Last week NOAA released a primer on what might happens if a hurricane crosses the spill area. Other than delaying containment operations, NOAA believes that a hurricane could help the situation by thinning oil slicks and dispersing the oil over wider areas. Should a hurricane pass to the East of the spill, more of the oil would be driven further inland by the storm.

Liability

As the crisis rolls on and tempers fray, the issue of who is going to pay how much for the enormous damage that is being done to the Gulf Coast and its seafood and tourism industries grows. The BP spill has already cost it nearly a billion dollars and many observers are estimating that the ultimate cost of the disaster could run into the $10s of billions. Current BP management, in responding to the continuing surge of bad publicity, reiterates at every opportunity that it will pay for all damages. A future BP management may not be so willing to bankrupt the company to pay for the ultimate costs.

Given the company-busting size of the potential liability, BP and its partners, including Transocean, the drilling rig operator, have been maneuvering since the first hours of the disaster to position themselves for the innumerable court cases, fines and penalties that are likely to arise.

There are laws on the books dating from 150 years ago and from 1990 that could limit corporate liability ensuing from the explosion. If negligence can be proved, the limitations would not stand. Swiss-based Transocean has already petitioned the courts to limit its liability to $26 million.

In addition to cleanup costs and damages to coastal industries, BP faces civil fines, which could be as much as $4,300 for each barrel blasted into the Gulf. This could amount to some $50 to $100 million a day for each day the flow goes unchecked. There is also the possibility that BP could lose any contracts it has with the US government and be barred from drilling on federal property and in US coastal waters. On top of this, there has been discussion of possible criminal prosecutions for negligence that led to deaths when the drilling rig exploded.

The Moratorium

So far the explosion’s major impact on the future of oil production has been the moratorium that has been placed on US offshore drilling. On Thursday President Obama banned new drilling in deep coastal waters and ordered 33 rigs to stop work on exploratory wells until the report of the Presidential inquiry is complete six months from now. The moratorium will cost some 300-400 very high paying jobs per rig unless the rigs are moved promptly to projects overseas. Industry sources are saying that the moratorium could defer as much as 350,000 b/d of oil or equivalent by 2015-2016. Wells already partly drilled will have to be sealed so the rigs can detach and move away. Some are likely to be moved to overseas drilling projects such as off Brazil.

The President also blocked drilling planned for Alaskan waters this summer and cancelled the sale of new leases in the Eastern Gulf of Mexico and off the coast of Virginia. At the same time, he lifted a ban on new drilling in water less than 500 feet deep.

While environmentalists cheered, the order immediately set off a wave of protests from those affected by the decision. The American Petroleum Institute warned of the danger to America’s energy and economic security that would result from the ban. Senators from states affected by the ban such as Alaska and Louisiana denounced the moratorium as overkill.

The Longer Term

With close to half the world’s oil production and 25 percent of US production scheduled to come from deepwater wells by the end of the decade, it is apparent that such drilling cannot be banned altogether, but will likely take place under more stringent and expensive safety regulations at least in US waters. The EU however has already moved to review its offshore drilling regulations and is likely to follow the US lead in strengthening regulations and oversight. When other countries such as Brazil, Angola and Nigeria come to appreciate the damage that can be wrought by an unstoppable deepwater blowout, they are likely to adopt more stringent rules even if the International Oil Companies (IOCs) doing the drilling don’t adopt them first.

Insurance premiums for offshore drilling have already risen by 15 percent and are likely to continue to rise by as much as 50 percent, depending on the depth of water involved. Increasing costs of operation are likely to drive small drillers out of offshore operations.

As the global oil situation tightens, the fight over US offshore drilling is likely to carry over into the 2010 and 2012 elections. As deepwater drilling sites are among the few prospects still open to the IOCs, the fight is likely to be long and rancorous.

Costs and Safety

One of the themes that is starting to emerge from the inquiries already underway is that BP may have cut safety corners due to the extraordinarily high costs and delays it had suffered on the ill-fated project. When the explosion took place, BP had been drilling for six months, was spending some $2 million a day and was going to end up with a well costing $200 million – double the going rate for a deep-water well.

Congressional investigators possess documents showing that BP officials chose a cheaper casing pipe for the well that may have contributed to the conditions causing the explosion. On the day of the explosion, there was a heated argument between employees of rig-owner Transocean and those of BP over the proper way to seal the well. BP, which was in overall charge of the operation, apparently won the argument and the rest is history.

The issue of the tradeoff between the very high costs of deepwater drilling and essential safety standards are sure to come up during the Presidential inquiry.

Quote of the Week

  • [After reviewing a live video of BP’s oil leak in the Gulf] “It’s not going well. You have more or less the equivalent of six fire hoses blasting oil and gas upwards and two fire hoses blasting mud. They are losing the competition.”

Tad Padzek, Chairman Petroleum and Geosystems Engineering Dept., University of Texas at Austin

The Briefs

  • Petroleo Brasileiro, the world’s biggest deepwater oil driller, aims to start production within five years at the offshore Franco field, Brazil’s second-largest discovery. Initial production from the field that Petrobras plans to buy from Brazil’s government in exchange for new stock will be 50,000 to 100,000 barrels a day. (5/24, #5)
  • Iraqi Kurdistan could raise oil production to 200,000 b/d by the end of 2010 and hopes to resume crude exports. Iraqi Kurdistan halted oil exports — of about 60,000 b/d through a pipeline to neighboring Turkey — in October last year due to a payment dispute with Baghdad. A recently signed deal paves the way for exports to resume. (5/29, #3)
  • During 2010, spending on overseas acquisitions by oil and gas companies in China and India may more than double to $30 billion in 2010 from a year earlier, assuming oil prices stay between $70 and $80 a barrel. (5/28, #11)
  • Kuwait’s oil minister said OPEC ministers are “not yet” concerned that oil costs less than $70 a barrel, and there is no need for the group to hold an emergency meeting. (5/26, #7)
  • BHP Billiton more than doubled its resource estimate for the BP-operated Mad Dog field in the Gulf of Mexico, underscoring the region’s importance after last month’s disaster. BHP expects the field, which started production in 2005, to hold an additional 2 billion barrels of oil equivalent. (5/27, #9)
  • China may increase its annual crude- oil refining capacity by 50 percent in the next five years to meet rising demand in the world’s fastest-growing major economy. (5/265, #6)
  • Alyeska Pipeline Service Co., whose biggest shareholder is BP, temporarily shut down the Trans-Alaska system after a leak of “several thousand barrels.” (5/27, #19)
  • Marathon Oil Corp., the fourth- largest U.S. energy producer, cut back 2010 drilling plans in shale formations after natural-gas prices tumbled. (5/27, #12)
  • Shell agreed to buy most of closely-held East Resources Inc. for $4.7 billion in cash, expanding its holdings of US shale gas deposits. As part of the deal, Shell will obtain new positions in “high potential” US shale gas acreage, in the Marcellus and Eagle Ford plays. (5/28, #22)
  • Global energy consumption will rise 49% between 2007 and 2035, led by economic growth in developing nations, the US Energy Information Administration said Tuesday. (5/26, #6) [Editor’s note: under any reasonable scenario, can supply rise by 49% in 25 years? Over the last 25 years, world energy consumption grew about 60%, but oil supply in 2035 will be notably lower than it is today.]
  • A US House committee has proposed barring the Pentagon from buying fuel from companies that do business with Iran’s energy industry – a stance that is a long shot for becoming law. This underscores US lawmakers’ continuing dissatisfaction with international efforts to slap tough sanctions on Tehran. (5/25, #4)
  • Currently the federal government is offering a $7500 tax credit to purchasers of electric cars with batteries as large or larger than the Chevy Volt. This tax credit can be applied to the first 250,000 electric vehicles each manufacturer sells. Now the Senate and House have submitted new proposed bipartisan legislation which seeks to spend up to $11 billion to spur the adoption of electric cars. (5/28, #27)
  • A California-based electric-car startup-Coda Automotive-will build a factory in Ohio that could employ more than 1,000 workers initially and that will use Chinese technology to produce automotive-grade lithium-ion batteries for an all-electric car the U.S. company plans to launch in California later this year. (5/25, #20)
  • Daimler announced today that it is partnering with China’s BYD to build a new brand of electric cars via a joint venture called Shenzhen BYD Daimler New Technology. (5/29, #19)