Why do oil and natural gas markets appear complacent?

 By Ross McCracken


In this month’s selection on The Barrel from Platts’ Energy Economist, Ross McCracken wonders why in the midst of so much turmoil, markets are relatively calm.
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The energy sector is beset by crises, but the price response has been muted.

Two days after the fall of the northern Iraqi city of Mosul to Islamic Sunni militants, international benchmark Dated Brent was assessed at $109.77/barrel, more than $1/b less than two weeks earlier. It then rose to $113.25/b June 16, the highest level since February 2013, but still only about a 3% jump overall. By June 19, it had reached $115.31/b, falling back to $114.52/b June 20 and to $113.13/b June 23. This despite a major uprising in Iraq, chaos in Libya, a civil war in Syria, and, somewhat below the radar, the spread of Al-Queda linked activity in the Sahel.



European month-ahead gas prices at the UK’s NBP and Zeebrugge in Belgium have fallen, despite eastern Ukraine becoming the scene of armed conflict between pro-Russian separatists and the Ukrainian army. Spot LNG prices have plummeted from around $20/MMBtu at the start of the year to pre-Fukushima levels below $12/MMBtu. Both the relative calm of the oil markets and the decoupling of the dynamics of the LNG spot market and European gas prices from oil are notable.



But why so calm? The boom in US oil and gas production is a key element. World oil markets are no longer dependent on OPEC supply growth to meet additional demand (but they are still dependent on OPEC production.) European gas stocks are high and demand muted, while both Brussels and Moscow have a mutual interest in seeing gas flows continue, whatever happens in Ukraine. Asian demand for LNG is also weak and the supply picture for new LNG capacity good.



Yet, while the immediate threat to the bulk of Iraqi oil production may be low, it is genuine, and there is a clear risk that Iraq will now fail to boost production and/or export capacity over the next five years as planned. Simply needing to combat the insurgency will be a major drain on Baghdad’s resources and a deterrent to investment in the country. As noted by Statoil Chief Economist Eirik Waerness at the International Association of Energy Economics conference in New York June 16, the range of outcomes regarding Iraqi supply is larger in volume terms than the expected increases in US crude production.



With a target of raising crude output capacity to 8.4 million b/d by 2017-18, Iraq is expected to play a key role in meeting rising international demand for oil. However, exporting that volume depends on alternatives above and beyond the expansion of the southern export terminals. It would involve the rehabilitation of the Kirkuk-Ceyhan export route to carry 1 million b/d and the construction of a planned 1 million b/d pipeline through Jordan, which in turn is contingent on the rehabilitation of the strategic North-South pipeline within Iraq. None of these projects is feasible in the current security environment.



In Europe, Ukraine’s vast storage tanks are not being filled fast enough to cope with a cold European winter. Moreover, energy relations between Europe and Russia could hardly be worse. Although Russia continues to deny its support for the rebels, there appears to be a clear flow of military equipment from Russia. NATO satellite images show T-64 tanks without markings in Ukraine. The separatists’ weaponry and organization from the start has been more sophisticated than might be expected for a localized civilian uprising. Their weapons now include anti-aircraft guns and armored troop carriers. These weapons are entering eastern Ukraine despite a threatening cordon of Russian troops along the Russian/Ukrainian border, which indicates complicity.



Moscow appears to believe that the “economic realities” of mutual gas dependency will prevail, hence its support for the separatists and its rash start to construction of South Stream, despite the lack of EU regulatory approvals. This view has been fostered by the EU’s pragmatic short-termism, which prioritizes gas flows over a more robust response to Russia’s actions. But a long-term relationship cannot survive mutual distrust.



The argument, or some variant of it, is often put that the “economic realities” of conflicts will eventually produce rational responses from the parties involved. In other words, reason will prevail. It is a flawed, reductionist argument and the world is littered with sub-optimal economic outcomes as a result of politics. Pride, prejudice, principle and nationalism often prove more powerful forces than immediate economic well-being. The situations in both Ukraine and Iraq remain volatile and dangerous, suggesting that current market conditions reflect a significant degree of complacency.



Source: http://blogs.platts.com/2014/06/26/iraq-ukraine-oil-market/?sf3482872=1