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National Energy Security Issue: Effects of Cheap Oil

Photo Liberated from Patterson UTI Drilling

Once again the oil and gas industry has done too good a job is finding and developing new sources - so much so that its success is eating the drilling industry - the Oil & Gas Journal reports US rig count nearing lowest level in generations:

The US rig count dropped 12 units to 502 during the week ended Feb. 26, according to Baker Hughes Inc. data. While the decline is the smallest thus far this year, it represents the eighth straight weekly double-digit drop to begin 2016.
The total is the lowest since Apr. 30, 1999, a week after the 1998-99 downturn hit its bottom of 488. With additional losses in the coming weeks, the current count could dive to a level not seen in generations.

The NYTimes has reported on the "simple economics" behind the drop in oil prices:

. . . [I]t boils down to the simple economics of supply and demand.

Well, yeah.

The NPR folks have noted that these low prices, coupled with a decline in exploration and drilling, might just have an impact on the overall U.S. economy as businesses associated with that part of the oil and gas industry find less demand in Why Cheap Gas Might Not Be Good For The U.S. Economy:

Arora analyzed government data, and found that what's changed is that the oil and gas industry as a share of GDP has about doubled in the past decade. Now it has grown so large that it's changed the basic equation of whether cheap gas is a good thing overall.

"The benefits to consumers could be around $140 billion from gasoline savings," Arora says. "But the losses on the other side due to lower production, less investment, less build-out of infrastructure could be around that amount. So we're kind of at a wash."

This might help to explain why the economy still isn't exactly charging forward even with the stimulus of cheap energy. But Arora himself notes that the question needs more study.

Meanwhile, analysis by the research firm Moody's Analytics finds that cheap oil and gas are still a net positive. And plenty of experts remain in that camp.

Last year the NYTimes offered up Lower Oil Prices Provide Benefits to U.S. Workers:

Wall Street may be growing anxious about the negative impact of falling oil prices on energy producers, but the steep declines of recent weeks are delivering substantial benefits to American working-class families and retirees who have largely missed out on the fruits of the five-and-a-half-year economic recovery.

Just last week, the federal Energy Information Administration estimated that the typical American household would save $750 because of lower gasoline prices this year, $200 more than government experts predicted a month ago. People who depend on home heating oil and propane to warm their homes, as millions do in the Northeast and Midwest, should enjoy an additional savings of about $750 this winter.

“It may not have a huge effect on the top 10 percent of households, but if you’re earning $30,000 or $40,000 a year and drive to work, this is a big deal,” said Guy Berger, United States economist at RBS. “Conceptually, this is the opposite of the stock market boom, which was concentrated at the top.”

Of course, more dollars in the pockets of the 90% of the households not in the top 10% really ought to mean much more money available in the economy because of the law of big numbers. More from the NYT:

But the latest drop in energy prices — regular gas in New England now averages $2.35 a gallon, compared with $2.94 in early December, and it is even cheaper in the Midwest at $1.95 — is disproportionately helping lower-income groups, since fuel costs eat up a larger share of their more limited earnings.
**
“Oil prices, gas prices, food prices — luckily it’s going down, which is great,” Ms. Smith said, explaining that when prices were higher she had to scale back on groceries to save money for heating oil. “I hope it keeps going.”

You might want to, at this point, recall President Obama's plan to increase taxes on oil as discussed in Oil Dumbness from President Obama an increase in taxes is paid for by customers of the oil companies just like Ms. Smith.

This ought to be self-evident, but here's another source talking about the effect of higher gas prices.

It's not just the U.S. that rides this roller coaster of oil prices. Oil exporting states like Saudi Arabia are also taking hits, as discussed in this Forbes article, 4 Reasons Saudi Arabia Can't Control Oil Supply:

In the past, OPEC—led by Saudi Arabia—would reduce production in order to maintain the oil price. Today, however, the process isn’t that easy, and there are four reasons for that…

Reason #1: The US
Oil above $60 or $70 would mean that US production would continue to increase, and the US is already the world’s #1 producer. OPEC would have no choice but to keep cutting further in order to maintain that price.

Reason #2: Cheating among OPEC Members
OPEC members (other than Saudi Arabia) almost always cheat on their production quotas when they can. Considering that other OPEC nations are desperate for income, the incentive to cheat is all powerful.

Reason #3 The US-Iran Nuclear Deal
The deal and subsequent lifting of sanctions means that an additional one million barrels per day will soon hit the market. As international oil companies vie for the privilege of drilling more oil in Iran, it will put further upward pressure on supply.

Reason #4: US Production in the Market
Although drilling rig usage in the US is down by nearly 75%, production has just now begun to fall off. It will take some time before enough US production comes off the market to put upward pressure on prices.

The U.S. Energy Information Adminsitration produces all sorts of reports on oil production like this one:

The "International Energy Agency" (which is actually a creature of its 29 member countries)has issued its 2016 Medium Term Market Report:

Global oil supply growth is plunging as an extended period of low prices takes its toll, the International Energy Agency (IEA) said in its annual Medium-Term Oil Market Report (MTOMR) released today. While U.S. light, tight oil (LTO) output is falling steeply for now, the market will begin rebalancing in 2017 – and by 2021 the United States and Iran are seen leading production gains among non-OPEC and OPEC countries, respectively.

There is this warning:

“It is easy for consumers to be lulled into complacency by ample stocks and low prices today, but they should heed the writing on the wall: the historic investment cuts we are seeing raise the odds of unpleasant oil-security surprises in the not-too-distant-future,” said IEA Executive Director Fatih Birol, launching the report at IHS CERAWeek.(emphasis added)

What "oil-security surprises?"

From the downloadable Overview of the IEA report:

Another downside to low oil prices is the impact on investment. The IEA has regularly warned of the potential consequences of the 24% fall in investment seen in 2015 and the expected 17% fall in 2016. In today’s oil market there is hardly any spare production capacity other than in Saudi Arabia and Iran and significant investment is required just to maintain existing production before we move on to provide the new capacity needed to meet rising oil demand. The risk of a sharp oil price rise towards the later part of our forecast arising from insufficient investment is as potentially de-stabilising as the sharp oil price fall has proved to be.

In addition to the effects of insufficient investment there are the lost "experience" costs that will result from personnel cutbacks in the oil and gas industry as rig counts and exploration budgets drop. Experienced oil field workers will, as they have in the past, move to other jobs (assuming they exist) that might pay less.

Ah, you might say, "So what?"

The "so what" is the lag time it would take to get those workers back into the fields should there be a national need for an increase in U.S. crude oil and natural gas production.

That lag time has national security issues.

Suppose, for example, Russia decides to cut off natural gas supplies to Europe beginning in late 2016 using that gas as an economic weapon to force the nations dependent on Russian gas to accept Russian claims in the Ukraine or the Baltic States. One way for the West to resist this pressure is to have some assurance that the U.S. and its allies will be able to set into motion a stream of LNG ships carrying gas to replace that of the Russians, ameliorating the gas situation for those affected states. In addition to LNG shipping, a force of air and naval escorts protecting that LNG stream at sea might be required to prevent interference with the flow of gas in competition with that of the Russians.

Or, suppose the Chinese interfere with the flow of gas and oil through the South China Sea sea lanes to Taiwan,South Korea and Japan. Can the U.S. and Canada help mitigate the harm while alternative sea lanes that avoid the South China Sea are developed? Who will protect those shipments and how?

Or, what if Iran or someone else takes the big step of managing to destroy the Saudi oil production - say through using nuclear weapons - can the U.S. and non-Middle East producers step up and provide  at least minimal supplies to the world now depending on Middle East oil?

Cheap oil is good, but not all good.

Global Shipping Worry: "China is living hand to mouth . . ."

A "Bulker"

In the past, we have looked at the world of "dry bulk" shipping to gauge the direction of the global economy - high demand for such shipping equates to a growing economy, low demand, well, not so much.

China, measured by dry bulk shipping, has become a matter of some concern in certain circles, as reported at here":

The Baltic Exchange's main sea freight index, which tracks rates for ships carrying dry commodities was flat on Monday, as weak Chinese demand weighed on rates for dry bulk vessels.

***

China is the world's biggest consumer of iron ore, coal and other base metals, but recent data has shown the economy cooling more quickly than expected, with industrial output growth slowing sharply in April.

Analysts expect the dry bulk segment to face short-term weakness as Chinese buyers are deferring delivery or have defaulted on coal and iron ore deliveries to weather the current slide in steel and raw material costs.

Well, there was a brief bump up a day or so ago on the Baltic Dry Index when China announced a continuation of its "growth" plan, but . . . here's graph of the BDI:

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View the full INDEX:BDIY chart at Wikinvest

Which means that the demand for hulls to ship stuff is weak and that means that a key leading indicator is not looking good for an improved global economy. Keep an eye on this and in the trans-Pacific container shipping business.

UPDATE: Oh, that title quote? From The Guardian here:

Chinese consumers of thermal coal and iron ore are asking traders to defer cargos and defaulting on their contracts, the Financial Times reported on Monday.
The newspaper cites traders as saying the deferrals and defaults, which have only emerged in the last few days, have contributed to a drop in iron ore and coal prices.
"We have some clients in China asking us this week to defer volumes," a senior executive with an unnamed global commodities trading house is quoted as saying.
The deferrals are described by the FT as the clearest sign yet of the impact of the country's economic slowdown on the global raw materials markets.
"China is hand to mouth at the moment," the unnamed source is quoted as saying.

The BDI described here:

Baltic Dry Index is a daily average of prices to ship raw materials. It represents the cost paid by an end customer to have a shipping company transport raw materials across seas on the Baltic Exchange, the global marketplace for brokering shipping contracts. The index is quoted every working day at 1300 London time. This index can be used as an overall economic indicator as it shows where end prices are heading for items that use the raw materials that are shipped in dry bulk.

World Oil Transit Chokepoints - Add One More to the List

The U.S. Energy Information Agency has a dandy list of those narrow places on the earth where oil flowing in commerce on ships can be threatened by "pirates, terrorist attacks, and political unrest" at World Oil Transit Chokepoints. The list includes the Strait of Hormuz, the Strait of Malacca, the Suez Canal, Bab el-Mandab, the Bosporus, Panama Canal, and the Danish Straits.

Time to add another narrow area to the list, the "O Gap" sometimes located in Washington,DC and, unique to chokepoints, known to be more a part of a calculation than a real spot on the planet.

Shown below is a rare capturing of the "O Gap" as it begins to close off a route of oil to the U.S.:

Some might feel that the "O Gap" would be better known as the "Keystone Twist". Many people are unhappy with its existence, as set out in Expected Keystone XL permit rejection strongly criticized:

US Sen. Richard G. Lugar (R-Ind.), the primary sponsor of legislation that set a deadline for a decision, said the administration misled the American people on the pipeline. “In the face of Iranian threats against oil affordability, [it] once again is trying to blame Congress and the State of Nebraska instead of taking responsibility for American jobs and security,” he said during an appearance at a Greenwood, Ind., instruments and gauges manufacturer who potentially would be doing work for the project. “This political decision offers hard evidence that creating jobs is not a high priority for this administration,” said US Chamber of Commerce Pres. Thomas J. Donohue. “By placing politics over policy, the Obama administration is sacrificing tens of thousands of good-paying American jobs in the short term, and many more than that in the long term.”*** “Blocking the Keystone pipeline would be an enormous mistake by the Obama administration,” said National Center for Policy Analysis Senior Fellow H. Sterling Burnett. “We need the oil and we need the jobs it would bring. This is as ‘shovel ready’ as anything Obama has proposed, yet because his radical environmental constituency objects, he’s apparently halting the pipeline.”

Or, as set out in the video linked at Instapundit, “He chose Venezuela over Canada.”, which really ought to be watched.

China must like the result, Canada will look to China to sell its oil. I guess the oil tanker owners will be happy, too.

Remember the "O Gap" - the new chokepoint. UPDATE: Here, read Re-Election Obsessed Obama Goes Political On Keystone By ROBERT J. SAMUELSON

Trend Lines

Chinese Shipping company Freezing Payments.

Baltic Dry Index:

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View the full BDIY chart at Wikinvest

Baltic Dry Index is a daily average of prices to ship raw materials. It represents the cost paid by an end customer to have a shipping company transport raw materials across seas on the Baltic Exchange, the global marketplace for brokering shipping contracts. The index is quoted every working day at 1300 London time. This index can be used as an overall economic indicator as it shows where end prices are heading for items that use the raw materials that are shipped in dry bulk.

Generally, a decrease in the BDI means demand is down for raw materials and that portends a decline in future planned production because of weak consumer demand. In the chart above, you will note a slight increase trend in the BDI in the past few days. In the last 12 months, the BDI has ranged from a low of 1043 (Feb 2011) to a high of 2261 (Dec 2010). Here's the last two years:

What's it all mean? Chinese shipping company not paying ship owners?

Is it because their demand is down and they don't need to be especially nice to the ship owners to ensure they can get ships in a tight market? Because they know there's too many ships chasing too few charters?

Glenn Reynolds gets an interesting question from one of his readers:

“Did the Administration punt on Keystone because there are more Solyndras out there dependent on high oil prices and Alberta oil threatens to lower the price enough to put more of them out of business?

"You don’t need a weatherman To know which way the wind blows," Dylan once wrote. How else do you create a market for overpriced fuels and products? Jack up the prices and costs of your competition. In private business it would be a violation of the law. Apparently, in government when the goal is "saving the planet" there are no rules. So we see the Department of the Navy getting into the "market creation business" for an unproven business (or, as the insiders put it, "investing in").

Of course, "investments" are always better when the fix is in. But, as Solyndra proves, sometimes the "fix" doesn't take. Which means, with private investors the investors take a bath. With taxpayer money? It was just "unexpected" that competition could drop the price model of Solyndra into the garbage pit.

Despite strong growth in the first half of 2011 and traction in North America with a number of orders for very large commercial rooftops, Solyndra could not achieve full-scale operations rapidly enough to compete in the near term with the resources of larger foreign manufacturers. This competitive challenge was exacerbated by a global oversupply of solar panels and a severe compression of prices that in part resulted from uncertainty in governmental incentive programs in Europe and the decline in credit markets that finance solar systems.

 A "global oversupply of solar panels?" Surely, someone should have been monitoring the market before a ton of money was "invested?"

Half a billion here, half a billion there, pretty soon you're talking real money.

Somali Pirates: Cost to the Sailors and Some Very Poor Shipping Practices

Very nice blog post at Sub-Standard Ships And Human Costs Of Piracy: The Case Of Captain Prem Kumar – Analysis - Neptune Maritime Security:

Irresponsible shipowners who send poorly prepared ships into piracy-prone areas must accept some share of the responsibility both for the incidence of ship hijackings off the Horn of Africa and for the associated ill-treatment of seafarers. If ransoms are not paid promptly, crews are likely to suffer more.

Read the whole thing.

The plight of most third-world crews of "sub-standard" ships held by pirates is an largely untold story. Good on Neptune Maritime Security for shining a little light on the issue.

Sea Lines of Communication or Sea Lanes

Back in the beginning days of this blog, I had a couple of posts about "sea lanes" and their importance. For example, from 2005, there was a post cleverly titled "Sea Lanes". I wrote then:

I keep posting about sea lanes. What are these things? Sea lanes are trade routes - almost like highways in the sea, where due to geography, ocean going vessels follow certain paths to avoid islands, shallows and other impediments to their travel. They are also generally the most efficient routes to get from Point A to Point B - as close to straight line travel as a ship can accomplish given the number of obstacles in its path.

Since then, there have been hundreds of posts here in which I refer to either "sea lanes" or "sea lines of communication" (see, e.g. Sea Lines of Communication (SLOCs)). There can be a difference between the two terms, since SLOC can have a military meaning that I have generally ignored here.

However, what is important to know about sea lanes or SLOCs is that they exist and that they are a major reason that nations interested in international commerce have navies - to keep the sea lanes open. In discussing maritime security, keeping sea lanes open is a major topic.

We hear a lot about how many things travel by sea. From crude oil to grain to large screen TVs to cars and much more, cheaper shipping has allowed the entire world to benefit from global product distribution (see here and here). Where do these products travel? Sea lanes. An excellent example of these sea lanes is shown on this Naval War College slide (which I have borrowed without shame):

There it is, a picture of world commerce. Those are not war ships wending their way across oceans, those are merchant ships moving the goods that make the world go. You might note that there are places where the traffic converges to pass through narrow areas. These are referred to as "chokepoints", "Chokepoints are narrow channels along widely used global sea routes . . ."

Large ships sail on rigid schedules, carrying parts from Japan to the U.S. or to Europe in such a reliable manner that warehouse costs are reduced by planning for "just in time" deliveries of products.

So, when there is a disruption in the smooth flow of goods, say from the recent earthquake in Japan, there are ripple effects that impact more than the Japanese part manufacturers.

A similar effect is caused by things that interfere with sea lanes. These might be something like a catastrophe that strikes a chokepoint like a closure of the Suez Canal.

Taking the map above, I added some blue arrows to point at a few chokepoints, like the Suez Canal, Strait of Malacca, Strait of Hormuz, Strait of Bab el-Mandab, Strait of Gibraltar, and the general area of straits leading from the Caribbean into the Gulf of Mexico (see below).

Want to look at Caribbean chokepoints? I added some destroyer images to make the point - most of the oil imported into the U.S. by ship has to pass through these straits. In turn, these straits need to be protected if our economy is to work.

Finally, let me again refer to an older post about the Somali pirates and how cleverly they've been in moving out into the major sea lanes of the Indian Ocean area as they ply their trade. See Where the Somali Pirates Operate and Why where I put up this consolidated image of the Indian Ocean sea lanes and pirates strikes:

While there seem to be logistical limits on the Somali pirates as to the number of captive ships and hostages they can host at any given time and this limits their impact on the sea lane flow of commerce, they are certainly well-versed in the exploitation of the known sea lanes. Even this relatively minor bump in the flow of traffic, though, has been enough to get 20 or more naval vessels from many different countries out into the Indian Ocean attempting to thwart interference by the pirates of these vital sea lanes.

The greater lesson of the Somali pirates is how relatively easy it may be to cause trouble on sea lanes or at chokepoints and why it is vital to have in place assets to counter any such attempted trouble making.

We have now reviewed sea lanes, sea lines of communication and choke points and their importance to the global flow of commerce on the highway of the sea.

I suppose we also have covered why we, a nation dependent on maritime commerce, have a Navy and a Coast Guard out there keeping the sea lanes open. As noted here:

70% of the world is water, 80% of the world lives on or near the coastline and 90% of our commerce sails across it. Any disruption in that chain caused by instability has a direct impact on American quality of life.