The European Oil Quandary and <br>Supercharged Volatility

The European Oil Quandary and <br>Supercharged Volatility

by | published April 2nd, 2012

As you read this, Marina and I are on a flight to Germany. Two grandchildren await us on other side of the Atlantic.

Several meetings await me as well.

Most will center on shale gas production in Poland. But recent developments have added more pressing concerns.

I’m reminded of the old days – in another life – when I would board a government jet with one series of briefing documents (the ones I had been working on “round the clock). Once on board, though, I would find an entirely new set of documents suddenly dumped my lap at takeoff.

(Believe me, that will shift your priorities quickly. If nothing else, you learn to become both flexible and creative.)

That’s kind of like what Europe’s going through.

In the U.S., we’ve discussed the impending European Union (EU) embargo of Iranian oil for several weeks.

In Europe, however, they’re already living with the repercussions.

And, over the past few days, another wrinkle is sure to ratchet up the uncertainty.

Last week, yo-yoing of crude oil prices resulted from rumors that the U.S., U.K., and France would release strategic oil reserves to lower the price (a futile gesture).

But before this happened, another dynamic took shape.

And this underlying pressure is now certain to rise again.

Here’s What’s Wreaking Havoc on Iran’s Oil Trade

We have known that the Western sanctions against Iranian oil exports are beginning to take a bite out of Tehran’s oil proceeds. Remember, Iran is dependent on its oil sales for about 80% of its national budget.

On March 23, crude oil prices rose significantly in both New York and London trading, after the release of two estimates indicating that Iran had reduced exports in February by at least 300,000 barrels – or roughly 14% month-on-month.

The International Energy Agency (IEA) then reported that Iranian production fell by 50,000 barrels per day in February.

Short-term levels may end up equaling reduced volumes from three decades ago (during the Iran-Iraq War).

The IEA also predicted in 2010 that Iranian production capacity would decline about 890,000 barrels per day through 2016 because of tightening sanctions.

Last week, the agency re-confirmed that projection, saying that projection for the decline may even be on the low side.

In other words, the combination of making it difficult and expensive for Iran to access international banking (an essential part of trading oil, when virtually all global oil trades are in dollars), and the decision by Europe to stop all imports from Iran effective July 1, is wreaking havoc on the Iranian oil trade.

Now, if the purpose of the sanctions is to make it difficult for Tehran to continue its nuclear ambitions, this is good news.

But if you are wrestling with how Europe can cope with the fast-approaching instability, that is another issue altogether.

That’s because the European Union has yet to determine how markets in general – and its own market, in particular – are going to deal with the shortfall of volume resulting from declining Iranian exports.

This remains a very tight supply environment, with the constriction likely to worsen as a result of the embargo.

In the short term, Saudi Arabia has pledged to meet the import requirements of the three most affected EU members – Greece, Italy, and Spain.

Greece receives up to 30% of its monthly crude imports from Iran. Iranian crude accounts for almost 14% of supply in Italy and 13% in Spain.

But it is not just locating new sources of crude that will be the problem.

There’s a Whole New Pricing Story, Too

For one thing, Saudi Aramco (the Saudi state company and largest producer in the world) is guaranteeing volume. However, they are not guaranteeing similar prices.

For another, increasing Saudi oil flow to Europe will assure rising prices in Asia, where there is also considerable reliance on both Saudi and Iranian crude.

We need to remember that the oil market has become increasingly globalized, and pricing reflects that character.

The global market will not run out of oil because the Iranians find it difficult to sell their crude.

But the price may accelerate beyond where most of us had pegged it for this summer.

This is because in international oil trading – whether it is in the more speculative futures contracts (the “paper” barrels) or in the actual consignments of oil (the “wet” barrels) – an overall principle applies.

During times of low volatility and ample supply (will we ever see this idyllic period again?), prices are essentially determined by the cost of the next available barrel. However, in unstable market conditions, that price is determined by the cost of the most expensive next available barrel.

As uncertainty increases, therefore, prices tend to increase more quickly in advance. Europe is now poised to receive the first shockwave of these price increases as it moves closer to July 1.

Still, it is not simply oil pricing that is being affected.

Western Majors Suffer from the Sanctions

The financial constraints from the sanctions already are making life difficult for some Western oil majors.

It is becoming more of a challenge to shift funds involved in Iranian oil sales in either direction, or, for that matter, to receive oil consigned as payment for previous projects.

On March 26, Italian major Eni SpA (NYSE: E) said it is still owed more than $1 billion worth of oil by Iran and has a special exemption enabling it to continue receiving that crude despite the impending EU embargo. Seems it does not help much.

For several years, Tehran has been using oil to pay Eni for deals that are a decade old or more.

Three years ago, the total stood at about $3 billion in oil; Eni CEO Paulo Scaroni recently said “the amount is in the range of $1 to $4 billion.”

If Eni cannot obtain the oil, that loss hits its bottom line and will be passed onto shareholders.

Then, in contrast, there is Royal Dutch Shell (NYSE: RDS-A).

Shell is struggling to find a way to pay off a least $1 billion it owes Iran for oil exports on contracts it entered before the imposition of sanctions. Sources at the major acknowledge that the E.U. and US sanctions are making it almost impossible to process payments.

Such further dislocations are simply going to serve as a supercharger for the price volatility coming anyway.

All of this is what I am facing when I deplane in Frankfurt.

We are still three months from the beginning of a European embargo of Iranian crude, and, already, the market dislocations are kicking in. They will have an effect on New York oil pricing, sure, but they will hit in Europe first.

Today there’s no agreement on the best way to temper price shock or its effect on already weak credit markets on the continent.

Iran has a hunch that Europe will have to blink first.

Over the next week, I’ll be in meetings in Frankfurt, where European banking intersects. We’re going to see if we can prevent that from happening.

I’ll let you know the results.



[Editor’s Note. We are entering unprecedented times here in the global energy markets. But few politicians, reporters, or analysts really understand why oil prices are headed upward… and fast.

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  1. Linda Best
    April 2nd, 2012 at 12:33 | #1

    Why doesn’t Shell just pay ENI Then they could buy the oil they need?
    I’m sure this could be worked out by intelligent people.

  2. Thomas Pam
    April 2nd, 2012 at 12:57 | #2

    A thought on both the Eni and Shell problem: Since one is owed money and the other has a bill to pay perhaps they could net this out thus eliminating Shell’s problem and reducing Eni’s

  3. April 2nd, 2012 at 15:10 | #3

    Does the USA surplus of Ethanol factor in to lower the price of oil?

  4. David Goldman
    April 2nd, 2012 at 15:48 | #4

    Dr Moors: First, I want to thank you immensely for turning me on to amazing investments via Energy Advantage-I have profited by most suggestions and continue to believe you know what you’re doing on the ones that have gone into “the red”…likely temporarily (ARII for instance). And MMLP has languished as well.
    But there is a tangent technology to all of this oil/gas exploration that I believe should be considered as a special penny stock opportunity-a company you advise in Stuart FL, Ecosphere Technologies. As we both know, their Ozonix patents have the potential to revolutionize frac-exploration and mitigate government concerns about waster water in the field and more importantly ON SITE. IF you will not address this to your public forum, between us men, can you give me a few lines on your “take” on ESPH? I have about 70K shares (full disclosure) since 2009. Love the Icahn and CIE plays-you truly rock…also like STO-not yet recommended by you. DG

  5. Dennis Miller
    April 2nd, 2012 at 17:58 | #5

    why doesn’t Shell just pay Eni the 1 billion it owes to Iran? Eliminate the middle man Iran and call it a day. Iran gets zip this way!

  6. eric taylor
    April 3rd, 2012 at 19:37 | #6

    Dr Moore, perhaps Marina is right that you prophecy the oil market,
    even though you use mega trends of data available to those who are
    engaged in research methodology of a more earthly utilitarian nature.
    Our policy against Iran is surely moving the ball into the prophets
    court for higher oil prices, but even the variable of our response to
    Iran has been added in. It could just as easily been another country
    having been targeted on behalf of the Chaos Theorists. I don’t believe
    in killing a mockingbird, but this is no Black Swan developing either,
    unless many other mega trends diverge together in unison to undue the
    global economy, and some may even prophecy such an occurrence.

  7. Frank Farnham
    April 3rd, 2012 at 21:37 | #7

    The comcast email address will become inactive April 6th. Please use the hotmail address in the future.

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