A Ceiling Made of Politics

 EL TALADRO AZUL

Published in Zignox. July 11, 2023

The oil market seems to have found a reason for its optimism, but the upside potential remains evasive amid the prospect of interest rate hikes, which are still seminal to the Fed and the European Central Bank policies. A meager economic recovery in China can also curb any initial enthusiasm. 

JUAN M. SZABO, LUIS A. PACHECO

In a market as shaky as today’s oil market, the release of economic and industry-driven statistics provides information that gravitates over the expectations of those moving the barrels, both physically and on paper.

Last Friday, the US Department of Labor published its labor report offering two messages. Both the unemployment rate, at 3.6%, and the number of unemployed, at 6.0 million, were little changed in June. Important to highlight that since March 2022 the unemployment rate in the world’s largest economy has fluctuated between 3.4% and 3.7%.

Total non-farm payroll employment rose by 209,000, while employment in government, health care, welfare, and construction continued its upward trend. Non-farm employment has grown by an average of 278,000 per month during the first six months of the year, well below the monthly average of 399,000 in 2022.

Under ordinary conditions, the slowdown in job creation would have adversely affected oil prices, but under current conditions, the market seems to have chosen to interpret the downtrend as an element that could dissuade the Federal Reserve (Fed), albeit temporarily,  from its monetary tightening campaign.

However, in our view, this slowdown alone, as interpreted by capital markets, is not enough to prevent further Fed rate hikes. In June, median hourly earnings for all employees on private non-farm payrolls rose 0.4% to USD33.58. Over the last 12 months, average hourly earnings have increased by 4.4%. This increase surely causes concern among the FOMC’s members.

An element that helps prop prices up is the reduction in inventories of crude oil, gasoline, and distillates in the US. And reports from the API (American Petroleum Institute) and the EIA (Energy Information Administration) showed a drop of about 5.0 MMbbls, despite a rebound in imports.

The decrease in inventories is directly related to the growth in demand for gasoline, typical of the summer season, and the increase in the nation’s exports. A third element is also relevant: the increase, in the US and the rest of the world, of air transportation activity, which has exceeded pre-Covid levels. In fact, the higher rate of air activity has caused a bottleneck in the air traffic controllers and pilots available to absorb the increase in flights.

OPEC+ and Geopolitics

No less important has been the verification that Saudi Arabia is honoring its commitment to cut production by 1.0 MMbpd, extending it to July and August. In the same order of ideas, Russia announced that it would reduce its oil output by 0.5 MMbpd, fulfilling its commitment to OPEC+, and contributing to putting some order in the market. The reality is that far from being a measure of collaboration or “altruism”, it is the result of having consumed its floating inventories and cornered the reduction opportunities in its domestic market, leaving its exports at the mercy of its limited crude production: from about 9.3 MMbpd.

Geopolitics also brought renewed tension to relations in the Gulf of Oman, when Iranian coast guard ships tried to capture, on separate occasions, two tankers in international waters: TRF Moss and Richmond Voyager. In the case of the Richmond Voyager, the Iranian Navy resorted to firing when it failed to heed calls to stop. In both instances, the US Navy guided-missile destroyer USS McFaul showed up to defend the tankers, and the Iranians withdrew. Chevron (NYSE: CVX), the Richmond Voyager's charterer, confirmed that although the tanker was hit by small caliber ammunition, there were no casualties, and it was continuing to sail.

Drill activity, published by Baker Hughes, shows an increase of 8 units in the US, although still 72 rigs below the figure 12 months ago.

At first glance, all of this could be interpreted as a change in the prospects for oil companies. But a more detailed analysis indicates that the reduction in drilling activity in the Shale Oil basins continues and that the growth corresponds to natural gas activities. An uptick in the swamps of southern Louisiana; Globally, activity looks healthy (+143 drills for May 2023 versus 12 months ago, but its effect on supply has not yet been detected.

In short, all voluntary or unexpected events, such as the Pemex accident described below, confirm that of contracting supply versus demand.

Thus, crude oil prices, at market close, were at their highest values in the past two months. The reference crudes Brent and WTI were trading at USD78.5/bbl and USD73.9/bbl, respectively. For the week, WTI rose 4.6%, building on the 2.1% rise from the previous week. Brent rose 4.8% on the week, following a 1.4% gain the week before.

Although the market seems to have found a foothold for its optimism, the upside potential remains limited by the prospect of interest rate hikes, which remains part of the agenda of both the Fed and the European Central Bank, ECB, and the weak recovery of the Chinese economy. These factors appear to set an imaginary ceiling that limits prices, even though strong supply and demand fundamentals support a bullish view.

A matter of investment

Recently, a discussion has arisen about the investment levels that the hydrocarbon industry must maintain to develop its productive assets. The absolute numbers show a significant decline since the post-2014 price war, a trend that was accentuated by the effects of the pandemic on the global economy.

According to Rystad Energy, the industry’s annual investments have fallen from a peak of USD900 billion, reached in 2014, to an estimated USD580 billion for this year, and the market expects this trend to continue, leading to a chronic lack of investment and a shortage of oil supply in the years to come.
But this widespread belief is contrary to the predictions modeled by Rystad. According to this consulting firm, "lower unit prices, efficiency gains, productivity gains, and evolving portfolio strategies have significantly increased the efficiency of the upstream industry, in other words, the industry can do the same," than before, but at a much lower cost.”

Although there is no doubt that the industry's operating efficiencies have improved substantially, Rystad appears to be failing to account for two factors that have the opposite effect. On the one hand, exploration and production activities are carried out in increasingly complex areas and in basins whose productivity is declining due to the weight of time. For example,  increasing depths of water; and the increasing presence of interspaced wells (“ child wells ”) in unconventional basins. The other factor that has to be considered is inflation, which currently weighs on investments and operations alike.

On this same subject, Goldman Sachs recently published an interesting report on the industry. The New York-based investment bank expects “oil and gas activity to grow +9% per year (+13 and 24% for deepwater and LNG respectively) by 2025, a 2.4x increase in investment decisions since the minimum. The industry currently has 70 giant projects in development, 25% more than in 2020, but still 35% below the 2014 level.” On the other hand, “7 years of insufficient investment has reduced the useful life of the oil reserves of the main projects, to almost half the value shown since 2014.”

Finally, several important news are in full swing, but their effect on the oil balance is still unknown:
• The leader of the Libyan National Army, Khalifa Haftar, has threatened to use force unless the country's political leaders agree on a fair way to distribute oil revenues, which must be agreed upon by August. Libya, despite the armed conflict between East and West, with hidden international intervention, has managed to increase its oil production to 1.2 MMbpd, which is now being threatened.
• Peme’x Nohoch Alfa platform, in the Gulf of Campeche, about 100 km north of Ciudad del Carmen, was severely damaged by fire. The tragic toll: 321 people have been evacuated, 2 died and 4 are missing. The platform handles gas compression for the company's most important oil complex. The magnitude of the event indicates that, despite President López Obrador's announcement, ruling out collateral effects, crude oil, and gas production will suffer a material reduction. The closure of the facility could affect more than 300 Mbpd until production begins to reopen.
• Egypt has started a USD1.8 billion investment program to drill natural gas exploration wells in the Mediterranean Sea and the Nile Delta. According to Oil Minister Tarek El Molla, the program is being carried out with ENI, Chevron, ExxonMobil, Shell, and BP, and consists of drilling 35 wells in two years, 21 in the current fiscal year 2023/2024 and 14 in the next year.
• OPEC has held consultations with four countries – Azerbaijan, Malaysia, Brunei, and Mexico—in a bid to expand the group's membership, Secretary General Haitham Al Ghais said. Difficult to understand the incentives for countries like Mexico to actually agree to join.
• The ExxonMobil-led consortium has received approval from Guyana's environmental regulator to drill, through 2028, 35 new exploration and appraisal wells on the offshore Stabroek block.

Energy transition, the sun shines for everyone

It is not possible to discuss the energy transition without including solar energy. Solar power is a form of renewable energy that uses sunlight to generate electricity or heat. Solar energy has a long history of development and innovation, dating back to ancient times.

Since the human species began to search for explanations of the world in which it lived, the sun and the moon have occupied a central place in its concerns. The veneration of the Sun throughout history is well attested, and many ancient cultures developed the solar cult; the ancient Egyptians did, as did Indo-European cultures and Mesoamerican cultures.

Understanding the comings and goings of the sun and the moon was of vital importance for agricultural societies, which developed their social structure around this knowledge: when to get up, when to lie down, when to sow, when to harvest, when to prepare for the heat, when to protect themselves from the cold.

The Babylonians and the Aztecs, just to mention two of the best-known ancient cultures, developed what we could now call scientific knowledge, to manage their society according to the signals they interpreted from the celestial bodies.

One of the fathers of modern science, the Florentine Galileo Galilei (1564 -1642), was persecuted by the Catholic Church for having defended the heliocentrism thesis of Nicolaus Copernicus. Copernicus' model postulated that the sun was the center of the universe, and the planets revolved around it. The church, based on biblical texts, held that the center of the universe was the Earth – geocentrism . The sun, no longer as a God to be adored, but as a natural phenomenon to be explained.

In 1839, the French physicist Alexandre Edmond Becquerel discovered, while conducting experiments with electrolytic cells, the “photovoltaic effect” [1], observing that certain materials produced an electric current when exposed to light. Becquerel's work provided the initial understanding of the conversion of light to electricity and marked the first recognition of the photovoltaic effect.

In 1876, William Grylls Adams and Richard Evans Day, English physicists, further explored the photovoltaic effect by studying the behavior of selenium exposed to light. They observed that selenium produced an electrical current when illuminated.

Building on that work, Charles Fritts developed the first functional solar cell in 1883. The American inventor built a device consisting of a thin layer of selenium coated with a thin layer of gold, forming a junction that produced electricity when exposed to light. Although inefficient by today's standards, Fritts ' invention laid the foundation for future advances in solar cell technology.

The Swiss-German physicist, Albert Einstein, published in 1905 an article on the photoelectric effect. The photoelectric effect describes the release of electrons by certain materials when exposed to light, which is also related to the conversion of light into electricity. Interestingly, this was the article cited when he was awarded the 1921 Nobel Prize in Physics, and not his article on his famed special theory of relativity, which he also published in 1905 – his Annus Mirabilis .

In 1954, researchers at Bell Laboratories in the US, including Daryl Chapin, Calvin Fuller, and Gerald Pearson, developed the first practical and efficient silicon-based solar cell. Its silicon solar cell achieved a conversion efficiency [2] of around 6%, marking a significant improvement over previous designs.

After this breakthrough, solar cell technology has advanced rapidly. The development of more efficient materials, improvements in manufacturing techniques, and increased research efforts have contributed to the continued progress of solar cell technology. Throughout the second half of the 20th century and into the 21st century, the conversion efficiency of solar cells has increased, while costs have decreased significantly.

Advantages

• The Sun is an inexhaustible source of energy, providing a virtually unlimited power supply.
• Solar power production does not emit greenhouse gases or other harmful pollutants, reducing carbon footprints and mitigating climate change.
• Once installed, solar panels require minimal maintenance and have no fuel costs, leading to significant savings in the long run.
• Solar energy can be used for a variety of purposes, including generating electricity, heating water, and powering vehicles.
• Job Creation: The solar industry has the potential to create numerous employment opportunities, fueling economic growth and supporting local communities.

Disadvantages

• The initial investment required to install solar panels can be expensive, discouraging some individuals and businesses from adopting the technology.
• Intermittent nature: Solar power production is dependent on the availability of sunlight, making it intermittent and inconsistent, requiring energy storage solutions or grid integration.
• Land and space requirements: Large-scale solar power plants require considerable areas of land, which may conflict with other land uses or face opposition from local communities.
• Manufacturing and Disposal Issues: Solar panel production involves the use of rare earth elements and potentially toxic chemicals. Appropriate recycling methods must be implemented to prevent damage to the environment.

Solar energy has experienced remarkable growth recently. According to the International Energy Agency (IEA), solar generation increased by a record 179 TWh (22% more) in 2021, to exceed 1,000 TWh; It accounted for 3.6% of global electricity generation and remains the third-largest renewable electricity technology after hydropower and wind power. In the IEA forecast, cumulative solar PV capacity nearly triples for the period 2010-2027, with growth of almost 1,500 GW over the period, surpassing natural gas in 2026 and coal in 2027. [1]

In the big economies, China is the largest producer and installer of solar panels in the world, which could present geopolitical problems ahead. India has seen significant growth in solar power installations, driven by government initiatives and a focus on expanding renewable energy sources to meet growing demand for electricity.

The United States is one of the leading countries in the deployment of solar energy. Several states, such as California and Texas, have implemented policies and incentives to promote the adoption of solar energy. In Europe, Germany has been a pioneer in solar energy, with a strong commitment to renewable energy as part of its policy.

Going forward, this technology will continue to grow its penetration. However, this growth will go hand in hand with restrictions on access to land, materials and the development of effective storage and transmission options.

Venezuela, political events, and others matters

Although the contacts, between the regime and the opposition, continue informally around electoral conditions for 2024 in exchange for modification of economic sanctions, no agreement is expected to unlock the political situation.

Given the apparent advance of the opposition candidacies, in particular the advance of Mrs. María Corina Machado in the polls, the regime seems to have opted to "Orteguizar"[2] the electoral process, that is, to eliminate the participants with a chance in a contest justice using rigged judicial procedures and intimidation by the security forces.

On the other hand, inflation continues its upward course, affected by lower amounts of foreign currency processed by Chevron through the national banking system; in the parallel market, 29.6 Bolivares were traded per dollar.

Hydrocarbons Sector.

At the end of June, the PDVSA Western Production team and the oil minister, Pedro Tellechea, visited the Lama Plant, located on Lake Maracaibo, to witness the start-up of the Lama 3 Module, equipment that allows the incorporation of 5 Mbpd of incremental crude oil production.

On the afternoon of July 6, a fire broke out in the facilities of the same Lama complex (Lama Generation), specifically in the electricity generation platform, in which a turbine exploded catastrophically, with two deaths and one injury to regret. The fire was controlled, but the plant will be out of service for a long time. This incident occurred just a few days after the explosion at the Tejero Operations Center (COT), in Punta de Mata, in the eastern part of the country, both affecting the country's fragile oil production. 

Production: The weekly production of crude oil was affected by the events described above. Production averaged 689 Mbpd geographically distributed was as follows:

• West:               97 (Boscán 50)
• East:                146
• Belt:                 446 (Chevron 71)
• Total:               689 (Chevron 121)

The production of the JVs managed by Chevron averaged 121 Mbpd, the result of the incorporation of a couple of additional wells in the Boscán Field.

Refining: 220 Mbpd of crude oil and intermediate products were processed in the national refineries. The Puerto la Cruz refinery is operating at operational minimums due to the lack of light crude oil. The El Palito refinery continues with the stabilization work on its processes. Although they claim to have produced some gasoline and diesel, this has not been independently confirmed.

The Paraguaná refining complex increased its production of diesel, and maintained its levels of supply to the national market of a “gasoline” produced by mixing naphtha and reformate. By the way, PDVSA increased the price of diesel for companies to $0.32/liter, this fuel had been delivered free of charge. The change is due to an attempt to cut the fuel subsidy, although it will continue to be “donated” to health institutions and other entities benefiting from preferential treatment.

Whenever these differential treatments and subsidies are presented, the temptation of smuggling and corruption arises. It is estimated that, currently, some 20 Mbpd of fuels have this destination.

Exports: Exports for the month of June closed with a total of 540 Mbpd, and 26 Mbpd in floating inventory. On the product side, some 60 Mbpd were exported.

Crude exports were : 136 Mbpd to the US, via Chevron; 24 Mbpd to Cuba; 30 Mbpd to Spain, in the barter with ENI/Repsol; and 350 Mbpd to China (130 Mbpd through Iranian barter and 220 Mbpd via intermediaries). On the product side, Cuba and China received 30 Mbpd each.

Of the total 136 Mbpd exported by Chevron, 50 Mbpd were Boscán crude, 52 Mbpd Hamaca upgraded crude, 17 Mbpd Merey and 17 Mbpd DCO. These last two segregations, Merey and DCO, are mixed with light and diluent crude brought by Chevron from Mexico.

Of the total crude and products, 626 Mbpd, that were shipped from Venezuelan terminals, only 382 Mbpd are considered commercial sales generating foreign exchange earnings.

Using the estimated prices for the month of June, these volumes represent foreign exchange inflows of the order of $400 million. Using Gulf of Mexico prices, we estimate that PDVSA's debt with Chevron was reduced by close to $100 million during the month.
 

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[1]This summary of the history of the solar cell is based on the book: “ Numbers Don't Lie”, Vaclav Smile . 2020

[2]The conversion efficiency of a photovoltaic (PV) cell, or solar cell, is the percentage of solar energy received by a PV device that is converted into usable electricity.

[3]https://www.iea.org/reports/renewables-2022/executive-summary

[4]In reference to the actions carried out by Daniel Ortega in Nicaragua against his political adversaries 

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Note: A version of this article was published in Spanish by La Gran Aldea on July 11, 2023.