El Taladro Azul Published originally in Spanish in LA GRAN ALDEA
M. Juan Szabo y Luis A. Pacheco
Oil prices had become news due to their unexpected drop. However, the Hamas terrorist attack on Israel introduced new complexities to the oil market, which we are only beginning to understand. Initially (10/09/2023), prices have reacted upwards.
During the week, we noted with some surprise the decrease in oil prices, after several months of increases that seemed impossible to control. These increases were based on the market responding logically to the gap between persistent demand and deficient supply, resulting from the general lack of investments in the production sector and reinforced by the supply control policies promoted by OPEC+.
If we look at oil prices recently, we find extreme movements that turn the curves into true roller coasters; with lows of $13.8/BBL (Brent) during the pandemic and highs of $123.8/BBL caused by the energy crisis and the Russian invasion of Ukraine. In the latter part of 2022, once oil flows were rearranged to accommodate sanctions on Russia, inflation, and the policies to control it, became credible threats to the sustainability of oil demand, and prices fell to $80/BBL.
However, the expected recession never materialized, demand exceeded 103 MMbpd, and global commercial inventories were gradually consumed to compensate for the lack of production. Indeed, global crude oil consumption exceeded supply by almost 2.2 MMbpd in the third quarter of this year and according to OPEC predictions, that gap would increase to 3.0 MMbpd by the end of the year. Faced with this reality, prices reacted upward, reaching $97/BBL temporarily.
What happened? Was there an unexpected change in supply and demand fundamentals? The short answer is no. What happened was a combination of elements, some concrete and others just perceptions, that tend to influence the oil market.
The most likely explanation for this change in price trend is found in a combination of overcorrection as it approaches $100/bbl, and the reaction to some recent events and economic data, which together revive the threat of demand contraction.
On the facts side:
· Gasoline inventories showed a surprising increase, according to the EIA, confirming that demand was affected by high prices, even though crude oil inventories, according to the same source, continued to decline.
· Likewise, the publication of the number of jobs created in the US in September showed robust growth. This growth confirms the resilience of the US economy but also increases the probability that the Federal Reserve (FED) will decide to make an additional increase in interest rates before the end of the year.
· Hedge funds and other financial operators, who maintained a position of betting on the rise of oil, as they began to perceive the correction that was in progress, began this week a liquidation of future contracts that also contributed to the fall. Of the prices.
On the perceptions side:
· The short-term US economic outlook this week has begun to feel more uncertain, and what the Federal Reserve may do weighs on market expectations.
· The growth of 10-year treasury bond yields is about to reach 5%. These increases adversely affect the financial system by increasing borrowing costs, which affects the entire real economy.
The collapse of oil prices began on October 2, losing almost 10% of its value in less than a week. On the last day of the week, crude oil had a modest rebound, in line with the rest of the capital markets. At market close, on Friday, October 6, it was trading at $84.58/bbl (Brent) and 82.79 (WTI), having lost close to $8/bbl.
In summary, several situations are developing simultaneously in a disconnected manner, which may or may not converge in the coming days and weeks to upend the market.
Energy Transition.
The section that follows was written before the Hamas terrorist attack on the state of Israel began. This tragic coincidence makes it even more relevant to try to understand part of the history of this tormented region, which, since the end of the Second World War, has affected the dynamics of the world energy market. Hence, we have added a preliminary analysis of the current situation.
The Yom Kippur War—Fifty years of a crisis
This past week marked five decades since the Yom Kippur War, also called the October War, the Ramadan War, or the fourth Arab-Israeli war. The reason for addressing this event in this space is that its impact on the oil market continues to this day.
Since the Six-Day War, in 1967, Israel occupied the Sinai Peninsula and the Golan Heights, territories taken from Egypt and Syria, respectively. In 1973, the Egyptian leader, Anwar Sadat, and the Syrian president, Háfez al-Assad, secretly coordinated to launch a military operation under the cover of Yom Kippur, the Jewish day of atonement, and Ramadan, the holy month of fasting in Islam, in an attempt to recover their territories.
On the afternoon of October 6, Egypt and Syria attacked Israel simultaneously on two fronts. With the element of surprise in their favor, Egyptian forces successfully crossed the Suez Canal more easily than expected, suffering only a fraction of the expected casualties, while Syrian forces were able to launch their offensive against Israeli positions and force their way to the Golan Heights.
The intensity of the Egyptian and Syrian attacks, so different from the situation in 1967, quickly began to deplete Israel's ammunition reserves. Israeli Prime Minister Golda Meir asked the US for help, while the Israeli General Staff hastily devised a battle strategy. The US's initial reluctance to help Israel quickly changed when the now-defunct Soviet Union began its military resupply effort to Egypt and Syria.
The war, which eventually brought the United States and the Soviet Union into an indirect confrontation in defense of their respective allies, was launched with the diplomatic goal of persuading a chastened, though still undefeated, Israel to negotiate on terms more favorable to the Arab countries. Israel had become complacent and underestimated the willingness of Egypt and Syria to launch a new war to recover the territories lost in 1967.
After several weeks of fighting, a ceasefire mediated by the United Nations (UN) came into effect on October 25, 1973. The war ended inconclusively. Israel ended up making territorial concessions to Egypt in subsequent peace agreements.
One of the surprises for the Western powers was that the war demonstrated the willingness of Arab states to unleash their oil power to pursue geopolitical interests. On October 19, 1973, after the decision of the US president to provide Israel with $2.2 billion in emergency aid, the Organization of Arab Countries Exporters of Petroleum Exporters (OAPEC ) approved an oil embargo on the United States and other countries that supported Israel in the conflict, triggering an energy crisis.
Before the embargo, a barrel of oil was trading at around $2.90, quadrupling to $11.65 per barrel in January 1974. This led to an increase in the price of regular gasoline in the US, from an average of 39 cents per gallon before the crisis, to 53 cents in 1974, an increase of about 36% in less than a year. In addition to rising prices, there were shortages, leading to rationing at gas stations and long lines of cars waiting to fill their tanks. Some consumers tried to hoard gasoline and related products, making the situation even worse.
The oil crisis occurred in a context where there was an ongoing dispute between oil multinationals and OPEC countries. That same year, the organization demanded that foreign oil corporations raise prices and give a greater proportion of revenue to their local subsidiaries. In April, the Nixon administration announced a new energy strategy to boost domestic production to reduce the United States' vulnerability to oil imports and ease the strain of fuel shortages across the country.
To replace Arab oil, the United States had little excess capacity to boost production. Even with rising oil prices, the time and capital required to discover new deposits and bring new wells online could take years.
The embargo ended in March 1974. However, the western oil-dependent economies of the OAPEC experienced inflation and recessions due to steep price increases and supply constraints. The crisis demonstrated the ability of oil-producing countries to influence prices and disrupt consuming nations through an embargo, putting energy issues at the forefront of Western political priorities.
Industrialized nations made efforts to reduce dependence on oil through conservation, efficiency improvements, and the development of new energy sources, and new non-OPEC production areas such as the North Sea, Alaska, and the Gulf of Mexico. In short, the energy crisis that arose because of the Yom Kippur War sowed many of the changes that led to the oil panorama that we know today.
OPEC's ability to influence prices and disrupt economies by tightening supply; the creation of the International Energy Agency and efforts to replace dependence on the Middle East; and gasoline consumption standards, are all consequences of the war. An example is how residual fuel oil, which was a cheap and abundant byproduct before 1973, was transformed into a much pricier and niche product, accelerating its decline in power generation and maritime transportation.
The embargo and the resulting rise in oil prices were both a blessing and a potential curse for the oil-exporting countries of Latin America, two of which, Venezuela and Ecuador, were members of OPEC. However, much of the region was dependent on imported energy, and sharp increases in oil prices had a significant impact on balance of payments challenges, wreaking havoc on the economies of most countries.
Venezuela's role in that crisis required its best diplomatic skills. The South American country, the founder of OPEC, occupied a middle ground during the crisis, abstaining from the OAPEC oil embargo while benefiting from rising prices (it became the country with the highest per capita income in Latin America). Venezuela criticized the political origins of the embargo and continued exporting oil to the United States and Europe. This stance aligned with Venezuela's close ties to Western markets.
Venezuela followed a careful line: cooperating with OPEC's pricing strategies to reap windfalls while maintaining good relations with the West through continued oil flows.
It has also been argued that the sudden increases in oil prices caused by the 1973 crisis strongly influenced Venezuela's decisions to advance the nationalization of its oil industry in the mid-1970s, seeking greater control over its main resources and income. In 1976, Venezuela completed the nationalization process by creating the state oil company PDVSA to fully own oil production.
The fifth Arab-Israeli war?
This October 6, during the celebration of the Jewish religious holiday of Simjat Torah, the armed wing of the Islamist group Hamas began a major offensive, by land, sea, and air, against Israel, the most extensive and lethal since it took control of the Gaza Strip in 2007. Israeli Prime Minister Benjamin Netanyahu declared the country in a state of war and mobilized all its security forces.
It remains to be defined how this war, which could involve Lebanon and Syria, will develop, since Iran, the most likely promoter of the attack, has strong terrorist settlements in both countries. It will also depend on the positioning of the great powers in the war. For now, little is known about the Israeli response, due to the application of strict censorship applicable to war scenarios.
In addition to the unfortunate loss of life, this war, like the Russian invasion of Ukraine, will affect the oil market by putting the Middle East in crisis. After all, the Middle East produces and moves more than a quarter of the crude oil consumed daily by the world. The Israeli retaliation strategy, limited to the Gaza Strip or expanded to Iran, could directly impact Iranian crude supplies.
The US administration, on the other hand, will likely change its policy of active ignorance regarding the flagrant violation of sanctions imposed on Iranian crude oil: which would likely reduce Iranian exports by 500 MBPD, which would be music to the ears of Russia and Saudi Arabia.
Saudi Arabia, Egypt, and Qatar were also surprised in their good faith since negotiations to establish diplomatic relations between the Saudis and Israel were advancing with the mediation of the other two countries. For practical purposes, this process can be considered dead, after a Saudi statement in which they attribute the origin of the attack to the occupation, provocations, and deprivation of the rights of Palestinians by Israel. It is possible that the progress of those negotiations pushed Iran to promote the attack.
If we add the uncertainty introduced by this crisis in the Middle East to all the other variables at play, we are faced with an unpredictable oil market. Although many analysts at this time do not project a repeat of the 1973 crisis.
Venezuela
Political Events
The energy crisis, which could arise from the attack by Hamas and Israel, could result in benefits for Venezuela. Its oil potential, far from all war fronts, and in the middle of a negotiation process to lift economic sanctions through electoral agreements, could move the Biden administration to be more pragmatic and make concessions that it had not planned.
The widespread perception is that the talks between the two countries, which are being held in secret, will conclude in some type of agreement before the end of the year. The recent decision by the Biden administration to initiate deportations of illegal immigrants to Venezuela is evidence that the two countries have permanent communication. Something that the political opposition would do well to understand.
The primary process continues to occupy political attention and creates expectations about what the outcome of the fight between the National Electoral Council (CNE) and the National Primary Commission (CNP) will be. The process is also under threat that it may be challenged before the Supreme Court of Justice or its organizers may be accused of improper financial management.
After a brief stagnation of the Bs/$ exchange rate, it resumed its upward trend, being quoted in the parallel market at 37.45 Bs/$, a loss in value of the Bs of close to 2% in the week.
Hydrocarbons Sector.
Although power outages continue, their effect on production has not been as negative as in other weeks. Drilling activity at the PetroMonagas operations, the only one in Venezuela currently, was reduced from two to one unit, but Chevron is preparing to add two units that will begin drilling wells at PetroIndependencia in early 2024.
Production: production for the first week of October averaged 751 Mbpd, distributed geographically as shown below:
• West: 133 (Boscan 55)
• East: 152
• Orinoco Belt: 466 (Chevron 79)
· Total: 751 (Chevron 134)
Chevron produced 134 Mbpd, reaching the highest weekly production since it took over the operation of its joint ventures at the beginning of the year, 2023.
Refining: The national refining system processed 323 MBPD of crude oil and intermediate products during the week. The Cardón refinery's catalytic cracking unit is slowly increasing its load, which, together with the gasoline and products received from Italy, is alleviating the gasoline shortage; although smuggling also seems to have been fueled by this increase.
Exports: October monthly exports cannot be projected based on information less than one week old. However, we can infer from the current tanker schedule, that October tends to replicate the results of September; with the apparent difference that a greater participation of Chevron due to its increased production, can result in exports of about 150 Mbpd, between crude oil and diluent (132/18). The rest of the activity is summarized in shipments destined for China, Europe (under barter), and Cuba.
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