OilVoice Magazine | December 2014

Edition Thirty Three – December 2014

What happened to $100 oil?

Is US oil production set to plummet?

The only oil price going UP in the world right now

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OilVoice Magazine | DECEMBER 2014

Adam Marmaras Chief Executive Officer Issue 33 – December 2014 OilVoice Acorn House 381 Midsummer Blvd Milton Keynes MK9 3HP Tel: +44 208 123 2237 Email: press@oilvoice.com Skype: oilvoicetalk Editor James Allen Email: james@oilvoice.com Director of Sales Mark Phillips Email: sales@oilvoice.com Chief Executive Officer Adam Marmaras Email: adam@oilvoice.com Social Network

Welcome to the 33rd edition of the OilVoice Magazine.

The team at OilVoice would like to thank all those that download the OilVoice Magazine each month; it feels like it was only yesterday that we were putting together the first edition.

We’d also like to take the opportunity to thank all of our guest authors for their great articles on everything Oil & Gas – the magazine wouldn’t be the same without you!

This month we have great articles from some of our regular authors, including Gail Tverbeg, Anthony Franks, Loren Steffy, Keith Schaefer, and Kurt Cobb.

Thanks again for reading the OilVoice Magazine, and we hope you look forward to an exciting 2015 with us.

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OilVoice Magazine | DECEMBER 2014

Contents

Featured Authors The biographies of this month’s featured authors

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Will oil industry learn from Denton's fracking ban?

by Loren Steffy

5

Is there really an oil glut?

by Kurt Cobb

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Is US oil production set to plummet?

by Keith Schaefer

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Did Russia and China just sign a death warrant for U.S. LNG exports?

by Kurt Cobb

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Continental's Hamm stares down OPEC in oil price standoff

by Loren Steffy

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What happened to $100 oil?

by Andrew McKillop

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Baghdad/Irbil Oil Deal - unlocking value at last?

by Anthony Franks OBE

24

Oil price slide - no good way out

by Gail Tverberg

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An emerging oil deal between Baghdad and Irbil?

by Anthony Franks OBE

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The only oil price going UP in the world right now

by Keith Schaefer

39

Bubble trouble for the oil asset bubble

by Andrew McKillop

43

Richmond investor helped keep Halliburton's deal on track

by Loren Steffy

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Featured Authors Keith Schaefer Oil & Gas Investments Bulletin Keith Schaefer is the editor and publisher of the Oil & Gas Investments Bulletin.

Loren Steffy 30 Point Strategies A senior writer for 30 Point Strategies and a writer-at-large for Texas Monthly. Loren worked in daily journalism for 26 years, most recently as an award-winning business columnist for the Houston Chronicle, and before that, as a senior writer at Bloomberg News.

Andrew McKillop AMK CONSULT Andrew MacKillop is an energy and natural resource sector professional with over 30 years’ experience in more than 12 countries.

Anthony Franks OBE Mars Omega LLP Anthony is responsible for managing and controlling the extensive information networks, as well as directing and working with the analysis team to create reports for clients, and also works with Hamish in the Liaison and Mediation service.

Kurt Cobb Resource Insights Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude.

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Gail Tverberg Our Finite World Gail the Actuary’s real name is Gail Tverberg. She has an M. S. from the University of Illinois, Chicago in Mathematics, and is a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries.

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Will oil industry learn from Denton's fracking ban?

Written by Loren Steffy from 30 Point Strategies As residents in Denton, Texas, voted last week to become the first community in Texas to ban hydraulic fracturing, I found myself thinking about another city far to the south: Galveston.

Fifty-nine percent of voters in Denton, northwest of Dallas, voted for the ban. The decision is significant because of its location. The process we know today as fracking was developed not far away, in the same Barnett Shale formation that has attracted drilling companies to Denton.

As a production technique, fracking had been used for decades, but it was in the Barnett in neighboring Wise County that Houston oilman George P. Mitchell developed the current process of using sand, water and chemicals to fracture shale rock thousands of feet below the surface. That technique, copied and enhanced by others, has allowed the U.S. to slash oil imports, saved Americans billions in fuel costs, and lifted an otherwise sluggish economy.

Today, Denton has 272 active wells within its city limits. The city is practically the cradle of the current energy boom, and residents have said enough is enough.

This isn’t the typical anti-fracking fight, though. There are no videos of residents setting water from their faucets on fire. What set of residents in Denton, more than anything else, was wells drilled too close to homes and a city park. They objected to the noise and the smells and the traffic congestion that comes with drilling projects.

In many ways, this is the ultimate NIMBY case.

“It says that industry can’t come in and do whatever they want to do to people,” Cathy McMullen, the home health nurse who led anti-fracking drive and collected some 2,000 signatures to get the issue on the ballot told the Fort Worth StarTelegram. “They can’t drill a well 300 feet from a park anymore.”

The Denton vote, in other words, is a referendum on the how the oil industry regards the communities in which it now works. In America’s energy renaissance, companies can’t just consider regulations in making their drilling plans, they must also consider public perception.

It’s a lesson that seems lost, as oil industry groups already are planning to challenge the ban in the courts and at the state level.

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“Bans based on misinformation — instead of science and fact — potentially threaten this energy renaissance and as a result, the well-being of all Texans,” Texas Railroad Commissioner David Porter, in a statement said.

While opponents certainly raised health concerns about the fracking process, the industry hurt itself in the fight by ignoring the concerns of the community. Fracking has moved the oil industry into uncharted territory – urban drilling.

Companies accustomed to setting up wells in remote areas find themselves drilling adjacent to suburban homes. Yet they consistently failed to recognize the community’s concerns. For example, Denton enacted a 1,200-foot setback between wells and homes, but some companies said their permits, issued before that ordinance took effect, allowed them to drill closer, the Star-Telegram reported.

That sort of behavior and the consistent tin ear – if not outright contempt – for public sentiment on the part of some drilling companies was the driving factor behind the ban.

Now, the industry faces the prospect that similar bans could crop up in other cities where companies have demonstrated callous disregard for residents’ concerns. In recent years, some companies have made a better effort at reaching out the communities in which they operate, but many of the efforts have been too little or come too late.

Ironically, George Mitchell had an early experience with urban drilling – in Galveston.

In the late 1960s, years before he developed fracking, his company discovered seismic data pointed to a large oil and gas reservoir under the main part of Galveston, one of Texas’ oldest cities and Mitchell’s hometown.

Rather than upset residents by setting up a rig in the middle of the city, Mitchell leased a warehouse and put the rig inside with only the tip of the derrick showing through the roof. After confirming the discovery with a vertical well, he developed the field using directional drilling, which would later become an important component in fracking.

In Galveston, most homeowners also owned their mineral rights, so Mitchell’s employees had to go door to door to acquire mineral rights, but eventually the field, which became known as Lafitte’s Gold, was a successful project, with multiple wells drilled from one discrete location.

“That brought a lot of desperately needed revenue into Galveston,” Howard Kiatta, who developed the project for Mitchell, told me in an interview for an obituary of Mitchell, who died last year.

To be sure, Mitchell had his share of disputes, including a lawsuit filed by residents near Denton who claimed his drilling contaminated their water wells. He ultimately prevailed in the case.

But Mitchell was more than an energy pioneer. He believed that by unleashing more natural gas, fracking would reduce our use of coal and oil, decreasing fossil fuel’s

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environmental impact and creating a more livable planet. But he also cautioned that his industry, left to its own devices, would drill without regard for the consequences to people or the planet.

The industry can do better. If companies that today are using Mitchell’s techniques had also adopted his concern for the surrounding communities, the outcome of the vote in Denton may have been different.

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Is there really an oil glut?

Written by Kurt Cobb from Resource Insights Back in March 1999 "The Economist" magazine carried a cover photo of two men drenched in oil as they attempted to close a faulty valve that was spraying a huge stream of crude skyward. Over the photo was the headline: "Drowning in oil." At the time it really did seem as if the world were drowning in oil.

The previous December crude oil on the New York Mercantile Exchange touched $10.72 per barrel. That month U.S. gasoline prices averaged 95 cents per gallon.

"The Economist" opined that oil might go down to $5 per barrel.

But, of course, in retrospect the magazine's cover proved to be the perfect contrarian indicator, for oil had already begun its historic ascent toward $147 per barrel. The 2008 price spike was the culmination of a 10-year bull market that had begun in December 1998.

After dipping briefly to around $35 per barrel at the end of 2008 in the wake of the financial crisis, the new oil bull market sent world benchmark Brent Crude to a daily average of more than $100 per barrel for all of 2011, 2012 and 2013. Through October 27 the average daily price for this year has been $104.86, not all that different from the last three years.

The swift price decline of Brent Crude from $110 on July 1 to about $85 today has

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the media buzzing about a glut. But can oil which now trades at eight times its price in 1998--when there really was a glut--be said to be experiencing a glut now?

Certainly, there is more oil available than people are willing to pay $100 per barrel for. While there have been many explanations for the downward move in price, all we can say for sure is that recently there were more sellers than buyers; and so, the price slid as the buyers stepped away, waiting for the price to come down.

But, is this really a glut? In 1998, even what poor people were paying for oil and oil products was relatively affordable, making it easier for them to enjoy the power and comforts that cheap oil and cheap energy in general make available to individuals.

Now, the price of energy and oil, in particular, is leading some of the newly poor in Greece (made so by that country's ongoing economic depression) to seek out firewood--both legally and illegally obtained--to heat their homes instead of heating oil. The drop in vehicle miles traveled in the United States in recent years suggests that high gasoline prices are in part responsible for fewer miles traveled.

When it comes to total U.S. petroleum consumption, the top 10 weeks for consumption occurred from 2005 to 2007. The most recent consumption number (week ending October 24) remains 2 million barrels per day below the peak reading in 2005. European petroleum consumption remains in a downward trend as well. All this suggests a decline in the standard of living for most Americans and Europeans, at least, when it comes to oil and its benefits. (One colleague of mine now speaks of peak benefits from oil rather than peak oil.)

Yes, the price drop has only just occurred, and, of course, we can't expect that it will have an immediate affect on consumption. But, increased consumption would likely take the oil markets back above $100 per barrel since small changes in supply and demand tend to move the oil price sharply. At the $100 level no one would be calling the situation a glut.

The oil industry has been using the term "abundance" for years as a public relations ploy to prevent people from realizing that oil is neither cheap nor abundant anymore.

But the word "glut" has produced night terrors in the minds of oil executives. "Glut" implies that investors should stay away from a market that cannot make them any money. "Abundance" is okay for industry television ads aimed at lulling the public and policymakers to sleep. But, "glut" is bad for business.

The real problem is that it is costing more and more to get the oil that remains out of the ground. Consumers will buy oil depending on their ability to pay, not on the price which the oil companies need to charge in order to cover the cost of producing it.

Ironically, the swoon in oil prices could easily lead to renewed price spikes as the price falls below the cost of producing the most expensive barrels of oil. Under such conditions, the industry will stop producing these barrels and supply will decline-leading to another price spike when demand picks up.

It turns out that between consumers who can't afford to pay higher and higher oil prices and companies which can't afford to produce the extra oil we'd like at lower

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prices, we are stuck in an ever-shrinking no man's land, a price band really--one that will eventually disappear as the average cost of producing the extra barrel of oil the world desires goes beyond what consumers including businesses can and will pay.

That will have us wondering why we allowed ourselves to sleepwalk through the last few years, even as continuing high prices and consumption declines sounded the alarm--one that told us we needed to speed up a transition to a renewable energy economy and reduce our energy use wherever possible instead of falling for talk of "abundance" and "glut."

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OilVoice Magazine | DECEMBER 2014

Is US oil production set to plummet?

Written by Keith Schaefer from Oil & Gas Investments Bulletin

American oil production is set for a fast pullback, says Chris Theal, founder and CEO of Canadian energy fund Kootenay Capital.

And that has two important implications 1. America is now the swing producer in the global oil market.

2. If the bottom in oil prices wasn’t set Nov. 5, it’s very, very close.

“We do think shale will rollover in output and it will be much sooner than most people think,” says Theal. “We could very well see negative week over week contraction in output in the US before the OPEC meeting” on November 27.

The oil rig count in the US has gone down four weeks in a row. It will be interesting to see how this shows up in the Wednesday EIA report on overall US production.

Only 13 of the 42 weeks in 2014 so far have shown drops in US production.

Theal and his team went back through weekly production data in the US starting after 2011—when tight oil production really took off.

He says the data is more conclusive in the three instances when WTI fell below $85 a barrel; US output fell up to 200,000 barrels a day in literally a span of eight weeks—from a much lower production base than now.

“If you see an initial roll in US output in the next few weeks it will be a major piece of data that the market will notice. The mentality is so negative that I think if you get some bullish data point like that you can see a fairly aggressive reversal” in oil pricing, Theal says.

“If you get another drop in the rig count this week and a reversal in output—that’s an instantaneous measurement of the Saudi objective.”

Umm…and..what’s the Saudi objective?

“Just put a governor on the pace of growth.”

Here’s why he expects such a quick turn-down in US production: Producers in almost all the major oil basins in the US receive a discount to WTI. So

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they are receiving even less cash flow than many investors might think.

Bakken prices are $8/barrel below WTI, which closed at $78.68 Thursday. And that’s what the oil marketers get. Producers get a $1-$4/barrel below that as their field price—so that’s about $70/barrel or even a bit less.

Theal says that realized price equals about a 10% return for industry—not enough.

In fact, he estimates that the Top 5 North Dakota Bakken producers—Continental, Whiting, Oasis, Northern and Kodiak—have seen 2015 cash flow estimates fall by $870 million since oil prices dropped in the summer. That’s $870 million that won’t be going into the ground over the coming months.

And with the high declines in tight oil production, the impact of that should be immediate.

So that’s the immediacy of dollars that aren’t getting reinvested in the ground. The chart above uses a term called “Instantaneous Declines” which is how fast production would drop if ALL drilling in each basin stopped tomorrow.

Of course, that is not going to happen, but Theal says that chart should give the Market an understanding of how much high-and-fast declines there are from “flush” production in the USA right now. Flush production is that high initial flow rate that falls off rapidly—65% or so—in the first year before flattening out to a 30%, then 25% then 20% declines in the following years.

On their quarterly conference calls this week, several US producers were being very cautious about growth plans. Talisman (TLM-NYSE/TSX) said it would cut 2015 capex by $200 million. Rosetta Resources (ROSE-NASD) lowered spending by 20% and cut growth forecasts from 30% to 17-26%. Comstock Resources (CRK-NYSE) said it was committed to living within cash flow in 2015—which should mean a cutback in spending as their $510 million capex budget is $95 million more than estimated cash flows.

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Small cap Bakken operator Emerald Oil (EOX-NYSE) said it would drop a rig if oil prices stay sub $80/barrel.

With the Saudis allegedly being firmly committed to keeping their production and market share up, that makes the high cost producer the swing producer—as logic would dictate they would cut back production first.

That would be the USA, with its shale production. How does having a market based swing producer differ from when and how the Saudis managed the oil supply demand balance?

“I think it makes a strong case for upside volatility being less pronounced; the oil price is now somewhat capped outside of geopolitical issues,” Theal says.

“There is a governor on how high it can go because at some price shale grows aggressively—like at $100/barrel. Everybody and their brother is drilling plays that can make hurdle rate economics at that level.

He has already begun buying a basket of Canadian junior and intermediate light oil producers. If light oil does move higher, he doesn’t think it’s going to back to $100/barrel—which means investors increasingly need to avoid producers that require high oil prices to make their growth and/or dividend models work.“I think there are a lot of businesses that rely on $100 crude…divco’s and their models don’t work at these prices.”

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OilVoice Magazine | DECEMBER 2014

Did Russia and China just sign a death warrant for U.S. LNG exports?

Written by Kurt Cobb from Resource Insights Russia and China have signed two large natural gas deals in the last six months as Russia turns its attention eastward in reaction to sanctions and souring relations with Europe, currently Russia's largest energy export market.

But the move has implications beyond Europe. In the department of everything is connected, U.S. natural gas producers may be seeing their dream of substantial liquefied natural gas (LNG) exports suffer fatal injury because of Russian exports to the Chinese market, a market that was expected to be the largest and most profitable for LNG exporters. Petroleum geologist and consultant Art Berman--who has been consistently skeptical of the viability of U.S. LNG exports--communicated in an email that Russian supply will force the price of LNG delivered to Asia down to between $10 and $11, too low for American LNG exports to be profitable.

Now, let's back up a little. U.S. natural gas producers have been trying to sell the story of an American energy renaissance based on growing domestically produced gas supplies from deep shale deposits--now being exploited through a new form of hydraulic fracturing called high-volume slick-water hydraulic fracturing.

The problem has been that overproduction and low prices--now only a fraction of the $13 per thousand cubic feet (mcf) at the peak in 2008--have undermined the financial stability of the natural gas drillers. Here's why: Natural gas from shale, referred to as shale gas, is generally more expensive to produce than conventional natural gas and will require that natural gas prices go much higher than they are today--from around $4 per mcf almost certainly to over $6 per mcf and perhaps more to pay the costs of bringing that gas out profitably.

But at that price, U.S. LNG is no longer competitive in Europe. And now, because of the Russian-Chinese natural gas pipeline deals, it may no longer be competitive in Asia. Those are the two largest markets for LNG. Without them it is doubtful that the United States will be exporting much LNG--except perhaps at a loss.

Here's the problem: To convert U.S. natural gas to liquefied natural gas, put it on specially built tankers and ship it to Europe or Asia will cost about $6 per mcf. If the price of U.S. natural gas averages around $6 per mcf, the total landed cost of U.S. LNG will be the cost of the gas plus the cost of converting it and shipping it, that is,

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around $12 per mcf.

The most recent landed prices for LNG to Asia as reported by the Federal Energy Regulatory Commission were $10.10 per MMBtu* for China, $10.50 for Korea and $10.50 for Japan. For Europe the numbers are even more sobering: $9.15 for Spain, $6.60 for the United Kingdom, and $6.78 for Belgium. All amounts are U.S. dollars.

These are probably reflective of spot prices rather than long-term contracts, and they are down due to softening energy demand that may be the result of an economic slowdown in Asia and Europe.

But, they give an indication of how difficult it will be for U.S. LNG to compete on the world market. LNG prices may well improve, but buyers of LNG typically sign costplus contracts. In the United States that would be the cost of Henry Hub natural gas (traded on the New York Mercantile Exchange) plus the cost of liquefaction and transportation. With no assurances--and a good deal of evidence to the contrary-that Henry Hub gas will remain at current prices (around $4) for the long term, it's difficult to see how there will be many long-term buyers of U.S. LNG. One wonders under such circumstances just how many of the 14 proposed U.S. LNG export terminals will actually be built.

Having taken the long way around, let me return to the Russian-Chinese natural gas pipelines and their significance in this drama. Gazprom, the Russian natural gas giant that will actually deliver the gas, valued the earlier deal in May at around $10.19 per MMBtu. The latest deal has no announced value, but one analyst believes the Chinese will be asking for around $8 per MMBtu. Even if the Chinese end up accepting a price closer to the previous deal, some 17 percent of the Chinese natural gas supply will be coming from Russia when the pipelines are complete several years from now. And that will likely anchor the price of Chinese LNG imports between $10 and $11 per MMBtu, making the price too low to be reliably profitable for U.S. LNG exporters.

The implication is that today's soft prices for imported LNG to China and the rest of Asia may become the norm in a few years just as America's LNG export terminals are about to become operational. If investors fund these terminals and the RussianChinese pipelines get built, there is likely to be some epic capital destruction on the American side of the Pacific.

There are other reasons to be skeptical about America's future as a natural gas exporter. The rosy predictions of the industry and the U.S. Department of Energy for domestic natural gas production from shale may be overblown according to a new report from the same analyst who foresaw the massive downgrade of recoverable oil from California's Monterey Shale. Despite rising domestic natural gas production, the United States remains a net importer of natural gas. Natural gas imports accounted for about 10 percent of U.S. consumption through August of this year.

(Full disclosure: I worked as a paid consultant to help publicize the report mentioned above. But, as longtime readers know, since 2008 I've been skeptical about the wild claims of a long-term U.S. bonanza in oil and natural gas due to shale deposits. This

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report offers the first comprehensive analysis based on industry data and is produced independent of industry influence or money. Anyone with a stake in the industry or in U.S. energy policy should read it.)

It's possible that some U.S. LNG export projects may move forward in any case. If the buyers for this LNG sign long-term, cost-plus contracts as described above, those buyers will be in for a big surprise when U.S. natural gas prices rise. And those exports will create something of a self-reinforcing feedback loop by raising overall demand which will hoist domestic prices even higher for U.S. natural gas--even more so if there is not as much U.S. production as is currently being projected. If U.S. natural gas production remains at or below the level of domestic consumption, the United States could be faced with the rather bizarre prospect of having to import high-priced LNG from some countries to fill the gap created by LNG export shipments committed to others.

Higher U.S. natural gas prices will be a double-edged sword for those concerned about a cleaner energy future. U.S. natural gas producers and renewable energy companies will simultaneously rejoice if exports raise prices appreciably--producers because their financial fortunes will turn more positive and renewable energy companies because renewable energy will become more competitive with higher priced natural gas. Environmentalists, however, will gasp in horror as profitability rises enough in the shale gas fields to justify ever greater encroachments on the American landscape.

And, U.S. politicians who favor LNG exports may ultimately find themselves pilloried by consumers who must pay those higher prices and environmentalists who abhor the environmental costs--even as those politicians watch the campaign contributions flood in from a grateful shale gas industry.

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OilVoice Magazine | DECEMBER 2014

Continental's Hamm stares down OPEC in oil price standoff Written by Loren Steffy from 30 Point Strategies Wildcatters may not be the gamblers they once were, but the Oil Patch hasn’t lost all of its swagger. Harold Hamm, who founded Continental Resources in 1967 and turned it into the biggest producer in North Dakota’s Bakken Shale, is making a big bet that oil prices won’t continue their swoon.

Hamm told investors the company has decided to eliminate essentially all of its oil hedges, basically betting the company on the belief that oil prices won’t sink much more than the 25 percent decline they’ve experienced since June. In a statement, he said: We view the recent downdraft in oil prices as unsustainable given the lack of fundamental change in supply and demand. Accordingly, we have elected to monetize nearly all of our outstanding oil hedges, allowing us to fully participate in what we anticipate will be an oil price recovery.

Continental decided to take profits on more than 31 million barrels of U.S. and Brent crude hedges for 2015 and 2016, as well as 8 million barrels of outstanding positions for the remainder of this year, Reuters reported. The company said eliminating the hedges boosted fourth-quarter profit by $433 million.

The move caps a month in which Saudi Arabia declared it would not cut oil production to stabilize prices and other OPEC members also held firm on production.

Many analysts saw the decision as a move by the Saudis to reassert their control over global oil markets by trying to grab market share at the expense of other OPEC members such as Iran, as well as Russia and U.S. shale producers like Continental.

By eliminating his company’s hedges, Hamm, who’s sued OPEC in the past, may be calling the cartel’s bluff. He recently called OPEC a “toothless tiger” and has urged Congress to lift the 40-year ban on oil exports, which could further depress world crude prices. Hamm dismisses concerns that the current price slump will persist, as many analysts predict. Then again, Hamm built Continental by going against conventional thinking. He bet on the Bakken when many oil companies believed crude could never be extracted profitably from the shale formation. While they looked overseas and offshore, Oklahoma City-based Continental doubled down at home.

Along the way, Hamm also sued OPEC. He owns about 68 percent of Continental, but his outside investors may be less

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impressed with his decision. As Philip K. Verleger, president of consultancy PKVerleger LLC and a one-time adviser to President Jimmy Carter, told Reuters: My expectation is that Continental’s investors will rue this decision because it changes the firm’s business. Hedging provides an assured cash flow. By dropping the hedges the firm is gambling that prices go up. If they go down, Continental will go bust.

The question is how quickly Hamm expects prices to recover. While he may not think prices will go much lower, he also doesn’t appear to expect a quick rebound. He said Continental would maintain its current activity level for 2015 and won’t add any new rigs in the Bakken. The company had announced plans in late September to increase capital spending to $5.2 billion from $4.6 billion this year, but Hamm said it now intends to keep its spending flat, essentially cutting its capital budget by $600 million.

Earlier this week, wrote about big producers such as ConocoPhillips and Shell pulling back on exploration spending in the U.S. I also noted that for smaller independents, oil prices would probably have to fall farther before they started feeling the pinch. Yet some, like Continental, are beginning to slow their expansion plans.

For example, Rosetta Resources, a big producer in the Eagle Ford Shale of South Texas, said it will cut next year’s capital program to $950 million from the $1.2 billion it’s spending this year.

Across the U.S. oil industry, producers seem to be taking a collective pause while they figure out how persistent the price decline will be.

Hamm has placed his bet, but if prices keep falling, he may be revising those numbers yet again in the coming months.

View more quality content from 30 Point Strategies

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What happened to $100 oil?

Written by Andrew McKillop from AMK CONSULT The Paradigm Shift Business news provider Bloomberg, November 14, cited a Tass interview in which Vladimir Putin says that Russia is prepared for "catastrophic falls" of world oil prices and export revenues - on a day when Nymex oil market players and manipultors engineered a classic "sucker's rally" with a one-day 2.5% jump in Brent and WTI prices! Putin is unlikely to be fooled by that rally and Russia, like China has been making very large gold purchases as an insurance policy on likely or probable major currency upheavals, in Russia's case including intensified attacks in the present "war on the ruble" to punish its support for rebels in eastern Ukraine.

To be sure, lower oil prices and export revenues will also cut petrodollar inflows to Saudi Arabia at the same time, hindering the Wahabite Kingdom's previously reliable funding of rebels fighting in the Syrian war slaughterhouse, but depriving Russia of oil revenues is now a major goal of several OECD-country leaders. The OECD's "oil watchdog agency", the IEA has to reflect the goal of its masters but the IEA's delayed response after 30% of the dollars fell off the barrel price in the past 3 months was surprising. The Agency has been forced to temporarily shelve its constant forecasting of "oil at $150 a barrel" and readers of its Oil Market reviews and world energy summaries may temporarily see a little less of the Agency's creative writing output designed to bolster oil prices.

When it was founded as the "OECD oil watchdog" immediately after the 1973-1974 Oil Shock's 350% price hike, on an "initative" or rather kneejerk reaction by Nixon and Kissinger, the IEA's official mission was to bring prices back to the $2 a barrel range they were pegged at before 1973. That was the Nixon-Kissinger led, official OECD-wide reaction to the oil shock, but anticipating it in 1972, the same pair of US politicians secretly set the petrodollar recycling deal, only with Saudi Arabia, that still spills ink today. And the $2 peg has moved on a little - or a lot. Today, media coverage of the slump in oil prices features a supposed $80 a barrel "price peg" for Brent as a newsworthy feature spurring the question if or whether market minders and manipulators can push it back above $80 ? Compared to gold's massive price slump since 2011, oil is trailing by a large margin. We can conjecture what Mr Putin means by "catastrophic" falls in oil prices.

IEA Doctrine of High Priced Oil The IEA mutated into an outrigh shill for high=priced oil as far back as 2009, or even before. We can presume it found that overpriced oil fits well with its general paradigm shift to Global Warming Doom, claiming that the consumption of all fossil

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fuels, of all kinds, must be set on a tightly planned international schedule for total elimination "by the end of the century". Or even before that - some of its publications say it should be wiped out by around 2075, with absolute zero growth of fossil energy demand by at latest 2040..Conversely and very recently, the IEA has become "shale friendly", treating shale gas and oil as as a "bridging fuel", and to a slight extent has toned down its fantastic bias in favor of nuclear power. The IEA doesn't tell us what the oil price would or might be at that time, around 2075-2099 but since world oil demand would finally be zero we could suggest the right price will be zero US cents per barrel! Before that, the IEA fairy story goes on, higher oil prices will grease the wheels of massive and carefully chosen market-led investment in nonfossil energy.

Riding on Overpriced Oil As we know, the low carbon energy investment plays of "the market", in the past decade, have very often been disastrous - for example the global boom-slump in solar PV production, which for the moment and provisionally has been won by China but at fantastic cost to the state in bailouts and forced restructuring of nonperforming enterprises. The IEA's flimsy energy transition goals will never be met by this asset playing game, with or without $150 oil.

Asset creation and inflation, for and in the oil sector and by spillover in a range of niche parts of the energy space is a long way behind the exact same process operating since 2008-2009 for Apple, Amazon, Facebook, Whats App and other stars of delirious asset over-valuation, but high priced oil was (or is) a major player in the playtime future economy which does not exist. One of the biggest spillovers has been, and is the outright dependence of revenues from overpriced oil to prop the finances of the state of almost any major producer country. Kick away that prop, and we can say goodbye to G-20 chatter about "two percent extra growth". In the case of oil, keeping its price sky high is openly described by the IEA as helping permit and enable so much energy investment, good or bad or neiher, that its goal of eliminating all fossil energy becomes vaguely credible.

The Agency's publications carefully steer away from the debt-based financial hole which the US natural gas sector has dug for itself - and prefers to talk about the technological triumph of shale gas instead of its financial disaster of greed, confusion and self-delusion. The outright financial (as well as national security) disaster of nuclear power never darkens a page of any IEA report or study. In the case of US shale gas, though you would never know this from any IEA publication, for at least the past 4 years gas producers live with the hope that oil prices can go on growing and by strange magnetic influence, this will pull up US domestic gas prices. They also are totally dependent on "free finance" at extreme low interest rates, enabling them to use debt to produce even more gas - and drive the gas price lower! Never mind that in fact the USA's oil and gas markets are almost firewall-separate and different gambling arenas. For years, higher oil prices was the no brainer easy bet, while lower US domestic gas prices was the same easy bet.

Proving there is no such thing as a "global energy market", even for oil but especially for gas, overpriced natural gas in Europe and Asia made it seem a nice idea to bet on extreme high-priced assets in LNG. The Australian LNG boom-bust is a useful

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cautionary tale. The now vastly overheated Mozambique and Tanzania gas plays could go the same way, all of them based on the fundamental cargo cult belief that world gas prices would move up to European-Asian levels, and would never move down twards US domestic price levels.

Oil Hysteria Using the IEA as a surrogate or outlet for OECD leadership thinking (if we can use that word) on energy transition, climate change, oil prices, and relations with oil exporter countries we are forced to accept that $150 oil is totally acceptable or even sought after by these leaders. This in itself is a revolution - the 1991 Kuwait liberation war against Iraq was steamrolled through the press and media as needed because oil prices had reached "as high as $45 a barrel".

Today, massaging oil prices towards the joint goal of Goldman Sachs and the IEA $150 oil - looks like it has been shelved, but I suggest this is only temporary. To be sure, the timeframe for getting over and through a "downward blip" in prices, needed to sort out Vladimir Putin even if it harms Saudi Arabia, may be a few months or even a few years but Goldman Sachs, Bloomberg, and the financial "community" in general is in favor of renewable energy, urban bicycle paths, driverless cars and low carbon limousines, all of them needing overpriced oil to rationlize and justify an epic spending spree on "energy transition". Much more prosaically and right now, nearly all major (and some minor) oil exporter countries need $100 oil to prevent a debt spiral engulfing their economies. One wished-for example is Russia, and one unwanted example is Iraq.

Conspiracy theorists will have no problem linking the recent oil price crunch to the number of Russian armored columns entering eastern Ukraine. For example, every armored column in means another dollar off the barrel price! The market has been told what to do. The apparent major logistic, military and political problems for doing anything serious about the ISIS or ISIL cancer in the Middle East and North Africa, can when wanted be tied to the Islamic terrorists selling their stolen oil at $33 to $40 a barrel, depriving al Assad (s well as Baghdad) of revenues and supplying fantastic profits for the upstream operators of this scam, possibly including Genel Energy.

However the big picture is that for several decades, not one-only, oil has been slipping as a provider of world energy and will soon be overtaken by coal as No 1 and this isn't difficult to link with oil being usually overpriced as well as etxremely volatile-priced. The surprise is thereore that the OECD developed countries continue to treat oil as such an exciting and dangerous plaything for justifying extreme spending on everything from military security to low carbon living. When this elite fantasy cracks, we can expect and forecast real major changes in word energy nnd the economy.

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OilVoice Magazine | DECEMBER 2014

Baghdad/Irbil Oil Deal - unlocking value at last?

Written by Anthony Franks OBE from Mars Omega LLP According to Reuters, late yesterday Baghdad and the Kurdistan Regional Government (KRG) “reached a deal to ease tensions over Kurdish oil exports and payments for civil servants from Baghdad.”

The Iraqi Minister of Finance (a Kurd) - and former federal Foreign Minister Hoshyar Zebari said Baghdad has agreed to resume payments from the federal budget for the KRG’s civil servants' salaries.

Initial reports suggest that Kurdistan will transfer the revenue from some 150,000 bpd of crude exports – some 50% of current production - to the federal budget. This will be in return for a cash injection from Baghdad, reported to be some $500M per month, to ease pressure on KRG finances.

KRG DPM Qubud Talabani, wrote on Twitter, said "today's important agreement between the KRG and Baghdad is a first step towards a lasting agreement on revenue sharing and oil exports."

The UN noted this morning that this is “a very important first step.” UN SecGen BanKi moon welcomed the agreement and congratulated PM-HA and KRG PM Barzani, for the willingness to negotiate and conclude agreements that are in the interest of the Iraqi people. The UN SecGen also encouraged the Federal and Regional authorities to build on this important first step and to solve all remaining outstanding issues within the framework of the Constitution.

In Baghdad, the UN envoy to Iraq Nickolai Mladenov said "I welcome the agreement...on resolving the budget dispute. This agreement will allow public sector employees in the governorates of Irbil, Dohuk and Sulaimaniyah to begin receiving their salaries. It will also allow the Kurdistan Regional Government to resume its contribution to the federal budget at a time of national crisis.”

The KRG has pronounced the agreement with Baghdad to be a "comprehensive and just" solution between the two sides, with KRG PM Nechirvan Barzani and Iraqi Minister of Oil Adel Abdul Mahdi hailing it as "a first step".

PM Barzani will now visit Baghdad to "finalise overall pending questions between the two sides” in order to “reach a comprehensive, fair and constitutional solution to all outstanding differences between the federal government and the KRG.”

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And those questions are still likely to be pretty significant: the agreement must be set in the context of the KRG approving plans yesterday to create an E&P company separate from the federal government, and a sovereign wealth fund (SWF) for all hydrocarbons’ revenue.

PM Barzani said the new company will “oversee all the oil and gas sectors, for example, the signing of contracts for oil exploration, extraction, development, investment, export and marketing. This company can become within a limited time a shareholding company, and all the citizens can buy shares in it.”

The bureaucratic reality is that it would be easy to create the SWF, but building an E&P company from scratch would take a significant amount of time to do, but - as the more expert Oil Voice readers than I know only too well - such beasts are complex and complicated to set up and run.

But, on the KRG’s own website, PM Barzani said bluntly the KRG would not hand oil control to the Iraqi State Oil Marketing Organisation (SOMO). He noted the federal government cannot export oil from Kirkuk without involving the Kurdistan Region.

This will of course be anathema to SOMO which believes it has the right to do all the above, and therefore the announcement by the KRG PM has to be seen as the KRG drawing a line in the sand, and this line must be seen in the context of a longer term political agreement that is acceptable to Irbil.

Nonetheless, this deal must be seen as one of the most strategically significant achievements by Prime Minister al-Abadi and stands in stark contrast to the stagnant stasis that was the status quo of the previous Iraqi regime. Importantly for the IOCs in Kurdistan, and those contemplating market entry, this is a sign that Baghdad and Irbil are serious about coming to both economic and political accommodations.

Clearly, the KRG is intent on controlling its own E&P activities, and current public statements suggest that this is not negotiable. In the wider context of the need for Baghdad to shore up its revenue base, it seems likely that talks will broaden and deepen.

The price of Kurdistan staying within Iraq may well be control of their own hydrocarbons. If Baghdad can see or persuaded – probably by the US to - see the geopolitical and socio-economic value of that price, then it will unlock huge value for IOCs, and this seems a more likely outcome than it has done for many years.

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OilVoice Magazine | DECEMBER 2014

Oil price slide - no good way out Written by Gail Tverberg from Our Finite World The world is in a dangerous place now. A large share of oil sellers need the revenue from oil sales. They have to continue producing, regardless of how low oil prices go unless they are stopped by bankruptcy, revolution, or something else that gives them a very clear signal to stop. Producers of oil from US shale are in this category, as are most oil exporters, including many of the OPEC countries and Russia.

Some large oil companies, such as Shell and ExxonMobil, decided even before the recent drop in prices that they couldn’t make money by developing available producible resources at then-available prices, likely around $100 barrel. See my post, Beginning of the End? Oil Companies Cut Back on Spending. These large companies are in the process of trying to sell off acreage, if they can find someone to buy it. Their actions will eventually lead to a drop in oil production, but not very quickly–maybe in a couple of years.

So there is a definite time lag in slowing production–even with very low prices. In fact, if US shale production keeps rising, and Libya and Iraq keep work at getting oil production on line, we may even see an increase in world oil production, at a time when world oil production needs to decline.

A Decrease in Oil Prices May Not Fix Oil Demand At the same time, demand doesn’t pick up quickly as prices drop. We are dealing with a world that has a huge amount of debt. China in particular has been on a debt binge that cannot continue at the same pace. A reduction in China’s debt, or even slower growth in its debt, reduces growth in the demand for oil, and thus its price.

The same situation holds for other countries that are now saturated with debt, and trying to come closer to balancing their budgets.

Furthermore, the Federal Reserve’s discontinuation of quantitative easing has cut off a major flow of funds to emerging markets. Because of this change, emerging market demand for oil has dropped. This has happened partly because of the lower investment funds available, and partly because the value of emerging market currencies relative to the dollar has fallen. Again, a decrease in oil price is not likely to fix this problem to a significant extent.

Europe and Japan are having difficulty being competitive in today’s world. A drop in oil prices will help a bit, but their problems will mostly remain because to a significant extent they relate to high wages, taxes, and electricity prices compared to other producers. The reduction in oil prices will not fix these issues, unless it leads to lower wages (ouch). The reduction in oil prices is instead likely to lead to a different

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problem–deflation–that is hard to deal with. Deflation may indirectly lead to debt defaults and a further drop in oil demand and oil prices.

Thus, oil prices are likely to continue their slide for some time, until real damage is done, perhaps to several economies simultaneously.

The United States’ Role in the Oil Over-Production / Under-Demand Clash The United States is the country with the single largest increase in oil production in the past year. This growth in oil production seems not to have stopped, in recent weeks.

Figure 1. US Weekly Crude Oil Production through Oct 24. Chart by EIA. At the same time, the US’ own consumption of oil has not increased (Figure 2).

Figure 2. US oil consumption (called “Product Supplied”). Chart by EIA. The result is a drop in needed imports. A number of oil exporters have been hit by the US drop in imports. Nigeria extracts a very light oil that competes for refinery space with oil from shale formations. Our imports of Nigerian oil have been reduced to zero (Figure 3). (The amounts I am showing on this and several other charts are “net imports.” These reflect transactions in both directions. Often the US imports crude oil and exports oil products, sometimes to the same country. In such a case,

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we are selling refinery services.)

Figure 3. US Net Petroleum Imports from Nigeria. Chart by EIA. Our imports of oil from Mexico are way down as well (Figure 4), in part because their oil production has been falling.

Figure 4. US Net Imports of Petroleum from Mexico. Chart by EIA. It is only in the past few months that US imports from Saudi Arabia have started to be significantly affected (Figure 5).

Figure 5. US net oil imports from Saudi Arabia. Chart by EIA.

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Saudi Arabia, like other oil exporters, depends on the sale of oil revenue to provide tax revenue for its budget. While it has a reserve fund for rainy days, over the long term it, too, depends on revenue from oil exports. If Saudi Arabia’s exports to the United States decrease, Saudi Arabia needs to find someone else to sell these would-be exports to, or revenues to fund its budget will drop.

Alternatively, it can reduce the price it charges to US refineries, to influence purchasing decisions–something it has just done. Lowering its price to US refineries tends to push the world price for oil down.

Of course, the US also talks about allowing an increasing amount of crude oil exports, as its oil from shale formations rises. This increase would make the surplus of oil on the market worse, and world prices lower, if oil demand does not pick up.

Depending on Saudi Arabia and OPEC In the West, we have been led to believe that OPEC in general and Saudi Arabia in particular exert great control over oil prices. We have been told that several OPEC countries have spare capacity. Several of the Middle Eastern countries claim that they have very high reserves, and we have been led to believe that they can ramp up their production if they invest more money to do so. We have also been told that these countries will reduce oil production, if needed, to hold up oil prices.

A very significant part of what we have been led to believe is exaggerated. Saudi Arabia’s oil exports were much higher back in the late 1970s than they are now (Figure 6). When they cut oil production and exports in the 1980s, they likely did have spare capacity.

Figure 6. Saudi oil production, consumption and exports based on EIA data.

But where we are now, the situation has changed greatly. The population of the

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Middle Eastern oil producers has risen. So has their own use of the oil they extract.

Their budgets have risen, and the countries need increasing revenue from oil taxes to meet their budgets. Some countries, including Venezuela, Nigeria, and Iran, require oil prices well over $100 per barrel to support their budgets (Figure 7).

Figure 7. Estimate of OPEC break-even oil prices, including tax requirements by parent countries, from APICORP. If oil prices are too low, subsidies for food and oil will need to be cut, as will spending on programs to provide jobs and new infrastructure such as desalination plants. If the cuts are too great, there is the possibility of revolution and rapid decline of oil production. Virtually none of the OPEC countries can get along with oil prices in the $80 per barrel range (Figure 7).

Most of OPEC’s actions in recent years have looked like actions a person would expect if OPEC countries were not all that different from other oil producers–their oil supplies were subject to limits and they tended to act in their own self interest. When oil prices were rising rapidly in the 2007-2008 period, they ramped up production, but not by very much and not very quickly (Figure 8). When oil prices dropped, they dropped their production back to where it had been, before the big ramp up in prices.

Figure 8. OPEC and Non-OPEC Oil Production, Compared to Oil Price. (Production is Crude and Condensate from EIA.)

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Another situation occurred when Libya’s production declined in 2011. Saudi Arabia said it would increase its own supply to offset, but it could only produce extra very heavy crude when light oil was what was needed. In fact, even the increase in heavy oil is somewhat in doubt.

Furthermore, the dynamics of OPEC have been changed considerably in the last few years. Part of the problem relates to fact that both oil prices and the quantity of oil exports have been approximately flat in the period between 2011 and mid-2014. In such a situation, revenue from oil exports tends to be flat. OPEC members have found this to be a problem because their populations continued to grow and their need for water and imported food has continued to rise. These countries need evermore tax revenue, but oil revenue is not providing it. At a minimum, OPEC countries have a strong “need” to maintain their current level of oil exports.

The other part of changing OPEC dynamics relates to increased oil production volatility. The bombing of Libya and sanctions against Iran have both produced unstable situations. Oil exports from both of these countries are lower than in the past, but can suddenly rise as their problems are “fixed,” adding to downward price pressures.

Another issue is the significant attempt to raise Iraq’s oil production in recent years. If Iraq’s oil production (plus US shale production) is too much to satisfy world demand for oil, should the rest of OPEC be the ones to try to “fix” the problem?

Figure 9. US net imports from Iraq. Exhibit by EIA. Figure 9 seems to indicate that US imports from Iraq have increased in recent months. Of course, if we import more from Iraq, we will likely need to cut back on imports elsewhere. This doesn’t create good feelings among OPEC exporters.

Shouldn’t the United States Take Some Responsibility for Fixing the Problem?

One might ask whether the United States should be cutting back in its oil production, in response to low prices. Of course, as indicated above, US oil majors (like Shell, Chevron, and Exxon) are cutting back on investment in new fields, and this is eventually likely to lead to lower production. The question is whether this will be a sufficient change, quickly enough.

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It is less likely that shale drillers will intentionally cut back quickly. The shale drillers have taken on leases on huge acreage and are reluctant to step back now. For one thing, part of their costs has already been paid, reducing their costs going forward on acreage already under development. They also have debt that needs to be repaid and many contractual arrangements with respect to drilling rigs, pipelines, and other services. Some may have futures contracts in place that will soften the impact of the oil price drop, at least for a while. Because of all of these factors, there is a tendency to continue business as usual, for as long as possible.

Whether or not shale drillers intentionally plan to cut back on oil production, some of them may be forced to, whether or not they believe that the production is likely to be profitable over the long run. The problem is likely to be falling cash flow because of lower oil prices, if the price drop is not mitigated by futures contracts. Because of this, some companies may be forced to cut back on drilling quite soon. Another alternative might be to ramp up borrowing, but lenders may not be very happy with such an arrangement.

We notice that some companies are already in very cash flow negative situations–in other words, in situations where they need to keep adding more debt. For example, Capital Resources, the largest operator in the Bakken, shows rapidly growing outstanding debt through 6/30/2014, without seeming to take on significant new acreage (Figure 10).

Figure 10. Selected figures from SEC filings by Continental Resources.

When companies are already in such cash flow negative situation, there may be more problems than otherwise.

If Lower Oil Prices “Hang Around” for Months to Years, What Could this Mean?

We are in uncharted territory, in such a situation.

One of the big issues is potential deflation. The issue seems to be not only lower oil prices, but lower prices for many other commodities, as well. The concern is that

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wages will drop, as will government receipts. Lower wages already seem to be happening in Spain. Unless governments figure out a way to “fix” the situation, this situation will make debt repayment very difficult. Lower debt will tend to reinforce the low prices of oil and other commodities.

If low prices become the norm for many kinds of commodities, we can expect major cutbacks in production of these commodities. This would be the situation of the 1930s all over again. Ben Bernanke has said he would send helicopters of money to prevent such a situation. The question is whether this can really be arranged, given that the United States (and several other countries) have already been “printing money” since 2008. At some point, it would seem like the arsenals of central banks will get used up.

If there is a cut back in debt and cutback in production of commodities, many goods we have come to expect in the market place will disappear, as will many jobs. There are likely to be breaks in supply chains, leading to more cutbacks in production.

With all of the debt problems, there is a question of how well international trade will hold up. Will would-be explorers trust buyers who have recently defaulted on their debt, and don’t look likely to be able to earn enough to pay for the goods that they currently are ordering?

The discussion has been mostly with respect to oil, but liquefied natural gas (LNG) is likely to be affected by low prices as well. Reuters is reporting that likelihood of US exports of LNG to Asia is down, for a number of reasons, including the discovery that costs would be higher than originally expected and the regulatory process less smooth. Another reason LNG exports are likely to be low is the fact that Asian prices dropped from a high of $20.50/mmBtu in February to a low of $10.60/mmBtu in August. Without sustained high LNG prices, it is hard to support the huge infrastructure investment needed for LNG exports.

Can Oil Prices Bounce Back?

If we could somehow fix the world’s debt problems, a rise in the price of oil would seem to be much more likely than it looks right now. As long as the drop in demand is related to declining debt, and the potential feedbacks seem to be in the direction of deflation and the possibility of making defaults ever more likely, we have a problem.

The only direction for oil prices to go would seem to be downward.

I know that we have very creative central banks. But the issue at hand is really diminishing returns. Prior to diminishing returns becoming a problem, it was possible to extract and refine oil cheaply. With cheap oil, it was possible to create an economy with low-priced oil, inexpensive infrastructure built with that low-priced oil, and factories built with low-priced oil. Workers seemed to be very productive in such a setting, in part because low-priced oil allowed increased mechanization of production and allowed cheap transport of goods.

Once diminishing returns set in, oil became increasingly expensive to extract, because we needed to use more resources to obtain oil that was very deep, or in shale formations, or that required desalination plants to support the population. Once

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we needed to allocate resources for these endeavors, fewer resources were available for more general uses. With fewer resources for general activities, economic growth has become inhibited. This has tended to lead to fewer jobs, especially good-paying jobs. It also makes debt harder to repay. History shows that many economies have collapsed because of diminishing returns.

Most people assume that of course, oil prices will rise. That is what they learned from supply and demand discussions in Economics 101. I think that what we learned in Econ 101 is wrong because the supply and demand model most economists use ignores important feedback loops. (See my post Why Standard Economic Models Don’t Work–Our Economy is a Network.)

We often hear that if there is not enough oil at a given price, the situation will lead to substitution or to demand destruction. Because of the networked nature of the economy, this demand destruction comes about in a different way than most economists expect–it comes from fewer people having jobs with good wages. With lower wages, it also comes from less debt being available. We end up with a disparity between what consumers can afford to pay for oil, and the amount that it costs to extract the oil. This is the problem we are facing today, and it is a very difficult issue.

We have been hearing for so long that the problem of “peak oil” will be inadequate supply and high prices that we cannot adjust our thinking to the real situation. In fact, the two major problems of oil limits are likely to be shrinking debt and shrinking wages. The reason that oil supply will drop is likely to be because customers cannot afford to pay for it; they don’t have jobs that pay well and they can’t get loans.

In some ways, the oil prices situation reminds me of driving down a road where we have been warned to look carefully toward the left for potential problems. In fact, the potential problem is in precisely in the opposite direction–to the right. The problem gets overlooked for a very long time, because most of us have been looking out the wrong window.

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An emerging oil deal between Baghdad and Irbil?

Written by Anthony Franks OBE from Mars Omega LLP Yesterday the Kurdish news outlet RUDAW reported that Kurdistan Regional Government (KRG) Prime Minister Nechirvan Barzani said Iraqi federalism had failed but the Kurds are not seeking independence but greater autonomy.

Barzani stated bluntly “Federalism has failed and if we can’t establish federalism, we are asking for additional autonomy, not for the destruction of Iraq. It would be very hard after 1991 and 2003 to go back to square one.”

This is one of the hardest hitting comments from a senior KRG politician that independence might be on the back burner since the attacks by ISIS in June. Even after Mosul fell in that month, the KRG leadership were still vocal about seceding from federal Iraq.

The former PM of the KRG, Barham Salih, noted the time was not right for independence, saying even if the Kurds were go it alone, Baghdad would remain their most important neighbour: “As southern Kurds, Baghdad is more important to us.”

Salih also said Kurdistan needed to diversify away from a “consumption economy” and PM Barzani said “I support Barham’s speech, we have to reorganise our house.”

So why do we think that an oil deal might be on the cards, especially as the signs are counter-intuitive?

The Wall Street Journal reported yesterday that foreign investors including Western oil companies are scaling down operations and laying off local staff. Major construction and infrastructure projects are at a standstill because contractors have not yet been been paid.

The KRG owes some $1.2B to O&G companies that have PSAs with the region and since March 2014 has been exporting crude oil to Turkey, to the fury of Baghdad.

But the Kurdish Peshmerga have also fought heroically to stem the black-clad tide of ISIS extremists that stormed into northern Iraq n the summer. The Peshmerga were a thin but determined defensive line that held the extremists back, and the KRG is hoping that gives Irbil political leverage.

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However, PM Barzani noted there appears to be no shift in Baghdad’s position over the KRG’s oil exports, so he wants Washington to intervene to put pressure on Baghdad to at least release some of the funds owed to Erbil. Barzani also said the KRG is ready to work out all issues with Baghdad, but “No way we will give you [Baghdad] control after what you did to us.”

Nonetheless, there are signs of increased and more substantive cooperation; for example on Tuesday PM Barzani and Iraqi Minister of Defence (MinDef) Khalid alUbaidi were reported by Kuwaiti media to have “agreed on the importance of coordination between the Iraqi army and Peshmerga forces against the Islamic State in Iraq and Levant.”

The MinDef also commended the Peshmerga for their confrontation with ISIS and their recapture of key terrain; and also noted the "Peshmerga [were] part of the defence regime in Iraq,” and thus as a subtext, Baghdad should or will have a say in their deployment. But the only way that Irbil would ever agree to that would be if a suitable negotiating position can be found. And that means a Baghdad/Irbil deal is probably being discussed.

Consider these facts: KRG FM Falah Mustafa Bakir said on Monday after a speech in the US, at the Johns Hopkins School of Advanced International Studies, that the KRG is “not ready to go back to pre-June Iraq” – referring to the fall of Mosul and the KRG’s swift annexation of Kirkuk.

Bakir said bluntly to the audience during the Q&A session “Today in Kurdistan we want to exercise more political power, more economic power and more sovereignty.”

So does “more sovereignty” mean more freedom to determine their own geopolitical and socioeconomic future still within a federal Iraq? We think it is entirely possible, and that also speaks to the idea of a deal.

It is clear that cash is king even for governments, and PM Barzani said recently that that “The federal government has used the bread of the people of Kurdistan as a trump card in its dispute with the Kurdistan government. Baghdad cut our budget saying that the Kurdistan Region had independently sold its oil, but that is far from the truth. But up to that point we hadn't sold any oil.”

He went on to point out “Only after cutting the budget by Baghdad did the Kurdistan Region begin to sell oil, and, key for us is the almost throwaway comment “But our efforts continue to solve this financial crisis and we will gradually solve it”.

And then the hint emerged when PM Barzani said “the new Iraqi government was multiparty” and that “the Kurds will seek to solve their issues with dialogue” and “Our participation was for this purpose.”

The new Minister of Finance – the key man to run Baghdad/Irbil federal budget negotiations is Hoshyer Zebari – a Kurd, and usefully, President Barzani’s uncle.

And consider the fact that this week PM al-Abadi visits Irbil for his first official visit to Kurdistan, with Kurdish media reporting PM al-Abadi and four of his advisers “have

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set new conditions on the Kurdish oil issue which they will present at the meetings.”

Add into the mix the PM Barzani wants military support from Baghdad and Washngton; and we note that the MinDef said “The Peshmerga are part of the Iraqi defence system and our support is with them. What the army has is for the Peshmerga, and what is required from the army is required from the Peshmerga.

When we have weapons, God willing, they [Peshmerga] will have their share like other Iraqi troops.”

Renas Jano, a Kurdish MP in Baghdad is reported to have said “Abadi’s visit to the Kurdistan region is a part of his visits to all of Iraq’s provinces and it’s an opportunity for him to discuss the issues between Baghdad and Erbil.”

Serwan Serini, also a Kurdish MP in Baghdad, said “Iraq is currently suffering a financial crisis and has now reached an understanding that they have to let oil from the Kurdistan Region and Kirkuk be exported to survive.”

The International Monetary Fund said last week Iraq's economy is set to shrink by 2.75% in 2014, its first contraction since the invasion of 2003. And there is still no federal budget agreed, thanks to the lack of both inter and intraparty consensus on the allocation of funds to Irbil, which remains dangerously cash-starved.

And Dow Jones Newswire (DJN) reported today “without a budget in place, Iraqi policy makers say they are mostly reacting to the country's economy rather than planning it.”

Tellingly, DJN noted “the greatest barrier in the negotiations has been a dispute with the northern Kurdish Regional Government, a semi-autonomous region that has its own oil wealth and ambitions for statehood.” A deal must therefore be struck between Baghdad and Irbil.

If you add into the mix that the US Congress is now going to be run by Republicans who are typically more Hawks of War than Doves of Peace, and they want to see an increased effort against ISIS, and the fact that Kurdistan and Iraq need the US arguably more than the US needs them, it seems to us that the deal wheel is turning again. Taken together, the snippets of information, soundbites and speeches might well add up to a Washington-brokered deal that will address federal budgets, Kurdish independence, oil and revenue sharing, military training and more advanced weaponry to the Iraqis and the Kurds.

And that is potentially good news for the cash-strapped Kurdish hydrocarbons’ sector, and bad news for ISIS.

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OilVoice Magazine | DECEMBER 2014

The only oil price going UP in the world right now Written by Keith Schaefer from Oil & Gas Investments Bulletin Here’s a current chart of the oil price you probably don’t recognize:

This is a custom built chart of Canadian heavy oil prices (Western Canada Select– WCS)—in Canadian dollars. (Canadian dollar charts are hard to find!). This chart takes into account the lower Canadian dollar against the greenback. It shows that heavy oil producers aren’t hurting—in fact, they’re getting some of the best prices ever in the last five years.

But that hasn’t helped their share prices. Oilsands and heavy oil producers have seen their stocks drop 30% or more in the last few weeks—the same as everyone else.

The weak Canadian dollar shielded just under half the drop in oil prices for producers in the Great White North.

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At the start of 2013 the Canadian dollar was at par with its American counterpart.

What that meant was that for every US dollar of barrel sold Canadian producers received one Canadian dollar. Today one US dollar is now worth $1.125 Canadian. If WCS prices are at $70 US per barrel that means that heavy oil producers would receive $78 Canadian.

But the other reason for the strength in heavy oil is strong demand and better access to market. That is reducing the discount that heavy oil prices get around North America.

It could mean that heavy oil stocks are the best place for energy investors…but not yet. There is no emotion in upstream E&Ps until the oil price finds a bottom. And only God and Allah know when that will be.

But stronger demand for heavy oil should be a long term trend.

Investors hear all the time about the Shale Revolution—but that’s high quality light oil. But the US refinery complex has been moving to produce more lower quality heavy oil for a decade. Just this year, BP’s Whiting Indiana refinery finished switching from 70% light oil to 70% heavy oil—despite being so close to Bakken light oil in North Dakota.

Until tight (or shale) oil became economic, the crude slate the world over was getting heavier. And the oils are so different that you can’t put light oil in a heavy oil refinery and make much money.

But US refineries also want heavy Canadian crude for economic reasons—it has been VERY cheap in the last few years. Another way the industry says this is—WCS has a big discount to WTI, or West Texas Intermediate, the US light oil benchmark price set in Cushing OK. Heavy oil should have a discount because it costs more to refine than light oil—the “heavy” in heavy oil means asphalt and other products are in the oil and have to be removed (they get used for paving roads across North America).

But refineries are more concerned about the discount from Brent—the international benchmark price out of London England. All the refined products like gasoline get

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sold on Brent pricing (or whatever benchmark is highest at the time).

As fast growing production from the Shale Revolution overwhelmed US refineries in 2011-2013, the WTI price dropped from even with Brent to $20/barrel below! But increased refinery runs, refinery expansions and crude exports to Canada have brought that down to a $2/barrel Brent-WTI discount lately.

Second, Canadian heavy oil typically trades at a discount to WTI. In the last two years a lack of pipeline capacity has led to that discount blowing out to as much as $40 per barrel at times–as you see on the chart below. During the last two Decembers, Canadian heavy oil producers got no Christmas presents as they were selling oil as low as $58/barrel!

Source of graph data: Alberta Office of Statistics It’s easy for that Canadian dollar chart of heavy oil to go up when it starts at low prices like that.

Thanks to oil by rail, that discount has stabilized at much lower levels in 2014 and is now at its lowest levels in recent memory.The Market is predicting that the WCS “differential”, or discount, will stay low. Current strip pricing shows the WCS discount going from under $15 today to around $20 by the end of 2015 and staying there longer term.

Crude-by-rail will continue to be key for heavy oil as more pipeline capacity has become so political. Few people could see how quickly rail has rescued heavy oil producers.

Rail uploading capacity in Canada is now 600,000 barrels per day. That is expected to nearly double to 1.1 million barrels per day by the end of 2015.

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There has been a lot of positive news for WCS pricing just in the last week: 

 





Phillips 66 (PSX-NYSE) said the supply of Mexican heavy oil, called the Maya blend, is being reduced into the Gulf Coast. This is Canada’s major competitor in the Gulf Coast Refinery Complex. They are looking for more Canadian heavy crude.

Phillips is also building a 30,000 bopd transloading facility at its Ferndale WA refinery, just south of the Canadian border, to take more crude by rail.

International energy consulting firm PIRA said in their September MidContinent Oil Forecast that Enbridge’s Flanagan South pipeline from Illinois to Cushing is now being filled with heavy oil, which will reduce the regular seasonal discount for heavy oil this year. o This is potentially very good news, and long lasting news for heavy oil producers. Railing crude from western Canada is roughly $17$18/barrel. But if half that distance can now be piped–from Chicago down to the Gulf–then the overall blended transport cost to all those heavy-crude hungry Gulf Coast refineries is more like $10-$11/barrel.

It’s potentially a huge structural change in the heavy oil market.

Marathon (MPC-NYSE) is considering “potential commercial opportunities” for its 1.2 million bopd Capline pipeline, which starts in Louisiana and ships oil north to Midwest refineries near Chicago. The obvious option is to reverse it north-to-south and get more cheap WCS barrels to the Gulf Coast. (Then Keystone really becomes meaningless for a few years). Management said there is big demand for Canadian crude in the Louisiana refining corridor—“a lot of volume that could go that direction someday.”

Marathon added that by the fourth quarter, the WCS-WTI differential is expected to narrow to the mid- teens – approaching Gulf Coast refiner parity with Maya, adjusted for transportation costs and quality.

Another big factor increasing profitability for heavy oil producers is lower condensate prices. Condensate is a very light oil that is used to dilute the gooey heavy oil so it flows better in pipelines. In Canada it usually trades $3-$5 above the Canadian light oil price, called Edmonton Par. Condensate trades lock-in-step with light oil, so it is down 25% to $76/barrel since July. That reduced blending cost goes directly to

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increased netback–profit per barrel–for heavy oil producers.

The conclusion here is that market forces are actually raising Canadian heavy oil prices AND lowering costs—completely against the grain of every other hydrocarbon in North America. Despite all the volatility, heavy oil producers continue to generate cash flows ABOVE their 2014 budgets.

It’s counterintuitive, and it could be a huge opportunity for investors—but when?

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Bubble trouble for the oil asset bubble Written by Andrew McKillop from AMK CONSULT Nothing Ikonic about the Gold / Oil Ratio Assuming for discussion that a 15-to-1 ratio between the price of I Troy ounce of gold and 1 barrel of oil is a long-term average or 'ikonic ratio', (http://www.zealllc.com/2005/gorex2.htm) this would apply for $2 oil and $30 gold as much as $120 oil and $1800 gold. But the asset bubbles built around oil and gold would be rather different, each time. Also, coming down and off highs for the gold price, or for the oil price, there would be major bloodshed among the related overpriced and now-irrational asset values, but in the case of oil assets this will include national budgets, national FX values and even global economic growth.

Deflating an oil asset bubble has a lot more ramifying impacts than coming down from a high for gold.

The major problem for both these highly symbolic, emotional and political 'stores of value', is that while we can identify probable or possible absolute minimum prices for both of them, using the shaky yardstick of the US dollar and its own changing value.

We however can't identify a maximum. For gold and depending on your scenario, you can say $2500 or $5000 or $10000 an ounce, all of them being disaster

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scenarios for the world economy!

To be sure and not so long ago, in 2010 respected oil and commodity price commentators like Matt Simmons and T. Boone Pickens for oil, and Jim Rogers for general commodities, joined by corporate chiefs with an interest in high-priced oil like Carlos Ghosn and Richard Branson gave interviews where they argued oil could attain 'at least 250 US dollars a barrel'. Very theoretically therefore, gold could or might attain north of $3750 an ounce in the same scenario. The IEA and Goldman Sachs prefer the $150 oil scenario, which GS already briefly 'goosed' into the real world in 2008.

Today we could or might divide the IEA/GS 'nice price for oil' by three, and get closer to reality. With no doubt at all, however, overpriced oil will always weigh heavier on the global economy than overpriced gold. On the one hand it stokes investment, economic growth and balances the budgets of a large number of oil exporter countries. On the other hand it theoretically stokes inflation and interest rates except that this didn't happen with oil at more than $100 for a long time in the recent past. Being heretical, I could suggest that recently at least, overpriced oil was deflationary and a brake on economic growth and investment, anywhere outside the 'oil patch'.

Forget About Keynes Keynes never got around to calling oil a barbarous fossil relic and wasn't known for worrying about 'carbon residues' building up in the atmosphere, but preferred to argue that gold bullion reserves in national banks should not be allowed to build up, and should be replaced by debt. His wishes were massively exorcized although it took some time from his 1930s and '40s-era outbursts on the subject.

His adage that if I owe you $10 and can't pay I am in trouble - but if I owe you $10 million and can't pay it is you who are in trouble has become the cornerstone of IMF and central bank thinking, private banking and insurance company practice, and the entire consumer-debt economy. Oil is a side issue in this debt debate, in fact the belief that overpriced oil 'helps inflation' is comforting for Neo Keynesians including every single central banking chief in the western world. Claiming there is some 'prudent ratio' between a central bank's total assets and the tonnage of its gold bullion reserves is nonsense. China's central bank for example has about 1% of its total assets in the form of bullion. The US Fed's proud claim, whether it is true or false, is about 20%. Other central banks, notably Germany's, are closer to a ratio of 20% with their real world metal bullion reserves, including the gold they lent to the US Fed, or other central banksters who 'let it disappear' such as the Bank of England.

Above-ground oil reserves have no meaning. Oil is hard to store and effectively pointless to store. So-called SORs (strategic oil reserves), where they exist, need highly expensive management and cycling in-and-out, and at best could only run national armed forces and food production for a few months, assuming of course that the war-time emergency concerned a conventional or 'classic' war something like World War I. The belligerants would of course run a gentlemanly war whey they did not simply take out all the NPPs (nuclear power plants) of the enemy in the first days

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after the war was declared - making oil use for any above-ground activity pointless and useless. SORs are a luxury item and prestige waste of time for national sentiment purposes, only. Oil prices have a clear supply-demand relationship although you might find that hard to believe!

Not so for gold. Including the gold-equivalent of SORs in the shape of central bank (and bullion bank) metal reserves, gold mining company reserves, jewelry, coins, bars and other above-ground gold, WGC and other sources suggest it is about or above 180 000 metric tons. This equals about 70 years of world total gold mine output at current rates - the world's SORs, located mostly in the OECD countries hold a small fraction of 1 year's world total of oil production. Adding to the metal reserves, paper gold 'reserves' are so immense it is pointless trying to make an estimate - except to say it is minuscule compared to the world total of M1-M2-M3 money plus financial assets in circulation!

The net result, which Keynes would likely have approved, is that gold prices can range through an immense pricing space, even if oil could (we can suggest) 'only' range from about $250 to $40 per barrel under present real world economic conditions. To be sure, neither of these extremes would be long-term sustainable, although through 1986-1999 oil rarely strayed far from $18 per barrel and gold prices were similarly 'range-bound' and low as they drifted down from their 1980 panic peak.

Bubble Trouble The last 30 - 40 years tells us that both gold and oil prices can spike and crash in a short period of time - sentiment is all. Price peaks guarantee price crashes, but here we find that oil price peaks and crashes have a much bigger economic hit, when they happen. For the same reason which led Saudi Arabia to 'open the taps' in 1986 and spark a 67% oil price crash in 6 months - to punish the enemies of the day, and today, Iran and Russia (the USSR in 1986) - the Saudi agenda also included the highly theoretical concept of 'driving high cost producers out of business'. Quite simply, this did not happen in 1986-99. British and Norwegian North Sea oil producers - high cost producers - soldiered on and opened their own taps, forcing oil prices even lower! The Saudi goal of driving out the high cost producers will almost certainly not happen today. Nor did the theoretical Saudi concept of 'forcing quota respect among OPEC suppliers' For a large number of reasons, these oil-theory concepts are even less likely to be proved true in today;s real world-real economy circumstances where, for example, high cost US and Canadian shale and tar sand oil producers will resort to more debt before they 'close the taps' and this can be a long drawn out process.

To be sure, the 'cheap oil interval' of 1986-99 had a major downward impact on oil exploration and development, and oilfield services spending. For several lowerincome oil exporters, both OPEC and nonOPEC producers the 'recourse to debt' caused by a slump of oil revenues was a major cause of a long lost decade for the economy in these countries and deepened the Third World debt crisis by the knockon effect of falling non-oil commodity prices. In that cheap oil interval, cheap oil was a major driver of slower global economic growth. Conversely since about 2005, and absent the short financial crisis-related oil price slump of 2009-10, overpriced oil has

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enabled and driven a vast spending spree spreading far out from the oil and energy sector, and this includes government spending by all the OPEC states, Russia, and other producers both small and large.

Cheap oil is surely and certainly deflationary. Wheeling back Keynes (and Krugman!) into the discussion, deflation is perceived and feared by central bankers like garlic is feared by vampires. Asset deflation is their big worry. Monetary instability is their next worry. Higher interest rates is the next phase of their paranoid fear and loathing - and by supreme irony, they will start buying gold, or buy more gold in these circumstances, and become less easygoing about IMF 'gold swaps' where the metal disappears and is replaced by SDRs and other bits of paper. The Swiss referendum of November 30 is a tell-tale example of this fear.

The current and probably ongoing slide in oil prices is called a 'game changer' by some, but it is happening at the end of a near-decade of overpriced oil. Oil exporter country borrowing on the back of this 'can't fail asset' was comensurate and proportionate - that is disproportionate and extreme like oil corporate net worth as measured by their overblown market caps. Like the market caps for oil E&P companies and field service providers, these can only become shaky and fragile, possibly subject to dawn, midday and afternoon raids by short sellers on equity markets. Interest rates for sovereign loans of oil exporter countries can and should rise. Their national currencies (like Russia's!) can take a hammering on FX markets.

Ironic Outcomes There is nothing ironic about an overblown oil sector fattened by overpriced oil taking a hiding but for gold the irony is that prices will have to rise. Measuring this, the 'ikonic' 15-to-1 price ratio will fade from the scene for some while. The deflationary impact of cheaper oil may significantly outweigh its growth-stimulating impact on the consumer economy, for one reason because the deflationary impact will act sooner.

The deflationary impacts of cheaper oil will be joined by the also-deflationary impact of higher-priced gold will also be deflationary. Tfor as long as the net impact is deflationary this will keep central bankers 'holding off' from any decision to raise interest rates, stoking the now massive potential for an inflation outburst - when the right conditions are together. For the oil sector on the production side, as already shown by present OPEC 'crisis talk and debate' the reaction to falling prices - of raising output to cover lower barrel prices - will likely win out against 'quota discipline'. Adding-in the geopolitical desiderata, the playact of Saudi Arabia cutting production to help protect Russia and Iran from falling oil prices - or the opposite can be forgotten as talk fodder for 'experts' on TV news shows!

Overall, lower oil prices will likely have their 'traditional' impact on production, of raising it, before some time later, lower prices cause lower output. For gold the situation is different, and annual 'fresh mine output' or new gold supply is likely falling at a considerable rate. Gold price spikes, as we know, have nothing to do with production and we can expect little warning before the next spike occurs, totally unlike oil where its overpricing had reached extremes until 3 months ago. The real irony of cheaper oil and higher priced gold, therefore, will be higher economic

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growth, but in a deflationary context - even if this does not figure in a Keynesian crystal ball.

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Richmond investor helped keep Halliburton's deal on track Written by Loren Steffy from 30 Point Strategies When it looked as if the year's biggest energy merger, between Halliburton and Baker Hughes, was about to collapse, Halliburton resorted to a hardball tactic to keep the deal from falling apart. It threatened to propose its own slate of directors to replace Baker Hughes' board.

In Richmond, Harold Mathis was smiling as he read about the showdown between the two Houston oilfield service giants in the Wall Street Journal. Mathis now holds about 100 shares of Baker Hughes, but he played an important, if unheralded, role in keeping the $35 billion deal on track.

Halliburton couldn't have threatened to replace Baker Hughes' board if Mathis hadn't spent years convincing the company to change its policy for nominating directors.

'I really feel like I laid the groundwork for what's taken place when I started calling for the annual election of the directors and to de-stagger the board,' Mathis told me.

I first wrote about his battle a decade ago, after a colleague pointed out that for several years Mathis had garnered a huge percentage of shareholder votes in favor

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of his proposal, but the company appeared to be ignoring it.

By April 2004, 90 percent of Baker Hughes' shareholders voted in favor of Mathis' proposal to elect all directors annually. At the time, the company elected directors to staggered three-year terms.

Mathis first proposed the idea, which he championed at other public companies as well, in 2000, when he owned about 800 Baker Hughes shares. Each year, the idea drew overwhelming support, but because the resolution was non-binding, Baker Hughes' management didn't have to act on it.

Eventually, the company came around. After mulling the 2004 results, it decided to submit a management-sponsored plan to declassify the board in 2005, which also won approval from investors. That way, it looked like management's idea.

Mathis, of course, never anticipated the measure would be used in a hostile takeover of the company. He simply wanted greater accountability for Baker Hughes' directors.

'It was to make every man stand on his own two feet and make everyone stand for their action,' Mathis says when I asked why he pursued the issue so relentlessly. 'It was to make them be more responsible to the shareholders. If these guys didn't do their job, they had staggered boards and it would take three years to get them all out.'

He prevailed in convincing other companies to make similar changes, too. Today, staggered boards are more the exception than the rule.

'My success sort of put me out of business,' he says, noting that he doesn't file many shareholder proposals these days.

For Halliburton, the election policy that Mathis championed created an opportunity to push the merger forward. Baker Hughes had rebuffed Halliburton's advances in October. The deadline for nominating directors at Baker Hughes was Nov. 14, and Halliburton used it to put pressure on its target after talks reached an impasse, the Journal reported.

Baker Hughes complained that Halliburton was putting pressure on it to make a hasty decision. It wanted more time. Two days later, Halliburton chief executive David Lesar drove to Baker Hughes headquarters and hammered out the final details of a friendly deal over a coke and coffee, Bloomberg News reported.

Neither of them probably gave any thought to how the actions of an individual investor from a small Texas town had brought them to that point. In fact, Mathis' battle seems to have been largely forgotten. Most of the directors from that time are still on Baker Hughes' board.

Mathis doesn't see his effort as futile, though. The point wasn't to shakeup the board, it was to make the company's governance more democratic.

With Halliburton paying a premium of more than 40 percent for its crosstown rival, he

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likes to think his efforts played at least a small role in generating value for Baker Hughes' shareholders.

'Without a proposal like that, Halliburton could not have made the threat,' Mathis said. 'It was there to be used. It just took nine years for somebody to get around to it.'

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