Iran and Oil Prices in 2018

The turn of the year brought the usual year-end analyses of energy events, along with predictions and issues to watch in the year to come. I tend to focus on tallies of risks and large uncertainties. There's no shortage of those this year, and the current unrest in Iran moves the risks associated with that country higher up the list, at least for now.

The implications of instability in Iran extend well beyond oil prices, but let's focus there for now. The sources of instability include both the internal economic and political concerns apparently behind the protests, as well as US-Iran relations and the fate of the Iran nuclear deal and related sanctions.

As former Energy Department official Joe McMonigle noted, a decision by President Trump to allow US sanctions on Iranian oil exports to go back into effect could remove up to one million barrels per day of crude oil from the global market. He sees the protests making the reinstatement of sanctions likelier. Whether that would lead directly to much higher oil prices is harder to gauge.

A little history is in order. Sanctions on Iran, including those covering the receipt of Iranian oil exports, were one of the main tools that brought its government to the nuclear negotiating table. For a roughly three-year span beginning in late 2011, international sanctions reduced Iran's oil exports by more than one million barrels per day, at a cumulative cost exceeding $100 billion based on oil prices at the time. The effectiveness of those sanctions was also enhanced by the rapid growth of US oil production from shale. 

Starting in 2011, expanding US "tight oil" production from shale began to reduce US oil imports and eased the market pressures that had driven oil back over $100 per barrel as the world recovered from the financial crisis and recession of 2008-9. In the process, shale made it possible for tough oil sanctions to be imposed on Iran and sustained without creating a global oil price shock.

Instead, oil prices actually declined over the period of tightest sanctions. By 2014 US oil output had grown by more than Iran's entire, pre-sanctions exports and cut US oil imports so much that OPEC effectively lost control of oil prices. Seeking to drive shale producers out of the market, OPEC's leadership switched tactics and attempted to flood the market, driving the price of oil briefly below $30. That cut even further into Iran's already-reduced oil revenues and put the country's leadership in an untenable position, forcing them to negotiate limits on their nuclear program. 

If Iran's oil exports were to drop again this year, for whatever reason, the impact on oil prices would depend on the extent to which the factors that allowed us to absorb such a curtailment just a few years ago have changed. One measure of that is that after several years of painfully low prices--at least for producers--the price of the Brent crude global oil benchmark is now well over $60. Yesterday it flirted with $68/barrel, a three-year high. 

That recovery is the result of a roughly 18-month slowdown in US oil production in 2015-16, an agreement between OPEC and key non-OPEC producers like Russia to cut output by around 1.2 million barrels per day, and production problems in places as diverse as Venezuela and the North Sea.

These events have largely put the oil market back into balance and worked off much of the excess oil inventories that had accumulated since 2014. Commercial US crude oil inventories, which are among the most transparently reported in the world, have fallen 100 million barrels since their peak last spring. However, they remain about 100 million barrels above their typical pre-2014 levels. 

Viewed from that perspective, a reduction in supply from any source might be exptected to send prices higher. However, although global oil demand is still growing, we should realize that today's tighter oil market is largely the result of voluntary restraint, rather than shortages. Potential production increases from the rest of OPEC, Russia and the US could more than compensate for another big drop in Iran's oil exports.

In particular, US shale output has been climbing again for the last year, boosted by rising prices and the amazing productivity of the venerable Permian Basin of Texas. Meanwhile, production from the deepwater Gulf of Mexico is also increasing as projects begun when oil was still over $100 reach completion. In its latest forecast the US Energy Information Administration projected that US crude production will reach an all-time high averaging 10 million barrels per day this year. Despite that, US shale producers still have thousands of "drilled-but-uncompleted" wells, or DUCs, waiting in the wings. 

So, short of instability in Iran morphing into a regional conflict involving Saudi Arabia and the other Gulf producers, oil prices might drift higher but would be unlikely to spike anywhere near $100. And that's without factoring in the scenario suggested by the Financial Times' Nick Butler, who proposes that the Iranian government might choose to break the OPEC/Russia deal and increase their oil exports, in order to boost their economy and mollify the protesters, thereby shoring up the regime. 

The last point brings us back from a narrow focus on oil prices to larger geopolitical uncertainties. As a noted Iran expert at the Council on Foreign Relations recently observed, Iran's religious government faces challenges similar to those that led to the collapse of the Soviet Union.

It's far from clear that 2018 will be Iran's 1989, or that President Rouhani is capable of becoming his country's Mikhail Gorbachev. Yet surely the 2015 nuclear agreement was a bet by the US and its "P5+1" partners that Iran would be a very different nation by the time its main provisions start to expire in the next decade. The whole world would win if that prediction came true.

On that note I'd like to wish my readers a happy start to the New Year. My top resolution is to post here more frequently and more regularly than in 2017. 

Energy Projects Seem Less Urgent in A Post-Energy-Crisis World

• Rather than being another component of an ongoing energy crisis, opposition to various energy projects points to the alleviation of a decades-long string of US energy crises.
• The audience for concerns about pipelines and fracking would be much smaller if oil were still at $145 per barrel and natural gas over $10 per million BTUs.

To someone living in 1974, during the first energy crisis of the last 40 years, the idea of mass protests to block a pipeline for importing crude oil from Canada would have seemed incomprehensible.  Our environmental awareness has expanded in the interim, along with new channels for exchanging information, including "enduring misconceptions".  Yet the current opposition to so many different energy projects--natural gas drilling, long-distance transmission lines and even wind farms--can also be viewed as an unintended consequence of recent energy successes on a broad front.

The alleviation of what seemed to many a permanent energy crisis might not be obvious, because it has crept up on us. But consider a few of the big-picture elements that have changed:

In crisis mode, US energy security was focused on steadily rising oil and later natural gas imports, while "energy independence" was a goal embraced by politicians but rarely energy experts. Cars offering better fuel economy were available but entailed trade-offs in size and performance. Today, oil imports are falling, the US is a net exporter of refined petroleum products, and public concern about Peak Oil is waning, as measured by internet search activity. Ethanol from corn supplies 10% of US gasoline demand, while other forms of renewable energy are growing rapidly, from a small base. The big question for the federal government this summer is how many natural gas export facilities to allow. Meanwhile, the threshold for fuel-efficient cars has shifted from 30 mpg to 40 mpg, offered in numerous attractive models.

Another way to gauge the success of technologies like hydraulic fracturing, or "fracking", in shifting our energy landscape is to remind ourselves how bad we thought today's situation would be, just a few years ago.  In 2005 the official US annual energy forecast projected oil imports to increase from 11 million barrels per day (MBD) in 2003 to nearly 15 MBD by this year, due to rising demand and domestic production that was expected to remain flat, at best (see below chart.)

The Energy Information Agency (EIA) also expected US natural gas imports to increase steadily, reaching 3.5 trillion cubic feet  (TCF) of LNG imports this year, on their way to 6 TCF per year by 2022. As a consequence, in 2005 the EIA forecast that coal would still generate 48% of US electricity by 2013.
 

Now imagine energy prices in that alternative 2013. With US natural gas suppliers importing an average of 90 LNG tankers per month, would the wellhead price of gas still be under $4 per million BTUs, or closer to the $16 price paid in some international markets? And with US refiners importing up to twice as much crude oil as they are actually on track to do this year, in the context of sanctions on Iran and turmoil in North Africa, how likely does it seem that oil would be at $105-110/bbl, instead of much higher? $100 oil is a drag on the economy, but US consumers have adjusted to gasoline priced around $3.50-3.75/gal., on average. Every $1 per gallon above that would take another $130 billion per year away from other purchases, with adverse effects on the US economy.

More to the point, in such an environment how much tolerance would there be for opposition to oil pipelines or gas drilling that had the potential to lower energy prices, or at least reduce imports and enhance energy security? If oil were above its 2008 high of $145/bbl, and gasoline flirting with $5 per gallon, it would surely be much harder for elected officials to delay approving projects like the Keystone XL pipeline, or to sustain gas drilling moratoria. Ironically then, the successful large-scale application of shale drilling techniques, which has resulted in a 29% increase in US natural gas production and 33% rise in oil production since 2004, helped make it possible for opponents of Keystone or fracking to be heard, rather than dismissed out of hand.

I was recently struck by a reported remark by a pipeline executive. "Shale is everywhere," he said, but it won't be produced everywhere because "people make choices." I agree with that insight, while recognizing that such choices are available mainly because altered economic conditions and the same technologies to which some now object have enabled us to shed an energy crisis mindset.  This situation might have future parallels for other technologies that have escaped much pushback, so far. 

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

What Europe Pays

With American consumers reeling from gas prices that have gone up by fifty cents per gallon since the beginning of the year, it occurred to me to wonder what Europeans are now paying. Although the decline of the dollar has amplified the impact of recent increases in oil prices, Europe hasn't been immune, either. Crude oil expressed in Euros or Sterling is roughly 75% and 110% higher, respectively, than it was in January 2007, and this has boosted the price of fuels that were already much more expensive than those sold here. While searching for European fuel price data, I was surprised to discover proposals for gas tax cuts similar to those being debated here. Consumer displeasure with petroleum product prices is increasing the pressure on governments on both sides of the Atlantic to respond.

Having lived in both Germany and the UK, I chose them as my basis of comparison--one inside the Euro zone, the other outside. As of today, Normalbenzin (regular gasoline) averages €1.457/liter, or €5.51/US gallon. So whether you assess the dollar/euro exchange at its market rate of $1.55 to the Euro--which gets you to $8.55/gal.--or adjust it based on purchasing-power parity, or even the Economist's Big Mac Index, which was close to 1:1 last summer, gasoline in Germany is a darned sight more expensive than it is here, thanks to Europe's stout taxation of motor fuels. And while diesel is taxed at a lower rate, to promote the use of diesel automobiles as a means of reducing oil consumption and greenhouse gas emissions, €5.26/gal. ($8.15/gal.) is hardly a bargain. Petrol is not much cheaper in the UK, either. At a current average of 110 pence per liter, or £4.18/US gallon ($8.25/gal.), even filling up your Mini would set you back $80.

Of course, it's not only the absolute fuel price that counts, but the magnitude and rate of its recent change. A big part of our problem is that most Americans are still driving cars that were purchased when gasoline was under $1.50/gal., to commute between work and home locations that were chosen when fuel was even cheaper. As of this week, nominal US retail gasoline prices have gone up by 25% in the last year and by 130% in the last five years. How does that compare to other countries? Well, motorists in the UK are experiencing prices that are now 25% higher than the average of last year, and 42% higher than five years ago, but gas hasn't been cheap in Europe for more than a generation. Buffered by the strong Euro, gasoline in Germany has increased by a smaller percentage, 19% vs. the 2007 average and 29% over five years.

Although proportional fuel-price increases have thus been smaller in Europe than here, the high absolute price level is still causing serious discomfort and prompting calls for governments to act, particularly by reducing fuel taxes. Consider that while it accounts for more than 70% of the US retail gasoline price, crude oil makes up less than a third of the gas price in Germany. Because most of the difference is attributable to taxes, the scope for reducing the retail price via tax relief is enormously greater than here. A member of the German coalition government has suggested instituting a cap on gasoline, diesel and heating oil prices, adjusting the tax rate periodically to hold prices steady. Other proposals include rolling back the 3% increase in the value-added tax that kicked in on 1/1/07, which at current prices is worth as much as the entire US federal fuel excise tax that Senators McCain and Clinton wish to suspend this summer. The arguments against lower German gas taxes are similar to those economists have raised here: fuel supplies will tighten even further, and government revenues will fall.

It's small comfort, but high gasoline prices are a global phenomenon, unless you live in a major oil exporting country, such as Kuwait or Venezuela. Consumers in Europe are no happier about this than we are. But instead of waiting for our governments to decide whether higher fuel prices or lower tax receipts are more harmful to the economy, we could follow the advice on fuel conservation from the Alliance to Save Energy. As reported in yesterday's Wall St. Journal, a combination of six strategies could save the average household up to $600 per year, or at least 20 times the expected benefit from a summer gas tax holiday. And instead of protesting in Washington, truckers might achieve more by posting "Slow Down" signs on our highways. Even the airlines are reducing aircraft speeds to save fuel.

Boycott Season

A friend recently forwarded an email that invited him to participate in a May 15 national protest of high gasoline prices. It urged him to forgo filling up that day, in order to send a signal to the oil companies to reduce their prices. The organizers claimed that a previous boycott in 1997 forced gas prices down "30 cents a gallon overnight." We seem to get this sort of thing every year at about this time, linked, no doubt, to the demonstrated seasonality of gasoline prices. Snopes, the urban legends website, does a nice job of poking holes in the organizers' logic, and MSNBC has researched the non-existent 1997 price drop. Rather than piling on, as I normally would, it occurred to me to ponder whether some other action might have a similar effect to what people expect from this boycott, aside from the obvious step of driving less.

While Snopes and MSNBC are correct that a one-day protest does nothing to change demand, they forget that the demand that oil companies see isn't the consumption of individual cars, but the restocking requests they receive from their retailers and distributors. Although a one-day change in refueling habits wouldn't alter those, a persistent shift would. The 243 million cars on the road in the US have a combined fuel capacity of about 87 million barrels, assuming 15 gallon tanks, on average. That's a sizable fraction of the 200 million or so barrels of gasoline in industry inventories at any point in time. In fact, the recent price increase correlates nicely with a gasoline inventory draw of 30 million barrels since February.

If we all reduced our personal gasoline inventory by just 1 gallon, which could be done by waiting until the gas gauge was closer to empty to refuel, we could put 5 million barrels back into commercial inventories. The restored inventory cushion would help cool off the market and dampen speculation. That should translate into lower pump prices within a few weeks.

There is no mystery to any of this: gasoline prices respond to changes in supply and demand. Consumers can't affect the former, but we are the latter. Anything we can do to improve our fuel economy and reduce our consumption will help, incrementally. If a family has two cars, and if they haven't already shifted as much of their driving as possible to the more economical vehicle, they can cut their bills and put another dent in demand. Inflating tires properly and driving closer to the posted speed limit also cuts demand. There's less spleen-venting satisfaction in these steps, of course, but they will save money twice. They are also a lot more appropriate than taking out our frustration on the local gas station, which is generally a small business, not a multi-national corporation.