Copenhagen fatigue

Chinese smog (NASA)

Put it down to “Copenhagen fatigue” as the hype levels reach mind-numbing proportions ahead of next month’s big climate summit, but some of the headlines of the last two days might give the impression that the US and China have finally put in place firm carbon emissions-cutting commitments that will allow the world to reach a deal in Denmark.

On Friday, it was the turn of the Chinese to capture front pages. In the US, the New York Times had “China joins US in pledge of hard targets on emissions“, while the Los Angeles Times went with “China vows to cut greenhouse gas emissions 40% by 2020“.

China’s commitment is neither a hard target nor has it agreed to cut emissions. Rather, the Chinese pledge is an aim to cut energy intensity by between 40% and 45% by 2020 compared to the 2005 level, where energy intensity is measured as the unit of energy required to produce a unit of GDP. That announcement is not just a diplomatic sop aimed at appeasing doubters over China’s commitment to act on climate change, as the South China Morning Post argues (subscription required). Nonetheless, it is best described as an aspiration, and not even a new one; also, it is something which is a fruit of development rather than specifically aimed at cutting emissions. Countries get less energy-intense naturally as heavy industry becomes a smaller proportion of economic growth.

China has made great strides in energy efficiency over the last couple of decades, but progress has been patchy and it gets more difficult as development progresses. The graph below comes from a blog in September by Roger Pielke, an environmental studies professor at University of Colorado, and maps recent Chinese progress. It shows that China should already have achieved half the goal it has pledged – under its 2005-2010 plan it aimed to cut energy intensity by 20%. However, it had only managed to cut by 7.4% through 2008. To achieve its new aim by 2020 will require feats that are well beyond anything that has been demonstrated hitherto.

In any case, as a Reuters story points out, how will we know? The measuring and verifying process for carbon emissions makes nuclear weapons verification look like small  beans.

The headlines are being generated, of course, to soften the fact that Copenhagen will fail to create a new convention to supplant the Kyoto protocol, something that will have to wait until next year at the earliest. (see Copenhagen countdown subscription required).

The pledge from President Obama, such as it is (cuts of “around 17%” from 2005 levels by 2020), also is only an aspiration until it can be ratified in Congress next year. As The Economist magazine points out:

“The promised target is no different than that already passed by the House of Representatives, and considerably lower than what other rich countries (especially in Europe) have promised.”

It has also been noticed that Mr Obama’s visit to Copenhagen is a somewhat half-hearted affair, timed to coincide with his trip to Oslo to collect the Noble Peace Prize and coming early on in proceedings—the opening day—”well before the crunch time near the end” (see It’s off to Denmark we go subscription required).

Andrew Mitchell, the UK’s shadow development secretary, sees the “litmus test” of success as the world’s ability to keep global warming to two degrees. Worryingly as The Independent pointed out earlier this month, scientists are already planning for worse. Mitchell added that if the “deal on the table doesn’t look like it is going to do this, then the British delegation must have the nerve to reject the usual back-slapping and face-saving statements”. With delegates already managing expectations such a stand is likely to prove fruitless.

Yvo de Boer, the UN’s climate change head, has also been managing expectations this week. On Wednesday, at a pre-summit press conference, he talked of four elements of success at Copenhagen, starting with firm emissions-cutting commitments from developed countries, especially the US. The other aims about helping the developing countries to fund their plans for curbing emissions growth are contingent on the first, which won’t happen. So, he said, look out for a deal in Copenhagen to allow the Kyoto protocol to continue after it expires in 2012; but whatever the headlines, such a small achievement shouldn’t be confused with a meaningful replacement for Kyoto that would bring in countries accounting for more than two-thirds of the world’s CO2 emissions.

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Thank you for warming

With the stakes so high, it is little wonder that controversy is being ratcheted up ahead of next month’s Copenhagen climate change summit.

The timing of leaked email traffic between climate scientists – the fruits of hacking into computers at the University of East Anglia – and a BBC investigation into apparent abuse of UN climate change funds may be coincidence, but they’ve certainly had the effect sought by sceptics of global treaties like Kyoto.

The Washington Post does a good job of capturing the back-and-forth that is at the heart of “Climategate” (a tediously inevitable sobriquet) with a series giving voice to both sides.

Whatever the debate about temperature data, one group of leading scientists has issued a report, timed to land ahead of Copenhagen, which loudly and unequivocally argues that the effects of warming are there for all to see.

The stoking of the scientific debate may have stirred the sceptical side of the argument, but still there is an overwhelming majority, even in the US, that accepts anthropogenic global warming.

So, it is the BBC story on funding that may signal the more lingering controversy. Even for those that accept the enormous task of energy transformation and climate change mitigation needed, there is scepticism around any efforts that are intermediated by big non-governmental organisations – such as the UN, the European Union – and the possibility for corruption and incompetence.

The EU cap-and-trade effort has had very mixed results so far, and there are many doubters about the carbon “offsets” devices set up under Kyoto, and certainly not restricted to the climate-change-sceptic camp.

The main parties may manage to come together to reach at least a political agreement at Copenhagen, but there is still a lot of work needed to demonstrate clearly that the nuts and bolts of a Kyoto successor deal won’t be full of waste and fraud.

All tanked up

The blame gameThe story may be old hat in the oil market, but the Daily Mail (Britain’s top-selling “middle market” newspaper), nonetheless splashed on its front page Thursday with a populist “Sharks off the British coast” headline over a story about oil tankers that have been moored off the south coast of England for some months.

In early October, local media stories also noticed the tankers sitting in Lyme Bay, off the coast of Devon, though while they (see Tanker storage blues) focused on the plight of the poor sailors being denied duty free booze and smokes by Customs officials, the Daily Mail frets that “profiteering traders and speculators” are refusing to sell their oil until prices go even higher, leading to higher petrol prices for the British driving classes.

The broad point to make about the story is that it’s stale — similar stories have been running for more than a year (see, for example, All at sea and Still they come). The more salient point is that the story misses the point: it’s not that the owners of the crude in Lyme Bay (or anywhere else where it’s stored at sea) refuse to sell their crude — they’ve already sold their crude via the futures market, locking in profits. They’ll roll over their positions and keep the crude stored as long as it is profitable to do so.

Because of the arbitrage opportunities — buying at lower prices, selling at a profit via the futures market and storing it cheaply because of a glut of oil tankers — the crude stored at sea has remained high since summer 2008. The International Energy Agency in its monthly oil market report last week reckoned that still some 60m barrels of crude oil is stored in tankers worldwide.

However, while the stored crude has been edging down in recent months as the “contango” (the futures premium) has dissipated, refined products (e.g. gasoline, diesel) stored at sea has been rising — the IEA estimated it to be 80m barrels in October.

The bottom line: the signal from the shipping world is that the world demand for oil and oil products is still to show signs of a sustained rebound. Indeed, the IEA says that some of the biggest increases in oil products storage is in Asia, where new refineries have started up recently adding to world overcapacity in the refining sector.

The sea storage arbitrage strategy may lose its luster soon, a victim of its own success. Gibson EA, a shipping brokerage, predicts that if storage remains at current levels average charter rates (for very large crude carriers, VLCCs) next year will increase to US$35,000 per day, up from roughly US$28,000/d this year. For now, however, the tanker parking lots are full up.

Disruptive behaviour

Never before has there been so much uncertainty about the future supply and demand of hydrocarbons.

That somewhat Churchillian premise of a new study about “disruptive” energy technologies, authored by Melissa Stark, a partner at consultant group Accenture, (see pdf link below*), is also one of the main underlying themes of the big climate change debate about how to curb carbon emissions without devastating the world economy.

While the statement is unarguable, it also underlines how much harder it has become to predict a whole array of key elements of the energy future, such as how oil demand will change, how the energy mix might evolve, what will be the effect on lifestyle options such as transport, etc.? And the changes are likely to come much more quickly than many might think, the study argues.

That forecasting difficulty was demonstrated by last week’s unveiling by the International Energy Agency of its annual World Energy Outlook, which was met with an unusual degree of excitement in some quarters amid the pre-Copenhagen hype. George Monbiot of the Guardian, in particular, doesn’t want to let go of his outrage that the IEA has adjusted quite substantially its predictions for some oil forecasts. [NB, it seems from the link title to Mr Monbiot’s blog entry that some Guardian wag thinks the pique might be out of control].

Given the heightened uncertainty, the Accenture study, in another Churchillian flourish, concludes, “Never before have we demanded so much from our regulators and governments”. It goes on to prescribe what governments must do to help the 12 identified technologies reach commercial viability, which varies considerably from country to country, including controversial moves such as supporting genetic engineering of biofuel crops.

The bottom line: “In five years, we will be looking at a different landscape of fuel supply, fuel demand and options to reduce [greenhouse gases] than is currently forecast today given the pipeline of disruptive technologies. It is important that these technologies be considered when forecasting supply and demand.” We’ll try to bear that in mind.

*Accenture_Betting_on_Science_Study_Overview

Dollar driven?

Daniel Yergin, the chairman of Cambridge Energy Research Associates in Boston and a kind of oracle for the oil markets, is quoted on Monday saying that oil price movements currently are a function more of financial market gyrations, particularly the US$/€ exchange rate, than of supply and demand factors.

Brent_dollar_euro

Dollar driven?

The benchmark crude oil futures (both Brent and WTI) have been dancing around either side of US$80 a barrel for some weeks, having more than doubled since their lowest point earlier this year. That rebound has come in anticipation of an improving world economy, it seems, though evidence of that turnaround is still fairly scant, especially in the developed economies.

Whether or not a weaker dollar is the main reason for oil’s relative strength, that reason has been invoked several times in the last two years to explain oil price moves when no other obvious reasons are available. No doubt there are investment flows into oil when the dollar weakens, but the correlation between oil prices and the dollar has been quite erratic during that period (see graph), with their strongest correlation occurring after the dollar strengthened and oil prices had plunged around the turn of the year.

Lately, in fact, the correlation has been less strong, with oil prices staying fairly steady as the dollar has weakened; put another way, the € rise in oil prices hasn’t been that strong in recent months.

Mr Yergin is also quoted in the same article saying that supply and demand are ultimately the only things that matter, even if financial factors (such as inflation worries because of a weaker dollar) take over from time to time.

The problem is, of course, that the supply and demand picture for the world oil market only really comes into focus in the rear-view mirror, and even then it can remain fuzzy. This seemed to be the sub-text last week when Fatih Birol, the chief economist of the International Energy Agency, also struggled while trying to rationalise the IEA’s price forecast. Last year, the IEA was saying that high oil prices are here to stay and, despite the subsequent crash, Mr Birol was adamant that the agency was sticking with that general view for the future. There was a contradiction, however, in his assertion that the very high oil prices in the early part of 2008 “were not without guilt” in contributing to the economic slump that was triggered by the world financial crisis. Part of the explanation for oil prices stalling at current levels is fear that higher prices might act as a brake on the world economy, a view that is supported by recent signals from Saudi Arabia (as de facto leader of OPEC) that it is content for prices to stay more or less where they are.

Other pieces of the jigsaw include the level of investment in exploration and development (E&P) in the oil sector, the real effect of which also depends on the level of inflation – or, indeed, deflation – in the sector. A lot of oil sector investment has certainly been stalled during recession, which worries the IEA and others because that may again lead to a supply crunch (as was the case from 2003 through 2007). However, costs have come down sharply too, so the real effect on E&P projects will only be known some way down the road.

Which all goes to show, as the Financial Times pointed out last week (subscription required), that there are just too many variables in the world oil market to be able to predict prices with any sharp degree of accuracy. That is not to say that supply and demand for oil cannot be fairly accurately guessed at (within a percentage point or two), but the effect of oil traders’ anticipation of that supply-demand can be extraordinarily volatile. And there is nothing traders love more than a volatile market.

Repsol as bellwether

With oil prices down 40% from a year earlier, oil companies’ third-quarter earnings were defined by their relative decline (see Refining woes). In the case of Spain’s oil champion, Repsol YPF, the term plunge was truly justified, especially in its domestic operations.

Repsol refiningThe company’s net income fell 61% (“clean” net income, after accounting and inventory adjustments, was €279m) as oil and natural-gas prices declined and refining margins narrowed, the company said in its statement. Though that was well above what share analysts had, on average, predicted, the virtual disappearance of Repsol’s Spanish refining margins stood out.

Repsol is Spain’s largest refiner, according to the Oil & Gas Journal, and like European peers Total and Eni, its downstream business suffered from slack European markets.  Repsol’s refining margin indicator for Spain (a measurement of the profit from turning crude into fuels) fell nearly 96% year-on-year to just US$0.3/barrel in the third quarter. Repsol has responded by shutting refining units in light of the pitiful margins.

Nonetheless, gains in marketing and sales of liquefied petroleum gas (LPG) helped Repsol’s downstream business exceed expectations — at €106m in the quarter, the year-on-year decline was 79%, about a third less than most forecasters had expected. But there is a big question mark about the sustainability of those earnings, given that it is running significantly below capacity to save on costs.

Repsol’s upstream holds the most promise, although output fell year-on-year. In terms of exploration Repsol performance has excelled — reporting a record 15 discoveries, including important finds off the coast of Brazil, as well as in Venezuela (see Repsol’s risks), the Gulf of Mexico and Sierra Leone.

As Repsol seeks funds to develop these prospects, especially its subsalt prospects off Brazil, selling more of its stake in its Argentine unit YPF remains on the cards but elusive.

However, its Spanish refining exposure will remain a concern as well as its balance sheet — debt and debt costs have been rising and the board of directors will decide in two weeks to decide whether or not to cut its dividend.

Repsol’s outlook was reflected in the range of opinion from the big banks’ analysts. UBS, for example, rated Repsol a “buy” on the grounds that its upside potential in oil & gas exploration and production outweighs the risks in other divisions, whereas Deutsche Bank took the opposite view and cut Repsol to a “sell”. There’s a lot of room between their respective share price targets of €21 and €16. Repsol has rebounded strongly this year from just above €13 a share to above €18 on Friday, though it is still a long way below its mid-2007 high above €30.

The company has many of its own issues, but its uncertain outlook is something of a metaphor for its “second tier” European oil peers.

Geology v geography

Conscious, perhaps, of the political problems Exxon Mobil faced when it tried to enter the highly prospective play off west Africa (see A new frontier), Royal Dutch Shell is betting on a different mix: African geology in South America with European politics.Location-Guyane-France

The Guyane Maritime licence, covering more than 35,000 square metres off of French Guiana, belongs to Tullow Oil, which held a 97.5% operating interest before it sold Shell a 33% stake (with the option for a further 12%, according to reports). Tullow believes that it has identified “a number of leads and prospects…on the block which include the giant Matamata structural trap in the north and a number of stratigraphic traps analogous to Tullow’s Jubilee field in Ghana in the south of the block.”

Or, put another way, Tullow believes that the basin off the tiny French colony, north of Brazil, shares the same geology as the much-hyped basin running along Africa’s west coast, from Ghana to Sierra Leone. Shell, an expert in the above-ground risks of operating in Africa, is convinced enough to stump up US$167.4m for the stake in, technically, the EU. As access to cheap, hassle-free oil diminishes, expect to see more speculative deals of this type.