Russia, Iraq, and an Oil Price Jump
If your weekend was consumed by shopping, gridiron goings-on, or observing our thrill-a-minute political primary, you might have missed a trio of serious, ultimately energy-related events. When taken together, they indicate an oil world that just might be headed for chaos. Should global energy become chaotic, crude prices could quickly ascend to economically destructive levels, a key reason for constant attention to the sector.
Easily the most tragic of the weekend events, was the capsizing of a Russian drilling rig being towed through a winter storm in the Sea of Okhotsk toward Sakhalin Island, off the eastern coast of Russia. The rig, named the Kolskaya, was being dragged by two tugs and was carrying a crew of 67 on a flawed journey from Kamchatka.
About 125 miles from Sakhalin the Kolskaya suddenly keeled to one side, before sinking in 3,400 feet of 34-degree (Fahrenheit) water. That temperature gives its victims a brief 30 minutes before they are frozen to death. At last report, more than 50 members of the crew remained missing.
The Kolskaya was a jack-up rig owned by (there will be a spelling test) Arktikmorneftegazrazvedka, a sector of Russia's state-owned Zarubezhneft. It's of some significance that, during the weekend, Reuters incorrectly described a jack-up rig as having "three support legs that can be extended to the ocean floor while its hull floats on the surface."
Actually, the legs do extend to the ocean floor and often below it in soft conditions. But the hull does not float. Rather, once the legs have been set, the hull is "jacked up" hydraulically above the water, all of which provides for maximum stability during operations in difficult wind or water conditions.
A desolate, 600-mile swath, Sakhalin Island is described effectively by a recent Businessweek article: "Sakhalin...is about as extreme as they come. Anton Chekov, who visited in 1890, described the island, then a penal colony, as a hellish place. Even today Sakhalin is a remote, sparsely populated area whose towns are dominated by shabby Soviet-era apartment blocks and patrolled by packs of semi-wild dogs."
Exxon's back for more
ExxonMobil (NYS: XOM) has been successfully operating the Sakhalin-1 project for several years, and Royal Dutch Shell (NYS: RDS.B) was the operator of Sakhalin-2 until late in 2006, when it was forced to sell its primary position to huge, state-owned natural gas producer and distributor Gazprom. The term "forced" should imply a bargain-basement price from Gazprom's perspective.
Unfortunately, Sakhalin doesn't stand as it relates to virtually impossible operating conditions in Russia. To maintain its post-Soviet production high of 10.3-million barrels a day, which the country hit in October, Russia is expanding to other "garden spots." For instance, the TNK-BP joint venture, which is half owned by BP (NYS: BP) , is operating a field in eastern Siberia with another Russian tongue-twister-of-a-name: Verkhnechonsk. It's hard to twist your tongue, or much else, when temperatures descend to minus 70 degrees (Farhenheit), which they occasionally do at this field.
ExxonMobil workers are unlikely to request sunscreen if, as is planned, they begin operating a partnership with Rosneft, the Russian state-owned oil company, in the geologically promising Russian Arctic four years hence. The partners are obviously certain to face indescribably frigid conditions in the arctic. Further, Exxon will need to contend with the Russian tendency for corner-cutting to accommodate a weak and dated infrastructure. Given the severe weather and the typical condition of Russian equipment, it's important to consider that this excessively miserly approach was a key factor in the Kolskaya disaster.
Taxed to the hilt
Companies working in Russia also are victimized by the government's overwhelming tax system, which, despite his new Rosneft pact, induced one Exxon executive to note recently that for the deals in Russia to work, "[There] needs to be some significant changes to the fiscal regime." One or more of these significant drawbacks -- to which you can add truculent administrators -- may be part of the reason why Chevron (NYS: CVX) in June pulled out of a new partnership with Rosneft in the Black Sea.
A second type of Russian "rig"
Another of the weekend's significant events also occurred in Russia. As they had done the prior week, thousands from the Communist Party, along with others, ignored severe weather to conduct demonstrations outside the Kremlin and in St. Petersburg. The crowds were expressing frustration with the decadelong regime of Prime Minister Vladimir Putin and his United Russia Party.
That frustration has been intensified by national parliamentary elections Dec. 4. While Putin's party saw its majority status in the Duma narrowed, there have been numerous challenges to the integrity of the election, along with pique regarding Putin's candidacy to return to the country's presidency after a March election. The nature of relationships between now and March are difficult to predict, but when all is said and done, the attitude and composition of the government will be crucial to the willingness of Western companies to provide energy investments and technical expertise in Russia.
He's started already
The third event of the weekend involved Iraq, but dangerously changing circumstances there could involve Iran, and ultimately Russia. As some Fools know, I've maintained a concern for some time about the potential for military eruptions involving Iraq and its neighbors, Iran and Saudi Arabia. As recently as Friday, I speculated that, with U.S. forces officially having withdrawn from the country, an "onerous effort" involving Iran beginning to help itself to Iraq's big oilfields "could seemingly begin before my February birthday." In reality, it may already be in its first stages.
As of this eventful weekend, and with the last U.S. soldiers having just cleared the country, there are already reports that Iraqi Prime Minister Nouri al-Maliki, a Shiite, intends to arrest the vice president, Tariq al-Hashimi, a Sunni. And beyond that, Sunnis have generally become concerned that Maliki has set about consolidating his power in the country. That process would primarily involve placing his proverbial boot on the necks of Sunni politicians, which he already may have initiated.
The primarily Sunni Iraqi bloc -- the largest vote-getter in last year's election -- has pulled out of parliament, given Maliki's increasingly autocratic approach to the government. Beyond that, it's vital to keep in mind that Maliki resided in largely Shiite Iran during the years of Saddam Hussein's regime. Consequently, he's well fixed for contacts there.
Whether this might make it easier for Iran to insert itself into Iraq's expanding oil scene is clearly a worthwhile consideration. At the same time, energy watchers will be thinking about the plight of the Western energy companies with operations in Iraq should an eruption occur in the country. These companies include the likes of ConocoPhillips (NYS: COP) , Eni (NYS: E) , and services provider Schlumberger (NYS: SLB) .
Grab your heavy coat
This then leads us back to Russia, which maintains an essentially solid relationship with Iran. Indeed, the former has already warned the U.S. regarding any sort of military advances against Iran. At the same time, to the consternation of U.S. officials, Russia is completing a nuclear power plant in Iran. So an Iraqi-Iranian combination would likely drive even more of a wedge than already exists between Russia and the U.S.
There clearly are more questions than answers in this complex and rapidly changing set of circumstances. Nevertheless, with the events of the weekend just past, the global energy world appears potentially more capable of lapsing into chaos than it did as recently as a few weeks ago. For that reason alone, I urge Fools to redouble their efforts to determine that their portfolios are well represented in energy -- to my mind, the most important of sectors.
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At the time this article was published Fool contributorDavid Lee Smithdoesn't own shares in any of the companies named in this article.Motley Fool newsletter serviceshave recommended buying shares of Chevron. Try any of our Foolish newsletter servicesfree for 30 days.We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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