How High Oil Prices Will Fuel Europe’s Next Economic Crunch (USO, UCO, OIH, ERX, ERY)

Kent Moors: As I met with the Polish officials last Friday in Krakow to begin government sessions on shale gas policy, and European  Union (EU) ministers met in the southwestern city of Wrocław, Poland,  thoughts turned once again to oil (NYSE:USO) pricing.

In case you haven’t been watching, Brent prices in London are approaching $113 per barrel, while the West Texas Intermediate (WTI) benchmark traded in New York is about to break the $90 per barrel level again.

The spread between the two remains at all-time highs, indicating that Brent will continue to appreciate quicker than U.S. pricing, although both are rising.

That spread is “in favor” of Brent.

This creates a continuing problem for the EU, which is faced with mounting Eurozone currency and liquidity problems, weakness in its banking sector, and a European Central Bank (ECB) that’s experiencing dissent – within its own ranks – over the proper course of action regarding Greece’s debt issues.

Friday’s meeting in Wrocław concerned whether Greece will receive the next tranche of a bailout package. That package is already widely perceived as being insufficient to prevent some sort of Greek default. Plus, the Germans are taking a hard line on what is necessary for that largess to keep coming.

Meanwhile, the internal dispute is getting intense.

A good example is the decision made last Friday morning by  the ministers. Or perhaps more accurately, the non-decision. The ministers decided, well, not to decide until next month.

The prospect of higher prices for Brent further complicates matters with the common currency.

The euro has been losing ground against the dollar throughout the latest period of the debt crisis. Of course, that says less about the dollar’s strength than it does about the euro’s enduring weakness.

That, combined with a rise in the cost of energy, means Europe is facing the prospect of a new economic crunch.

This one has the potential of completely derailing this continent-wide recovery already distinguished by its anemic performance.

In Krakow, Too, Our Problem Is Oil

There are essentially three reasons Poland has decided to expedite decisions on developing its domestic shale  gas.

First, they may well have a lot of it. The estimate I gave them puts the extractable reserves in the five basins already identified in the country at more than 187 trillion cubic feet – five times the rest of Europe combined.

Second, Poland is dependent upon Russian imported gas, the latest stage in a political disagreement 500 years in the making.

But it is the third reason that is most compelling.

Russia sells that gas to Europe according to long-term contracts of 20 years to 25 years in duration, and two provisions of those contracts are causing great concern in places like Poland.

The first is a “take-or-pay” provision. That requires an importing country either to take at least 80% of the contracted gas … or to pay  up anyway.

As grating as that is, though, it is less significant than the second troubling provision.

That one lets Russia set the price for gas according to a basket of crude oil and oil-product prices. This means, as the price of oil increases, the price of natural gas increases right along with it.  With Brent pricing levels moving up, staying warm in Europe this winter is looking more and more expensive.

That is, of course, if the latest row between Russia and Ukraine does not turn into a repeat of January  2009. Then, a similar dispute prompted Kiev to cut gas  passing through its territory to Europe. You see, 70% of all Russian gas going west crosses Ukraine.

It could get ugly.

As we sat down to a late lunch Friday, a reminder of the massing problem began to circulate: Goldman Sachs Group Inc. (NYSE:GS) issued a report forecasting the price of oil to exceed $130 a barrel in the next year.

Most of us just smiled.

There wasn’t anybody at the table who thought the price would be that low 12 months from now.

Related Tickers: United States Oil ETF (NYSE:USO), ProShares Ultra DJ-UBS Crude (NYSE:UCO), Oil Services HOLDRs (NYSE:OIH), Direxion Daily Energy Bull 3X Shares (NYSE:ERX), Direxion Daily Energy Bear 3X Shares (NYSE:ERY).

Written By Kent Moors, Ph.D. From Money Morning

Dr. Kent F. Moors is an internationally recognized expert in global risk management, oil/natural gas policy and finance, cross-border capital flows, emerging market economic and fiscal development, political, financial and market risk assessment. He is the executive managing partner of Risk Management Associates International LLP (RMAI), a full-service, global-management-consulting and executive training firm. Moors has been an advisor to the highest levels of the U.S., Russian, Kazakh, Bahamian, Iraqi and Kurdish governments, to the governors of several U.S. states, and to the premiers of two Canadian provinces. He’s served as a consultant to private companies, financial institutions and law firms in 25 countries and has appeared more than 1,400 times as a featured radio-and-television commentator in North America, Europe and Russia, appearing on ABC, BBC, Bloomberg TV, CBS, CNN, NBC, Russian RTV and regularly on Fox Business Network.

Moors is a contributing editor to the two current leading post-Soviet oil and natural gas publications (Russian Petroleum Investorand Caspian Investor), monthly digests in Middle Eastern and Eurasian market developments, as well as six previous analytical series targeting post-Soviet and emerging markets. He also directs WorldTrade Executive’s Russian and Caspian Basin Special Projects Division. The effort brings together specialists from North America, Europe, the former Soviet Union and Central Asia in an integrated electronic network allowing rapid response to global energy and financial developments.

Leave a Reply

Your email address will not be published. Required fields are marked *