Energy disputes between the Ukraine and Russia are becoming as much of a New Year's tradition as the Waterford ball falling in Times Square. Once again as the new year approaches, we have another dispute between Russia and the Ukraine that may or may not be settled and rising tensions in and around Iran may cause more caution from sellers as we get ready to celebrate another holiday.
Sometimes the price gets ahead of the fundamentals. Other times the fundamentals catch up to the price. Last week in a holiday shortened trading week, oil got too excited about cold weather and a flawed weekly inventory report as the marketplace lacked the type of perspective it has when there is more volume. Yet yesterday I feared that the market might not be taking seriously enough the threats that were evolving in Europe and Iran. Of course if you assume that last week went too high and now we are holding gains it looks like once again the market had it right in the first place. It seems that rising geo-political heat is in part helping justify the extended rise.
Yesterday Russia warned Slovakia about a possible disruption in crude oil supply via the Druzhba pipeline that connects Siberian oil fields with the European Union to Slovakia, the Czech Republic and Hungary. This came after reports that the Ukraine sought to modify the current contract under which it transits Russian oil shipments to Europe. This of course raised the risk that we might see the same type of moves in oil that we have seen in past Russia Ukraine disputes. In fact the last major bottom in oil was in part inspired by a Russian Ukraine dispute.
Last New Year holiday oil prices got beaten up. Oil hit a low of 3240 December 19, 2008 and rallied in part because they were oversold but in part on rumors that gas supply would be cut by Russia to the Ukraine. On New Year's Eve oil was as low as 3694 before hitting a high of 4554 on news supplies had been cut and 8 European countries saw major falls or cut-offs of their gas supplies from Russia transported through Ukraine. By January 6, the dispute drove prices to above $50 to 5547 before a break back down 3270. Then oil reversed and never looked back for the rest of the year.
Another dispute in 2005-2006 over natural gas and transit prices caused another major move. Then Russia claimed Ukraine was not paying for gas, and diverting gas exported to EU from the pipelines. It was the first of January, 2006 when Russia cut off gas supplies passing through Ukrainian territory. Oil Prices that started the month at 6104 surged to 6920 in the aftermath of the dispute. Even though a preliminary deal was signed on January 4, 2006 and the supply restored, the situation the increased perception of global risk and the credibility of Russia as a reliable supplier.
Will we be spared a repeat? Overnight the AFP reported that Russia and Ukraine have signed a new agreement on Russian oil transits through Ukraine to Europe. Dow Jones reported that Russia agreed to an increase in fee for transit of close to 22%. The transit fee rise is part of the deal between the countries on the oil transit for 2010. Dow says that while Ukraine was successful in raising the transit fee, it failed to add what is dubbed a pay-or-pump clause to the bilateral agreement on crude oil transit through Ukraine's territory. Under the pay-or-pump principle a payment is made for a certain guaranteed volume of oil transit irrespective of whether the actual oil has been pumped.
Still will word of this deal totally ally concerns? The market pulled back a bit on word of the deal but still seems unconvinced. Especially after the inflammatory rhetoric from Russian Prime Minister Vladimir Putin who accused Ukraine of abuse of Russian oil transits via its territory. Plus there is the issue of Ukraine's payments for gas to Russia. Will they want to raise rates in return? The Ukraine says they can pay their gas bill and not to worry but the AFP reports that a senior Russian official appealed Friday for the European Union to enact preemptive measures to prevent another gas crisis in Ukraine this winter. We call for the EU to actively join in a package of preemptive measures, including financial assistance, to ensure uninterrupted transit of energy resources through Ukraine, said Vladimir Chizhov, Russia's EU envoy. His comments came two days after Russian Prime Minister Vladimir Putin fired a fresh warning shot at Ukraine saying Moscow would cut supplies should Kiev attempt to remove Russian gas from its pipelines without paying for it. In other words despite the agreement this may be far from over. We should also mention that the Ukraine has a presidential election scheduled for Jan. 17 and Russia would love to influence the outcome. What better way than to start a crisis? It might work better than poison.
As for the big picture, the key for oil and many other commodities will be interest rate sensitive. The biggest move in energy will be inspired by the Fed and their exit strategy. Dow Jones reports that Fed-funds futures significantly raised expectations for funds rate increase in mid-2010, and does not rule out tightening earlier than that. July prices in 76% chance for FOMC to raise funds rate to 0.5% at late June meeting, from 64% chance last Thursday and 50% chance last Wednesday.