Weekly Offshore Rig Review: Nuclear Fall Out

This week, offshore rig utilization held steady with 83.6% of the fleet currently under contract.

North Korea Shakes Things Up
With an underground blast that was felt by seismic sensors around the world, North Korea demonstrated its nuclear weapons capability in a way that will be affecting world politics and economics for years to come. This detonation of a nuclear device by the communist government of Kim Jong Il has rather far-reaching implications, but it will be felt most strongly in the Far Eastern nations that neighbor North Korea.

Already, European and American experts in nuclear technology and weapons detection have declared that the blast was not a very powerful one, and speculation has been rather rampant that the detonation may have been at least a partial failure. However, whether North Korea's nuclear detonation achieved its intended explosive force, it certainly achieved a form of political success by establishing the North Koreans as a much more viable military force within the region. Additionally, and possibly more importantly, it demonstrated that the North Koreans are not yet bowing to increased economic sanctions imposed by the United States and Japan.

The long term impacts of the nuclearization of North Korea are still very uncertain. Depending on the moves taken by nations on both sides of the situation, several different scenarios could possibly unfold. One possibility that would cause a greater degree of instability in the region would be the development of a regional arms race between Japan, China, North Korea, South Korea, and possibly Taiwan. Alternatively, and probably more likely, the nuclear threat could cause an economic slow down in the region as trade between North Korea and its neighbors is restricted and spending decreases due to increased political and economic uncertainty.

Japan's Quick Response
Japan is the country most threatened by the possibility of North Korean nuclear weapons. Kim Jong Il's government has a history of provocations against the Japanese, including the kidnapping of Japanese citizens, the 1998 firing of a long-range missile over northern Japan, and the recent missile tests into the Sea of Japan. With its very limited military capabilites and strong anti-nuclear weapons sentiment, the Japanese are somewhat vulnerable to the aggression of the North Koreans, and as such, they have been the most vocal opponents of the North's weapons testing.

In the short term, Japan has demonstrated its displeasure by blocking almost all North Koreans trade and travelers from entering Japanese ports and airports. North Korean ships are reportedly being forced out of Japanese harbors and turned back by their Coast Guard. This further tightening of trade with North Korea comes on the heels of earlier sanctions that the Japanese government put in place after North Korea test-fired several long range missiles into the Sea of Japan in early July 2006. While trade with North Korea is a fairly small part of the Japanese economic picture, comprised mainly of agricultural and seafood products, Japan is North Korea's third largest export market, accounting for about 13% of North Korea's $1.3 billion in yearly exports.

With these new sanctions in place, the Japanese hope to divert the North Koreans from their current path and bring them back to the so-called six-party negotiations between North Korea on one side and China, Russia, Japan, South Korea and the United States on the other. Whether these new sanctions are successful is one of the biggest uncertainties in the North Korea situation.

China - North Korea's Most Important Neighbor
North Korea shares a 1,416 kilometer (880 mile) border with China, far longer then the 238 kilometer (147 mile) border it shares with its sister to the south. As such, China is North Korea's primary trade partner, accounting for almost 50% of North Korea's exports. China is also the leading source of North Korean imports, accounting for about one third of the nation's imported goods, including being the source of all North Korean oil imports, which amount to only about 25,000 b/d.

Relations between China and North Korea have traditionally been strong, as the two nations have shared similar Communist ideals for more than 50 years. With its permanent seat on the United Nations Security Council, China has often acted in the interests of North Korea in order to curb or veto proposed sanctions against its smaller neighbor.

However, even China has seemingly grown weary of the North Koreans' behavior of late. During the summer of 2006, the Chinese government froze millions of dollars in accounts believed to be used for money laundering by North Korean elites. More recently, spokesmen and ambassadors of the Chinese government have openly denounced the North's nuclear tests and called for "punitive" sanctions to be put in place.

Why It Matters to the Oil & Gas Industry
While the ultimate outcome of North Korea's nuclear test is unclear, what is apparent is that the actions of a very small nation are impacting political and economic policy in one of the most important oil consuming areas of the world. With a population of only 23 million, and a land area smaller than the state of Mississippi, the North Korean government is still able to move giants.

China and Japan are two of the most important economic powers in the world. Their combined GDP surpasses that of the United States and the European Union, and even independently, they rank as the second and third largest national economies in the world. To fuel those economies, particularly the growing Chinese economy, more and more oil is being demanded by these oil-poor nations.

In addition to Japan and China, South Korea is also one of the fifteen largest national economies in the world, and a leading importer of oil. Even the much smaller nation of Taiwan, which sits farther to the south, is a major importer of oil, ranking within the top fifteen oil importers.

Together, Japan, China, Taiwan, and South Korea import more than 12 million barrels of oil per day. That places the group of four Far Eastern countries as the third largest importing region of the world, behind the European Union and the United States.

Oil Usage in the Far East
Country Oil Consumption (b/d) Rank Oil Imports (b/d) Rank
China 6,400,000 b/d 2nd 3,300,000 b/d 3rd
Japan 5,600,000 b/d 3rd 5,600,000 b/d 2nd
South Korea 2,200,000 b/d 8th 2,200,000 b/d 6th
Taiwan 1,000,000 b/d 18th 1,000,000 b/d 13th
Total: 15,200,000 b/d 2nd 12,100,000 b/d 3rd

With the amount of uncertainty introduced by the North Korean nuclear test, it is quite possible that the economies of these nations, particularly Japan and South Korea, could begin to slow. As such, the demand for oil from these nations would also likely decline, which would alleviate some supply tightness in the market and have a general downward pull on oil prices.

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