Get documents about "The Case for higher oil prices Part 2.1_final
Shared by: pragcap
-
Stats
- views:
- 869
- posted:
- 10/10/2011
- language:
- English
- pages:
- 14
Document Sample
Diapason Capital Markets Report
Special Report – July 2011 Updated: October 8, 2011
Robert Balan and Alessandro Gelli
robert.balan@diapason-cm.com
alessandro.gelli@diapason-cm.com
The case for higher oil prices by 2012: Part 2
The market’s surplus capacity is so meagre, an “oil shock” is just one “event” away
The physical oil market continues to show a remarkable strength even if futures prices are
lagging amid worries about the impact of an economic slowdown on crude oil demand. The latest
signals of supply and demand tightness come from Asia and the Middle East. One example: the
cost of Oman-Dubai crude, the regional benchmark, in the spot market has surged significantly
above the price for delivery into early 2012, as reported recently by the Financial Times.
The downward slope of the forward curve, known as backwardation (i.e., "inverted), is an
indication of immediate tightness. Another: the premium that Saudi Arabia charges to Asian
refiners for its main crude stream has jumped to an all-time high. The dire macro outlook
continues to weigh on the oil futures complex, but there remains very little in the way of
weakness visible in the physical crude oil market itself. The first-to-second month
backwardation in Oman-Dubai crude – an indicator of physical tightness – has spiked recently to
$1.40 a barrel, up from just 7 cents a month ago and about 60 cents six months ago.
The backwardation is among the strongest in recent years. The strength of Oman-Dubai is even
more surprising taking into account that the seasonal peak in oil demand in the Middle East – the
air conditioning season over the summer – has just ended.
Just at the same time, Saudi Arabia has raised the premium at which it sells its main crude
stream, known as Saudi Light, to Asian customers in November to a record $2.70 a barrel above
the cost of Oman-Dubai crude, up from $1.65 in October. The premium is 35 cents higher than
the previous record, set in November 2007, when the market was heading towards the super-
spike of nearly $150 a barrel in 2008.
Asia, the Middle East and the BRICs (ex-Russia) will account for the bulk of oil demand growth
both this year and in 2012, according to estimates by the International Energy Agency (IEA), the
oil watchdog representing the interests of western countries. The collective strength of
Asian/Middle East/BRICs demand is lifting the physical market even as Saudi Arabia, Kuwait
and United Arab Emirates supply almost record volumes of crude -- pricing seems to have
completely dissociated with the current stock of available oil above the ground.
The conundrum of international oil trade
And that perfectly describes the conundrum of international crude oil trade -- ¨the almost
vertical price rises in the past two years (especially in 2010) have never been due to a shortage
of physical barrels in the short-term but plenty of concern about shortages in the future (later in
2011 or 2012, and the 3 years thereafter). The market has been trading expectations about
supply and demand 6, 12 or even 18 months forward rather than the near-term balance.
In a previous report, we looked at the structural process of crude oil price-setting, bringing forth
the structural arguments why we believe crude oil prices will be higher going into year-end and
2012 (see "The Case for Higher Crude Oil Prices By 2012: Part 1”). We showed that a
"servomechanism negative feedback loop" governs the current crude oil price setting process
due to the narrowing gap between GDP growth tip-over threshold and crude oil supply
constraints (actual and perceived).
We said that an economic system that is dependent on oil is a dynamical process and is very
complex and no linear model can readily explain what we have been witnessing in terms of oil
prices and economic activity (the general so-called "health of the economy"). As such it is often
useless to look for a linear chain of cause and effect. However, in the case of crude oil pricing,
the underlying truth of all the wide gyrations in prices would have been the increasing scarcity
of crude oil. Crude oil is depleting and will become so expensive, both in monetary and energy
terms, to extract that production rates will begin to decline and less oil will flow over time.
Please refer to the risk and legal disclaimer at the end of the document 2
We concluded in Part 1 of the report that henceforth, constraints posed by these two factors
(growth and supply) suggest that the trend over the next few years will almost certainly to be on
the upside, with a temporary structural peak expected in 2012, and a likely subsequent price
crash as predicted by the model. We expect this sequence to be replicated henceforth over the
next few years, until the global economy produces sufficient backstops for crude oil or learns
how to live with less oil, or finds an efficient way to allocate the remaining oil resources.
The interaction of oil supply/demand and economics
The current article will explore the supply and demand equation, and build the case that crude
oil prices will rise towards year-end and 2012, and will subsequently cause another (growth)
recession and a subsequent crude oil price crash as economic laws reassert.
Crude oil prices have fallen in recent months after the Brent front month reached $11100/barrel
(on September 1). The price pullback was caused by concerns related to the sovereign debt
crisis in Europe, temporary industrial dislocations in Japan, a self-imposed growth slow-down
in China, and a temporary fall in consumer spending in the U.S., and subsequent downgrade of
global growth expectations.
Before the price decline, there was scant indication that the confluence of those negative factors
would derail what looked then like a classic global V-shaped recovery normally seen after a
sharp decline in growth. At the beginning of the year, crude oil prices surged on the back on
strong demand, of which some was structural, and some transient. The northern hemisphere had
seen a strikingly cold winter in late 2010, leading to increased heating oil usage. And the global
economy was recovering from a deep recession, with demand bouncing off the recessionary
trough. These were, to an extent, passing events. But in many respects, the increase in prices
fundamentally reflected an oil demand that was (and still is) increasing faster than supply.
Please refer to the risk and legal disclaimer at the end of the document 3
Oil Demand Growth y/y 3-Month Average
5.0
Sources: Diapason, EIA
4.0
3.0
2.0
Million Barrels per Day
1.0
0.0
-1.0
-2.0
-3.0 Others
Brazil/China/India/Middle East
-4.0 OECD
World Net
-5.0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Indeed, the recent growth of demand has been described as “astonishing” by oil analysts
(Steven Kopits, 2011), and this was true even during the crude oil price decline from early May
-- the truth is demand growth remains resilient. According to the EIA, world petroleum liquids
consumption was up 1.40 mbpd, that is 1.62%, in the eight months through August 2011,
compared to the same eight months a year earlier.
This number corresponds to the average annual growth between 1999 and 2007 and it is not
unprecedented. In the twelve years to 1972, world oil consumption increased by 30 mbpd,
representing 150% demand growth over the period and 2.5 mbpd average annual growth. This
is in contrast with the data seen between 1966 and 2010, when oil consumption increased by
56.60 mbpd and growth averaged 1.26 mbpd -- global oil consumption growth in 2010 was
highest since 2004.
Oil production growth in 2010 reached 2.67 mbpd, this is 1.6 standard deviations above the
1990-2010 average, which for us is pretty unusual. It can be easily be explained by the fact that
oil demand rebounded from low level as the economic activity recovered.
The 2007 recession closely resembles that of 1973
In the three years of recovery following the oil shock of 1973 and the 2001 recession, demand
increased by 2-5 mbpd. These recessions were arguably the most comparable to the recent one.
We must also remember that China was not yet a factor for crude oil demand during the 1970s.
And between 1974 to 1976, global oil demand increased by 2.89 mbpd, while between 2002 to
2004, demand rose by 4.56 mbpd.
Please refer to the risk and legal disclaimer at the end of the document 4
Oil demand growth remained strong in the second half of the 1970s. Between 1976 and 1979,
global oil demand increased by 5.99 mbpd or 2.34 mbpd per year in average. This was also true
after 2001, when China first made its impact on global oil markets, which allowed a rapid
rebound in oil demand growth.
Oil Consumption Growth
5'000
1973
4'000
3'000
Thousand Barrels per Day
2'000
1'000 2001
-
-1'000
-2'000
-3'000 Non-OECD Oil Consumption Growth
Sources: Diapason, BP OECD Oil Consumption Growth
-4'000
1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
Today, as after 1973 and 2001, the pace of motorization continues in the developing world -
indeed, it has even accelerated - and thus crude oil demand growth at a pace of 2.1 mbpd/year
through 2012 should not be surprising. Our models show that global oil demand growth could
be between 1.3 mbpd (conservative) (world GDP growth of 3.5%) and 1.7 mbpd (progressive)
(world GDP growth of 3.9%) in the coming years.
Please refer to the risk and legal disclaimer at the end of the document 5
Nor should oil demand growth compared to other energy sources be a surprise. Natural gas and
coal consumption increased by 3.0% and 4.8% per annum, respectively, from 2002 through
2008, the start of the recession. It is hard to imagine that oil consumption would forever lag
other fuel sources if the oil were available. And available it was in 2010, with no constraints.
The world had just dodged what looked at the outset like a replay of the Great Depression of
1929 or worse. And the oil producers were more than willing to open the crude oil spigots.
The demand momentum in 2010 carried over into the New Year. According to the EIA, the oil
supply increased by 1.56 mbpd in the three months through Jan. 2011 (despite the Libyan
uprising), compared to the same period a year earlier. Still, over the period, supply lagged
demand by 635,000 barrels per day over the last three months compared to a year earlier, and it
showed in prices, which have risen $8/ barrel over the period.
What should we expect prospectively? The forecasts of the IEA, EIA and OPEC fall into the
1.0-1.4 mbpd range for oil demand growth for the whole of 2011. The EIA sees a break in the
demand trend, with growth in 2011 and 2012 literally half that of 2010, the first full year of
economic recovery. However, final 2010 demand data surprised everyone, so we tend to be
very careful with these projections. The EIA has a mixed record: in January 2009 the EIA
expected global oil consumption to reach 85.11 mbpd in 2009 while it actually reached 84.51
mbpd -- EIA overestimated demand.
Many energy analysts say that the IEA and EIA expectations were perhaps 500,000 barrels low
in 2010, and they may be low again by a similar amount going forward. Based on both technical
and historical analysis, demand growth in the 1.3-1.7 mbpd range for 2011 and 2012 seems
more likely.
Global Oil Consumption Growth
5.0%
Global Oil Consumption Growth Model
4.0% Global Oil Consumption Growth
3.0%
2.0%
1.0%
0.0%
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016
-1.0%
-2.0%
-3.0%
-4.0%
Sources: Diapason, BP
-5.0%
Please refer to the risk and legal disclaimer at the end of the document 6
There are other variances which account for our more optimistic outlook for demand. We
believe that the global recovery will resume in Q4 2011, and that no material break in demand
activity will occur in the developing world, notably China. The Chinese August energy imports,
despite recent tightening measures, remain robust. Energy commodities were the brightest spot
in the report, with net crude oil imports up in August by 8.8% month-on-month (up 1.3% y/y);
net diesel exports halving from April’s levels (-105.1% y/y), while net gasoline exports were at
their weakest since December 2010 (-59.5.0% y/y).
Thus, demand pressures in the coming year and a half are anticipated to be similar to the 2010,
and similar to the recoveries of comparable recessions in the past, especially 1973.
As a consequence, our forecast is higher than that of the EIA as a whole. By the end of 2012,
the difference between our forecast and that of the EIA totals 0.4 mbpd, with peak demand
hitting 90 mbpd in some months.
On the supply side, the EIA’s outlook appears plausible. In 2011 and 2012, OECD production is
set to decline among half of the members, albeit only slightly. North Sea and Mexico crude oil
production will fall considerably. The Former Soviet Union (FSU) production will be
essentially flat (but net exports will decline), while Brazil adds significantly to “other Non-
OECD” supply. Brazil will likely, and Azerbaijan and Kazakhstan may conceivably, post better
numbers than forecast, which is doubtful. But overall, the EIA numbers appear defensible.
As consequence, OPEC must increase production to meet incremental demand, and the EIA
sees OPEC crude oil production capacity declining by 1.0 mbpd in 2011, and to increase by
0.77 in 2012, as the end of the civil war in Libya will gradually restore capacity.
Major FSU Net Oil Exports
10000 20%
Kazakhstan Net Oil Exports (lhs) Sources: Diapason, BP
Azerbaijan Net Oil Exports (lhs)
Russia Net Oil Exports (lhs) 15%
9000 Azeri, Kazakh and Russian Net Oil Exports 1y Change (rhs)
10%
8000
Thousand Barrels per Day
5%
7000 0%
6000 -5%
-10%
5000
-15%
4000
-20%
3000 -25%
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
20
20
20
Please refer to the risk and legal disclaimer at the end of the document 7
The Saudi’s spare capacity the only thing that matters
Furthermore, Libya is unlikely to restore crude production to past level in the next 18 months.
Production capacity will be restored gradually. So we estimate that OPEC crude capacity will
decline by around 1.5-1.7 mbpd in 2011 and increase by 0.8 mbpd in 2012. The EIA presumes
that the lion’s share of this incremental growth will come from Iraq and Libya. Thus, the EIA
supply side forecast depends on Iraq posting two stellar years back-to-back. This is at best
optimistic -- Iraq increased production by only 0.3 mbpd in 2010 -- but it is not impossible.
Iraq’s contribution, however, has already been fully valued-in by the market. The reality is that
no major oil projects will come on-stream in OPEC countries ex-Iraq before 2013, so
significant addition to OPEC capability will only come by then.
OPEC Spare Capacity and Crude Oil Price
$80 -6.0
Sources: Diapason, EIA
$60
-4.0
$40
-2.0
Million Barrels per Day
$20
Dollars per Barrel
$0 0.0
-$20
2.0
-$40
4.0
-$60 Brent Spot Price 1y Actual Change (lhs)
OPEC Spare Capacity 1y Actual Change (Inverted, rhs)
-$80 6.0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
With our outlook for demand running ahead of the EIA and our supply outlook aligned,
presumably the difference would be made up from reductions in spare capacity as OPEC lifts
output. And in OPEC, only Saudi Arabia matters. As of January 2011, Saudi represented 78%
(3.65 mbpd) of OPEC spare capacity and, as a practical matter, global spare capacity.
How much of this capacity actually exists? During the oil price spike of 2008, Saudi Arabia
never committed the last million barrels of its nominal capacity. Many analysts, including us,
believe that the Kingdom lacked the capacity -- it withheld nothing from the market. If we
apply this same metric to Saudi’s stated production reserves today, its excess capacity could be
only 2 mbpd, or perhaps a bit more (it was 2.24 mbpd in August 2011).
Please refer to the risk and legal disclaimer at the end of the document 8
The Saudis may indeed actually have the spare capacity but it may be the wrong oil -- the
market at that time did not need the last million b/d of Saudi Arabia because it was mostly
composed of heavy crude oil and all refineries were running near full capacity. There was very
little available capacity for refiners and hence little capacity to handle heavy crudes from Saudi
Arabia. This is an issue that is sometimes forgotten in calculating the Saudi's spare capacity --
what the world need is light crude oil, of which the Saudis have in short supply.
How will the Kingdom commit this reserve? Many analysts believe that Saudi Arabia will never
pump more than 10 mbpd -- only 0.2 mbpd more than its produces today. This belief is based
on history: Saudi crude oil production has never been sustained above 10 mbpd. Some analysts,
including us, doubt that the Saudis can or are willing to lift production volumes much further,
and indeed, recent Wikileaks documents cast doubt on Saudi reserves and production limits.
With new projects coming on stream in 2013, there were talks that Saudi Arabia may allow
maximum capacity up to 12-13 mbpd.
Nonetheless, when the Saudis were pushed prior to the 2007 recession, they were able to add
nearly two million barrels of capacity is relatively short order and at comparatively modest cost.
Saudi Arabia is no longer an Iraq (an under-developed resource) but with 260 billion barrels of
proved reserves, the Kingdom still is a formidable producer capable of lifting production if its
national interests so dictate.
Saudis' national interests come first
The last phrase ("if its national interest so dictate") holds the key to future Saudi willingness to
meet the globe's insatiable thirst for crude oil. The Saudis may also have other reasons not to lift
the extraction rate of crude oil much above the levels that they are currently undertaking.
Having produced aggressively for more than half a century, the Saudis can envision a future,
perhaps seventy years from now, when Saudi Arabia’s resources will be largely depleted.
Even if Saudi Arabia is not yet half way through its oil resources, it is now close to the time for
them to realize that the crude oil reserves in the their kingdom are finite. This perspective may
have led King Abdullah to command in 2008 to “leave it in the ground, by Allah, our children
will need it.” As a result, the Kingdom may be reluctant to increase production. It is certainly
fair to posit that the Saudis would prefer higher prices to higher volumes, and the global
environment over the next five years looks likely to oblige. So both the Kingdom’s long term
view and expected oil prices may encourage it to limit production.
There are also political considerations in the Saudi's strategy: Saudi Arabia says it does not
want too high prices because it fears demand destruction, like that seen in the 1980s. Saudi
Arabia wanted OPEC to increase production in their last meeting but Iran and Venezuela
prevented it. So consequently, Saudi Arabia is increasing volume in order to take the share
away from Iran in order to retake control over OPEC. The rift between Saudi and Iran also
shows in other examples.
Please refer to the risk and legal disclaimer at the end of the document 9
In the payment issues in recent months between India and Iran, Saudi Arabia proposed to India
that it will replace Iranian crude oil. The Saudis are now using Oil as a political tool against
Iran, which they believe is the biggest threat to them in the future.
Saudi Arabia Crude Capacity and Production
13
Sources: Diapason, JODI
Saudi Arabia Production Capacity
Saudi Arabia Crude Oil Production
12
Heavier
11 Crudes
Million Barrels per Day
10
9
8
7
6
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
So do we then take Saudi Arabia’s stated nominal spare capacity at face value? No one,
probably not even the Saudis, knows for sure. However, for policy purposes, a conservative
approach would assume that the Saudis will not exceed 10 mbpd, and that based on history, an
effective capacity of more than 11 mbpd should and could not be assumed from them.
As a result, effective spare capacity in the global system should be considered 1.4 - 2.4 mbpd,
much smaller than the 2.85 mbpd currently reported by the EIA. This buffer is too meagre -- it
is just 1.6% to 2.7% of total oil demand in 2010. Another "event" like Libya will inevitably
throw the crude-consuming world into another paroxysm of soaring crude oil and commodity
prices (which soaring crude oil prices will inexorably pull along).
Further, if we pair reduced spare capacity with our forecast for increased demand, then effective
surplus capacity will be consumed at a brisk pace. By the middle of 2012, spare capacity could
be as low as 1 mbpd, or even less, if the Saudis indeed decide to limit production at 10 mpbd.
To a certain extent, these developments could be forestalled by inventory draw-downs, and
indeed, the EIA forecasts inventory draws averaging a quarter million barrels a day in 2012 to
sustain spare production capacity. Such draws are not unprecedented or unusual in themselves,
but they are another factor suggesting tight markets.
Please refer to the risk and legal disclaimer at the end of the document 10
In any event, when surplus capacity falls below one million barrels per day, an oil shock cannot
be precluded, in fact it is constantly just one "event" away. Thus, in the better case scenario, the
world is facing another tight oil markets in 2012; in the worst case scenario, the global economy
may be heading into another oil price shock and subsequent global recession.
For policy makers, this has a number of implications:
- To start with, it suggests that Saudi Arabia will have a material influence on the 2012 US
elections. The Kingdom will be able to create constricting oil prices not only by withholding
production, but by releasing it too slowly. Therefore, the nature and quality of US relations with
the Kingdom will matter.
- It also suggests that an oil shock becomes very likely by 2013, even if the world is lucky
enough to escape one in 2012. Such shocks are typically associated with recessions, which
would imply increased unemployment, surging budget deficits and possibly more pressure on
housing prices and the financial sector.
- Financial asset prices will have very volatile trajectories -- strategic asset allocation ironically
becomes crucial -- but is even more crucial that tactical asset allocation be a part of the
investment repertoire.
Saudi Arabia Crude Oil Exports and Demand/Production
8'500 10%
Sources: Diapason, JODI Higher seasonality of crude oil Production and exports
exports because of an increase of increased to replace
direct crude burning Libyan crude oil
8'000 12%
7'500 14%
Thousand Barrels per Day
7'000 16%
6'500 18%
6'000 20%
5'500 22%
Crude Oil Exports (lhs)
5'000 Domestic Oil Demand/Domestic Crude Oil Production (Inverted, rhs) 24%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Please refer to the risk and legal disclaimer at the end of the document 11
REFERENCES:
The Financial Times: "Oil's strength defies slowdown woes" - Sept. 25, 2011
Steven R. Kopits: An Oil Shock in 2012? - ASPO-USA: Association of Peak Oil
Dave Cohen: The next oil shock - Energy Bulletin, August 2009
James D. Hamilton: Understanding Crude Oil Prices - UCLA San Diego 2008
Rune Likvern: Global Oil Supplies - EIA's Petroleum Monthly, November 2010
Ron Alquist: What do we learn from the price of crude oil? - U. of Michigan 2007
Byung-Sam Yoon: Market inversion in commodity prices - 2001
International Monetary Fund: Structure of the oil market and causes of high prices
Please refer to the risk and legal disclaimer at the end of the document 12
DISCLAIMER
General Disclosure
This document or the information contained in does not constitute, an offer, or a solicitation, or a
recommendation to purchase or sell any investment instruments, to effect any transactions, or to
conclude any legal act of any kind whatsoever. The information contained in this document is
issued for information only. An offer can be made only by the approved offering memorandum. The
investments described herein are not publicly distributed. This document is confidential and
submitted to selected recipients only. It may not be reproduced nor passed to non-qualifying
persons or to a non professional audience. For distribution purposes in the USA, this document is
only intended for persons who can be defined as “Major Institutional Investors” under U.S.
regulations. Any U.S. person receiving this report and wishing to effect a transaction in any
security discussed herein, must do so through a U.S. registered broker dealer. The investment
described herein carries substantial risks and potential investors should have the requisite
knowledge and experience to assess the characteristics and risks associated therewith.
Accordingly, they are deemed to understand and accept the terms, conditions and risks associated
therewith and are deemed to act for their own account, to have made their own independent
decision and to declare that such transaction is appropriate or proper for them, based upon their
own judgment and upon advice from such advisers as they have deemed necessary and which they
are urged to consult. Diapason Commodities Management S.A. (“Diapason”) disclaims all
liability to any party for all expenses, lost profits or indirect, punitive, special or consequential
damages or losses, which may be incurred as a result of the information being inaccurate or
incomplete in any way, and for any reason. Diapason, its directors, officers and employees may
have or have had interests or long or short positions in financial products discussed herein, and
may at any time make purchases and/or sales as principal or agent.
Certain statements in this presentation constitute “forward-looking statements”. These statements
contain the words “anticipate”, “believe”, “intend”, “estimate”, “expect” and words of similar
meaning. Such forward-looking statements are subject to known and unknown risks, uncertainties
and assumptions that may cause actual results to differ materially from the ones expressed or
implied by such forward-looking statements. These risks, uncertainties and assumptions include,
among other factors, changing business or other market conditions and the prospects for growth.
These and other factors could adversely affect the outcome and financial effects of the plans and
events described herein. Consequently, any prediction of gains is to be considered with an equally
prominent risk of loss. Moreover, past performance or results does not necessarily guarantee
future performance or results. As a result, you are cautioned not to place undue reliance on such
forward-looking statements.
These forward-looking statements speak only as at the date of this presentation. Diapason
expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any
forward-looking statements contained herein to reflect any change in Diapason’s expectations
with regard thereto or any change in events, conditions or circumstances on which any such
statement is based. The information and opinions contained in this document are provided as at
the date of the presentation and are subject to change without notice.
Electronic Communication (E-mail)
Please refer to the risk and legal disclaimer at the end of the document 13
In the case that this document is sent by E-mail, the E-mail is considered as being confidential and
may also be legally privileged. If you are not the addressee you may not copy, forward, disclose or
use any part of it. If you have received this message in error, please delete it and all copies from
your system and notify the sender immediately by return E-mail. The sender does not accept
liability for any errors, omissions, delays in receipt, damage to your system, viruses, interruptions
or interferences.
Copyright
© Diapason Commodities Management SA 2011
Any disclosure, copy, reproduction by any means, distribution or other action in reliance on the
contents of this document without the prior written consent of Diapason is strictly prohibited and
could lead to legal action.
Last update on 9 February 2011.
Please refer to the risk and legal disclaimer at the end of the document 14
