The oil market in 2013: thoughts & riddles aplenty

Over a fortnight into 2013 and a mere day away from the Brent forward month futures contract for February expiring, the price is above a Nelson at US$111.88 per barrel. That’s after having gone to and fro between US$110 and US$112 intra-day.

As far as the early January market sentiment goes, ICE Future Europe said hedge funds and other money managers raised bullish positions on Brent crude by 10,925 contracts for the week ended January 8; the highest in nine months. Net long positions in futures and options combined, outnumbered short positions by 150,036 lots in the week ended January 8, the highest level since March 27 and the fourth consecutive weekly advance.

On the other hand, bearish positions by producers, merchants, processors and users of Brent outnumbered bullish positions by 175,478, down from 151,548 last week. It’s the biggest net-short position among this category of market participants since August 14. So where are we now and where will we be on December 31, 2013?

Despite many market suggestions to the contrary, Barclays continues to maintain a 2013 Brent forecast of US$125. The readers of this blog asked the Oilholic why and well the Oilholic asked Barclays why. To quote the chap yours truly spoke to, the reason for this is that Barclays’ analysts still see the Middle East as “most likely” geopolitical catalyst.

“While there are other likely areas of interest for the oil market in 2013, in our view the main nexus for the transmission into oil prices is likely to be the Middle East, with the spiralling situations in Syria and Iraq layered in on top of the core issue of Iran’s external relations,” a Barclays report adds.

Macroeconomic discontinuities will continue to persist, but Barclays’ analysts reckon that the catalyst they refer to will arrive at some point in 2013. Nailing their colours to mast, well above a Nelson, their analysts conclude: “We are therefore maintaining our 2013 Brent forecast of US$125 per barrel, just as we have for the past 21 months since that forecast was initiated in March 2011.”

Agreed, the Middle East will always give food for thought to the observers of geopolitical risk (or instability) premium. Though it is not as exact a science as analysts make it out to be. However, what if the Chinese economy tanks? To what extent will it act as a bearish counterweight? And what are the chances of such an event?

For starters, the Oilholic thinks the chances are 'slim-ish', but if you’d like to put a percentage figure to the element of chance then Michael Haigh, head of commodities research at Société Générale, thinks there is a 20% probability of a Chinese hard-landing in 2013. This then begs the question – are the crude bulls buggered if China tanks, risk premium or no risk premium?

Well China currently consumes around 40% of base metals, 23% major agricultural crops and 20% of ‘non-renewable’ energy resources. So in the event of a Chinese hard-landing, not only will the crude bulls be buggered, they’ll also lose their mojo as investor confidence will be battered.

Haigh thinks in the event of Chinese slowdown, the Brent price could plummet to US$75. “A 30% drop in oil prices (which equates to approximately US$30 given the current value of Brent) would ultimately boost GDP growth and thus pull oil prices higher. OPEC countries would cut production if prices fall as a result of a China shock. So we expect Brent’s decline to be limited to US$75 as a result,” he adds.

Remember India, another major consumer, is not exactly in a happy place either. However, it is prudent to point out the current market projections suggest that barring an economic upheaval, both Indian and Chinese consumption is expected to rise in 2013. Concurrently, the American separation from international crude markets will continue, with US crude oil production tipped to rise by the largest amount on record this year, according to the EIA.

The independent statistical arm of the US Department of Energy, estimates that the country’s crude oil production would grow by 900,000 barrels per day (bpd) in 2013 to 7.3 million bpd. While the rate of increase is seen slowing slightly in 2014 to 600,000 bpd, the total jump in US oil production to 7.9 million bpd would be up 23% from the 6.4 million bpd pumped domestically in 2012.

The latest forecast from the EIA is the first to include 2014 hailing shale! If the agency’s projections prove to be accurate, US crude oil production would have jumped at a mind-boggling rate of 40% between 2011 and 2014.

The EIA notes that rising output in North Dakota's Bakken formation and Texas's Eagle Ford fields has made US producers sharper and more productive. "The learning curve in the Bakken and Eagle Ford fields, which is where the biggest part of this increase is coming from, has been pretty steep," a spokesperson said.

So it sees the WTI averaging US$89 in 2013 and US$91 a barrel in 2014. Curiously enough, in line with other market forecasts, bar that of Barclays, the EIA, which recently adopted Brent as its new international benchmark, sees it fall marginally to around US$105 in 2013 and falling further to US$99 a barrel in 2014.

On a related note, Fitch Ratings sees supply and demand pressures supportive of Brent prices above US$100 in 2013. “While European demand will be weak, this will be more than offset by emerging market growth. On the supply side, the balance of risk is towards negative, rather than positive shocks, with the possibility of military intervention in Iran still the most obvious potential disruptor,” it said in a recent report.

However, the ratings agency thinks there is enough spare capacity in the world to deal with the loss of Iran's roughly 2.8 million bpd of output. Although this would leave little spare capacity in the system were there to be another supply disruption. Let’s see how it all pans out; the Oilholic sees a US$105 to US$115 circa for Brent over 2013.

Meanwhile, the spread between Brent and WTI has narrowed to a 4-month low after the restart of the Seaway pipeline last week, which has been shut since January 2 in order to complete a major expansion. The expanded pipeline will not only reduce the bottleneck at Cushing, Oklahoma but reduce imports of waterborne crude as well. According to Bloomberg, the crude flow to the Gulf of Mexico, from Cushing, the delivery point for the NYMEX oil futures contract, rose to 400,000 bpd last Friday from 150,000 bpd at the time of the temporary closure.

On a closing note, and going back to Fitch Ratings, the agency believes that cheap US shale gas is not a material threat to the Europe, Middle East and Africa’s (EMEA) oil and gas sector in 2013. It noted that a lack of US export infrastructure, a political desire for the US to be self-sufficient in gas, and the prevalence of long term oil-based gas supply contracts in Europe all suggest at worst modest downward pressure on European gas prices in the short to medium term.

Fitch’s overall expectation for oil and gas revenues in EMEA in 2013 is one of very modest growth, supported by continued, if weakened, global GDP expansion and potential supply shocks. The ratings agency anticipates that top line EMEA oil and gas revenue growth in 2013 will be in the low single digits. There remains a material – roughly 30% to 40% – chance that revenue will fall for the major EMEA oil producers, but if so this fall is unlikely to be precipitous according to a Fitch spokesperson.

That’s all for the moment folks! One doubts if oil traders are as superstitious about a Nelson or the number 111 as English cricketers and Hindu priests are, so here’s to Crude Year 2013. Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2013. Photo: Holly Rig, Santa Barbara, California, USA © James Forte / National Geographic.