Volatile yet flat-ish Q1 points to $40-50/bbl price

The first quarter of 2016 has been pretty volatile for oil benchmarks. Yet if you iron out the relative daily ups and downs in percentage terms, both global benchmarks and the OPEC basket are marginally higher than early January (see chart left, click to enlarge). 

Brent, at $37.28 per barrel back then, ended Friday trading at $41.78, while WTI ended at $39.53, up from $37.04 in early January. That’s a fairly flat outcome following the end of a three-month period, but in line with the Oilholic’s conjecture of an initial slow creep above $40 per barrel by June, followed by yet another crawl up to  $50 per barrel (or thereabout) by Christmas (as the Oilholic opined on Forbes).

Moving on from pricing matters, a new report from GlobalData suggests crude refining capacity is set to increase worldwide from 96.2 million bpd in 2015 to 118.1 million bpd by 2020, registering a total growth of 18.5%.

In line with market expectations, the research and consulting firm agrees that global growth will be led by China and Southeast Asia. A total of $170 billion is expected to be spent in Asia alone to increase capacity by around 9 million bpd over the next four years, GlobalData added.

Matthew Jurecky, Head of Oil & Gas Research at the firm said: “The global refining landscape continues its shift eastwards; 40% of global refining capacity is projected to be in Asia by 2020, up from around 30% in 2010.

“China has led this growth, and is projected to have a 15% share of global crude refining capacity by 2020. This activity is putting pressure on other regional refiners, especially now that China has become a net exporter, and will become a larger one.”

In Europe, growth is expected to occur at a substantially slower rate. Although demand is decreasing and is less competitive, older refineries in Western Europe are being closed, these factors are being countered by investment in geographically advantaged and resource-rich Russia, which sees Europe’s capacity increasing marginally from 21.7 million bpd in 2015 to 22.5 million bpd by 2020.

Away the refining world to the integrated majors, with a few noteworthy ratings actions to report – Moody’s has downgraded Royal Dutch Shell to Aa2 with a negative outlook, Chevron to Aa2 with a stable outlook, Total to Aa3 with a stable outlook and reaffirmed BP at A2 with a positive outlook. 

Separately, Fitch Ratings has affirmed Halliburton at A-, with the oilfield services firm’s outlook revised to negative. That’s all for the moment folks, keep reading, keep it crude! 

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OPEC just about gets the basics right

On occasion, signs around Austrian bars and shops selling souvenirs humorously tell tourists to get one basic fact right – there are no kangaroos in Austria! In more ways than one, last week’s OPEC meeting in Vienna was also about getting its 12 member nations to recognise some basic truths – not so much about the absence of marsupials around but rather about  surplus oil in the market.

Assessing demand, which is tepid in any case at the moment, comes secondary when there is too much of the crude stuff around in the first place. Of late, OPEC has become just a part player, albeit one with a 30% share, in the oil market’s equivalent of supermarket pricing wars on the high street, as the Oilholic discussed on Tip TV. Faced with such a situation, cutting production at the risk of losing market share would have been counterproductive.

Not everyone agreed with the idea of maintaining production quota at 30 million barrels per day (bpd). Some members desperate for a higher oil price were dragged around to the viewpoint kicking and screaming. Ultimately, the Saudis made the correct call in refusing to budge from their position of not wanting a cut in production.

Though ably supported by Kuwait, UAE and Qatar in his stance, Saudi Oil Minister Ali Al-Naimi effectively sealed the outcome of the meeting well ahead of the formal announcement. Had OPEC decided to cut production, its members would have lost out in a buyers’ market. Had it decided on a production cut and the Saudis flouted it, the whole situation would have been farcical.

In any case, what OPEC is producing has remained open to debate since the current level was set in December 2011. The so-called cartel sees members routinely flout set quotas. In the absence of publication of individual members’ quotas, who is producing what is never immediately ascertained.

Let’s not forget that Libya and Iraq don’t have set quotas owing to leeway provided in wake of internal strife. All indications are that OPEC is producing above 30 million bpd, in the region of 600,000 barrels upwards or more. Given the wider dynamic, it's best to take in short term pain, despite reservations expressed by Iran, Venezuela and Nigeria, in order to see what unfolds over the coming months.

After OPEC’s decision, the market response was pretty predictable but a tad exaggerated. In the hours following Secretary General Abdalla Salem El-Badri’s quote that OPEC had maintained production in the interest of “market equilibrium and global wellbeing”, short sellers were all over both oil futures benchmark.

By 21:30 GMT on Friday (the following day), both Brent and WTI had shed in excess of $10 per barrel (see right, click to enlarge). That bearish sentiment prevailed after the decision makes sense, but the market also got a little ahead of itself.

The start of this week has been calmer in part recognition of the latter point. Predictions of $40 per barrel Brent price are slightly exaggerated in the Oilholic’s opinion.

Agreed, emerging markets economic activity remains lacklustre. Even India has of late started to disappoint again after an upshot in economic confidence noted in wake of current Prime Minister Narendra Modi’s emphatic election victory in May. Yet, demand is likely to pick-up gradually. Additionally, a price decline extending over a quarter inevitably triggers exploration and production (E&P) project delays if not cancellations, which in turn trigger forward supply forecast alterations. 

This could kick-in at $60 and provide support to prices. In fact, it could even be at $70 barring, of course, the exception of a severe downturn in which case all bets are off. Much has also been said about OPEC casually declaring it won’t convene again for six months. Part of it fed in to market sentiment last week, but this blogger feels saying anything other than that would have been interpreted as a further sign of panic thereby providing an additional pretext for those going short.

Let’s put it this way - should the oil price fall to $40 there will definitely be another OPEC meeting before June! So why announce one now and create a point of expectation? For the moment, OPEC isn’t suffering alone; many producers are feeling different levels of pain. US independent E&P companies (moderate), Canada (mild), Mexico (moderate) and Russia (severe) - would be this blogger's pain level call for the aforementioned.

The first quarter of 2015 would be critical and one still sees price stabilisation either side of the $70-level. One minor footnote before taking your leave - amidst the OPEC melee last week, a client note from Moody’s arrived into the Oilholic’s inbox saying the agency expects Chinese demand for refined oil products to increase by 3%-5% per annum through 2015. This compares to 5%-10% in 2010-2012.

It also doesn’t expect the benchmark Singapore complex refining margin to weaken substantially below the level of $6 per barrel because lower effective capacity additions and refinery delays will reduce supply, while “the recent easing in oil prices should support product demand.” That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo: No Kangaroos in Austria plaque Graph: Weekly closing levels of oil benchmark prices since Oct 3, 2014 to date* © Gaurav Sharma.

Buyers' market & an overdue oil price correction

Recent correction in the price of crude oil should come as no surprise. The Brent front month futures contract fell to a 26-month low last week lurking around the US$98 per barrel level.

The Oilholic has said so before, and he’ll say it again – there is plenty of the crude stuff around to mitigate geopolitical spikes. When that happens, and it has been something of a rarity over the last few years, the froth dissipates. In wake of Brent dipping below three figures, a multitude of commentators took to the airwaves attributing it to lower OECD demand (nothing new), lacklustre economic activity in China (been that way for a while), supply glut (not new either), refinery maintenance (it is that time of the year), Scottish Referendum (eh, what?) – take your pick.

Yet nothing’s changed on risk front, as geopolitical mishaps – Libya, Sudan, Iraq and Ebola virus hitting West African exploration – are all still in the background. What has actually gotten rid of the froth is a realisation by those trading paper or virtual contracts that the only way is not long!

It’s prudent to mention that the Oilholic doesn’t always advocate going short. But one has consistently being doing so since late May predicated on the belief of industry contacts, who use solver models to a tee, to actually buy physical crude oil, rather than place bets on a screen. Most of their comparisons factor in at least three sellers, if not more.

Nothing they've indicated in the last (nearly) five months has suggested that buyers are tense about procuring crude oil within what most physical traders consider to be a "fair value" spot trade, reflecting market conditions. For what it’s worth, with the US buying less, crude oil exporters have had to rework their selling strategies and find other clients in Asia, as one explained in a Forbes post earlier this month.

It remains a buyers’ market where you have two major importers, the US and China who are buying less, albeit for different reasons. In short, and going short on crude oil, what’s afoot is mirroring physical market reality which paper traders delayed over much of the second quarter of this year from taking hold. Furthermore, as oversupply has trumped Brent’s risk premium, WTI is finding support courtesy the internal American dynamic of higher refinery runs and a reduction of the Cushing, Oklahoma glut. End result means a lower Brent premium to the WTI. 

However, being pragmatic, Brent’s current slump won’t be sustained until the end of the year. For starters, OPEC is coming to the realisation that it may have to cut production. Secretary General Adalla Salem El-Badri has recently hinted at this.

While OPEC heavyweight Saudi Arabia is reasonably comfortable above a $85 price floor, hawks such as Iran and Venezuela aren’t. Secondly, economic activity is likely to pick up both within and outside the OECD in fits and starts. While Chinese economic data continues to give mixed signals, India is seeing a mini-bounce. 

Additionally, as analysts at Deutsche Bank noted, “With refineries likely to run hard after the maintenance period, this will support crude oil demand and eventually prompt crude prices, in our view. This may be one of the factors that could help to eliminate contango in the Brent crude oil term structure.”

While the general mood in the wider commodities market remains bearish, it should improve over the remainder of the year unless China, India and the US collectively post dire economic activity, something that’s hard to see at this point. The Oilholic is sticking to his Q1 forecast of a Brent price in the range of $90 to $105 for 2014, and for its premium to WTI coming down to $5.

Meanwhile, Moody's has lowered the Brent crude price assumptions it uses for ratings purposes to $90 per barrel through 2015, a $5 drop from the ratings agency's previous assumptions for 2015. It also reduced price assumptions for WTI crude to $85 per barrel from $90 through 2015.

The agency’s price assumptions for 2016 and thereafter are $90 per barrel for Brent crude and $85 for WTI crude, unchanged from previous assumptions. Moody’s continue to view Brent as a common proxy for oil prices on the world market, and WTI for North American crude.

On a closing note, here’s the Oilholic’s second take for Forbes on the role of China as a refining superpower. Recent events have meant that their refining party is taking a breather, but it’s by no means over. That’s all for the moment folks! Keep reading, keep it ‘crude’!

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© Gaurav Sharma 2014. Photo: Russian Oil Extraction Facility © Lukoil. Graph: Brent curve structure, September 19, 2014 © Deutsche Bank