The drivers, the forecasts & the ‘crude’ mood

At times wild swings in the crude market’s mood do not reflect oil supply and demand fundamentals. The fundamentals, barring a geopolitical mishap on a global scale, alter gradually unlike the volatile market sentiment. However, for most parts of Q2 and now Q3 this year, both have seemingly conspired in tandem to take the world’s crude benchmarks for a spike and dive ride.

 

Supply side analysts have had as much food for thought as those geopolitical observers overtly keen to factor in an instability risk premium in the oil price or macroeconomists expressing bearish sentiments courtesy dismal economic data from various crude consuming jurisdictions. For once, no one is wrong.

 

A Brent price nearing US$130 per barrel in mid-March (on the back of Iranian threats to close the Strait of Hormuz) plummeted to under US$90 by late June (following fears of an economic slowdown in China and India affecting consumption patterns). All the while, increasing volumes of Libyan oil was coming back on the crude market and the Saudis, in no mood to compromise at OPEC, were pumping more and more.

 

Then early in July, as the markets were digesting the highest Saudi production rate for nearly three decades, all the talk of Israel attacking Iran resurfaced while EU sanctions against the latter came into place. It also turned out that Chinese demand for the crude stuff was actually up by just under 3% for the first six months of 2012 on an annualised basis. Soon enough, Brent was again above the US$100 threshold (see graph on the right, click to enlarge).

 

Fast forward to the present date and the Syrian situation bears all the hallmarks of spilling over to the wider region. As the West led by the US and UK helps rebels opposed to President Bashar al-Assad, Russia is seen helping the incumbent; not least via a recent announcement concerning exchange of refined oil products from Russia for Syrian crude oil exports desperately needed by the latter.

 

A spread of hostilities to Lebanon, Jordan, Turkey and Iraq could complicate matters with the impact already having been seen in the bombing of Iraq-Turkey oil pipeline. Additionally, anecdotal evidence suggests the Saudis are now turning the taps down a bit in a bid to prop up the oil price and it appears to be working. The Oilholic will be probing this in detail on visit to the Middle East next week.

 

While abysmal economic data from the Old Continent may not provide fuel – no pun intended – to bullish trends, one key component of EU sanctions against Iran most certainly will. A spokesperson told the Oilholic that tankers insured by companies operating in EU jurisdictions will lose their coverage if they continue to carry Iranian oil from July.

 

Since 90% of the world's tanker fleet – including those behemoths called ‘supertankers’ passing through dangerous Gulf of Aden – is insured in Europe, the measure could take out between 0.8 and 1.1 million barrels per day (bpd) of Iranian oil from Q3 onwards according an Istanbul-based contact in the shipping business.

 

In fact OPEC’s output dipped by 70,000 bpd in month over month terms to 31.4 million bpd in July on the back of a 350,000 bpd drop in June over May. No prizes for guessing that of the 420,000 bpd production dip from May to July – 350,000 bpd loss is a direct result of the Iranian squeeze. Although Tehran claims it is a deliberate ploy.

With an average forecast of a rise in consumption by 1 million bpd over 2012 based on statements of various agencies and independent analysts, price spikes are inevitable despite a dire economic climate in Europe or the OECD in general.

 

Cast aside rubbish Iranian rhetoric and throw in momentary geopolitical supply setbacks like the odd Nigerian flare-up, a refinery fire in California or the growing number of attacks on pipeline infrastructure in Columbia. All of these examples have the potential to temporarily upset the apple cart if supply is tight.

 

“Furthermore, traders are wising up to fact that a price nudge upwards these days is contingent upon non-OECD consumption patterns and they hedge their bets accordingly. WTI aside, most global benchmarks look towards the motorist in Shanghai more than his counterpart in San Francisco these days,” says one industry insider of his peers.

 

When the Oilholic last checked at 1215 BST on August 23, the ICE Brent October contract due for expiry on September 13 was trading at US$115.95 while the NYMEX WTI was at US$97.81. It is highly likely that ICE Brent forward futures contracts for the remaining months of the year will end-up closing above US$110 per barrel, and almost certainly in three figures. Nonetheless, prepare for a rocky ride over Q4!

 

Moving away from pricing of the crude stuff, it seems the shutdown of Penglai 19-3 oilfield by the Chinese government in wake of an oil spill last year has hit CNOOC’s output and profits. According to a recent statement issued at Hong Kong Stock Exchange, CNOOC saw its H1 2012 output fall 4.6% on an annualised basis owing to Penglai 19-3 in which it holds 51% of the participating interest for the development and production phase. ConocoPhillips China Inc (COPC) is the junior partner in the venture.

 

This meant H1 2012 net income was down by 19% on an annualised basis from Yuan 39.34 billion to Yuan 31.87 billion (US$5 billion) according to Chief Executive Li Fanrong. CNOOC's US$15.1 billion takeover of Canada’s Nexen, a move which could have massive implications for the North Sea, is awaiting regulatory approval from Ottawa.

 

Away from the “third largest” of the big trio of rapidly expanding Chinese oil companies to a bit of good news, however temporary, for refiners either side of the pond. That’s if you are to believe investment bank UBS and consultancy Wood Mackenzie. UBS believes that for better parts of H1 2012, especially May and June, refining margins were at near “windfall levels” as the price of the crude stuff dipped in double-digit percentiles (25% at one point in the summer) while distillate prices held-up.

 

Wood Mackenzie also adds that given the refiners’ crude raw material was priced lower but petrol, diesel and other distillates remained pricey meant moderately complex refiners in northwest Europe made a profit of US$6.40 per barrel of processed light low sulphur Brent crude in June, compared with the average profit of 10 cents per barrel last year.

 

The June margin for medium, high sulphur Russian Urals crude was a profit of US$13.10 per barrel compared with the 2011 average of US$8.70, the consultancy adds. American refiners had a bit of respite as well over May and June. Having extensively researched refining investment and infrastructure for over two years, the Oilholic is in complete agreement with Société Générale analyst Mike Wittner that such margins are not going to last (see graph above, click to enlarge).

 

To begin with the French investment bank and most in the City expect global refinery runs to drop shortly and sharply to -1.3 million bpd in September versus August and -0.8 million bpd in October versus September. Société Générale also remains neutral on refining margins and expects them to weaken on the US Gulf Coast, Rotterdam and the Mediterranean but strengthen in Singapore. Yours truly will find out more in the Middle East next week. That’s all for the moment from London folks! Keep reading, keep it ‘crude’!

 

© Gaurav Sharma 2012. Photo 1: Russian oil pump jacks © Lukoil. Graph 1: Comparison of world crude oil benchmarks (Source: ICE, NYMEX, SG). Graph 2: World cracking margins (US$/barrel 5 days m.a) © SG Cross Asset Research, August 2012.

North Sea, Gaddafi, CFTC (Rhymes not intended)

The past week has been cruder than ever, loads to talk about – not least a bit of good news from the North Sea for a change. Following BP’s earlier announcement on its commitment to offshore west of the Shetland Islands to the tune of £4.5 billion, Statoil recently doubled the estimate of the size of its crude find in the North Sea.

The Norwegian energy major now says the Aldous Major South field, a prospection zone linked to the Avaldsnes field operated by Swedish firm Lundin Petroleum, could contain between 900 million and 1.5 billion barrels of recoverable oil.

While the find is perhaps one of the largest ever discoveries in the North Sea, what is of much more significance is the fact that much of extraction zone is in relatively shallower waters. Admittedly, the find and BP’s move are unlikely to increase British production levels to pre-peak (1999) levels. Nonetheless it is welcome news for a prospection zone, the British end of which has been bemoaning higher taxation and where the only overall bonanza independent observers sometimes see is the one related to decommissioning. (Not that, that’s over.)

From the North Sea to Col. Moammar Gaddafi – whose gory end had a near negligible impact on crude oil futures according to evaluations conducted by several City analysts. The former Libyan dictator was killed by revolutionary forces in his hometown of Sirte last Thursday. Most analysts felt focus had already shifted, following the fall of Tripoli, to restoring Libyan production. In fact damaged oil terminals, already factored in to the pricing strategy and supply/demand permutations, were more of a concern than the Colonel’s demise. As Libya moves forward, what sort of government takes shape remains to be seen.

Continuing with pricing, the ICE Brent forward month futures contract could not hold on to early gains last week and stayed below the US$110 level, but the WTI had a mini rally ending the week above US$87. Today in intraday trading Brent’s flirtation with the US$110 level and WTI’s with US$88 continues with all eyes on the outcome of the EU leaders’ summit on October 26th.

Analysts at Sucden Financial Research, expect some further consolidation in the oil market ahead of the meeting. “Thus, volume might be muted while high volatility and nervous trading are possible to dominate the markets. In the meantime, currencies movements will remain the key driver of oil direction, while it will be interesting to watch how the global equity markets will digest any breaking news,” they wrote in an investment note.

Moving away from pricing but on a related note, the Oilholic found time this weekend to read documents relating to the US Commodity Futures Trading Commission’s (CFTC) 20th open meeting on the Dodd-Frank regulations which approved, on October 18th, amongst other things, the final rule on speculative position limits.

To begin with the Oilholic, along with fellow kindred souls in the world of commodities analysis, wonders how a move designated to impose curbs on ‘excessive speculation’ does not actually define it or explains what constitutes admission to the category of ‘excessive speculation.’

The final ruling, according to the CFTC, will establish ground rules for trading 28 ‘core’ commodity futures contracts and also ‘economically equivalent’ futures, options and swaps. The limits are going to be introduced in two phases.

Wait a minute, it gets ‘better’ – limits for ‘spot-month’ will be introduced after the agency further defines what a ‘swap’ contract is (eh???). It seems there is no strict timeline for that definition to come about but the world’s press has been informed that the definition should come before the end of the year. The trading of four energy contracts will be affected – i.e. NYMEX Henry Hub Natural Gas, NYMEX Light Sweet Crude Oil, NYMEX New York Harbor Gasoline Blendstock and NYMEX New York Harbor Heating Oil.

Michael Haigh, analyst at Société Générale CIB notes, “In the short run therefore these rules might not impact price volatility (they still have to define a swap) and we believe the rules will not decrease volatility or stop commodity price spikes down the road. Increased volatility and price spikes are actually more likely in our opinion. The rules will also create a better paper-trail for the CFTC knowing who is holding what and in which market (swap or futures) but legal challenges to the rule are considered likely.”

As for the nitty-gritty, the initial spot month limits will be the CFTC's legacy limits for agricultural commodities (e.g., 600 contracts for corn, wheat and soybeans, 720 for soybean meal and 540 for soybean oil). For other commodities, exchange limits will be applied. Thereafter, spot limits will be based on 25% of the deliverable supply as determined by the exchanges and these will be adjusted every other year for agricultural contracts but each year for metals and energy.

In the second phase, the CFTC will set limits for positions in non-spot contracts (and all months combined) based on open interest. The CFTC should have that data by August 2012. In practical terms, it appears that the all months combined/single month limits will therefore take effect in late 2012 or early 2013 after the CFTC reviews the data, comes up with limits and imposes them.

The CFTC promises to conduct a study 12 months after implementation and would ‘promptly’ address any problems. However, Haigh notes that by all logical reasoning, the study would be at least one year after full implementation, so sometime in 2014. “A reversal of rules would obviously come much later. By then, the damage may have already been done and the markets would have seen even wider gyrations in prices with the removal of liquidity,” he concludes.

Rounding things up, ABN-AMRO – the ‘once’ troubled Dutch bank is attempting to ‘re-establish’ its international presence to energy, commodities and transportation clients according to a communiqué issued from Amsterdam this morning. To this effect, a new office was opened in Dallas staffed by a 'highly regarded' energy banking team swiped from UBS. More offices are to follow in Moscow and Shanghai over the coming year on top of an existing network of 10 international offices. Lets see how the reboot goes!

© Gaurav Sharma 2011. Photo: North Sea oil rig © Cairn Energy Plc