Grappling with volatility in a barmy crude market

The oil market is not making a whole lot of sense at present to a whole lot of people; the Oilholic is admittedly one of them. However, wherever you apportion the blame for the current market volatility, do not take the convenient route of laying it all at China’s doorstep. That would be oversimplification!

It is safe to say this blogger hasn’t seen anything quite as barmy over the last decade, not even during the post Lehman Brothers kerfuffle as a US financial crisis morphed into a global one. That was in the main a crisis of demand, what’s afoot is one triggered first and foremost by oversupply. 

As one noted in a recent Forbes column, the oversupply situation – not just for oil but a whole host of commodities – merits a deeper examination. The week before we saw oil benchmarks plummet after the so-called ‘Black Monday’ (August 24) only for it recover by Friday and end higher on a week-over-week basis compared to the previous week’s close (see graph above, click to enlarge)

This was followed on Monday, August 31 by some hefty gains of over 8% for both Brent and WTI. Yet at the time of writing this blog post some 48 hours later, Brent had shed over 10% and the WTI over 7% on Tuesday but again gained 1.72% and 1.39% respectively on Wednesday.

The reasons for driving prices down were about as fickle as they were for driving them up and subsequently pulling them down again, and so it goes. When the US Energy Information Administration (EIA) reported on Monday that the country’s oil production peaked at just above 9.6 million barrels per day (bpd) in April, before falling by more than 300,000 bpd over the following two months; those in favour of short-calling saw a window to really go for it.

They also drew in some vague OPEC comment (about wanting to support the price in tandem with other producers), knowing full well that the phoney rally would correct. The very next day, as the official purchasing managers’ index for Chinese manufacturing activity fell to 49.7 in August, from the previous month’s reading of 50, some serious profit-taking began.

As a figure below 50 signals a contraction, while a level above that indicates expansion, traders found the perfect pretext to drive the price lower. Calling the price higher based on back-dated US data on lower production in a heavily oversupplied market is about as valid as driving the price lower based on China’s manufacturing PMI data indicative of a minor contraction in activity. The Oilholic reckons it wasn’t about either but nervous markets and naked opportunism; bywords of an oversupplied market.

So at the risk of sounding like a broken record, this blogger again points out – oversupply to the tune of 1.1-1.3 million bpd has not altered. China’s import level has largely averaged 7 million bpd for much of the year so far, except May. 

Yours truly is still sticking to the line of an end of year Brent price of $60 per barrel with a gradual supply correction on the cards over the remaining months of 2015 with an upside risk. Chances of Iran imminently flooding the market are about as likely as US shale oil witnessing a dramatic decline to an extent some in OPEC continue to dream off.

But to get an outside perspective, analysts at HSBC also agree it may take some time for the market to rebalance fully. “The current price levels look completely unsustainable to us and a combination of OPEC economics and marginal costs of production point to longer-term prices being significantly higher,” they wrote in a note to clients.

The bank is now assuming a Brent average of $55.4 per barrel in 2015, rising to $60 in 2016 and $70-80 for 2017/18. Barclays and Deutsche Bank analysts also have broadly similar forecasts, as does Moody’s for its ratings purposes.

The ratings agency sees a target price of $75 achieved by the turn of the decade, but for yours truly that moment is bound to arrive sooner. In the meantime, make daily calls based on the newsflow in this barmy market. That’s all for the moment folks! Keep reading, keep it crude!

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© Gaurav Sharma 2015. Graph: Oil benchmark Friday closes, Jan 2 to Aug 28, 2015 © Gaurav Sharma, August 2015.

An OPEC seminar & an Indian minister

Indian oil minister S. Jaipal Reddy is rather sought after these days. You would be, if you represented one of the biggest consumers of the crude stuff. So it is just about right that OPEC’s 5th international seminar here in Vienna had Reddy speak at a session titled: “Oil and the World Economy.”

In face of growing international pressure to reduce its dependence on Iranian oil and running out of capital market mechanisms to actually pay for the stuff in wake of US/EU sanctions, the Indian minister certainly had a few things to say and wanted to be heard.

India is the world's fourth-largest oil importer with all of its major suppliers being OPEC member nations, viz. - Saudi Arabia, Iraq and Iran. Given what is afoot from a global macroeconomic standpoint, Reddy has called upon oil producing and consuming countries to work together to build trust and share market data to establish demand certainty in international oil markets.

Unsurprisingly, he admitted that in an oil-importing country like India, higher oil prices lead to domestic inflation, increased input costs, an increase in the budget deficit which invariably drives up interest rates and slows down the economic growth.

“There could not be a more direct cause and effect relation than high oil prices retarding economic growth of oil-importing countries,” Reddy said adding that a sustained US$10 per barrel increase in crude prices reduces growth in developing countries by 1.5%.

“We are meeting in difficult times. The Eurozone crisis, the continuing recession in the global economy, rising geopolitical tensions, a sustained phase of high and volatile international oil prices, extraneous factors continuing to influence the price formation of oil – all these pose serious challenges to the health of the global economy and stability of the world’s financial system. The current global financial crisis, which has lasted longer than we thought in 2008, is the greatest threat faced by the global economy since the Great Depression eight decades ago,” he said further.

Reddy revealed that between the Financial Year 2010-11 and 2011-12, India’s annual average cost of imported crude oil increased by US$27 per barrel, making India’s oil import bill rise from US$100 billion to a whopping US$140 billion.

“Furthermore, since we could not pass on the full impact of high international oil prices, we had to shell out subsidies to consumers amounting to US$25 billion dollars...India’s GDP grew at 6.9% during the last financial year down from the 8% plus growth rate experienced in the past few years,” he continued.

India and perhaps many others see themselves distinguishing two schools of thoughts here in Vienna. One school holds that the global economy has built up enough resilience to absorb oil price hikes due to (a) stronger demand from emerging economies and, (b) more enlightened Central Bank policies; the other school is categorical that high oil prices are one of the primary reasons for the weak conditions in the economies of the US and Europe.

“We subscribe to the latter view and hold that very high and volatile oil prices will continue to weaken global efforts for an expeditious recovery from the ongoing global economic recession and financial crisis,” Reddy concluded.

The viewpoint of an importers’ club member is always welcome at an exporting cartel’s event. For good measure, the representatives of Nigeria, Ecuador and Iran provided the exporters’ perspective and IFC’s spokesperson did the balancing act as a sideshow. As for the word “Iran” and the sanctions it faces; the Oilholic has been told in no uncertain terms by quite a few key people that it’s...er...ahem...a taboo subject at this meeting. That's all for the moment folks. Keep reading, keep it 'crude'!

© Gaurav Sharma 2012. Photo: Indian Gas Station © Indian Oil Corporation Ltd.

Is "assetization" of Black Gold out of control?

Crude oil price should reflect a simple supply-demand equation, but it rarely does in the world of oil index funds, ETFs and loose foresight. Add to the mix an uncertain geopolitical climate and what you get is extreme market volatility. Especially since 2005, there have been record highs, followed by record lows and then yet another spike. Even at times of ample surpluses at Cushing (Oklahoma) - the US hub of criss-crossing pipelines - sometimes the WTI ticker is still seen trading at a premium defying conventional trading wisdom. The cause, according to Dan Dicker, author of the book Oil’s Endless Bid, is the rampant "assetization" of oil.

The author, a man with more than 20 years of experience on the NYMEX floor, attributes this to an influx of "dumb money" in to the oil markets. Apart from introducing and taking oil price volatility straight to the consumers' wallets, this influx has triggered a global endless bid for energy security. Via a book of just under 340 pages split by three parts containing 11 chapters, their epilogue and two useful appendices, Dicker offers his take on the state of crude affairs.

While largely authored from an American standpoint, Dicker throws up some unassailable truths of global relevance. Principal among them is the fact that visible changes that have taken place in the oil markets over the past 20 years. Go back a few decades, and everyone can recollect the connection between price volatility and its association with a major economic or geopolitical crisis (economic woes, Gulf War I, OPEC embargo, etc.)

Presently, there is near perennial volatility as the trading climate and instruments of trade available place an incessant upward pressure on black gold. Reading Dicker's thoughts one is inclined to believe that at no point in history was the phrase "black gold" more appropriate to describe the crude stuff than it is now; particularly in the last six years, as investment banks, energy hedge funds and managed futures funds have come to dominate energy trading and wreak havoc on prices.

In his introduction to the book, Dicker makes a bold claim - that we've lost control of our oil markets and it has become the biggest financial story of the decade. When the Oilholic began reading it, he was sceptical of the author's claim, but by the time he reached the ninth chapter the overriding sentiment was that Dicker has a point - a huge one, articulated well and discussed in the right spirit.

Ask anyone, even a lay man, a non-technical question about why the price of oil is so high - the answer is bound be China and India's hunger for oil. A more technical person might attribute it to the US Dollar's weakening and perhaps investors playing with the commodities market as the equities markets take a hit.

But are these reasons enough to explain what caused prices to soar 600% from 2003 to 2008, only to take a massive dip and soar again over the next couple of years? Something is fundamentally wrong here according to the author and the latter half of his book is dedicated to discussing what it might mean and where are we heading.

Whether you agree or disagree is a matter of personal opinion, but the author's take on what broke the oil markets, and how can they be fixed before they drag us all down into an economic black hole, strikes a chord. He also uses part of the narrative to reflect on his life as a trader before and after passage of the US Commodities Futures Modernization Act opened up the oil markets to a flood of "dumb money."

Sadly, as Dicker notes, the biggest victim of oil markets frenzy is the average consumer, who pays the price at the pump, and in the inflated costs of everything - from food and clothing to electric power and even lifesaving medications. The Oilholic is happy to recommend this book to those interested in crude oil markets, the energy business, US crude trading dynamic, petroleum economics or are just plainly intrigued about why getting a full tank of petrol has suddenly lost the element of predictability in the last half decade or so.

© Gaurav Sharma 2011. Photo: Cover of ‘Oil’s Endless Bid’ © Wiley Publishers, USA 2011.

Moody’s Says Global Integrated Oil Industry Stable

A report published on Wednesday by Moody’s notes that the global integrated oil and gas industry outlook remains stable and the sector is likely to continue seeing a moderate recovery over the next 12-18 months. However, it adds that the recovery could be more subdued for international oil companies (IOCs).

Oil prices have generally averaged over US$75+ per barrel, and Moody’s has joined ranks with the wider market in noting that the oil sector is well past the bottom of the cycle.

Thomas Coleman, a Senior Vice President at Moody's, says, "The integrated oil companies on the whole enjoy a strong and competitive financial position today; with oil prices trading in a moderate level of about US$75 a barrel as the world's leading economies continue to emerge from the serious downturn of 2008-2009."

Overall, the report notes that the demand for crude oil will remain strong outside the OECD, as – well no prizes for guessing – China and other booming economies, most notably India, steadily increase consumption.

The report also notes that IOCs' earnings and cash flow are improving and could rise by almost 20% over the next 12-18 months - thanks to the H1 2010 revival in crude prices - but these companies remain exposed to fairly weak conditions in the refining sector, which is set to take on even more capacity in 2010 and in coming years.

In addition, high inventories worldwide and recent commodity price volatility amid deepening concerns over Eurozone debt issues further illustrate the risks to the sector, according to Moody's. On the Gulf of Mexico oil spill, the ratings agency noted that the "costs of drilling in the Gulf will escalate dramatically when the US government's ongoing moratorium ends, though deepwater drilling is unlikely to come to permanent halt."

© Gaurav Sharma 2010. Photo courtesy © Shell