The late afternoon session on day one of the Platts Crude Oil Markets Conference studied ‘the evolution of crude benchmarks, traditional pricing dynamics and risk management strategies in the current climate’, writes Vaughan O’Grady
If this sounds complex, Sabine Schels, senior director and global commodity strategist, Bank of America, Merrill Lynch, did her best to clarify the situation for her talk entitled ‘oil market dynamics in 2012 – stability or greater volatility on the cards?’
She supported the general view that emerging market growth was going to continue, although she also suggested that macro trends included a less than encouraging outlook for developed markets – and for some economies a debt deflation spiral.
High oil and gas prices “have further dented the chances of recovery”, she suggested.
But this is not an easily summarised topic and so this was a wide-ranging presentation that took in numerous factors, such as the crisis in the Eurozone, uncompetitive labour costs in that region, the vast US current account deficit and the equally vast surplus of countries and regions like China, Japan, Russia and OPEC.
In fact at just over six trillion dollars each, the deficit and surplus almost balance out.
You could (and Schels did) add to this the heavy reliance of countries like Spain on oil, the vast potential of US shale production (a recurring theme during the conference) the pegging of the Yuan to the dollar, the gradual lessening of Chinese reliance on exports, the effect of quantitative easing on real incomes as energy, food and other commodity prices keep on rising, and much more. All do, or will, affect the price of oil.
One message seemed clear, however. “High oil prices are here to stay for quite some time,” was Schel’s view. How high?
“On our estimate the highest price the world can afford for Brent is roughly equivalent to nine per cent of GDP”, equating to approximately US$120 a barrel last year, $130 this year and $160 a barrel by 2016.
Passing that nine per cent level has in the past prefigured a global economic recession, she suggested.
“In our view the crisis of 2008-9 was nothing else than a terms-of-trade shock because oil prices just became too high for the big oil importing countries to sustain,” she said.
There are other potential shocks, however, Johannes Benigni, Managing Director, JBC Energy, had some interesting, and not always encouraging observations of his own to add about supply and demand in a presentation simply called ‘market watch’.
Iran’s decline in production and sales was a “function of the sanctions that have been in place for many years” rather than the current ones, he suggested.
This clearly implies that worse is to come, but what does that mean for OPEC?
While OPEC production may have ramped up recently, Iraq has yet to hit its output targets.
That said, it should comfortably overtake Iran soon to be the second biggest producer.
“There’s a lot of debate about the ability of Saudi Arabia to fill the gap,” said Benigni.
Saudi production has not reached the often mooted 12.5 million bpd level, he suggested, in part because the country does not want to damage its reserves – it needs the spare capacity.
Also, he pointed out, “Saudi increasingly needs oil for their own purposes as domestic demand grows”.
Non-OPEC crude supply is also finding it difficult to fill the gap.
In fact a chart of potential against shortfall made for sobering reading: among factors affecting production are transport fee disputes in South Sudan, strikes in Yemen, slow recovery in Libya, partial shut-down in China or simply missed growth targets in Iraq and Brazil – not to mention the Iran issue.
However, demand has declined and will continue to do so in the US and OECD countries. Not all of this decline is down to belt-tightening.
In the US, in fact, it may in part be based on plans to mandate 56 miles per gallon fuel consumption by 2023. Benigni was not alone in highlighting this.
In fact the effect of efficiencies enabled by technology cannot be discounted globally, and won’t just affect oil use in cars.
On the other hand, how much they could affect oil consumption and price is as yet unclear.
Nevertheless world demand, led by pretty much everywhere else, including Africa and the Middle East but especially China, will rise this year and probably for some years to come.
So where are the extra barrels that will be needed coming from?
Ruth Cairnie of Shell mentioned the Arctic of course, but there are expectations that shale oil will offer one to three million barrels a day by 2020.
This is a very imprecise estimate but that’s because, as Benigni said, “every shale oil development is different”.
Even recent predictions have already been revised.
“The market is not so well supplied as it looks on spot right now,” Benigni pointed out.
And what if Iran were to block the Straits of Hormuz? This it could do with ease, though it seems unlikely.
Nor is that the only worry in a region where security issues, sanctions, civil war and piracy are, or could be, concerns.
“It is a very complicated situation,” Benigni said, with some understatement.
The Middle East situation is a cause for concern, but much more so if your country relies on the region for oil.
Thus, much of Asia seems to have more to worry about than the US, Europe and Japan. And that’s without factoring in the question of LNG availability.
World refining, meanwhile, has been hit by oversupply: not of crude but of refining capacity. All of which begs numerous questions for investors.
Could refining overcapacity lead to consolidation? Could Iran act or react in the Straits of Hormuz? Could a large-scale switchover in the US from coal to natural gas lead to a boom in steel mills and aluminium plant? And could a high oil price be acceptable to a US where natural gas is so much cheaper? What about the role of Russia, whose strength in supply has grown, even compared to a year ago?
More fundamentally, as Benigni asked: “In whose interest is it to have a stable US [or] a stable Middle East and a low oil price [or] a high oil price?”
Advising investors is, luckily, not our job. In any case there was no shortage of intelligent analysis at this conference.
However, controlling the flow of oil information and making an investment decision is clearly not for the faint hearted.
Vaughan O’Grady
