Focus on Crude Oil: Blowout?
August 20, 2008
By Steve Platt,
Archer Financial Services
Demand Headwinds
The drop in oil prices from a high of $147 to a low below $113 per barrel has given rise to talk of demand destruction undercutting values. Undoubtedly, the high prices have provided a strong headwind to usage in many areas. However there are a variety of factors to consider when trying to determine how far demand will be cut back on a global basis. These considerations include:
* The scope of economic growth in OECD areas and on a global basis.
* The extent of price rises in those areas where subsidies have softened the impact of higher prices.
* The prospective substitution of renewable fuels and natural gas for petroleum based products.
* Weather considerations during the Northern hemisphere winter.
Despite the high prevailing prices, demand in 2008 is expected to total 86.9 million barrels compared to 85.96 mb/d in 2007. For 2009, global oil demand is expected to reach 87.7 mb/d.
Anemic economic growth in the US, particularly in energy intensive areas such as construction and auto manufacturing, along with consumer resistance to high gasoline prices, is expected to cut into demand on an absolute basis with US disappearance expected to total 20.2 mb/d. The decline is likely to persist into 2009, with forecasted demand expected to total 19.8 mb. European demand given the significantly lower base along with the high retail prices will likely stagnate at 15.1 mb/d.
Due to the forecast for an absolute decline from the US and Europe, growth in demand will be reliant upon emerging market economies. In China, the domestic economy is beginning to show strains from high inflation which is encouraging an increasingly proactive role on the part of the government to moderate capital investment and likewise demand in order to control inflationary pressures. In India, fears have been apparent over the high cost of subsidizing domestic consumption of oil products. Subsequently, demand if anything might fall short of expectations as governments restrain growth through more rational pricing policies that do not strain national budgets. Subsequently, forecasts suggesting growth in Chinese demand in 2009 to 8.42 mb/d from 7.96 in 2008 might be overly optimistic. For non-OECD areas, demand is expected to reach 39.71 mb/d, an increase of 1.4 mb/d over forecasts for 2008. However, any shortfall in Chinese demand might hold out the potential for non-OECD demand falling short of forecast.
Supply Increases Enough?
Just as demand has responded to the higher prices, global crude oil supply availability has also started to expand. Although concerns remain over the depletion of existing fields in the US, North Sea and Mexico, high prices have encouraged an expansion in supplies from areas in Brazil, Saudi Arabia, Iraq and Nigeria. In addition, aggressive biofuel and LNG programs are beginning to have an impact. Only with higher prices could the gains in substitute programs and deep sea drilling have been achieved. The belief that the high price environment is finally becoming ingrained in assessing the potential profitability of projects is helping encourage investment, particularly in Brazil and the Gulf of Mexico. The high prices have also raised the pain threshold by which the costs, including environmental impact associated with drilling on the Continental shelf, are being reassessed.
Despite the favorable price environment, the gains on the production side are still not spectacular; yet appear to be enough for now to provide the basis for a balance tending toward surplus supply/demand situation. Led by steady gains in emerging markets and stabilization in developed areas, demand will eventually resume an upward growth path. The ability of supplies to keep up with these gains will be a key variable to the future price environment surrounding crude oil and the structure of its forward curve.
For 2009, global oil supplies including biofuels, natural gas liquids and condensate are expected on a preliminary basis to total 87.8 mb/d compared to 87.3 mb/d forecast for 2008. OECD supplies are expected to fall to 19.3 mb/d compared to 19.5 mb/d in 2007. European supplies are projected to fall the sharpest, reaching only 4.2 mb/d in 2009 compared to 4.5 mb/d in 2008. North American supplies will actually show an increase as production from the Canadian tar sands and higher US output attributed to further increases of ethanol supplies and expansion in production in the Gulf of Mexico more than offset declines in Mexico due to lower production from the Cantarell field.
In non-OECD areas, supplies are projected to increase by .5 mb/d to 28.5 mb/d. Major concerns are linked to the Russians, where abrupt policy changes and a punitive tax regime is discouraging investment. With uncertainty associated with the government support of joint ventures, foreign investment in new projects is likely to lag. A bright spot remains Brazil, but even there deepwater development will demand patience and substantial capital. In Asia, supplies are showing increases as the demand for energy remains buoyant and absorbs what increases might be attained in Vietnam, China and Thailand.
OPEC production levels led by Iraq and Saudi Arabia have continued to expand. Recently, OPEC production reached 32.4 mb/d. This is as much as 1.8 mb/d above year ago levels. Concerns had recently been expressed that due to dwindling spare capacity, OPEC had lost their pricing power. However, given recent declines it looks like the Saudis once again hold sway over the market. Currently they appear to have a desire for a stable price environment which will not threaten demand. What the breaking point might be on both the downside and upside remains to be seen but Saudi statements have tended to foreshadow any change in policy and will have to be watched closely. For 2009, it looks like sustainable capacity will likely expand by upwards of 1 mb/d. However, OPEC remains wary of committing further capital into new and expensive production until the depth of the recent economic slowdown and impact of renewables can be more accurately gauged. A move back below the 100.00 area could encourage calls by more radical OPEC members such as Venezuela and Iran to reign in production.
Conclusion
A surplus supply situation is likely as we move into 2009 based upon current supply/demand trends. Demand prospects will not only be influenced by apparent off take linked to economic activity but also by speculative involvement which will continue to be driven by the dollar and inflationary trends. Efforts to thwart institutional involvement will continue to be a potential weight on the market. On the supply side, Saudi Arabia will likely come under increasing pressure to cut production if prices break back near the 95.00 area particularly if the statistical balance has moved into surplus. Inventory levels, which have been slow to reflect a build in OECD countries, will need to be monitored closely. An increase in inventory levels would not only put pressure on prices but also provide validation to OPEC that supply availability has overtaken demand. The rebuilding in inventories could provide the basis for values falling back toward the 94.00 level, similar to what occurred in July of 2006 when values reached a high of 78.40 before falling back to a low of 50.00 basis the active contract. A key reflection point looks to be near the 110 level basis the nearby contract. Eventually OPEC looks like it will need to intervene and cut production to move supply/demand back into better balance.
Longer term, we see the potential for values to move higher as emerging markets try to satisfy a growing need for energy and production lags. Nevertheless, it will take time to shake off the economic malaise in the developed countries and rebuild demand growth in emerging markets.
Questions or comments about this article, please contact Steve Platt at 1.877.377.7931
The information and comments contained herein are provided as general commentary of market conditions and are not and should not be interpreted as trading advice or recommendation. The information and comments contained herein are not and should not be interpreted to be predictive of any future market event or condition. The information and comments contained herein is provided by ADM Investor Services, Inc. and not Archer Daniels Midland Company. Copyright © ADM Investor Services, Inc.
All Charts Courtesy of DTN.
About the Author
After graduating from Georgetown University in Washington, D.C., Steve Platt joined an economic consulting firm focused on agricultural policy and research. In 1979, he relocated to Chicago and worked for two major brokerage houses as Senior Analyst and Research Director, servicing the needs of both institutional and retail clients. In 1998, Steve set up and was given operational control of a trading desk at Morgan Stanley, DW Inc. specializing in precious metals, foreign exchange, and futures. The desk also serviced specialized spec and hedge futures accounts trading in U.S. and International markets. Over the years, Steve has been quoted in major financial publications and seen on a variety of financial news programs discussing market fundamentals. Steve can be reached at (877) 377-7931.
Source: FutureSource.com
Archer Financial Services
Demand Headwinds
The drop in oil prices from a high of $147 to a low below $113 per barrel has given rise to talk of demand destruction undercutting values. Undoubtedly, the high prices have provided a strong headwind to usage in many areas. However there are a variety of factors to consider when trying to determine how far demand will be cut back on a global basis. These considerations include:
* The scope of economic growth in OECD areas and on a global basis.
* The extent of price rises in those areas where subsidies have softened the impact of higher prices.
* The prospective substitution of renewable fuels and natural gas for petroleum based products.
* Weather considerations during the Northern hemisphere winter.
Despite the high prevailing prices, demand in 2008 is expected to total 86.9 million barrels compared to 85.96 mb/d in 2007. For 2009, global oil demand is expected to reach 87.7 mb/d.
Anemic economic growth in the US, particularly in energy intensive areas such as construction and auto manufacturing, along with consumer resistance to high gasoline prices, is expected to cut into demand on an absolute basis with US disappearance expected to total 20.2 mb/d. The decline is likely to persist into 2009, with forecasted demand expected to total 19.8 mb. European demand given the significantly lower base along with the high retail prices will likely stagnate at 15.1 mb/d.
Due to the forecast for an absolute decline from the US and Europe, growth in demand will be reliant upon emerging market economies. In China, the domestic economy is beginning to show strains from high inflation which is encouraging an increasingly proactive role on the part of the government to moderate capital investment and likewise demand in order to control inflationary pressures. In India, fears have been apparent over the high cost of subsidizing domestic consumption of oil products. Subsequently, demand if anything might fall short of expectations as governments restrain growth through more rational pricing policies that do not strain national budgets. Subsequently, forecasts suggesting growth in Chinese demand in 2009 to 8.42 mb/d from 7.96 in 2008 might be overly optimistic. For non-OECD areas, demand is expected to reach 39.71 mb/d, an increase of 1.4 mb/d over forecasts for 2008. However, any shortfall in Chinese demand might hold out the potential for non-OECD demand falling short of forecast.
Supply Increases Enough?
Just as demand has responded to the higher prices, global crude oil supply availability has also started to expand. Although concerns remain over the depletion of existing fields in the US, North Sea and Mexico, high prices have encouraged an expansion in supplies from areas in Brazil, Saudi Arabia, Iraq and Nigeria. In addition, aggressive biofuel and LNG programs are beginning to have an impact. Only with higher prices could the gains in substitute programs and deep sea drilling have been achieved. The belief that the high price environment is finally becoming ingrained in assessing the potential profitability of projects is helping encourage investment, particularly in Brazil and the Gulf of Mexico. The high prices have also raised the pain threshold by which the costs, including environmental impact associated with drilling on the Continental shelf, are being reassessed.
Despite the favorable price environment, the gains on the production side are still not spectacular; yet appear to be enough for now to provide the basis for a balance tending toward surplus supply/demand situation. Led by steady gains in emerging markets and stabilization in developed areas, demand will eventually resume an upward growth path. The ability of supplies to keep up with these gains will be a key variable to the future price environment surrounding crude oil and the structure of its forward curve.
For 2009, global oil supplies including biofuels, natural gas liquids and condensate are expected on a preliminary basis to total 87.8 mb/d compared to 87.3 mb/d forecast for 2008. OECD supplies are expected to fall to 19.3 mb/d compared to 19.5 mb/d in 2007. European supplies are projected to fall the sharpest, reaching only 4.2 mb/d in 2009 compared to 4.5 mb/d in 2008. North American supplies will actually show an increase as production from the Canadian tar sands and higher US output attributed to further increases of ethanol supplies and expansion in production in the Gulf of Mexico more than offset declines in Mexico due to lower production from the Cantarell field.
In non-OECD areas, supplies are projected to increase by .5 mb/d to 28.5 mb/d. Major concerns are linked to the Russians, where abrupt policy changes and a punitive tax regime is discouraging investment. With uncertainty associated with the government support of joint ventures, foreign investment in new projects is likely to lag. A bright spot remains Brazil, but even there deepwater development will demand patience and substantial capital. In Asia, supplies are showing increases as the demand for energy remains buoyant and absorbs what increases might be attained in Vietnam, China and Thailand.
OPEC production levels led by Iraq and Saudi Arabia have continued to expand. Recently, OPEC production reached 32.4 mb/d. This is as much as 1.8 mb/d above year ago levels. Concerns had recently been expressed that due to dwindling spare capacity, OPEC had lost their pricing power. However, given recent declines it looks like the Saudis once again hold sway over the market. Currently they appear to have a desire for a stable price environment which will not threaten demand. What the breaking point might be on both the downside and upside remains to be seen but Saudi statements have tended to foreshadow any change in policy and will have to be watched closely. For 2009, it looks like sustainable capacity will likely expand by upwards of 1 mb/d. However, OPEC remains wary of committing further capital into new and expensive production until the depth of the recent economic slowdown and impact of renewables can be more accurately gauged. A move back below the 100.00 area could encourage calls by more radical OPEC members such as Venezuela and Iran to reign in production.
Conclusion
A surplus supply situation is likely as we move into 2009 based upon current supply/demand trends. Demand prospects will not only be influenced by apparent off take linked to economic activity but also by speculative involvement which will continue to be driven by the dollar and inflationary trends. Efforts to thwart institutional involvement will continue to be a potential weight on the market. On the supply side, Saudi Arabia will likely come under increasing pressure to cut production if prices break back near the 95.00 area particularly if the statistical balance has moved into surplus. Inventory levels, which have been slow to reflect a build in OECD countries, will need to be monitored closely. An increase in inventory levels would not only put pressure on prices but also provide validation to OPEC that supply availability has overtaken demand. The rebuilding in inventories could provide the basis for values falling back toward the 94.00 level, similar to what occurred in July of 2006 when values reached a high of 78.40 before falling back to a low of 50.00 basis the active contract. A key reflection point looks to be near the 110 level basis the nearby contract. Eventually OPEC looks like it will need to intervene and cut production to move supply/demand back into better balance.
Longer term, we see the potential for values to move higher as emerging markets try to satisfy a growing need for energy and production lags. Nevertheless, it will take time to shake off the economic malaise in the developed countries and rebuild demand growth in emerging markets.
Questions or comments about this article, please contact Steve Platt at 1.877.377.7931
The information and comments contained herein are provided as general commentary of market conditions and are not and should not be interpreted as trading advice or recommendation. The information and comments contained herein are not and should not be interpreted to be predictive of any future market event or condition. The information and comments contained herein is provided by ADM Investor Services, Inc. and not Archer Daniels Midland Company. Copyright © ADM Investor Services, Inc.
All Charts Courtesy of DTN.
About the Author
After graduating from Georgetown University in Washington, D.C., Steve Platt joined an economic consulting firm focused on agricultural policy and research. In 1979, he relocated to Chicago and worked for two major brokerage houses as Senior Analyst and Research Director, servicing the needs of both institutional and retail clients. In 1998, Steve set up and was given operational control of a trading desk at Morgan Stanley, DW Inc. specializing in precious metals, foreign exchange, and futures. The desk also serviced specialized spec and hedge futures accounts trading in U.S. and International markets. Over the years, Steve has been quoted in major financial publications and seen on a variety of financial news programs discussing market fundamentals. Steve can be reached at (877) 377-7931.
Source: FutureSource.com
Labels: Articles, Fundamentals, Markets
