The Oil Price
So Brent has retreated 25% from $126 to ‘below par’ in less than two and a half months, and WTI, the US benchmark, is 20% lower over the same timeframe. What’s changed?
Then (March 22)
Amidst rising Iranian concerns and news that the IEA would recommend release of crude/product from various Strategic Energy Reserves (SPR), Saudi Oil Minister Naimi noted that the market was ‘well supplied, ‘ but promised to meet any shortfall, after Aramco announced a plan to boost output to 10 million b/d as disruption insurance (several analysts expressed disbelief that the Kingdom could deliver).
OPEC reduced its view of global demand, which implied a falling (Q2/Q1) Call on the Cartel.
March-May is typically the period of highest focus on gasoline production, ahead of summer demand, especially in the US.
Higher equity markets and the perception that a steady recovery from the Q4 global destocking seemed ubiquitous.
Now (June 1)
Saudi is producing over 10 million b/d, and OPEC on track for 31 million b/d, a million b/d ahead of the March plan.
Meanwhile, Iranian risk seems, for now, to have faded from ‘above the fold’ as multiple conversations (likely to fail, as usual?) are underway (more after I participate in a webinar with a US security expert, who has had numerous recent meetings with President Ahmadinejad).
No new supply outages, although Sudan, Yemen, and Syria are still essentially offline – roughly 1.2 million b/d). In other words, under ‘normal’ circumstances, the market was clearly ‘well supplied.’
Implied (that’s the best outsiders can do) Chinese demand slipped 2.2% in April, in part due to (a) a spike in nat gas substitution/availability, (b) slowing economy, (c) perceived cumulative efficiencies after years of investment in transport infrastructure. On the other hand, imports (not consumption) spiked to 6 million b/d in February (up 12.8% YoY), so ‘who knows, for sure?’
Clear slowing in global demand, as evidenced by weaker US exports, inventory accumulation of a variety of chemicals and commodities and, of course, renewed European concerns (from one precinct, most chemical companies were surprised, on Q1 conference calls, that European demand was ‘not as bad as feared.’
Reversal of the Seaway pipeline has improved, temporarily, the flow of WTI into the key US storage/pricing hub, accounting for the relative outperformance of WTI versus global benchmarks.
Analysis
Seasonal Weakness in the Oil Price – Not to Worry.
Second quarter oil fundamentals used to be the weakest of the year, masked over the past decade by seasonal strength in Asian (mostly Chinese) markets. Among other matters (above), with clear (?) slowing of Chinese demand, this seasonality may be more evident, once again.
Buyers sit on their hands – Not a surprise.
When prices are falling, it’s a no-brainer for customers to watch and wait while drawing down their own inventories. This is happening across a wide range of inputs – a more serious situation considering we just suffered through a material destocking during Q4 2011 (how many mid-cycle slowdowns are enough?).
Gee, do you think there will never be another ‘security premium?’.
No explanation needed here.
Longer term
Beyond the immediate market weakness, recent MEES /market reports add interesting color on the long term supply/demand argument:
1) The pressure for expanded longterm supply in UAE, Kuwait, and Qatar continues, with focus on the need for EOR (enhanced oil recovery) technology, political problems with JV arrangements, and the likelihood that Iraqi service projects may fail.
2) Saudi Arabia disclosed that proven reserves FELL (albeit slightly) in 2011 – a first – as the Kingdom announced only one major discovery in the year.
3) China is expected to announce, shortly, a commitment to flattening its total energy consumption by 2016, at a level 20% above 2011. This will involve a transition from coal (a third of the mix) and fuel oil to oil (only 10% of today’s mix) and natural gas (around 5%). An interesting report from Jefferies’ Asian energy analyst points to numerous infrastructure improvements which have reduced the oil content/unit of GDP. An interesting longer term chart points to ‘lower highs’ in Chinese consumption in every year since 2005, and a somewhat unique spike in natural gas supply this year.
Independent Oil Companies (IOC) versus Resource Owners (NOC)
On the other hand, the Resource Nationalism tussle between IOCs and NOCs has returned with higher prices and the emergence of certain fiscal terms which are ‘too tough’ for bidders. I believe that IOCs will gain relative position, as technology and capital turn out to be important parts of the equation:
1) Shell has abandoned its exploration rights in Libya, after technical failure, combined with onerous (90% of value to the government) terms. Shell is also negotiating to cut the production requirements of its Iraqi agreement.
2) The most recent Iraqi project tender, including 9 fields, was only able to award 3 projects due to disinterest on Iraqi ‘per barrel’ compensation requirements.
3) Nothing new on the rumors that Statoil and ExxonMobil seek a way out of their Iraqi projects.
4) Clear signs that Russia will figure out a way to acquire (on their terms) BP’s 50% position in TNK-BP, after pulling a key field license from Lukoil (not government controlled).
5) Mexico and Argentina, each essentially in control of massive shale/tight resources, now trying to figure out how to bring technology and capital to the commercialization task. Given the deteriorating energy situation in Argentina, and the shortage of gas in Mexico, it will be very interesting to watch the progress, if any of these Nationalized Energy Resources.
In short, I think that the oil price is very near the low end of a price which will allow enough investment to provide enough supply, even in a slower (1% AGR) long term scenario.