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THE above chart shows the extent to which this year's
oil-price rally has been led by futures markets. What is significant, though,
is that futures activity seems to have plateaued.
Sure,
futures activity could easily go the other way again, driving prices
significantly above the $50/bbl level. But barring a decision by the US Federal
Reserve to once again step away from interest rate rises and China further
loosening the credit tap, it is hard to see why the speculators would want to
go deeper into bull territory. The market remains heavily distorted by the
speculators, and so first and foremost you must analyse futures activity before
you then look at physical supply.
Right
now, I would argue that the Fed looks set on raising interest rates again in
June or July. And in China, credit growth contracted again in April. I believe
this indicates that economic reforms are gathering pace again.
As for
the real supply and demand of oil, you should have been asking yourselves two
questions throughout this rally: Shortages? What Shortages?
I'll deal
with the Fed, China, and today' crude supply position in more detail later on.
First of all, though, here is some historical context behind the role that
financial markets have played in determining the oil price over the last seven
years.
China, Jobs and
Economic Stimulus
I believe
that that the 2009-2014 rally in crude prices was driven by the fall in the
value of the US dollar, thanks to the Fed's ultra-low interest rate policies.
This forced hedge funds and pension funds etc. to seek an alternative 'store of
value'. This store of value was oil and other commodities.
What
seemed to justify this alternative store of value was China's parallel decision
to conduct the biggest economic stimulus programme in global economic history,
which cushioned the country from the impact of the Global Financial Crisis. It
was all about preserving jobs for the Chinese leadership of the time. They
didn't care about anything else, including the long term fundamentals of supply
and demand as overinvestment poured into manufacturing and real estate. To give
you an idea of the scale of what I am talking about, China increased lending by
$10 trillion in 2009, when its nominal GDP was only $5 trillion. Lending was an
astonishing $18 trillion higher by 2013.The long term economic benefits of this
extraordinary rise in credit didn't worry the financial speculators. Of course
not. It is not their job be worried about the long term. But other people who
should have known better, including CEOs of some chemicals companies, who
started talking about a 'new paradigm' of a rising middle class in China who
would very soon be as rich as the middle classes in the West. This not only
justified and underpinned the rallies in oil and commodity prices - but
crucially also added further momentum to the rallies.
As this
paradigm became the new consensus, the shale-oil industry took off in the US -
aided also by the availability of cheap financing thanks to the Fed's
interest-rate policies. Petrochemicals projects in the US, and elsewhere, were
also sanctioned on the theory that China - and emerging markets growth in
general - had entered this new paradigm.
It all
went very badly wrong from September 2014, when it became apparent that Chinese
economic stimulus had, after all, been unsustainable. Crude markets belatedly woke up to the notion
that China's stimulus had left behind vast domestic oversupply in manufacturing
and real, estate, and so a serious bad debt problem. The scale of China's environment crisis, made much worse by this overinvestment, was also
recognised.
What made
people wake up to these long-standing realities was that China's new political
leaders admitted the scale of the problems - and, more importantly, they
reversed course. They started reducing credit growth, and so the Chinese bubble
began to dramatically deflate. Credit growth began to decline from January
2014. And here is another extraordinary number: In 2015, growth in credit was
no less than $4 trillion lower than in 2014.
Back To The Future:
Q1 2016
After the
January 2016 collapse in oil prices and equity markets, the US Federal Reserve
got cold feet. It began to back away from further interest rate rises, on the
belief that weak crude and equities etc. meant that US economy was in too
perilous a condition to take that risk. This was the signal sent to the oil
speculators: The dollar was going to be weaker for longer than they had
expected, and so it was time to get back into crude as an alternative store of
value. This also led to recovery in other commodity markets, including iron ore.
What once
again added further momentum to the rally was China's decision to loosen
credit, which grewby some 58% in Q1
over the first quarter of 2015. The detail didn't matter here. All that
mattered to the crude-market speculators was the wider belief that China had,
somehow, turned the corner. The renewed economic stimulus created the erroneous
idea that China could spend its way out of trouble.
Now,
though, thanks to stronger US GDP growth and continued robust jobs growth, Fed
chairman Janet Yellen has indicated that two to three interest rate rises could,
be on the cards later this year - with the first hike possibly in June or July.
And in
China, credit growth fell in April. Total social financing plunged to 751 billion yuan during
month compared with 2.34 trillion yuan in March.
Any
sensible analyst would have told you that China's Q1 rise in lending was
unsustainable - and that, of course, it was a drop in the ocean compared with
the $4 trillion of credit withdrawn from the economy in 2015.
What told
you it was unsustainable was that this represented another example of a victory
for the short-term thinkers who in China, who prefer to prop-up immediate
growth rather than deal with the longer-term issues. But you also had to bet
that the reformers would reassert control - and, indeed, this has happened. In
this particular instance, local governments temporarily gained the
upper hand because of their struggle to cover their liabilities.
The end
result - and may have already seen early signs of this in the above chart -
could well be speculators switching back to the US dollar, as is strengthens -
away from their alternative stores of value.
Actual Supply And
Demand of Oil Itself
Last is
not meant to be least. Of course, this matters. But in all the noise created by
the speculators, the sound made by the data on physical production, storage and
demand can sometimes be impossible to hear.
Take last
year's oil-price rally as an example. Remember how we kept being told that the
US rig count was falling? This took Brent from $45.19/bbl in mid-January to
$69.63/bbl on 8 May.
Meanwhile,
US shale oil producers continued to push the innovation envelope on cost
reductions. Each rig in operation had also become much more productive. The practice of 'fracklogging' - storing oil in rocks ready to be fracked when
prices recovered - also increased. And thanks to stronger futures prices, the
shale oil industry was able to take out new hedges. This put them in the
position to be able to sell at lower prices in the physical market because they
had locked higher futures returns. Saudi Arabia also stuck with its market
share strategy, whilst the global economy remained weak. This all led to the
fall in oil prices during H2 2015.
The
physical justification for today's rally is on even more shaky ground.
We were
first told that there would be a production freeze agreement at the April Doha
meeting. I never believed that
this on the cards - and, of course, it didn't happen.
We did
then, however, see a dramatic decline in production as a result of wild fires
in Canada, attacks on Nigerian pipelines and more upheavals in Iraq. But I
think that this was seized upon by markets whilst they overlooked some signs of
long supply elsewhere. And, of course, this decline could well prove to be
temporary.
Signs of
long supply elsewhere includes oil in storage. Global oil stockpiles, including
floating storage, have increased for the last ten consecutive quarters,
according to this Hellenic Shipping News article, which adds:
It is estimated that almost 9% of the global VLCC fleet is
currently booked for floating storage, which is a 40% increase in tankers by
number since December. Reuters reported that at least 40 laden VLCCs anchored
off Singapore as floating storage, storing estimated volumes of up to 47.7m
bbl, thought to be the highest level in at least five years.
Crucially,
also the contango is narrowing. Last week, the one-month arbitrage on Brent in
floating storage was -$0.48/bbl, while the 12-month arbitrage was at
-$6.11/bbl, implying there was no profit incentive to store oil on ship.
Storage costs are a minimum of $0.74/bbl, and so there has to be a risk of
destocking.
Iran is
also raising production. By the summer its exports are expected to rise a
further 200,000 bbl/day to reach 2.2m bbl/day the middle of this summer.
And
nobody should be surprised over reports that the US rig count has stopped
declining, with early signs that the rig count may actually increase.The US is
the world's new 'swing producer'. The inventory of drilled but uncompleted US
wells has been building, driven by companies with contracted drilling
services. Ccompanies have merely postponed, rather than cancelled, completion
of wells. This could add 400,000 bbl/day to supply.
Let's not
forget yesterday's OPEC meeting. There was again, of course, no agreement to freeze, never mind cut, production.
As for
demand, the summer lull season in the northern hemisphere, when many people
take their holidays, is set to occur in August and July.
If this
market turns, those who want to short oil have plenty of physical ammunition to
support their positions.
John Richardson from ICIS
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Market Watch
Headline crude prices for the week beginning 9 September 2019 – Brent: US$61/b; WTI: US$56/b
Headlines of the week
Upstream
Midstream/Downstream
Natural Gas/LNG
Detailed market research and continuous tracking of market developments—as well as deep, on-the-ground expertise across the globe—informs our outlook on global gas and liquefied natural gas (LNG). We forecast gas demand and then use our infrastructure and contract models to forecast supply-and-demand balances, corresponding gas flows, and pricing implications to 2035.
Executive summaryThe past year saw the natural-gas market grow at its fastest rate in almost a decade, supported by booming domestic markets in China and the United States and an expanding global gas trade to serve Asian markets. While the pace of growth is set to slow, gas remains the fastest-growing fossil fuel and the only fossil fuel expected to grow beyond 2035.
Global gas: Demand expected to grow 0.9 percent per annum to 2035While we expect coal demand to peak before 2025 and oil demand to peak around 2033, gas demand will continue to grow until 2035, albeit at a slower rate than seen previously. The power-generation and industrial sectors in Asia and North America and the residential and commercial sectors in Southeast Asia, including China, will drive the expected gas-demand growth. Strong growth from these regions will more than offset the demand declines from the mature gas markets of Europe and Northeast Asia.
Gas supply to meet this demand will come mainly from Africa, China, Russia, and the shale-gas-rich United States. China will double its conventional gas production from 2018 to 2035. Gas production in Europe will decline rapidly.
LNG: Demand expected to grow 3.6 percent per annum to 2035, with market rebalancing expected in 2027–28We expect LNG demand to outpace overall gas demand as Asian markets rely on more distant supplies, Europe increases its gas-import dependence, and US producers seek overseas markets for their gas (both pipe and LNG). China will be a major driver of LNG-demand growth, as its domestic supply and pipeline flows will be insufficient to meet rising demand. Similarly, Bangladesh, Pakistan, and South Asia will rely on LNG to meet the growing demand to replace declining domestic supplies. We also expect Europe to increase LNG imports to help offset declining domestic supply.
Demand growth by the middle of next decade should balance the excess LNG capacity in the current market and planned capacity additions. We expect that further capacity growth of around 250 billion cubic meters will be necessary to meet demand to 2035.
With growing shale-gas production in the United States, the country is in a position to join Australia and Qatar as a top global LNG exporter. A number of competing US projects represent the long-run marginal LNG-supply capacity.
Key themes uncoveredOver the course of our analysis, we uncovered five key themes to watch for in the global gas market:
Challenges in a growing market
Gas looks the best bet of fossil fuels through the energy transition. Coal demand has already peaked while oil has a decade or so of slowing growth before electric vehicles start to make real inroads in transportation. Gas, blessed with lower carbon intensity and ample resource, is set for steady growth through 2040 on our base case projections.
LNG is surfing that wave. The LNG market will more than double in size to over 1000 bcm by 2040, a growth rate eclipsed only by renewables. A niche market not long ago, shipped LNG volumes will exceed global pipeline exports within six years.
The bullish prospects will buoy spirits as industry leaders meet at Gastech, LNG’s annual gathering – held, appropriately and for the first time, in Houston – September 17-19.Investors are scrambling to grab a piece of the action. We are witnessing a supply boom the scale of which the industry has never experienced before. Around US$240 billion will be spent between 2019 and 2025 on greenfield and brownfield LNG supply projects, backfill and finishing construction for those already underway.
50% to be added to global supplyIn total, these projects will bring another 182 mmtpa to market, adding 50% to global supply. Over 100 mmtpa is from the US alone, most of the rest from Qatar, Russia, Canada, and Mozambique. Still, more capital will be needed to meet demand growth beyond the mid-2020s. But the rapid growth also presents major challenges for sellers and buyers to adapt to changes in the market.
There is a risk of bottlenecks as this new supply arrives on the market. The industry will have to balance sizeable waves of fresh sales volumes with demand growing in fits and starts and across an array of disparate marketplaces – some mature, many fledglings, a good few in between.
India has built three new re-gas terminals, but imports are actually down in 2019. The pipeline network to get the gas to regional consumers has yet to be completed. Pakistan has a gas distribution network serving its northern industrial centres. But the main LNG import terminals are in the south of the country, and the commitment to invest in additional transmission lines taking gas north is fraught with political uncertainty.
China is still wrestling with third-party access and regulation of the pipeline business that is PetroChina’s core asset. Any delay could dull the growth rate in Asia’s LNG hotspot. Europe is at the early stages of replacing its rapidly depleting sources of indigenous piped gas with huge volumes of LNG imports delivered to the coast. Will Europe’s gas market adapt seamlessly to a growing reliance on LNG – especially when tested at extreme winter peaks? Time will tell.
The point-to-point business model that has served sellers (and buyers) so well over the last 60 years will be tested by market access and other factors. Buyers facing mounting competition in their domestic market will increasingly demand flexibility on volume and price, and contracts that are diverse in duration and indexation. These traditional suppliers risk leaving value, perhaps a lot of value, on the table.
In the future, sellers need to be more sophisticated. The full toolkit will have a portfolio of LNG, a mixture of equity and third-party contracted gas; a trading capability to optimise on volume and price; and the requisite logistics – access to physical capacity of ships and re-gas terminals to shift LNG to where it’s wanted. Enlightened producers have begun to move to an integrated model, better equipped to meet these demands and capture value through the chain. Pure traders will muscle in too.
Some integrated players will think big picture, LNG becoming central to an energy transition strategy. As Big Oil morphs into Big Energy, LNG will sit alongside a renewables and gas-fired power generation portfolio feeding all the way through to gas and electricity customers.
LNG trumps pipe exports...
...as the big suppliers crank up volumes