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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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The 9th edition of the Abu Dhabi International Petroleum Exhibition and Conference (ADIPEC) Awards, hosted by the Abu Dhabi National Oil Company (ADNOC), is now open for submissions.
In this fourth industrial age it is technology, innovation, environmental leadership and talented workforces that are shaping the companies of the future.
Oil and gas is set to play a pivotal role in driving technology forward, and at this year’s ADIPEC Awards emphasis is placed on digitalisation, research, transformation, diversity, youth and social contribution, paving the way towards a brighter tomorrow for our industry.
Hosting the ADIPEC Awards is one of the world’s leading energy producers, ADNOC, a company exploring new, agile and flexible ways to build its people, technology, environmental leadership and partnerships, while enhancing the role of the United Arab Emirates as a global energy provider.
Factors which will have a prominent influence on the eventual decisions of the distinguished panel of jury members include industry impact, sustainability, innovation and value creation. Jury members have been carefully selected according to their expertise and knowledge, and include senior representatives from Baker Hughes, a GE Company, BP UAE, CEPSA Middle East, ENI Spa, Mubadala Petroleum, Shell, Total and Weatherford.
Chairperson of the awards is Fatema Al Nuaimi, Acting CEO of ADNOC LNG, who says: “At a time when the industry is looking towards an extremely exciting future and preparing for Oil &Gas 4.0, the awards will recognise excellence across all its sectors and reward those who are paving the way towards a successful and sustainable future.”
Ms Al Nuaimi, continues: “we call upon our partners across the globe to submit their achievements in projects and partnerships which are at the helm of technical and digital breakthroughs, as well as to nominate the next generation of oil and gas technical professionals, who will spearhead the ongoing transformation of the industry.
These awards are recognising the successes of those companies and individuals who are responding in the most innovative and creative manner to the global economic and technological trends. Their contribution is pivotal to the development of our industry and to addressing the continuous growth of the global energy demand. “
Christopher Hudson, President of the Energy Division, dmg events, organisers of ADIPEC, says: “With ADNOC as the host and ADIPEC as the platform for the programme, the awards are at the heart of the worldwide oil and gas community. With its audience of government ministers, international and national oil companies, CEOs and other top global industry influencers, the ADIPEC Awards provide the global oil and gas community the perfect opportunity to engage, inspire and influence the workforce of the future.”
Entries can be submitted until Monday 29th July for the following categories:
Breakthrough Technological Project of the Year
Breakthrough Research of the Year
Digital Transformation Project of the Year
Social Contribution and Local Content Project of the Year
Oil and Gas Inclusion and Diversity Company of the Year
Young ADIPEC Technical Professional of the Year
A shortlist of entries will be announced in October and winners will be revealed on the first day of ADIPEC 2019, Monday 11th November, St. Regis Saadiyat Island, Abu Dhabi.
ABOUT ADIPEC
Held under the patronage of the President of the United Arab Emirates, His Highness Sheikh Khalifa Bin Zayed Al Nahyan, and organised by the Global Energy Division of dmg events, the Abu Dhabi Petroleum International Petroleum Exhibition and Conference (ADIPEC) is the global meeting point for oil and gas professionals. Standing as one of the world’s leading oil and gas events. ADIPEC is a knowledge-sharing platform that enables industry experts to exchange ideas and information that shape the future of the energy sector. The 22nd edition of ADIPEC will take place from 11th-14th November 2019, at the Abu Dhabi National Exhibition Centre (ADNEC). ADIPEC 2019 will be hosted by the Abu Dhabi National Oil Company (ADNOC) and supported by the UAE Ministry of Energy & Industry, Department of Transport in Abu Dhabi, the Abu Dhabi Chamber of Commerce and Industry, Masdar, the Abu Dhabi Future Energy Company, Department of Culture and Tourism - Abu Dhabi, the Abu Dhabi Department of Education and Knowledge (ADEK). dmg events is committed to helping the growing international energy community.
Source: U.S. Energy Information Administration, based on World Input-Output Database
Note: Dollar values are expressed in 2010 U.S. dollars, converted based on purchasing power parity.
The industrial sector of the worldwide economy consumed more than half (55%) of all delivered energy in 2018, according to the International Energy Agency. Within the industrial sector, the chemicals industry is one of the largest energy users, accounting for 12% of global industrial energy use. Energy—whether purchased or produced onsite at plants—is very important to the chemicals industry, and it links the chemical industry to many parts of the energy supply chain including utilities, mines, and other energy product manufacturers.
The chemicals industry is often divided into two major categories: basic chemicals and other chemicals. Basic chemicals are chemicals that are the essential building blocks for other products. These include raw material gases, pigments, fertilizers, plastics, and rubber. Basic chemicals are sometimes called bulk chemicals or commodity chemicals because they are produced in large amounts and have relatively low prices. Other chemicals—sometimes called fine or specialty chemicals—require less energy to produce and sell for much higher prices. The category of other chemicals includes medicines, soaps, and paints.
The chemicals industry uses energy products such as natural gas for both heat and feedstock. Basic chemicals are often made in large factories that use a variety of energy sources to produce heat, much of which is for steam, and for equipment, such as pumps. The largest feedstock use is for producing petrochemicals, which can use oil-based or natural-gas-based feedstocks.
In terms of value, households are the largest users of chemicals because they use higher value chemicals, which are often chemicals that help to improve standards of living, such as medicines or sanitation products. Chemicals are also often intermediate goods—materials used in the production of other products, such as rubber and plastic products manufacturing, agricultural production, construction, and textiles and apparel making.
Source: U.S. Energy Information Administration, WEPS+, August 2018
Note: Dollar values are expressed in 2010 U.S. dollars, converted based on purchasing power parity.
The energy intensity of the basic chemicals industry, or energy consumed per unit of output, is relatively high compared with other industries. However, the energy intensity of the basic chemicals industry varies widely by region, largely based on the chemicals a region produces. According to EIA’s International Energy Outlook 2018, Russia had the most energy-intensive basic chemicals industry in 2015, with an average energy intensity of approximately 98,000 British thermal units (Btu) per dollar, followed by Canada with an average intensity of 68,000 Btu/dollar.
The Russian and Canadian basic chemicals industries are led by fertilizers and petrochemicals. Petrochemicals and fertilizers are the most energy intensive basic chemicals, all of which rely on energy for breaking chemical bonds and affecting the recombination of molecules to create the intended chemical output. These countries produce these specific basic chemicals in part because they also produce the natural resources needed as inputs, such as potash, oil, and natural gas.
By comparison, the energy intensity of the U.S. basic chemical industry in 2015 was much lower, at 22,000 Btu/dollar, because the industry in the United States has a more diverse production mix of other basic chemicals, such as gases and synthetic fibers. However, EIA expects that increasing petrochemical development in the United States will increase the energy intensity of the U.S. basic chemicals industry.
The United States exports chemicals worldwide, with the largest flows to Mexico, Canada, and China. According to the World Input-Output Database, U.S. exports of all chemicals in 2014 were valued at $118 billion—about 6% of total U.S. exports—the highest level in decades.
The threat of military action in the Middle East has gotten more intense this week. After several attacks on tankers that could be plausibly denied, Iran has made its first direct attack on a US asset, shooting down an unmanned US drone. The Americans say the drone was in international waters, while Iran claims that it had entered Iranian air space. Reports emerging out of the White House state the US President Donald Trump had authorised a military strike in response, but pulled back at the last minute. The simmering tensions between the two countries are now reaching boiling point, with Iran declaring that it is ‘ready for war’.
Predictably, crude oil prices spiked on the news. Brent and WTI prices rose by almost US$4/b over worries that a full-blown war will threaten global supplies. That this is happening just ahead of the OPEC meeting in Vienna – which was delayed by a week over internal squabbling over dates – places a lot of volatile cards on the table. Far more than more than surging US production, this stand-off will colour the direction of the crude market for the rest of 2019.
It started with an economic war, as the Trump administration placed increasingly tight sanctions on Iran. Financial sanctions came first, then sanctions on crude oil exports from Iran. But the situation was diffused when the US introduced waivers for 8 major importers of Iranian crude in November 2018, calming the markets. Even when the waivers were not renewed in April, the oil markets were still relatively calm, banking on the fact that Iran’s fellow OPEC countries would step in to the fill the gap. Most of Iran’s main clients – like South Korea, Japan and China – had already begun winding down their purchases in March, reportedly causing Iran’s crude exports to fall from 2 mmb/d to 400 kb/d. And just recently, the US also begun targeting Iranian petrochemical exports. Between a rock and a hard place, Iran looks seems forced to make good on its threats to go to war in the strategic Straits of Hormuz.
As the waivers ended, four tankers were attacked off the coast of Fujairah in the UAE in May. The immediate assumption was that these attacks were backed by Iran. Then, just a week ago, another two tankers were attacked, with the Americans showing video evidence reportedly show Iranian agents removing mines. But still, there was no direct connection to Iran for the attacks, even as the US and Iran traded diplomatic barbs. But the downing of the drone is unequivocally the work of the Iranian military. With President Donald Trump reportedly ‘bored’ of attempting regime change in Venezuela and his ultra-hawkish staff Mike Pompeo and John Bolton in the driver’s seat, military confrontation now seems inevitable.
This, predictably, has the oil world very nervous. Not just because the extension of the current OPEC+ deal could be scuppered, but because war will impact more than just Iranian oil. The safety of the Straits of Hormuz is in jeopardy, a key node in global oil supply through which almost 20 mmb/d of oil from Iraq, Saudi Arabia, Kuwait and the UAE flows along with LNG exports from the current world’s largest producer, Qatar. At its narrowest, the chokepoint in the Straits is just 50km from Iranian land. Crude exports could be routed south to Red Sea and the Gulf of Aden, but there is risk there too; the mouth of the Red Sea is where Iranian-backed Yemeni rebels are active, who have already started attacking Saudi land facilities.
This will add a considerable war risk premium to global crude prices, just as it did during the 1990 Gulf War and the 2003 invasion of Iraq. But more than just prices, the destabilising effects of a war could consume more than just the price of a barrel. If things are heading the way the current war-like signs are heading, then the oil world is in for a very major change very soon.
Historical crude price responses to wars in the Middle East