Brent surrendered all the gains it had made since the last week of December in just five days of financial markets mayhem that began February 2. The pullback in WTI was a touch milder, with the US benchmark retracing to levels seen at the start of January. The spread between Brent and WTI continued to shrink.
While the major stock market indexes Dow Jones Industrial Average and S&P 500 were in correction territory — defined as a decline of 10% or more from a 52-week high —crude was lagging.
The Brent and WTI futures curves also remained firmly in backwardation, a sign of tightly balanced markets.
Inflation and high interest rates, the current bugbears of investors, have a direct bearing on equity and currency markets. Their connection with oil, however, is far more circuitous.
Fears of accelerating inflation, initially triggered by a better-than-expected US January wage growth report released on February 2, prompted the market to assume that central banks on either side of the Atlantic will raise interest rates by more than what had been previously factored in. That would mean higher borrowing costs for the corporate world, which is bearish for equities.
The week-long global stock markets rout dragged industrial commodities along with it, including oil. A recovering US dollar and short-term supply fundamentals also pressured crude prices down, but the financial markets were the single biggest influence.
The crude market will need time to assess the implications of inflation becoming a headwind for global economic growth and thus potentially a drag on oil demand. It would then need to connect the dots between the extent of that drag and the pace of the global oil market rebalancing. A rational assessment and a reconnection with the oil market fundamentals can only happen after the storm in the financial markets abates.
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Headline crude prices for the week beginning 11 November 2019 – Brent: US$62/b; WTI: US$56/b
Headlines of the week
The year’s final upstream auctions were touted as a potential bonanza for Brazil, with pre-auction estimates suggesting that up to US$50 billion could be raised for some deliciously-promising blocks. The Financial Times expected it to be the ‘largest oil bidding round in history’. The previous auction – held in October – was a success, attracting attention from supermajors and new entrants, including Malaysia’s Petronas. Instead, the final two auctions in November were a complete flop, with only three of the nine major blocks awarded.
What happened? What happened to the appetite displayed by international players such as ExxonMobil, Shell, Chevron, Total and BP in October? The fields on offer are certainly tempting, located in the prolific pre-salt basin and including prized assets such as the Buzios, Itapu, Sepia and Atapu fields. Collectively, the fields could contain as much as 15 billion barrels of crude oil. Time-to-market is also shorter; much of the heavy work has already been done by Petrobras during the period where it was the only firm allowed to develop Brazil’s domestic pre-salt fields. But a series of corruption scandals and a new government has necessitated a widening of that ambition, by bringing in foreign expertise and, more crucially, foreign money. But the fields won’t come cheap. In addition to signing bonuses to be paid to the Brazilian state ranging from US$331 million to US$17 billion by field, compensation will need to be paid to Petrobras. The auction isn’t a traditional one, but a Transfer of Rights sale covering existing in-development and producing fields.
And therein lies the problem. The massive upfront cost of entry comes at a time when crude oil prices are moderating and the future outlook of the market is uncertain, with risks of trade wars, economic downturns and a move towards clean energy. The fact that the compensation to be paid to Petrobras would be negotiated post-auction was another blow, as was the fact that the auction revolved around competing on the level of profit oil offered to the Brazilian government. Prior to the auction itself, this arrangement was criticised as overtly complicated and ‘awful’, with Petrobras still retaining the right of first refusal to operate any pre-salt fields A simple concession model was suggested as a better alternative, and the stunning rebuke by international oil firms at the auction is testament to that. The message is clear. If Brazil wants to open up for business, it needs to leave behind its legacy of nationalisation and protectionism centring around Petrobras. In an ironic twist, the only fields that were awarded went to Petrobras-led consortiums – essentially keeping it in the family.
There were signs that it was going to end up this way. ExxonMobil – so enthusiastic in the October auction – pulled out of partnering with Petrobras for Buzios, balking at the high price tag despite the field currently producing at 400,000 b/d. But the full-scale of the reticence revealed flaws in Brazil’s plans, with state officials admitting to being ‘stunned’ by the lack of participation. Comments seem to suggest that Brazil will now re-assess how it will offer the fields when they go up for sale again next year, promising to take into account the reasons that scared international majors off in the first place. Some US$17 billion was raised through the two days of auction – not an insignificant amount but a far cry from the US$50 billion expected. The oil is there. Enough oil to vault Brazil’s production from 3 mmb/d to 7 mmb/d by 2030. All Brazil needs to do now is create a better offer to tempt the interested parties.
Results of Brazil’s November upstream auctions:
Global liquid fuels
Electricity, coal, renewables, and emissions