The days of cheap U.S. dollars will grow dimmer by the second half of 2010, a game-changer for oil producers and consumers alike, if ever there will be one.
A beleaguered U.S. dollar proved a boon to net importers of oil in 2009 as central banks slashed inter-bank lending rates overnight in an attempt to combat the worst financial and banking crises since the Great Depression (see “What next?”). Central banks will assuredly look to mop up excess levels of liquidity in 2010 as the global economy recovers.
While consumption in the mature OECD economies never rebounded in 2009 to the extent expected, newly industrialized countries such as China and India were more resilient, preventing demand from deteriorating at an even faster pace than the one seen in 2009.
U.S. product stocks fell a cumulative 50.11 million barrels to 721.69 million barrels in the fourth quarter, according to data from the Energy Information Administration (EIA), leaving inventories 30.52 million barrels above the five-year average and 30.05 million barrels above year-ago levels. That looks like a hefty surplus against the averages, but that compares to the start of the fourth quarter, when product stocks were 72.464 million barrels above the five-year average and 109.5 million barrels above the previous year.
For product stocks to draw throughout the fourth quarter is not unusual because it is the highest demand period of the year. But the highly anticipated revival in oil demand did not play out as the U.S. economy continued to limp along. The rapid-fire decline in U.S. product inventories was the result of refiners slashing output to offset the ravages of demand deterioration.
EIA projects total U.S. oil demand will average 18.70 million barrels per day for all of 2009, according to its November short-term energy outlook, an 800,000 barrels per day decline year-over-year, in line with the International Energy Agency estimate for the United States at 18.72 million, a drop of 780,000 from 2008 (see “Higher demand, but how much?”).
DEMAND OUTLOOK
From there the two agencies diverge on where oil demand is headed in 2010.
EIA expects U.S. oil demand to average 18.97 million barrels per day in 2010, a 270,000 barrels per day increase year-over-year, while IEA in its December monthly oil report estimated U.S. oil demand at 18.86 million barrels for 2010, which would be an increase of 140,000 barrels.
More glaring were the two agencies’ estimates for total global oil demand. EIA expects total world oil consumption of 84.12 million barrels per day in 2009, a decline of 1.66 million year-over-year, while the IEA projection of 84.86 million for 2009 would be a drop of 1.36 million from 2008.
The contrasts in the two agencies’ projections for 2010 are even more divergent, as was the case in 2008. EIA estimates that total world oil consumption in 2010 will be 85.22 million barrels, an increase of 1.1 million year-over-year, while IEA expects global demand to average 86.33 million barrels, which would be an increase of 1.47 million in 2010. The two sets of demand projections diverge by 1.11 million barrels per day for 2010. IEA’s higher demand estimates seem predicated upon greater consumption growth in the non-OECD regions.
Chinese oil consumption in the first 11 months of 2009 was 7.79 million barrels, 4.1% higher than the same period in 2008, according to Platts’ estimates. But even if this rate of oil consumption fell far short of IEA and EIA estimates for 2009, IEA projected Chinese oil demand for 2009 to average 8.4 million while EIA was anticipating 8.21 million.
That global demand fell short of estimates for 2009 suggests the same may be true for 2010 given that mature economies are expected to rebound, but the recovery is expected by economists to be shallow and joblessness will likely remain a serious deterrent to any pick-up in oil demand.
WILL SUPPLY KEEP UP?
While the highly touted revival in global oil demand never materialized, at least in the United States, which still accounts for about 23% of total world consumption, non-OPEC supply surprised to the upside in 2009, a trend that is likely to continue in 2010.
Both U.S. and Russian production far outstripped forecasts and the surprise supply story became apparent late in 2009.
U.S. production is poised to post a 6.4% increase in 2009 and appears set to do so for at least the next several years with the primary driver being output in the Gulf of Mexico. Through October 2009, U.S. oil production averaged 5.268 million barrels per day, the highest level of output since 2004. In percentage terms, 2009 would be the largest increase in U.S. oil production since 1970, according to Platts’ estimates.
Russia’s crude oil production totaled 9.88 million barrels per day (b/d) in 2009, a 1.3% increase year-on-year, preliminary data by the energy ministry’s Central Dispatching Unit showed Jan. 2, 2010. In December, Russian crude output jumped 4% on the year to 10.01 million, after achieving record highs in the previous four months.
EIA is projecting OPEC supply to increase 1.07 million b/d to 35.05 million b/d in 2010 in response to an expected rebound in demand, but output is always readily adjusted by the producing group in response to the global economy, prices and shifts in stocks. OPEC signaled at its final meeting of 2009 that prices between $70-$80/barrel were, acceptable, but that too could change if the dollar appreciates as is expected. A stronger dollar would make lower oil prices acceptable since terms of trade would be more favorable for oil producers.
GASOLINE & DISTILLATES
A stronger U.S. dollar will arrest deteriorating terms of trade for oil producers, while dampening demand for net petroleum importers. While traders can’t rule out a run at the $90 per barrel level as demand starts to recover in the mature OECD economies, a recovery in the greenback will temper rallies in global oil markets (see “The biggest fundamental”).
More importantly, and key to gasoline demand, will be high levels of unemployment that are likely to persist throughout 2010. While the pace of job losses in the United States slowed by the end of 2009, America had yet to see job creation. The same was true in the UK, Europe and Japan.
Gasoline demand may be held in check by high levels of unemployment, while refiners have attempted to manage inventories by slashing output of product to prevent a run-up in oil stocks. The inventory overhang that was evident by the third quarter of 2009 started to erode by the end of the year as a result of lower refiner output. This has put a floor in prices, but does not necessarily portend run-away product markets in 2010.
Should refiners keep output levels of gasoline low through the first two quarters of 2010, prices for the front-month RBOB contract on Nymex could see a pop to the $2.54 per gallon level, or the 61.8% retracement of the move to 78.50¢ from a record-setting $3.631 seen in 2008. Low output combined with a recovery in demand would be the perfect combination for higher gasoline prices, but again, high levels of unemployment are apt to temper consumers’ discretionary spending habits.
The more daunting inventory overhang still resides in middle distillates, diesel and heating oil, the victim of a slowdown in global trade and a lack of trucking and rail traffic as consumption fell off a cliff — a recession-induced occurrence. But an abnormally cold winter in the Northern hemisphere put a floor in the price of heating oil and gas oil, as inventories suddenly started to erode at a fast pace. Between the uptick in demand for winter fuels and low refiner output, prices are not apt to undergo a violent pullback. But the window for winter fuels demand continues to narrow, leaving shifts in diesel consumption as the primary driver of middle distillate prices.
Prices are also not likely to spike given swollen diesel inventories, where most of the surplus resides.
NATURAL GAS OUTLOOK
Like heating oil, natural gas started 2010 spiking as the United States was battered by arctic-like temperatures and snow storms. Neither heating oil nor natural gas were in short supply, suggesting the price spikes were a knee-jerk reaction to weather rather than an objective analysis of fundamentals.
U.S. working gas in storage at 3.123 trillion cubic feet was 10.1% above year-ago levels and 1.3% above the five-year average the week ending Jan. 1, 2010, according to data from EIA. U.S. working gas in storage was at the upper end of its five-year average at the start of 2010. Given the amount of working gas in storage, prices for the front-month natural gas futures contract on Nymex are more likely to drift back towards $5 per mmBtu rather than spiking back above $6, especially with forecasts calling for a moderation in temperatures. As demand for winter fuels wanes, the natural gas market will be at the mercy of hurricane season. The 2009 hurricane season was the mildest since 1997, according to the National Oceanic Atmospheric Administration, whose 2010 forecast will not be released until May.
WILD CARDS
Weather is always a wild card for both natural gas and oil markets. But oil markets are global and several wild cards could play out in 2010.
• The ongoing face-off between western nations and Iran over the Islamic Republic’s plutonium enrichment program could push geopolitics back to the forefront of oil market concerns.
• Russia’s potential erosion of OPEC’s oil market share could set the two entities up for a quiet supply dispute.
• A more robust recovery by mature economies and the resultant pick-up in demand could cause oil prices to spike higher, although the current level of spare global production capacity makes that the least likely scenario.
An ongoing sluggish recovery could keep central banks, the U.S. in particular, from raising rates, leaving the dollar vulnerable to another bear attack, while pushing all commodity prices higher.
All these factors need to be considered because whether it is geopolitics, weather or Federal Reserve machinations — as we have learned over the last two years — any of these wild cards can trump traditional fundamentals when it comes to energy prices.
Linda Rafield is a senior oil analyst at Platts and editor of the weekly publication “The Futures and Derivatives Review.” For more information on the weekly publication go to www.platts.com.
