Quote of the Day
They can conquer who believe they can.
Ralph Waldo Emerson
The rally in oil prices that began last week continued for yet another day. The macro correlation trade is alive and well as just about all major risk asset markets added value today. On top of the normal movement from the macro trade oil prices were boosted from the crude oil unit fire at the Chevron refinery on the West Coast. Better than expected corporate earnings gave equities a bit of a spurt even after the negative macroeconomic data out of Europe...in particular out of Germany... the main economic growth engine of the EU. In addition the market is still expecting a bold move by the ECB over the next month or so as well as the possibility of more quantitative easing from the US Fed if the US economy continues to contract.
Today the EIA released their latest STEO report. Following are the main highlights relate to oil from the report.
EIA expects global liquid fuels consumption growth of about 0.8 million bbl/d in 2012 and 0.9 million bbl/d in 2013. Despite downside risks to global oil demand, the spot price for Brent crude climbed back above $100 per barrel in July after prices sank below $90 per barrel in June. Markets have rallied around expectations that policymakers in the European Union (EU), China, and the United States will provide more economic stimulus to counteract slowing growth. Additionally, Iran's threats to block oil from transiting through the Strait of Hormuz have triggered market anxiety and prompted upward price pressure. Although angst over global growth and supply disruptions may continue to contribute to price volatility, EIA believes that Brent crude oil, a benchmark for the global oil price, will average $104 per barrel for the third quarter of 2012. EIA estimates that world liquids consumption will outpace production by 0.9 million bb/d in the third quarter, as world demand reaches its seasonal peak. EIA expects that the significant stock builds that occurred in the first half of 2012 will help relieve global oil markets in the second half of 2012.
Several upside and downside risks could move prices higher or lower than projected. The possibility that the economic situation in EU countries could deteriorate further poses a downside risk to global oil demand and prices, though oil prices will likely rise and fall as perceptions about the likelihood of a deeper crisis evolve. In the current Outlook, consumption in Europe is expected to fall year-over-year by 0.4 million bbl/d in 2012 and by a further 0.2 million bbl/d in 2013. The possibility of slower growth in China, which has been a key driver of increased oil demand in recent years, could also curb demand. China's weakening exports, particularly to Europe, and slower industrial and domestic growth experienced in the first half of 2012 could place downward pressure on oil prices, while prospects for more economic stimulus could swing the pendulum towards higher prices. EIA currently projects annual increases in consumption in China of around 0.4 million bbl/d in both 2012 and 2013. On the supply side, oil prices could be higher than projected in this Outlook if recoveries from supply disruptions are slower than forecast, additional disruptions occur, or supply growth is lower than expected.
World liquid fuels consumption grew by an estimated 0.8 million bbl/d in 2011. EIA expects consumption growth of 0.8 million bbl/d in 2012 and 0.9 million bb/d in 2013, with China, the Middle East, Central and South America, and other countries outside of the Organization for Economic Cooperation and Development (OECD) accounting for essentially all consumption growth. Projected OECD liquid fuels consumption declines by 0.4 million bbl/d in 2012 and by a lesser 0.1 million bbd/d in 2013, buoyed by growth in liquid fuels consumption in the United States.
In the third quarter of 2012, world demand will reach its seasonal peak, reflecting both the U.S. driving season and increased oil use for electricity generation in the Middle East. Projected consumption exceeds production by 0.9 million bbl/d, leading to global stock draws. Given overall lower demand expectations, the impact of seasonality on the tightness of global oil markets is expected to be less than in 2010 or 2011, when third-quarter consumption outpaced production by 1.1 million bbl/d and 1.7 million bbl/d, respectively.
EIA expects that OPEC members will continue to produce more than 30 million bbl/d of crude oil over the next two years to accommodate the projected increase in world oil consumption and to counterbalance supply disruptions. Projected OPEC crude oil production increases by about 0.9 million bbl/d in 2012 and then remains flat in 2013 as non-OPEC supply growth increases and stocks rise slightly. OPEC non-crude oil liquids (condensates, natural gas liquids, and gas-to-liquids), which are not covered by OPEC's production quotas, averaged 5.3 million bbl/d in 2011 and are forecast to increase by 0.3 million bbl/d in 2012 and by 0.2 million bbl/d in 2013.
EIA expects Iran's crude oil production to fall by about 1 million bbl/d by the end of 2012 relative to an estimated output level of 3.6 million bbl/d at the end of 2011, and by an additional 200 thousand bbl/d in 2013. Iran's output decline has continued to accelerate since the fourth quarter of 2011. EIA believes that this acceleration reflects erosion in Iran's crude oil production capacity due to the country's inability to carry out investment projects that are necessary to offset the natural decline in production from existing wells, as well as the impact of lower Iranian crude oil exports due to recently enforced EU and U.S. sanctions. A number of foreign companies that were investing in Iran's upstream have halted their activities as a result of previous U.S. sanctions, which have been compounded by tighter measures enforced since the start of this year that have made it increasingly difficult to do business with the country. EIA expects that the forecast decline in Iran's output will be offset by increased production from other OPEC member countries.
The impacts of newly imposed EU and U.S. sanctions on supplies and exports of Iranian oil are not easily extricated from the effects of sanctions enacted in previous years, the more general decline in Iran's production capacity, and other oil market developments. Undoubtedly, the EU embargo eliminates a significant market for Iranian oil. U.S. financial sanctions and EU insurance provisions have also impeded other countries' transactions for Iranian oil, leading to reports that Iran's ability to produce oil has outstripped its ability to sell it. Until recently, Iran could react to lower demand for its oil by adjusting the amount of oil it uses domestically or holds in onshore and offshore storage, in order to temporarily maintain relatively normal, albeit declining, levels of production. EIA estimates that Iranian production continued to fall in July as production capacity continues to be affected by country's inability to carry out investment projects that are necessary to offset the natural decline in production from existing wells, as well as the impact of lower Iranian crude oil exports and possibly production shut-ins. EIA bases this assessment on preliminary commercial data on tanker liftings from Iran, press reports, official Iranian statements, and other relevant information. However, this tentative interpretation of a very fluid situation could change as data are revised, independent estimates of Iranian production are issued, and more details about Iranian storage levels, refinery utilization, and domestic consumption emerge.
Iran's threat to block oil shipments passing through the Strait of Hormuz is a potential risk to global supply. Hormuz is the world's most important oil chokepoint, which EIA defines as a narrow channel along widely used global sea routes. EIA estimates that about 17 million bbl/d passed through Hormuz in 2011, or roughly 35 percent of all seaborne traded oil. In response to the threat, Saudi Arabia and the United Arab Emirates (UAE) have recently increased their oil pipeline capacity to circumvent Hormuz. The UAE constructed the 1.5 million bbl/d Abu Dhabi Crude Oil Pipeline that runs from Habshan, a collection point for Abu Dhabi's onshore oil fields, to the port of Fujairah on the Gulf of Oman, allowing crude oil shipments to bypass Hormuz. However, the UAE currently does not have the ability to utilize the pipeline completely until it ramps to full capacity. Saudi Arabia recently converted a natural gas pipeline back to an oil pipeline. The pipeline is a part of a two-pipeline system called Petroline, or the East-West Pipeline, which runs across Saudi Arabia to the Red Sea, avoiding Hormuz. Despite the increased capacity, most potential bypass options in the Gulf are currently not operational and would require extensive renovations. EIA estimates that the available pipeline capacity to bypass Hormuz, which is not currently utilized, was 1 million b/d at the start of 2012 and could potentially increase to 4.3 million b/d by the end of this year.
OPEC members serve as the swing producers in the world market because only OPEC producers possess surplus or spare oil production capacity, most of which is in Saudi Arabia. EIA projects that OPEC surplus production capacity will average 2.3 million bbl/d in 2012 and rise to an average 2.6 million bbl/d in 2013.
EIA estimates that OECD commercial oil inventories ended 2011 at 2.59 billion barrels, equivalent to 56 days of forward-cover. Projected OECD oil inventories increase to 2.62 billion barrels and 57 days of forward-cover by the end of 2012, which is among the highest end-of-year levels in the last decade, because of the decline in OECD consumption.
Although there are now two tropical storms working at the moment the closest one... Ernesto does not look like it will be heading into the oil and Nat Gas rich portion of the US Gulf of Mexico while the other.... Florence looks like it may be on a path that takes it into the North Atlantic. Ernesto is now projected to move into southern Mexico and weaken to a depression over the upcoming weekend. Florence has already weakened and has been downgraded to a Tropical Depression and is projected to remain just a depression for the next five days as it moves more toward the north Atlantic. As it looks at the moment neither of these storms will wind up in the oil and Nat Gas rich area of the US Gulf of Mexico at this point in time. As I said last week the tropics now must be on everyone's radar and monitored on a daily basis.
The API report showed another surprisingly large draw in crude oil stocks but with builds in both gasoline and distillate fuel stocks. The API reported a draw (of about 5.4 million barrels) in crude oil stocks versus an expectation for a smaller draw as crude oil imports increased and refinery run rates decreased modestly by 0.5%. The API reported a strong build in distillate stocks. They also reported a small build in gasoline stocks versus an expectation for a modest build in gasoline inventories.
The report is mixed. The market has not reacted modestly in after hours trading with prices modestly higher ahead of the EIA oil inventory report at 10:30 AM today. The market is always cautious on trading on the API report and prefers to wait for the more widely watched EIA report due out this morning at 10:30 AM. The API reported a draw of about 5.4 million barrels of crude oil with a draw of 0.8 million barrels in Cushing, Ok and a 2.2 million barrel draw in PADD 2 which is bearish for the Brent/WTI spread. On the week gasoline stocks increased by about 0.4 million barrels while distillate fuel stocks increased by about 2.4 million barrels.
At the moment oil prices are still being mostly driven by the events discussed above along with the direction of the euro and the US dollar as well as by a view that the global economy is continuing to slow and one or two of the major central banks will come to the rescue. The tensions evolving in the Middle East between Iran and the West seem to be in the background for today. However, with the low level of trading activity and light economic calendar we may see a more pronounced reaction from market participants to this week's round of oil inventory data even thought the macro risk of the markets is still the main concern of all market players. This week's oil inventory report will likely be a primary price catalyst especially if the actual outcome is significantly different from the market projections.
My projections for this week’s inventory report are summarized in the following table. I am expecting the US refining sector to continue its campaign of converting a portion of the surplus crude that has been building for the last several months into refined products... in particular gasoline and distillate fuels whose inventories have been in decline. I am expecting a modest draw in crude oil inventories and a build in both gasoline and distillate fuel stocks even as the heart of the summer driving season is still in full play. I am expecting crude oil stocks to decrease by about 1.5 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 22.3 million barrels while the overhang versus the five year average for the same week will come in around 33.3 million barrels.
I am also expecting a modest draw in crude oil stocks in Cushing, Ok as the Seaway pipeline is now pumping and refinery run rates are continuing at high levels in that region of the US. This would be bearish for the Brent/WTI spread in the short term which is now trading around the $17.50/bbl premium to Brent level. I am still of the view that the spread will continue the process of normalization over the next 6 months.
With refinery runs expected to increase by 0.5% I am expecting a small build in gasoline stocks. Gasoline stocks are expected to increase by 1.0 million barrels which would result in the gasoline year over year deficit coming in around 4.7 million barrels while the deficit versus the five year average for the same week will come in around 3.4 million barrels.
Distillate fuel is projected to increase by 1.3 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 26 million barrels below last year while the deficit versus the five year average will come in around 24 million barrels. Exports of distillate fuel have been the main storyline this year with exports running around 1 million bpd.
The following table compares my projections for this week's report (for the categories I am making projections) with the change in inventories for the same period last year. As you can see from the table last year's inventories are mostly in the same direction as the projections. As such if the actual data is in line with the projections there will only be a modest change in the year over year comparisons for most of the complex.
I still think the oil price is overvalued and now with no action from either of the central banks this week I am downgrading my view back to neutral for oil. WTI is currently in a $85 to $95/bbl trading range while Brent is still in the $100 to $110 trading range. There are a lot of dynamics that will impact oil prices in the short term and the ranking of the price drivers are fluid and very susceptible to changing. The only constant for oil prices in the short term is above normal levels of volatility.
I am maintaining my view at cautiously bearish as it is starting to look like the hot weather alone will not be enough to keep the weekly injections underperforming at the same low level as over the last several months. In addition the level of nuke outages is about the same as last year.
Currently markets are mostly higher heading into Asian trading as shown in the following table.
Best regards,
Dominick A. Chirichella
