Sharp volatility continues to permeate through the oil markets. Crude prices were bolstered by a weakening US dollar and a conditional agreement between the world’s top two producers and exporters – OPEC’s Saudi Arabia and non-OPEC Russia – to freeze production levels. The global deal aims to slash expanding oversupply and in turn stimulate a price hike, after prices have slumped at their lowest for over a decade, with NYMEX WTI and ICE Brent contracts trading below US$35. Although the agreement is unprecedented in the sense it has been over 15 years since there was a global oil deal, there are doubts over its tangible impact.
First, the agreement threatens to be undermined by signatories ‘cheating’ the production freeze. Indeed, Saudi Arabia, Russia, Nigeria, Venezuela and Iraq, for example, are under immense pressure to ‘balance the books’ through crude exports and - unless the agreement is unanimously adopted - it would be little surprise if the imposed restrictions were flaunted.
Second, and perhaps more concerning is the fact the deal is subject to other powers joining in. This is a major stumbling block considering Iran’s fractious relationship with rival Saudi Arabia and ambition to re-establish itself as a central crude exporter after a number of years in the cold due to global trade sanctions over its nuclear program.
Finally, the ability of the deal to achieve its overarching goal – stimulating a crude price lift, remains debatable. Freezing production levels – effectively at historically high levels – will not ease the overhanging supply and with the global economic outlook appearing gloomy, it is understandable that the ‘impact’ of this deal may be more symbolic than hardened by fact or action.
Iran and crude quality balance: Iranian output could rise by 0.3-0.4 million tonnes per million barrels a day (mb/d) this year, mostly medium-sour and heavy crude, which will be welcomed by both India and China. Light/sweet crude production this year will be significantly impacted with flat to declining US Light Tight Oil (LTO) production, while medium/heavy-sour crude supply grows globally.
"Sweet-sour crude differential are likely to widen, putting sweet refiners under pressure."
Products and refining: Structural diesel demand in Europe has fallen sharply following the Volkswagen debacle. Gasoline demand remains very robust with demand from Asia, US and the Middle East. Yield switching in favour of gasoline is occurring earlier than expected and will continue to increase as the summer driving season approaches. After some 16 months of a healthy ride, refining margins have softened. Global demand growth is unlikely to be able to absorb the surplus in product stocks.
"An estimated 1.2-1.4 mb/d of new refining capacity is expected in 2016 which will keep margins abated below last year’s highs. Margins may still be supported on crude weakness and further closures.An estimated 1.2-1.4 mb/d of new refining capacity is expected in 2016 which will keep margins abated below last year’s highs. Margins may still be supported on crude weakness and further closures."
"Even with conservative global demand growth projections of 1.2 mb/d, and a non-OPEC supply decline of nearly 0.6 mb/d, the call on OPEC rises by 1.8 mb/d. Given where OPEC production currently stands, and even after adding incremental volumes from Iran, Iraq and Saudi, that’s a steep number to match. The balance points to global stocks likely drawing in 2H of this year, and on-shore inventories coming off from peak highs. A concerted OPEC/non-OPEC production cut of 2-4%, if materialized, would begin to reduce the stock surplus by 2Q 16."
Brent forecasts have fallen since last month across the forecast period. Analysts maintain their prediction of a supply overhang through 2016 before the market balances in 2017, and a medium-term recovery in prices as capex cuts and low spare capacity support Brent. The inventory overhang, new supply from Iran and possible demand weakness in Emerging Markets are seen as key risks.
Henry Hub forecasts have fallen slightly since last month. The market continues to be oversupplied, and this is expected to continue in the near term. Record inventory levels will be an overhang on natural gas prices through 2016, whilst production continues to climb despite a fall in drilling activity.
Last month, the first cargo of U.S. crude was exported following the repeal of a 40 year ban. This month, Cheniere LNG hopes to be the first exporter of U.S. lower 48 natural gas in the form of LNG. Over the next 5 years, construction will be completed on at least 6 additional LNG export facilities that will add just under 90 million tonnes per annum (mtpa) of LNG export capacity to the world’s LNG supply balance. By 2025, the US. will be the largest single source of global LNG, outstripping the current LNG export leader, Qatar, and nosing ahead of the #2 LNG exporter, Australia. U.S. shale oil and gas may soon become a major energy supply source for the world.
Table 1: FERC Approved Liquefaction Projects
(source: U.S. FERC)
|Cheniere LNG||Sabine, LA||2.8||20.7||2016|
|Dominion||Cove Point, MD||0.8||6.2||2017|
|Cheniere LNG||Corpus Christi, TX||2.1||16.1||2018|
|Cheniere LNG||Corpus Christi, TX||1.2||9.0
Note: 1 Bcfd ~ 7.5 mtpa
|Rest of World||171||189|
"U.S. shale gas may soon become a major energy supply source for the world. U.S. LNG exports could moderate any upside to LNG prices for term contracts and could contribute to continued depressed prices or spot LNG cargoes. In addition, U.S. LNG exports may accelerate the uncoupling of term LNG contract prices from oil indexation which has been the standard for many years. In time, Henry Hub, the U.S. benchmark for natural gas prices, may also become the benchmark for global LNG prices."
– Thomas G Ruck, Director, Market/Treasury Risk, KPMG in the US
Since the triggering of the crude price collapse in June 2014, China has capitalized on waning prices by ramping up its strategic petroleum reserves (SPRs) to strengthen its energy security. Moreover, the proliferation of China’s independent refiners, nicknamed “teapots”, has contributed to record levels of crude imports. In December 2015, China's crude oil imports hit a record 7.82 million barrels a day (bpd). The second week of February, however, has resulted in China primarily being closed for business due to its Golden Week – Chinese New Year. Traditionally during Golden week, global markets tend to see increased volatility and a drain in liquidity due to Chinese traders being out of the market. Based on historical data, we are seeing roughly double the levels of volatility compared to the same CNY period of the previous 25 years. The only year that remotely resembled such volatility was 2009!
"As a result of fluctuating supply and demand fundamentals, the oil market has proven to be a rollercoaster this month. In the second week of February, China closed for business, while major regional downstream centres: South Korea, Singapore and Japan, all held public holidays. Moreover in the long-run, a careful eye should be cast over China’s ability to absorb further crude volumes – a trend that has persisted over the last 18 months. Moderating economic growth could add to the crude price storm and dilute a demand that has supported falling prices. If Chinese crude demand were to lose steam, a plunge in prices is likely to be the end result."
– Oliver Hsieh, Associate Director, Commodity & Energy Risk Management for ASEAN, KPMG in Singapore