Uncertainty reigns in oil markets
Analysts see price drivers both to the upside and to the down
The Brent crude price was back below $70/bl in late May, having peaked above $74/bl in April, but still well above the $60-65/bl range observed during most of Q1.
Some of the oil analysis world's most recognisable names discussed the oil market's short-term outlook at the S&P Global Platts Gepec conference in May. The clearest conclusion was that the market faces unprecedented uncertainty on both the demand and supply sides.
The most immediate supply issue is disruptions, which—with Iranian and Venezuelan problems compounded by the Druzhba pipeline outage hitting Russian exports—is at "record levels", according to Chris Midgley, global director of analytics at consultancy Platts Analytics.
"We cannot yet know the full extent of the Druzhba outage," says Neil Atkinson, head of the oil markets division at the International Energy Agency (IEA). "Countries have drawn down on stocks, that is what they are there for. But, if it carries on, we are entering an entirely different situation."
Druzhba appeared to be partially on its way back, at least on its southern arm, in late May.
Libya remained another wildcard. "Libya could easily go from 1.1mn bl/d to 0.3mn bl/d overnight, if Haftar does not establish control," says Midgley. The fact that oil prices did not fall in line with the dollar, bucking the usual correlation, indicates to Midgley the tightness of supply.
He caveats that with additional supply options. Stocks are beginning to increase, he notes, and Opec is not the only actor with spare capacity. Strategic petroleum reserves (SPRs) play the same role, says Midgley, echoing Atkinson's view that post-Druzhba prices have not spiked because three countries released SPR volumes. The US SPR could, by Midgley's calculations, flow 300,000bl/d over six months.
Saudi Arabia might also be willing to increase production, or at least allow more storage withdrawals; he is confident that, at a sales level of 9.8mn bl/d, the Saudis are filling storage. Saudi sales could easily go to 10.8mn bl/d, although, given the uncertainty, Midgley wonders if it might take a wait-and-see attitude and even again postpone Opec's planned late-June meeting.
The Russian government wants companies to increase production to support the wider economy, says Ed Morse, global head of commodities research at bank Citigroup, noting that Russia's compliance with the Opec+ agreement was virtually non-existent in Q1 and may be brought into line only due to the Druzhba disruptions.
But he cautions that the Russian authorities and its producing firms want $60/bl oil, rather than maximising production and pushing prices lower, or flowing more into a rising market. Prices at $50/bl or at $70/bl mean the central bank must either buy or sell dollars, while moving away from $60/bl causes producers headaches by potentially altering their positions in Russia's complex tax regime.
Morse is unambiguously bullish, mainly due to potential supply losses in what he dubs the "fragile five"—Iran, Iraq, Libya, Nigeria and Venezuela. While he considers the potential for a nationwide supply disruption in Libya to be "remote", such circumstances would lead him to an $84/bl Brent forecast.
The recent cooldown in prices is due, in Morse's view, to profit taking. But he sees the steep backwardation of the Brent curve, with the spot market well above forward contracts, as indicative of traders lagging market fundamentals.
Dated to Frontline (DFL) contracts—an over-the-counter agreement used to hedge the basis risk against Dated Brent over short loading windows—are also very strong, trading around 2011-2013 levels when geopolitical disruptions dramatically tightened the global crude balance, Morse notes.
Even Morse can find reasons to be bearish on the short-term supply side, mainly around US production. He acknowledges the shift from private to public companies as the largest shale oil producers—in 2010, there was no shale drilling by majors, by January 2018 that had climbed to 10pc of drilling before the trend accelerated to 15pc in January 2019 and 18pc by May 2019.
However, he refutes the idea that the majors will necessarily turn down the taps due to a greater focus on capital discipline, citing ExxonMobil as an example of a firm relatively uninterested in such a strategy. "Oil firms generated $146bn of free cash in Q1, so we could expect four times that by the end of the year, or more if prices move higher," says Morse. "They are not going to give it all to shareholders, they are going to spend it." He also sees capital efficiency going up by 30pc, concluding the world is not capital constrained.
Midgley is unconvinced. While the US is "key" to global production growth, in his view "it is not going to fill the gap". "There will be more capital discipline and return of cash to investors; there are gas evacuation constraints; there is the IOC consolidation of the acreage—they will behave more logically, not just cycle capital," he says.
Whether or not US shale production growth slows, there is consensus there will be less frenzied activity in the basins. This has a knock-on effect for demand where, again, there is significant uncertainty.
There has been an "enormous increase in pipeline and storage, which reduces the need for trucking and rail as there is less need to move as much material and equipment around", says Atkinson, which will weaken US diesel demand. Morse agrees, citing a 10pc drop in drilling activity in the US and less trucking, both adding to a US distillate demand drag.
The IEA recently revised down its 2019 global oil demand growth forecast from 1.39mn bl/d to 1.3mn bl/d, which is higher than 2018's 1.2mn bl/d figure, but less than a 1.4mn bl/d average per annum growth since 2012.
Atkinson highlights the significant difference between various 2019 demand growth forecasts tracked by the IEA, from predictions at the high end of over 1.7mn bl/d—with 1.9mn bl/d the highest— but the lowest forecasts below 1mn bl/d. He cites "huge uncertainty" across a number of factors—price, currencies, developing markets' demand, US-China tension and its macro-economic impact, and Brexit-related disruption to the EU.
The IEA saw a very slow start to 2019; Q1 demand was lower than expected in China, India and some European economies. But Atkinson is bullish on a pick-up in later quarters. In 2018 the US was the biggest source of oil demand growth globally; while it is going to be less in 2019, says Atkinson, demand growth will be robust from the petrochemicals sector as it remains hungry for cheap LPG and ethane feedstock.
He also predicts China and India will "reassert themselves" during Q3 and Q4, with Chinese demand moving "remorselessly upwards". The country is, he admits, moving away from heavy industry towards a consumer-focused economy, which impacts demand for certain segments.
But "buying stuff means plastics, which means petrochemicals … which means demand for feedstocks", says Atkinson. Morse is less convinced: "China is starting a revolution where oil has a lower share of GDP".
India has demographic factors, such as increasing middle-class spending power and greater mobility, that will boost demand, says Atkinson. But all three analysts agree that demand is particularly price sensitive.
Oil price and currency conditions will "remain benign", boosting Indian demand, in Atkinson's view. Morse is less convinced, noting dollar weakness predictions have yet to come true and warns that its continuing strength could be a "headwind" for emerging market demand. Midgley cautions that upcoming fuel specification changes will increase gasoline prices and hurt the Indian economy.
On the other hand, refinery maintenance schedules give Midgley more reasons to be bullish. Refinery turnarounds are unseasonably high in May, he says, delayed from the usual March-April, particularly in China and Japan. Preparation for the IMO specification changes at the end of 2019 is Midgley's most likely explanation.
But this [maintenance] has softened May and June demand, with, in Platts Analytics' view, 3mn bl/d of additional refinery demand to come in for the summer, as well as 800,000bl/d of extra demand due to IMO.
The major demand uncertainty, though, remains the ongoing US-China tariff spat. By Morse's calculations, the "plunge" in global trade has had a 500,000bl/d impact on middle distillate demand, with an additional demand reduction due to a decline in global freight.
But Midgley warns that the effects of the dispute may be overstated, noting that US exports make up just 4pc of China's GDP and forecasting only a 0.3-0.4pc impact on China GDP growth for as long as the tensions continue.