Commodities | Jul 20 2012
– Oil market views updated
– Shale oil and Iran impacts assessed
– Price forecasts revised
– Product inventory levels a key indicator
– Russian oil exports set to rise
By Chris Shaw
Even allowing for a reduction in output from Iran, JP Morgan suggests others in OPEC, and primarily Saudi Arabia, will need to cut production from recent levels to rebalance the oil market. This process is likely underway, as evidenced in the broker's view by the resurgence of strength in the Brent and Dubai crude time structures, which points to additional forces supporting these markets.
Also supportive to the view rebalancing is underway is the fact Saudi Arabia recently raised Official Selling Prices, which are the price differentials for key regional crudes for August loadings.
In JP Morgan's view this may be a move by Saudi Arabia to incentivise refiners to limit crude purchases at the margin. This would allow for a pullback in production and help clean up an overhang of some Atlantic Basin crudes present since May.
Aside from questions around Saudi Arabia, Barclays Capital notes the sharp fall in oil prices in June generated some doubts as to the viability of shale oil at prices much below US$80 per barrel for West Texas Intermediate.
As Barclays points out, horizontal drilling is expensive given the intensive use of fracturing crews and other service industry inputs. With cost pressures in energy markets also rising, there has been a fall in rig counts in recent weeks as the lower oil price has taken its toll.
In the view of Barclays the fall in the oil price will at least create a stress test for shale oil, especially given the wide variability in economics from field to field and even within certain shale plays. This suggests to Barclays there are questions as to whether the argument of lower oil prices due to the growth of unconventional supplies in the US can be supported for much longer.
Since the June lows the oil price has recovered 14%, Brent crude again reaching the US$100 per barrel level. As RBS notes, the rally has been driven by falling inventories, the US driving season boosting demand and expectations for QE3 to be implemented.
For RBS there is cost curve support for oil around current levels, which implies an opportunity for investors. Supporting this in RBS's view is International Energy Agency (IEA) expectations for 2013, which forecast oil demand growth will accelerate by one million barrels per day or 1.1% year-on-year in 2013.
This would bring global demand to 90.9 million barrels per day. The IEA expects 2013 will be the first year non-OECD demand for oil exceeds OECD demand. From an average for the first half of 2012 of US$114 per barrel for Brent crude, RBS expects prices will average US$107 per barrel in the December half, for a full year average of US$110 per barrel. Prices are forecast to average US$115 per barrel in 2013.
Barclays sees some scope for oil prices to improve further into the September quarter, as expectations for market balances have become more constructive and the shale oil and European demand effects have been offset elsewhere.
For Barclays, shale is playing the role of defining a floor for oil prices more than it is bringing down the price ceiling. At the same time, the way back to a sustained oil price of US$110 per barrel for Brent crude is not yet fully clear in the group's view, as there remains significant sensitivity to macroeconomic sentiment.
At the same time, Barclays suggests while market expectations for oil remain negative, market data is painting a more positive picture. In this regard, balances for the September quarter seem tighter from the viewpoint of July than they did last December, especially with respect to the call on OPEC crude.
As well, Barclays notes the deficit of oil product inventories relative to five-year averages is now its largest since 2003, which further supports the view the oil market is actually tighter than many in the market realise.
The sanctions on Iran are also playing a role and Barclays sees potential for Iranian output and exports to fall faster than markets are currently pricing in, this at a time when the call on OPEC crude is set to increase.
For Barclays this suggests Saudi output of 10 million barrels per day appears justified as it offsets the shortfall from Iran, rather than the current market perception it represents a surplus to requirements.
Citi's mid-year review of energy markets leaves the broker with the view the oil price is most likely to stabilise around US$90 per barrel for Brent crude. This is a price level the market can both support and bear in Citi's view.
There should continue to be some sharp volatility around this price level, Citi seeing this as a necessary process in rationing away the marginal demand barrel. Beyond this year, Citi is forecasting an average Brent crude price for 2013 of US$99 per barrel and for West Texas Intermediate of US$85 per barrel. This compares to forecasts for 2012 of US$113 per barrel and US$94.50 per barrel respectively.
In the view of Standard Bank, product inventory levels are worth watching as if there is no improvement in the numbers through the US driving season it could be an indication of weaker demand for crude in later months.
Standard Bank suggests if the summer driving season is discounted, US gasoline demand remains weak given the fragile nature of the economic recovery. Demand has also been somewhat soft given a persistently weak job market and improving passenger car fuel efficiency.
This leads the bank to suggest while the market may see some positives in declining crude oil stocks, product inventory levels are a more important indicator for the medium-term direction of the market.
Elsewhere in the oil market, JP Morgan notes Russian crude exports are set to rise, as refining rates are now at all-time highs. One reason is the impact rapid changes in international oil prices can have on Russian producers.
In the Russian market crude exports are subject to export duties that depend on lagged average prices. This means if crude prices fall, the profit producers receive on exports can also decline sharply. With weaker oil prices in June producers had incentive to minimise crude exports via either maximising domestic refinery runs of placing crude into storage. With oil prices subsequently improving in July the crude netback has also risen and this has seen Russian crude exports pick up.
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