New York – Recently, Integrity Research Associates interviewed five independent research analysts about the outlook for the global oil market. We asked them to share their views on a wide range of issues, including the cause of the recent rise in oil prices, the impact of political unrest in the Arab world, and the availability of spare production capacity from other parts of the world. We also asked them to share their oil price forecasts for the short-term and intermediate-term, and to identify some sectors and companies that would benefit from the current energy market environment. The results of these discussions were compiled into a report distributed to Integrity Research clients. What follows is an extract from the report. If you would like to receive the full report, please contact Ronit Bhattacharyya.
Is the recent rise in oil prices being driven by underlying changes in supply or speculative activity?
Matt Smith, Summit Energy: The recent rise in crude has predominantly been a risk premium added to prices rather than a change in supply. Markets seemed pretty well priced back in January at the mid-$80s on WTI crude oil and the mid-$90s on Brent – this reflected the expectation that fundamentals will tighten this year, driven by emerging market demand. That said, the $15 or so rise in the past couple of months is pricing in an extended loss of production in Libya, as well as the potential of further supply coming offline. The fact that Saudi Arabia increased supply to cover the losses from Libya highlight that the price move is more driven by fear than fundamentals.
Kurt Wulff, McDep LLC: I believe oil prices are driven primarily by long term supply and demand. Speculation’s a good thing. People will say the current price is not justified by fundamentals. I would say that it is justified if you conduct a short term inventory analysis. People who hold more inventories get paid for it in the current risk environment. Short term inventories are not an indication of weak demand or excessive supply.
Peter Zeihan, STRATFOR: The majority of it is driven by speculative activity. The global money supply over the last 3 years has expanded enormously. The Chinese, Europeans, Japanese and Americans are all printing money. All of that money has to end up somewhere. This has provided an enormous amount of liquidity for investors to push capital into commodity markets. Obviously, events in Libya and elsewhere in the Middle East are meaningful, but that is secondary to monetary expansion in explaining the recent rise in oil prices.
James L. Williams, WTRG Economics: The answer is someplace in between. We’ve had rising Asian demand and we are now at or near record levels of petroleum consumption worldwide. But there has been more than sufficient supply of crude in the market, and an easy way to see that is to look at the number of days inventory of petroleum we have: that’s standing at 53 days of inventory now. In normal times, anything around 50-51 days of inventory is price neutral. Anything above 52 days of inventory, until recently, has been associated with lower prices. The simple fact is that short term inventories are ample.
But there are other issues to consider: Saudi Arabia has been producing more than we thought they were. That’s one reason why inventory is so high. The DoE recently revised upward its estimates of Saudi production, both for the last quarter and this year, to above 9 mln barrels a day. Saudi Arabia said they are 1.1 mln barrels a day over quota. Because Saudi production was more than we had previously thought, their spare capacity has been lowered by that amount of production – every time you produce extra barrels of oil, spare capacity is reduced. We are now looking at something in the neighborhood of 4 mln barrels/day spare capacity, which is lower than what we thought it was by 600,000-700,000 barrels/day. That is still historically, fundamentally, a bearish level of spare capacity. Typically anything much above 3 mln barrels/day has been associated with lower prices.
Then, due to Libya and unrest elsewhere, you have a supply interruption risk premium, which you might call a ‘revolution or war risk premium’. Do we have enough spare capacity to lose another major producer? Historically, we’ve seen it happen on many occasions (Iran, Iraq, Venezuela, etc.). When there are tensions in major exporting nations, you get a risk premium in the price of crude. You might call it a speculative risk premium, but it’s real risk. People respond to this by buying more futures as an insurance policy.
Speculation often amplifies the reaction to risk. The premium gets ramped up further by hedge funds and ETFs. In these periods, people tend to view oil as just another asset class. They will invest in a fund that’s heavy in oil simply because they think the price of oil is going to be higher, or as a hedge to stock prices being hurt by the rise in oil. The fund has to keep buying more futures as investor inflows come in. Demand for futures goes up, raising the price of futures. This has been a huge driver of prices from 2003 to present day.
In early 2003, there were about 500,000 contracts for oil (total open interest) on NYMEX. So far this month, it has averaged a little over 1.6 million. We are 300% higher in in demand for futures contracts. Worldwide, total petroleum consumption is up maybe 15% in the same period. If I told you: there are two different products, and in the next 7 years, demand for one will be up 15%, demand for the other will be up 300%, which one will see a greater price increase? You would expect futures contract prices to go up faster than crude oil if the two were divorced, just looking from a demand standpoint. But the futures contract is linked to a physical market. So as the volume of futures speculation goes up, so do oil prices for the physical commodity.
To summarize: Inventories are high, which should be a bearish indicator for prices. However, there is a legitimate war and revolution supply interruption risk premium, which increases every time there is a potential problem in an exporting country, and this supply interruption risk premium tends to be greater the lower our spare capacity is. Right now, our supply interruption risk premium is high, and our spare capacity is lower than we had expected. However, this is all amplified by hedge fund and ETF speculation in futures.
Max Krangle, ABS Energy Research: The current price of oil is based more on political, economic, transport factors, rather than underlying supply issues. Simple fact is that global proven reserves of crude oil are relatively stable – and is actually increasing if you count oil sands in Canada. Even with roughly 80m barrels/day pulled out of the ground, reserves appear to remain relatively stable. This has been true for the last 20-30 years. If you look at proven reserve trends, you can get to a figure of roughly 40 years worth of oil left in the ground. That number is based purely on worldwide proven reserves of roughly 1475 thousand million barrels of oil, including the Canadian oil sands. We keep finding new sources of oil, and proven reserves keep getting replenished. The fact is that no one truly knows what is under the ground. Saudi Arabia’s actual proven reserves are a state secret. No one, not even Wikileaks, has leaked what they have. There is no credible source we could find to give anyone a true picture of how much oil is left and what the actual reserves are.
The recent price increase is being driven by other issues: the political situation, uncertainty, government price manipulation. In any coming energy crisis, that crisis will be about a lack of capacity and refineries, and will have nothing to do with actual underlying supply of oil. It’s just not credible to say there is a serious supply issue.
About the Participants:
Matt Smith is a Commodity Analyst at Summit Energy, which provides energy management and sustainability services to organizations in a wide range of industries. Summit Energy consultants manage more than $20 billion in annualized energy spend for more than 650 companies and thousands of facilities worldwide.
Summit Energy Services, Inc.
10350 Ormsby Park Place, Ste. 400, Louisville, KY 40223
+1 502.429.3800 | www.summitenergy.com
Max Krangle is the Managing Director of ABS Energy Research. ABS is an independent energy market research company specializing in energy market research reports, energy market databases and energy market consulting as well as analysis and market forecasts.
ABS Energy Research
8 Quarry Road London, SW18 2QJ
+44 (0) 20 8432 6378 | www.absenergyresearch.com
Peter Zeihan is the VP of Analysis at STRATFOR. STRATFOR is a global team of intelligence professionals who provide decision makers and sophisticated news consumers in the US and around the world with insights into political, economic, and military developments. The company uses human intelligence and other sources combined with powerful analysis based on geopolitics to produce penetrating explanations of world events.
221 W. 6th Street, Suite 400, Austin, TX 78701
+1 512.744.4300 | www.STRATFOR.com
Kurt H. Wulff, CFA, is the founder of McDep LLC. Kurt Wulff founded McDep LLC in 1988. He is a past president of the National Association of Petroleum Investment Analysts. A Chartered Financial Analyst, Mr. Wulff belongs to the CFA Institute, the Petroleum Analysts of Boston, the Oil Analyst Group of New York, and the Boston Security Analysts Society. In his long career, he has also worked for Exxon, Chevron, and as a consultant for the governments of Alaska, Algeria, and the U.S.
399 Chestnut Street, Needham, MA 2492
+1 781.444.0621 | www.mcdep.com
James L. Williams is the President of WTRG Economics. WTRG Economics provides analysis, planning and research, forecasts, data services, and seminars for energy producers and consumers. The firm collects information from industry, government and proprietary sources. Research includes one-time studies as well as a monitoring and modeling system that provide continual updates to client forecasts. Additionally, WTRG Economics maintains thousands of energy cycles and assists clients in sourcing and updating the data they need for business decisions.
P.O. Box 250, London, AR 72847
+1 479.293.4081 | www.wtrg.com
For more information about these and other energy research firms, please contact Ronit Bhattacharyya at Integrity Research Associates, LLC: 212-845-9088 x6852 | Ronit@integrity-research.com