Tuesday, December 29, 2009

Oil Number to Watch in 2010

OPEC members and particularly the Saudi Arabians are the marginal global oil price setters due to their creation and use of spare production capacity.  Saudi Arabia is the de facto leader of OPEC with the highest production and spare capacity volumes.  Last week the government of Saudi Arabia outlined its budget for 2010.  With a few simple calculations the Saudi budget provides guidance as to the minimum oil price OPEC will likely seek to defend over the coming year.

2009 Saudi Budget in Review
Crude oil, basis NYMEX WTI, averaged US$62.02 per barrel between January 1 and December 29, 2009.  At this US$62.02 oil price the Saudi government ran a deficit and had to borrow to make up the difference:
"The ministry also said actual spending in 2009 stood at 146.7 billion dollars while actual revenues were 134.7 billion dollars" (Source: AFP)
With Saudi Arabian production of around 8.2 million barrels per day (Mb/d) of conventional crude plus 1.5 Mb/d of NGLs in 2009 the Saudis needed oil prices basis WTI to have averaged around US$65.40 rather than US$62.02 during 2009 to balance their budget.

2010 Saudi Budget Outlook
As global oil demand grows the Saudis are expected to marginally increase production volumes of both their conventional crude and NGLs in 2010.  With the expected increases in production volumes Saudi Arabia's 2010 budget breakeven oil price level will be slightly lower than that needed in 2009.

The Saudis are forecasting a second year of government deficits and borrowing for 2010.  WTI will need to average US$60.50 per barrel to balance the Saudi's 2010 budget without any deficit or US$55.50 with their planned deficit and borrowing to make up the difference.

Although oil prices are well above it now at close to US$79 per barrel, if demand falters or supply increases dramatically then this US$55.50 level will be the 2010 OPEC downside action trigger to watch.

Tuesday, December 22, 2009

2009 Oil Market Review as OPEC Meets

As OPEC members meet today Tuesday, December 22, in Angola, it is worth taking stock of why OPEC has no choice but to yet again refrain from making any production changes in order to maintain prices above the low US$70s per barrel. Compliance with the 4.2 million barrels per day (Mb/d) cuts announced by OPEC members in late 2008 is currently around 2.25Mb/d.

Oil Demand
During the 2008-2009 recession global oil demand fell by 2 Mb/d from over 86 to 84Mb/d (chart 1). Global demand is beginning to grow again. The charts in this post (click to enlarge) use monthly data and 12 month rolling averages to adjust for seasonality.  The latest point used for EIA data is November 2009.

(click to enlarge)

Almost all the global decline was concentrated in developed OECD nations (chart 2). Less developed non-OECD nations such as China and India only saw a temporary stagnation and are now exhibiting growing demand (chart 3).  Non-OECD oil demand has surpassed 2008 highs.

(click to enlarge)

Of the OECD decline, one third came from the US, one third from OECD Europe, and one third came from the remaining developed OECD countries.

The US accounts for just under 23% and Europe 18% of 2009 global oil demand. In late 2009 oil demand in the US and Europe appears to have stopped falling (see charts 4 and 5).

(click to enlarge)

Oil demand in the US was destroyed more in absolute barrels over the past few years than in any other region.

The severe demand destruction in the US had a lot to do with current US oil consumption patterns (76% of Americans get to and from work by driving alone) and infrastructure (average US vehicle fleet efficiency is less than half that of available technology). Relatively inefficient consumption allows for swift efficiency gains compared with other parts of the world which are already at or close to maximum technically available oil consumption efficiency.

Looking at total US oil demand (chart 4) one may perceive that it is in a steady decline which can perhaps be extrapolated into the future. However, delving deeper into the data provides clues as to exactly why US demand declined and why this decline has ended.

The total number of miles driven on US highways has stabilized and is increasing (chart 6-a).

(click to enlarge)

Interestingly, the pattern in which miles driven changes has defined every recession since the 1970s and defines the latest recession as V-shaped (chart 6-b).

(click to enlarge)

This stabilization and increase in highway miles driven is showing up in US gasoline demand which is no longer falling and has begun to grow again (chart 7). Gasoline demand accounts for almost half US oil consumption.

(click to enlarge)

The recovery in gasoline demand is because people are cutting back on vacation spending by driving rather than flying to holiday spots. This certainly syncs with the fall in jet fuel consumption (chart 8) and anecdotal evidence. Businesses have also been cutting back on flights.

(click to enlarge)

The decline in jet fuel consumption is more than offset by the increase in gasoline consumption. Combined, jet fuel and gasoline demand (together 57% of total US oil demand) are beginning to recover (chart 9).

(click to enlarge)

Where is the remaining weakness in US oil demand? It is in industrial oil demand. Demand for distillate (diesel and heating oil), residual fuel oil (mostly used for shipping and a little for electrical power generation) and other oils (lubes, waxes, asphalt, plastics and a bunch of other oils).

(click to enlarge)

Aggregating these three categories of US oil demand into “Industrial” demand, these industrial oils account for 43% of total US oil demand (chart 11).

(click to enlarge)

To see a strong recovery in US industrial oil demand there would have to be a recovery in consumer spending (linked to unemployment, housing and the savings rate), manufacturing activity (especially autos), and private services sector activity. Most indicators in these macroeconomic areas have begun to stabilize and improve over the past couple of months.

So why have oil prices stabilized in the US$70-80 per barrel range if the reduction in global demand is recovering such that it is now down only around 1Mb/d year/year?

Oil Supply
In the face of the oil demand collapse which began in mid-2008, OPEC members (which produce just over 40% of global supply) announced in Q408 that their new quota would be a 4.2Mb/d cut from their September 2008 output level of 31.4Mb/d. OPEC members implemented just over 3Mb/d of the cut at the beginning of 2009.

Throughout 2009 OPEC compliance slipped, with core OPEC producers such as the Saudis holding more firmly to their commitments and lesser OPEC producers cheating.

OPEC supply in December 2009 is down around 2.25Mb/d compared to September 2008. OPEC NGLs production (not counted in OPEC quotas) is up 0.8Mb/dd. So net total OPEC liquids (OPEC definition of “crude” Plus NGLs) is down 1.45Mb/d since September 2008.

Non-OPEC output (adjusting for the effects of hurricane shut-ins) is up around 0.5Mb/d year/year.

So net total liquids output (OPEC plus non-OPEC) will be down 0.95Mb/d in December 2009 compared to September 2008.

Global supply has done a masterly job of removing product from the market as demand collapsed.  The supply decline of around 1Mb/day is offsetting the current demand decline of 1Mb/day year/year with one exception: floating inventories.

The incentive to store crude oil, residual fuel oil and distillate (diesel, heating oil and jet fuel) on floating tankers has absorbed some of the supply which OPEC delivered into the market.  Due to a contango forward curve inexpensive tankers were used to store a very large amount of oil throughout the year until September 2009.  It has been this oil coming ashore since September which has capped prices at US$80 per barrel.

At the OPEC meeting today Tuesday, December 22, OPEC members have no choice but to maintain existing production cuts in order to keep the global market in balance (a balanced market has inventories neither increasing nor decreasing) and hold onto 2009 price gains.  If OPEC maintain their existing cut compliance levels of just over 2Mb/d then as soon as the drawdowns of floating inventories ends higher prices and a re-test of US$100 per barrel will be on the cards for 2010.
OPEC will have to wait until their next meeting to increase production if they want to defend US$70 per barrel.

Sunday, December 20, 2009

Globalization Directions: just add a Box and Oil

At this time of year it may be wise to dwell briefly on how consumer products are transported.  Globalization runs on container shipping and oil.  Beginning in the 1950s, standardized 20 and 40 foot intermodal containers revolutionized shipping and enabled vastly cheaper, quicker, longer, more complex supply chains.  For an interesting history of containerization see 'The Box'.

Wednesday, December 16, 2009

Fundamentals of Oil Pricing

Another research report released today, this time by JPMorgan, showing that oil market price movements are driven by fundamentals and not speculation.  I agree fully with the JPMorgan findings and it is interesting that almost everyone from academics to regulators such as the CFTC analyzing this issue reaches the same conclusion.

Tuesday, December 15, 2009

Barnes and Noble

Over the past day or so Amazon in the US (UK appears to be fine) has had some inventory outages for Oil 101. As an alternative you can order it here from Barnes and Noble. If you are looking for large volumes (greater than 100) you can email here.

Sunday, December 13, 2009

Most Controversial Oil Speeches Ever

Recently I have been dwelling on hard data research of the 1970s and early 1980s to gain insight into the oil situation we face today (see Oil 101 Chapter 1).

On April 18, 1977 US President Jimmy Carter delivered his "Moral Equivalent to War" speech (see below) on energy which is viewed as being one of the most controversial energy speeches ever:

(see transctipt here)

A couple of years later, on July 15, 1979, Carter delivered his infamous "Crisis of Confidence" speech:
(see tanscript here)

I am publicly indifferent toward Jimmy Carter's politics except his energy policies.  If you have met me in person recently you will know why being aware of these two speeches is important in understanding our situation today and the effects of government action.

Monday, December 7, 2009

Flying V Could Rock Jet Efficiency

An interesting story from The Economist describing how airlines could save jet fuel by flyng in formation.

Oil Books

Edward Morse outlines a useful "annotated Foreign Affairs syllabus on oil" in the latest issue of Foreign Affairs.

Thursday, December 3, 2009

Kerosene: Not Just a Fuel for the Jet Age

Long before gasoline and diesel came into widespread use, kerosene for lighting was the initial product which drove oil demand from 1859 until the early twentieth century. When oil transformed into a transportation fuel kerosene was repurposed to be used as jet fuel in the late 1930s.

Global demand for kerosene as a lighting fuel is now relatively tiny with almost all kero being used as jet fuel.

Kerosene is still used as a lighting fuel in rural India where 400 million people do not have access to mains electricity (population of the U.S. is just over 300 million). As you can see from the Wall Street Journal video below, kerosene in rural India is only now, 150 years after the start of the modern oil industry, being replaced by solar lanterns.

Dargay/Gately on Modeling Oil Demand

Year end is the season given to updates of long-range oil supply and demand forecasts, particularly from the OECD's International Energy Agency (IEA) and the US Energy Information Administration (EIA).  Many models used for forecasting rely on extrapolating past patterns.  However, is such a method reliable if those patterns reflect unrepeatable structural changes?

Is the oil demand pattern over past 40 years a reliable indicator of what may occur in the future? Or, as a very interesting research paper just released by NYU Professor Dermot Gately and Joyce Dargay of the Institute of Transport Studies at the University of Leeds in the UK indicates, has there been a one off structural change in the use of oil which if ignored and not backed out of past patterns could create a very large under estimation of potential oil demand? 

The one off structural change in oil demand was the global shift away from using oil for electrical power generation over the past 40 years.

Following is a summary of the paper in my words:

Dargay/Gately find that much of the efficiency in oil consumption in OECD countries since 1970 was due to oil being effectively phased out as an electricity generation fuel. The oil saved from electicity generation was used in transport. Transport demand for oil facilitates economic growth and is thus highly correlated with economic growth.

Now that this shift away from oil being used for electricity generation has been completed, growth in Total oil demand is going to be much more highly correlated to economic growth than it has been since 1970. Because of this, one cannot use growth in Total oil demand since 1970 as a predictor of future oil demand growth. Instead, growth in Total oil demand is likely to be higher than the 1970-today period.

Oil demand in 2009 is just over 84 million barrels per day (mbd). A major reason for the difference between the Dargay/Gately demand number by 2030 of 134 mbd and the IEA forecast of 105 mbd is due to Dargay/Gately incorporating the fact that the one off switching effect from electicity use to transport use cannot be repeated. Dargay/Gately are not stating that supply of 134 mbd or 105 mbd will be available. They are simply looking at the demand side of the equation and saying that if economic and population growth progresses as the OECD forecasts then the oil demand this implies is likely to be a lot higher than the IEA's forecast of 105 mbd.

The conclusion I take from Dargay/Gately's paper is that if supply is not available to meet this 134 mbd oil demand then economic growth cannot progress as the OECD forecasts and/or an extremely large and unprecedented change in the level of oil consumption efficiency will have to take place between now and 2030. This efficiency will likely be driven by high oil prices.

(click on Fullscreen below to enlarge)

Tuesday, December 1, 2009

US EPA Ethanol Decison Postponed

The US EPA has postponed to mid-2010 any decision to change ethanol limits in the US.  Last week I described why such a decision is anxiously awaited.  (HT/Xavier).

Oil 101: A Great Holiday Gift

An appropriate gift for all members of the family.

What would be a great gift this holiday season? Oil 101. Order here in the US and internationally and here in Europe (price in the UK has been reduced by 5 pounds over the past week to reflect the strength of the GBP relative to US Dollars). I am mentioning it today as if you need it before the holidays then you may need to order it soon. Thanks!

IEA to Japan: 85MPG by 2030

The OECD International Energy Agency (IEA) is the taxpayer funded energy advisor to the 28 most developed countries. The agency was created in 1974 by large oil consuming nations in response to an oil supply embargo which began in late 1973.

The IEA publishes an annual World Energy Outlook (WEO) each November. See a video of the 2009 WEO press conference here.

One of the conclusions which can be drawn from deconstructing the 2009 WEO, the IEA's forecast of energy supply and demand out 20 years to 2030, is that the IEA estimates that the average new vehicle sold in Japan in 2030 will have to attain on average 85 miles per gallon. Even small motorcycles cannot get close to that level of efficiency in everyday use today. Those 2030 Japanese vehicles will have to be plug in hybrids and Japan will have to build electrical capacity to handle this demand.

Oil supplied to the global market in 2009 is just over 84 million barrels per day (Mbpd). The big headline grabbing number in the WEO report this year is that the IEA believes global oil supply in 2030 will be around 105 Mbpd. Although the IEA's 105 Mbpd 2030 supply forecast is down significantly from previous WEOs it will still require the discovery and development of at least four Saudi Arabian sized oil producing areas before 2030. This huge challenge is the IEA's basic "reference scenario".

What most people are interested in from a modeling perspective is the logic and assumptions the IEA uses. In this regard, this years IEA supply side estimate methodology appears to have a certain predictability.

In fact, let me pull up an old chart of mine showing oil supply at 4.6 barrels per year per capita over the past 27 years (see chart below). What does the IEA 2009 WEO forecast for 2030? You will not be surprised that it is almost exactly 4.6. Plug in the current global population and UN population growth estimates between now and 2030 et voila: IEA global oil supply estimates almost to the barrel.

(click chart to enlarge)

There is nothing wrong with using 4.6. Using 4.6 is a reasonable starting point for modeling required oil supply. Remember that the IEA's basic supply side case to get to the 4.6 number assumes at least four Saudi Arabias will be among those discovered and developed over the next 20 years - a whopper of an assumption. Estimating actual oil supply out 20 years is much more challenging given that most of the oil which will be supplied in 2030 has not yet been discovered.

The IEA goes on to estimate how the 4.6 barrels per year per person globally will be broken out by geographic region on the demand side of the oil equation. Their conundrum is that if China, India and other non-OECD countries continue to grow as expected then someone else has to reduce oil consumption through voluntary or forced efficiency. The IEA is forecasting per capita oil consumption efficiency improvements of just over 20% in each of the US and OECD Europe. Amazingly the IEA is forecasting per capita efficiency of around 40% for Japan. This is after taking into account population changes. These efficiency numbers are the IEA requirements under their basic "reference scenario".

Another interesting point to note is that the IEA WEO forecasts non-OECD (which includes China and India) per capita oil demand to only increase by a total of 14% between now and 2030 despite forecasting compound annual economic growth of around 5% per year for non-OECD countries. This implies extremely large per capita oil demand efficiency, greater than Japan's 40%, in the non-OECD developing world.

What will cause this efficiency: climate change legislation, slower than expected economic and/or population growth, availability of niche alternatives such as CNG and electric vehicles or persistently high oil prices? It will be a combination of all these but most likely will be as a result of high oil prices. The IEA WEO report forecasts oil prices rising to an average of US$100 by 2020 and US$115 by 2030 (in year-2008 dollars). However, based on an analysis (see pages 15 and 16 of Oil 101) of rare past periods of oil consumption efficiency it is unikely that the IEA's price forecasts are sufficiently high by a long shot to create the required efficiency.

What to do? It cannot be stressed any more how the winners in the IEA reference scenario to 2030, which many outside the IEA see as too optimistic, will be those that get ahead in terms of efficiency. Reacting to oil prices is by definition too late. That is why a Vehicle Efficiency Market is the least painful way for individual countries to gain advantage. We have to create an economic incentive to become more efficient independent and ahead of oil prices.

Monday, November 30, 2009

End of the 2009 Hurricane Season

November 30 marks the end of Atlantic Hurricane Season which began back in June.  This has been an extremely mild season with only one (Hurricane Ida in early November) hurricane shutting down a small amount of US Gulf Coast oil and gas production for a few days.  Not a single hurricane made US landfall in 2009.

Comparing storm activity from one year to the next is a challenge.  Do you use lives lost, number of named storms, dollar damage, volume of oil and gas production shut in, or maximum intensity?

Taking a leaf from Google's attempt to analyze flu using words typed into its search engine, here are two charts which I am updating for the last time this year comparing the 2009 hurricane season to previous ones.  The first chart shows how many searches for the word "hurricane" were carried out over the past six years. The 2005 season which included Hurricane Katrina stands out.  Interestingly, the Google index registered a ZERO for the week up to November 29, 2009.  This is the first time the data showed no value.

(click chart to enlarge)

A second chart shows the same data as above, except in a cumulative form with the end of 2005 indexed to 100:

(click chart to enlarge)

The effects of seasonality on oil are described in Oil 101.

Downey City to Build Transport Future

It is often said that we need a 1960s Apollo Program Moon Shot type effort to meet future transport energy needs.

Coincidentally, the new Tesla electric car may be built in the same city which built the Apollo moon capsules: Downey, California.

Here is a video from ABC News describing the new plant. The AP describes the 7-seater sedan car as the "Model S, which is designed to travel as far as 300 miles on a three- to five-hour charge." Tesla currently produces an ultra-luxury electric 2-seater sports car which costs almost US$110,000. The new sedan is expected to cost around US$57,000. This is still expensive but as with most automotive technologies it tends to start in luxury vehicles before entering the mainstream.

Thursday, November 26, 2009

US Ethanol Decision Soon

As I mentioned at the beginning of May there is an oversupply issue with ethanol. Ethanol in the US is alcohol produced mostly from corn. US government mandated minimum ethanol volumes exceed what auto makers say most of their cars can handle. Typically cars can handle 10% ethanol blended with 90% petroleum-based gasoline without any special equipment.

The New York Times is reporting today that the US EPA may raise the US ethanol blend wall from 10% of gasoline to as high as 15% or 20% within the next week. Although such a change would be good for ethanol producers, this additional ethanol would displace petroleum-based gasoline and pressure oil refinery margins lower.

Update: On Tuesday December 1, 2009 the EPA announced it would defer making a decision on changing the US ethanol blend limit until mid-June 2010.

Wednesday, November 25, 2009

Happy Thanksgiving; enjoy the quiet airports

Thanksgiving is a big holiday in the US celebrated on the fourth Thursday of November each year. Is the travel associated with Thanksgiving significant for jet fuel demand? Not really.

The day before Thanksgiving is often incorrectly believed to be one of the busiest days for air travel in the US.  Here is an interesting story on the subject from CBS.

CNBC TV today

I appeared live on CNBC TV at 3:15pm New York time today to discuss commodities.

(click here to view on CNBC's site if it doesn't open below)

Update: As I predicted, within a week, on Tuesday December 1, 2009 spot gold traded above US$1,200 per troy ounce.

Tuesday, November 24, 2009

Is the Future of Transport in Niches?

Transport occurs in fairly stable patterns.  People commute to and from work, school and stores each day within a known range of miles and load. However, these stable patterns do not define the vehicles people buy. People tend to buy vehicles which cover a large array of contingencies.  Daily commuter vehicles are more often than not heavier than needed for a daily commute as they are purchased for events such as a once every month journey more than 200 miles with 6 people.  This contingency-link to vehicle purchasing creates a lot of fuel inefficiency.

(source: US Census Bureau)

As transport fuels become more diverse and expensive, powered transportation devices may also become more customized to fill niches.  These niche vehicles will be more efficient as they would just cover the vast majority of daily transport in the most efficienct manner.  Services such as car sharing Zip Car would meet the need for less frequent vehicle uses.

In cities, people tend to use taxis, subways and buses.  Taxis are expensive. Subways and buses, while most often the quickest way around, can be slow and infrequent at the edges of a city.

I was passing a motorcycle store the other day and saw this Ultra Motor A2B electric bicycle which can travel 20 miles at 20 miles per hour between charges.  It is an urban commuting vehicle.  One can pedal if the batteries have been drained.  The vehicle can be stored inside an apartment or an office which is an advantage over gasoline-powered scooters.  I am not endorsing this bike, it is simply interesting that products which would once have been considered gimmicks are now slowly at the edges of becoming more mainstream.

Monday, November 16, 2009

The Gold to Oil Ratio

In addition to fundamental supply and demand oil prices float against the US dollar. As the dollar weakens oil prices in dollars rise. This dollar weakness has accounted for some of the rally in oil prices since the 1990s.

(click image to enlarge)

Gold can be considered to be a currency just like the dollar or euro. Gold is at an all time high against the US dollar of US$1,135 per troy oz today. It is interesting that the price of oil in gold terms (1 troy oz currently buys 14.38 barrels) is at the bottom of the range in which it traded during the 1990s. In other words, oil in gold terms looks much less expensive than in US dollar terms.

(click image to enlarge)

Thursday, November 12, 2009

$500 Oil Calls Set Hyperinflation Probability

US oilman Boone Pickens said today  he thinks oil prices will be above US$100 per barrel at some stage during 2010 and US$300 within 10 years.

Pickens isn't alone in his bullish outlook.  Quite a few December 2015 NYMEX WTI crude oil US$500 strike call options have been purchased since the beginning of October this year (see chart below).

So someone out there thinks the probability of crude trading above US$500 per barrel by December 2015 is worth consideration at a value around US$1 per barrel.  That’s a big premium for a big oil number.

The oil market is placing a higher probability than other asset markets on the chance of outsized inflation.

(click chart to enlarge)

For more on oil options check out Chapter 19 of Oil 101.

Monday, November 9, 2009

Saudis Tap Brakes to Slow, Not Stall, Oil Rally

Saudi Aramco today announced that it will be increasing oil production slightly in December. This Saudi announcement is insufficient to bring the oil market into balance. The oil price rally of 2009 appears likely to continue, notwithstanding small corrections.

IEA to Public: You Can't Handle the Truth

An interesting news story this evening from the UK's Guardian newspaper which alleges that the International Energy Agency (IEA) changes forecasts to make them more rosy for oil consumers.  The IEA's annual World Energy Outlook (WEO) is used for energy planning by 30 OECD developed economies and is published tomorrow (Tuesday):
"The senior official claims the US has played an influential role in encouraging the watchdog to underplay the rate of decline from existing oil fields while overplaying the chances of finding new reserves.

The allegations raise serious questions about the accuracy of the organisation's latest World Energy Outlook on oil demand and supply to be published tomorrow – which is used by the British and many other governments..." (UK Guardian)
These are quite grave allegations by the Guardian as to who the IEA works for and to what end. OECD taxpayers fund it.

Sunday, November 8, 2009

World Oil Demand in Motion

When data is put in motion over time it becomes more interesting.  I have added World data to the Oil Demand Motion Chart. You can look at this chart any time from the link on the right side of this web site.  The oil data comes from the BP annual statistical review.  The population data is from the UN and the GDP data is from the World Bank.

Some interesting observations one can take from the chart are: 1. the evolution of oil demand in developing nations (click on Korea); 2. how developed nations oil consumption per capita is relatively stable (click on the US or UK); 3. that world oil demand has stuck at around 4.6 barrels per person for over 26 years despite huge population and economic changes over that time (discussed here previously).

I will be adding a lot more data to this chart over the coming weeks, especially some future oil demand scenarios.

The inspiration for the oil demand motion chart came from Fig. 1-13 on page 18 of Oil 101.

Hurricane Ida

(click here for updated Ida path)
This has been a very mild hurricane season for US Gulf Coast oil and gas production and refineries. Until yesterday there were no shut ins of production or refinery ouput due to hurricanes in 2009. Hurricane season ends on the last day of November and so Hurricane Ida is relatively late in the season. Ida is passing through an area in which oil and gas is produced and refined, which is why some companies are taking precautionary action.

Update: Monday Nov. 9th, 6:25pm. The US MMS says 384,642 barrels of oil production and 1.925 BCFD natural gas production shut in by Ida. This is roughly one quarter of US Gulf Coast offshore production.

Assuming no damage and that staff are back on platforms by Tuesday afternoon, it is likely that output will be shut down for a total of 2-3 days production. 

Click on the link here to see an amazingly detailed NASA image of the storm.

Thursday, November 5, 2009

Leading Edge Oil Demand Data

Is 2009 OECD oil demand destruction like 1974, when efficiency didn't stick, or the early 1980s, when efficiency almost bankrupted the oil industry? I have a much more detailed theory as to which version it is - which I will post at a later date. For now, let's dig into some data.

OECD oil demand growth is being written off by most oil analysts for the next few years. OECD demand growth is probably the most significant known unknown in the oil market. Early data indicates that we may be seeing signs of permanent OECD oil consumption efficiency. Given the huge numbers involved in OECD oil demand, it is worth teasing any data out for signs of how this efficiency is progressing and if it is lasting.

Automobile sales in the US are recovering (chart 1). The October sales numbers were at an annualized rate of 10.45 million units, up from 9.2 in September and 14.09 in August. The August number was prematurely high due to the cash for clunkers program which took place mostly in that month.

(click image to enlarge)

Now that the data dust of the cash for clunkers program has settled it is becoming clear that the mix between cars and SUVs/light truck sales is changing (chart 2). A higher share of car sales rather than heavier vehicles would tend to indicate that sticky changes in efficiency are occurring. Oil analysts factor these shifts into long term vehicles on the road when modeling oil demand. I speculated last month that the August cash for clunkers program had the effect of being a giant advertising program for efficient vehicles and would kick off this efficiency move.

(click image to enlarge)

What is interesting as an economic sidenote, but not so much for oil demand, is that US domestically produced automobiles appear to be gaining some ground (chart 3). Perhaps this is due to the weakness of the US dollar which makes imported vehicles more expensive as well as the recent report in an influential consumer survey of some US auto makers' vehicle quality improving.

(click image to enlarge)

Wednesday, November 4, 2009

How to Speak OPEC

As you may know from reading this blog, oil prices look like they will trade as high as US$95 before year end which will result in OPEC increasing production at their next scheduled meeting on December 22 in Angola. In other words, oil prices will continue higher until OPEC increases output.

OPEC have a relatively small amount of spare capacity and so once these production increases are done we will eventually see US$100+ oil again before the end of 2010.

Oil began 2009 close to US$30 per barrel. We are now at US$80 per barrel due to fundamental supply and demand. Oil bears have been blindsided in the past by an over-reliance on easy (OECD) data and OPEC double-speak. To help these oil bears out, here is a quick guide to the language of OPEC:

OPEC: Speculators are causing higher prices.
Means: OPEC wants, needs and causes higher prices by cutting output and creating an oil supply deficit. OPEC is the only group of oil producers with spare production capacity and has co-ordinated control of over 40% of global oil output - currently worth around US$3 billion per day, or US$90 billion per month.

OPEC: We think prices at US$70-US$80 are fair.
Means: OPEC will not increase oil production until oil trades above US$90 per barrel. OPEC members' target is US$70-$80, which means OPEC will increase production when oil trades above this range (perhaps to US$85-$95) to allow for some slippage. OPEC members do not want to encourage consumer efficiency or risk another recession with US$100+ oil, which is a psychologically important level for oil consumers.

OPEC: We cannot find buyers for our oil.
Means: OPEC members almost can't believe consumers are buying this line...but it actually worked when oil traded above US$100 last year because OPEC members had run out of spare capacity and were unable increase production.

OPEC: We do not want to increase production while OECD inventories are at record highs.
Means: Don't look at non-OECD inventories which are falling due to rapid demand growth in the developing world. Why do you think oil has risen from US$32 to US$80 over the past 10 months? If OPEC can keep consumers focussed on OECD inventories this allows OPEC to blame speculators and say "OECD inventories are high...it can only be speculators bidding oil prices up."

OPEC: Floating storage of oil is at record highs.
Means: It used to be that floating tankers were expensive and only used for storage when land-based tanks were full. Now these floating tanker owners are in such a bad way with a glut of tankers available that they are directly competing with land-based storage even though there is plenty of land based storage available. OPEC needs to point to any full barrel or container as an excuse not to increase production.

OPEC: We have almost 6 million bpd spare capacity.
Means: OPEC members have 2.5 million barrels per day (bpd) of spare capacity. The global oil consumer called OPEC members' stated spare capacity bluff in 2008.

Sunday, November 1, 2009

Oil Market Braces against Chill in the Air

Today was the first day cold enough in New York to require a coat. As we head into the Northern Hemisphere Winter chill it is worth putting seasonal heating in perspective.

The oil market splits the year into two seasons for heating purposes.
Winter is considered November through March. Summer is April through October.

The largest heating oil market in the World is in Western Europe followed by the US Northeast. Heating oil demand in Canada, Japan and Korea is also significant.

Winter Heating Oil Demand
(Click image to enlarge. Source: Oil 101, Table 13-2, Page 282)

Thursday, October 29, 2009

Don't Cry for WTI

Oil market pricing formulae and the benchmarks used in those formulae change over time as crude production that had been the basis for individual wells declines or the components of a blend change. Changes also occur when what is perceived to be an improved benchmark emerges.

A number of years ago, Saudi Aramco ceased using the day-end settlement of ICE Brent crude as a benchmark and switched to using a weighted average of Brent prices throughout each trading day. This new benchmark is called BWAVE (Brent Weighted Average).

Now, Saudi Aramco (which is a larger player among the hundreds of oil companies using WTI and other benchmarks) is switching from using Platts WTI to using Argus, a Platts competitor's, benchmark for US gulf coast sour crude.

The New York Mercantile Exchange (NYMEX) has tried in the past to launch a sour crude futures contract to compliment its less sour WTI. This may now give life to such an effort. A few years from now there may be two highly liquid US futures - WTI and Gulf Coast Sour.

Some have mentioned that this is a snub of NYMEX WTI futures or proof that WTI is "broken". On the contrary, I see this as a natural progression and fine tuning of benchmarks and formulae over time and something the NYMEX itself has embraced.

The Saudi decision is more of a win for trade journal Argus over its competitor Platts.

For more on oil pricing and benchmarks see Oil 101.

Thanks to the very interesting heatingoil.com for picking this up.

Update (Oct 30): As expected, the CME (parent of the NYMEX) is going to launch futures contracts based on the Argus Sour Crude Index. My guess is that this Saudi announcement will result in net increased volumes for WTI futures rather than less.

Sunday, October 25, 2009

Tale of the Curves

In each of the past four years the spot oil market has traded around US$80 per barrel (see chart 1 below). Over that time, we have seen a high of US$147.27 and a low of US$32.40.

Chart 1: NYMEX WTI Crude Oil 1st Month Price (click chart to enlarge)
What is interesting is the change in the shape of the forward curve each time we have traded at or close to US$80 (see chart 2 below).

For example, December 2015 was US$69.07 on September 14, 2007 (point A in chart 2 ) and is currently US$93.95 (point B). In other words, the expected price of oil in December 2015 has risen by almost US$25 per barrel in the past 2 years.

Chart 2: NYMEX WTI Crude Oil Forward Curves (click chart to enlarge)
The back end of the oil curve has risen steadily due to three reasons: 1. the expected marginal cost of future supply has increased over the past two years; 2. the US dollar is expected to weaken in oil terms; and 3. an early 1980s-type efficiency drive is expected to make demand more resilient to higher prices than demand has been over the past twenty years.

As you may be aware, oil forward curves have historically not been a good predictor of future prices. Forward curves are a summation of current market expectations. Expectations change over time as new information becomes available.

I don't think that the current forward curve correctly reflects the most probable oil price scenario over the next ten years. However, humility in the face of market expectations and an understanding of those expectations is essential before one can disagree with them.

For an explanation of forward curves, look at Chpt. 18 of Oil 101.

Tuesday, October 20, 2009

Vehicle Purchasing: Value...not Brand

Vehicle brand loyality in the US is dead (NYTimes). The shift in vehicle purchasing considerations toward value and efficiency and away from brand identity could have a significant impact on US oil consumption over the next 5-10 years.

Monday, October 19, 2009

Bloomberg TV This Afternoon

I appeared live on Bloomberg TV earlier today to discuss oil.
Oil may rise to $95 a barrel this year as demand for heating fuel kicks in and OPEC sticks to its output reductions...  "The oil market is in a glbal supply-driven price rally," said Morgan Downey...  "As we head toward the winter season, and so long as OPEC continue to hold oil off the market, the higher prices are likely." 
Opec, responsible for about 40 percent of global crude production, is due to meet on Dec. 22 in Luanda, Angola.  The December meeting  "may coincide with prices reaching the $85 to $95 price level, at which point they will increase production," Downey said.
Downey is the author of "Oil 101," a history of oil exploration and trading.  In March, when crude traded around $43 a barrel in New York, he correctly predicted that prices would rebound above $60 a barrel two months before it happened. (source: Blomberg, October 16, 2009)

Saturday, October 17, 2009

Financial Sense Newshour

An audio interview I had with the highly respected Jim Puplava of Financial Sense Newshour is here.

Toward the end of the interview Jim says:
“I’ve read many books on oil and I have to say that your book is in my top five...It’s one if the best books I’ve read....I highly recommend you pick up a copy.”

Thursday, October 15, 2009

Oil Market Break Out

(click chart to enlarge)
Crude oil hit a new high for the year 2009 today, crossing above US$78 per barrel.  We have finally broken out of the summer doldrums as we head into what is seasonally the highest demand period of the year for oil. 

OPEC members' publicly stated price target is US$70-$80 per barrel.  However, once OPEC members increase production prices tend to fall rather than move sideways.  So US$85-$95 per barrel is likely the level which has enough of a price buffer to be the range at which OPEC will increase production.  OPEC meet next in December and this may coincide with prices reaching the US$85-$95 price level at which point they will increase production.

One of the questions asked in feedback was where do I think the oil market is going longer term (3-5 years).  Over such a long time frame it is really only possible to estimate boundaries.  It appears unlikely that oil will price above US$150 per barrel in real inflation adjusted terms (2009 dollars) over any 12 month rolling average even if there is a supply shock or long term decline in supply.  On the downside, given that the marginal cost of non-OPEC production and the required oil price to balance OPEC government budgets are at least US$60 per barrel it is unlikely prices can persist beneath this level.

The next 5 years is also likely to be an era of extreme divergence within the hydrocarbon business.  Some areas are heading for distressful times.  Other areas are primed to do very well.  We are witnessing a replay of some of the same themes from the early 1980s (see Oil 101).  However, this time there will be the twist of a supply crunch and periods of little if any spare capacity.

Tuesday, October 13, 2009

Feedback 101

Do you have ideas to improve Oil 101 and/or this web site? The primary goal of the book and this site is to improve understanding of energy issues in order to provide the basis for informed debate. Please email ideas to: morgan@morgandowney.com  I respond to every email quickly and am keen to hear advice for improvement or any comments.

Monday, October 12, 2009

Clunker Flunker? An Observation In Hindsight

The US cash for clunkers program was designed to stimulate economic growth through the auto industry by encouraging individuals to trade in old vehicles for more fuel efficient models.  The US$3 billion program ran from July 24 through August 24, 2009.  The program resulted in an additional 690,114 cars being traded in. The average fuel efficiency of trade ins was 15.8 mpg and the average for the replacements was 24.9 mpg. Those receiving the clunker subsidy are supposed to be taxed on that benefit so the entire US$3 billion is not lost.

If you do the math, the saving in oil spending over the lifetime of the new vehicles could be great enough to justify the US$3 billion of taxpayer money spent.  However, critics point out that the taxpayer is out of pocket for donating this one off efficiency saving to fortunate clunker owners without any benefit in return.

Now that the program is over, the data show that there may be a single unexpected long-lasting benefit.

The month after the clunker program ended, consumers continued to purchase more cars and small vehicles rather than larger light trucks and SUVs.  Perhaps vehicle dealers realized that efficiency is the new best selling point - particularly as US consumers are in an increased saving mode following the severe recession? Maybe it took the surge in efficient vehicle sales during the clunkers program for this realization to become widespread?  This efficiency trend, if it persists, will help the US economy better survive future oil price spikes.

Let's take it to the charts. Chart 1 shows the brief recovery in US auto sales during the short lived clunkers program.

(click to enlarge chart)
Chart 2 below shows the numbers of cars sold in the US as a percentage of total.  The clunkers program achieved what US$147 per barrel could not: 57% of vehicles sold during August 2009 were cars rather than SUVs/Light trucks. This exceeded the 55% number of May08-July08 as oil prices hit record highs.  What is most interesting is that the share of car sales has not collapsed to pre-clunker program levels: in September 2009 car sales accounted for 54% of total US sales.

(click to enlarge chart)
Another criticism of the clunkers program was that it encouraged the purchase of imported vehicles rather than domestic.  Chart 3 clearly shows that the trend toward sales of imported vehicles has been in place for a long time and that the clunkers program barely made a difference to the trend.

(click to enlarge chart)

Conclusion: While the benefit to taxpayers may not be immediately significant, the cash for clunkers program appears to have had a halo effect on efficient vehicle sales in the US.  This efficiency will strengthen the US economy against future oil price shocks and if the trend continues it is a welcome unintended benefit of the clunkers program.

Saturday, October 10, 2009

Is Natural Gas the New Oil?

Source: EIA and IEA data.  Chart from Page 7, Fig. 1-3, Oil 101

There have been a number of stories over the past week about the growth potential of natural gas in the US.  The optimism over supply has resulted from the application of a technique which fractures natural gas bearing shale rock. The fracturing process involves pumping fluids at high pressure into wells to break the reservoir rock and permit natural gas to flow which would otherwise never move across the tight formation to the well.

The fracturing ("fracing") of tight shale formations is now being investigated for use in Europe and other areas outside the US.

Estimates as to how much additional natural gas can be extracted using such techniques vary extremely widely. Some say that natural gas could become an increasing alternative transport fuel to liquid hydrocarbons (crude oil) in certain applications and certain regions of the world for several decades. Natural gas may also increasingly displace solid hydrocarbons (coal) as a baseload (running all the time) electrical power generation fuel.

What is certain is that the industry is in a state of flux which could turn the oil and gas industry upside down over the next 10 years.

In fact, there is a now frantic effort bubbling to the surface in the US to try to avert a natural gas crisis due to prolonged oversupply and low prices. The effort is focussing on expanding alternative uses for natural gas and if possible linking natural gas prices to liquid hydrocarbon (crude oil) prices which are expected to trend higher due to global supply constaints.

Friday, October 9, 2009

Oil Demand Destruction Destroyed

The IEA this morning raised its 2010 forecasted oil demand by 0.35 million barrels per day (Mb/d) to 86.1 Mb/d. This means 2010 oil demand will be 1.7% (1.5 Mb/d) above 2009. Almost all of the growth is coming from non-OECD countries with OECD oil demand growth expected to be flat.

Thursday, October 8, 2009

Floating Storage Sinking

A great story by Brian Baskin in the Wall Street Journal about the financial risks involved in storing oil. While storing oil on an opportunistic basis was common earlier in the year. The Journal story shows that in free markets such arbitrages only exist for brief periods:
"Storing oil is rapidly becoming a losing proposition...companies will find it difficult to extricate themselves.." (WSJ)

CNBC This Afternnon

On CNBC's Closing Bell live today I spoke with Maria Bartiromo about commodities.

(click here to view on CNBC's site if it doesn't open below)

Monday, October 5, 2009

Oil and The Ugly Currency Contest

A story in the UK Independent claims that an international agreement ("confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong" - from the news story) is in place among many nations to begin a nine year transition toward trading oil in currencies other than the US Dollar.

However, once again, and as I mentioned here and here, I tell you that the inefficiency of trading a global commodity in many different paper currencies (crossing many currency bid/offer spreads) is far worse than the current USD oil trading system.

Every time this debate arises because some confuse a transactional currency decision with a reserve currency decision. First, the transaction currency decision: the currency in which oil is traded should be the one which is most liquid and widely traded. This minimizes costs for consumers and maximizes revenues for producers.

What consumers and producers do once they own this highly liquid currency after the oil transaction has been completed is a completely separate second decision - a reserve currency decision. Countries are free to sell their liquid currency reserves and immediately buy anything they want, including other currencies or hard assets. This is a separate decision which has nothing to do with why it is best to trade oil in dollars - the most liquid and widely traded currency.

I am not blindly biased in favor of the US Dollar. All paper currencies tend to lose value over time. As Anatole Kaletsky put brilliantly in a Times article a few months back:
"The currency game is not a beauty contest but an ugly contest, in which investors must choose the currency that is least ugly."
For oil trading, the least ugly currency is still the US Dollar.

Sunday, October 4, 2009

Final Brazilian Oil Use Observations

On my way to the airport, a few final interesting transportation observations about Brazil which you are likely to be familiar with if you have been here.

Video One: A significant number number of trucks have the ability to lift some of their wheels off the ground when not fully loaded (to save on fuel). You don't tend to see this to the same extent in other countries.

Video Two: Motorcycles quite commonly create their own unmarked lane between car lanes in which to speed by in convoys. Cars have to be very careful about changing lanes.

Petropolis and the Brazilian Ethanol Subsidy

This past week has been a big one for Brazil. It was announced that the country will host the 2016 Olympics in Rio de Janeiro.  Brazil had already being chosen to host the 2014 soccer World Cup. This was also a week of optimism about Brazil's petroleum sector with large expanded claims about deep offshore oil fields being made.

Although the US is the largest producer of ethanol by volume, ethanol accounts for a larger percentage of Brazil's transport fuel use.  Ethanol is the same alcohol in beverages (don't drink from the fuel pump though as there are many often poisonous additives - see footnote below about the bottle in the picture to the right).

In Brazil, most ethanol is made from sugarcane. In the US most ethanol is produced from corn, which is a less efficient energy-wise and a more expensive process. The US does not have the same Brazilian Amazonian conditions to grow such large sugar volumes.

One of the observations I made during my time here was that ethanol prices are extremely low at Brazilian pumps compared to gasoline.  I wondered: how this could be with twenty year high sugar prices (US24 cents per pound) and moderate petroleum crude prices (US$70 per barrel)?

A little background first:  all gasoline at Brazilian retail stations must by law contain at least 25% ethanol, with the other 75% being petroleum-based gasoline.  This blend is known as E25.  Most Brazilian retail stations have two pumps: one for E25 snf one for ethanol. All gasoline in the US must contain at least 10% ethanol (E10) and it tends to be only in the US midwest corn belt that second pumps offering high (E85) ethanol blends exist.

The US has a 54 US cents per gallon tariff on ethanol imports.  The US tariff is to try to prevent non-US ethanol producers from taking advantage of the hefty 51 US cents per gallon subsidy which ethanol producers in the US receive in order to kick start and scale up US ethanol production.

The US ethanol tariff effectively eliminates the ability of Brazil to export ethanol to the US. Brazil has no import tariff on ethanol.

Brazil has no ethanol subsidy now (it did until the 1990s) and Brazil has called many times for the US to remove its 54 cents per gallon import tariff.

However, in reality Brazil does subsidize ethanol by heavily taxing gasoline.  E25 Gasoline in Brazil is roughly US$5.15 per gallon at the retail pump at the moment (BRL 2.40 per liter).  Ethanol in brazil is currently US$2.95 per gallon (BRL 1.39 per liter).  This equates ethanol to 58% of the cost of E25 gasoline.  Ethanol should be around  of 70% the cost of E25 gasoline based on the mileage it permits.

The high Brazilian tax on E25 gasoline is effectively a clever ethanol subsidy.

You may wonder why everyone in Brazil doesn't switch away from petroleum gasoline to ethanol?  They are, with around 94% of new vehicles sold being flex fuel vehicles capable of burning high ethanol blends.  It tends to be imported luxury vehicles and older non-luxury vehicles which still use E25 gasoline.

(note on the picture above: the bottle contains a mineral water from the Brazilian city of Petropolis, which is named after Pedro, the second and last Brazilian Emperor, rather than petroleum.  I can vouch from my one bottle that the water is tasty and does not contain any hydrocarbons.)
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