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.
Follow @CommodityMD