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Rune Likvern

Holds an MSc from Norwegian University of Science and Technology (NTNU), 1980, Marine Technology. 20 years of experiences from several international oil companies, primarily Statoil…

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Where Are Oil Prices Heading?

Offshore rig

In this post I present developments in world crude oil (including condensates) supplies since January 2007 and up until June 2016. I then take a closer look at petroleum demand (consumption and stock changes) developments in the Organization for Economic Cooperation and Development (OECD) for the same period and what this implies about demand developments in non OECD.

The data used for this analysis comes from the Energy Information Administration’s (EIA) Monthly Energy Review.

• The OECD has about half of total global petroleum consumption.
• Since December 2015, OECD total annualized petroleum consumption has grown about 0.2 Mb/d [0.5 percent]. [Primarily led by growth in U.S. gasoline and kerosene consumption, ref also figure 6.]
• The OECD petroleum stock building was about 0.4 Mb/d during Jan-16 – Jun-16, which is a decline of about 0.6 Mb/d from the same period in 2015. This implies a 2016YTD net decline in total OECD demand of 0.4 Mb/d.
• World crude oil supplies, according to EIA data, have declined 1.3 Mb/d from December-15 to June-16, ref figures 1 and 2.
• The above implies that non OECD crude oil consumption/demand has declined about 1 Mb/d since December 2015.

This while oil prices [Brent Spot] averaged about $40/b.

This may now have (mainly) 2 explanations;

1. The present EIA data for crude oil for the recent months underreports actual world crude oil supply, thus the supply data for 2016 should be expected to be subject to upward revisions in the future.

2. Consumption/demand in some non OECD regions/countries are in decline, despite oil prices below $50/b.

If this should be the case, then it needs a lot of attention as it may be a vital sign of undertows driving world oil demand.

Oil is priced in U.S. dollars and U.S. monetary policies (the FED) affect the exchange rate for other countries that in addition have a portion of their debts denominated in U.S. dollars, thus their oil consumption is also subject to the ebb and flows from exchange rate changes.

(Click to enlarge)

Figure 1: The stacked areas in the chart above show changes to crude oil supplies split with North America [North America = Canada + Mexico + US], OPEC and other non OPEC [Other non OPEC = World – (OPEC + North America)] with January 2007 as a baseline and per June 2016. Developments in oil prices (Brent spot, black line) are shown against the left axis.

It was the oil companies’ rapid growth in debt [ref U.S. Light Tight Oil (LTO)] that brought about a situation where supplies ran ahead of consumption and brought oil prices down.

YTD 2016, only OPEC has shown growth in crude oil supplies relative to 2015.

Unit costs ($/b) to bring new oil supplies to the market is on a general upward trajectory while the consumers’ affordability threshold may be in general decline.

In this post I introduce the concept of “consumers’ affordability threshold”, and with that I am referring to the phenomenon that as crude oil prices start to grow, overleveraged consumers are likely to respond by reducing their consumption.

OPEC, primarily Libya and Nigeria, could add more than 1 Mb/d to global supplies in the near future.

[Added OPEC supplies may cancel out declines from other oil producers and provide some temporary growth in global oil supplies. This will likely prolong the period of depressed prices.]

• The oil companies CAPEX reductions will continue through 2017 and flow additions from sanctioned developments will gradually decline towards 2020.

• Any meaningful growth in oil companies CAPEX (sanctioned developments, FIDs [FID; Final Investment Decision]) will require a sustained oil price above $60/b.

[As most developments take 2-4 years from being sanctioned to flow, this introduces a time lag for when new developments will add to supplies.]

A big portion of oil companies’ portfolios of discoveries and infield drilling that met the sanction hurdle of $60/b were mostly expended while oil prices were expected to remain at $100/b or above. The results from recent years’ exploration has replaced a small portion of what was extracted.

World Crude Oil Supplies

(Click to enlarge)

Figure 2: The stacked areas in the chart above shows development in crude oil supplies split on some economic entities from January – 07 and per June -16. The oil price [Brent spot] is shown against the left axis.

(Click to enlarge)

Figure 3: The stacked areas in the chart above shows relative development in crude oil supplies split on some economic entities from January – 07 and per June -16. The oil price [Brent spot] is shown against the left axis.

EIA data now shows that OPEC is gaining global shares of crude oil supplies.

OECD Petroleum Consumption

(Click to enlarge)

Figure 4: The chart above shows development in petroleum consumption for the US [red area], OECD Europe [yellow area], and other OECD (which includes Canada, Japan and South Korea) [blue area]. The chart is complemented with lines showing smoothed 12 month moving averages (12 MMA) for the presented OECD countries/regions. The oil price (Brent spot) is shown against the left axis.

For the U.S., petroleum consumption started to grow while the price was above $100/b, while for OECD Europe, petroleum consumption growth started with the collapse in oil price.

Japan has reduced its petroleum consumption by about 10 percent since the oil price collapsed.

OECD Petroleum Stocks

(Click to enlarge)

Figure 5: The chart above show development in OECD petroleum stock developments. US believed to include SPR.

As supplies in 2014 started to run ahead of consumption, the oil price collapse allowed for a strong stock build in OECD (ref also figure 5) and in China, according to some reports.

More than 330 Mb has been added to OECD stocks since January 2015.

The high stock levels will for some time act to temper growth in oil prices.

A closer Look at Developments in U.S. Petroleum Demand

Figure 6: The chart above shows development in annualized [52 weeks moving averages] U.S. total petroleum consumption [blue line] and storage build [red line] both rh scale. The black line, lh scale, shows development in oil prices (WTI). Consumption and storage developments are relative to Janaury 2014 (baseline).

NOTE, changes in consumption and stocks are stacked, thus the red line also shows total annualized changes in demand.

Growth in U.S. consumption has primarily been driven by a longer lasting low oil price.

• EIA data shows that U.S. total demand has moved sideways since Sep-15 with a noticeable growth in consumption (lead by gasoline and kerosene) and slower growth in stocks building (ref also figure 7).

(Click to enlarge)

Figure 7: The chart above shows development in U.S. commercial stocks of petroleum, by some products, since Jan-14 [stacked areas, rh scale] together with the development in the oil price (WTI) [black line, lh scale].

Growth in Private and Public Debt for China and the U.S.

Figure 8: The chart shows Year over Year (YoY) growth in private and public debt for the world’s 2 biggest economies, the U.S. [blue line] and China [red line] and their total [black line] from Q1-2000 and as of Q1-2016.

The chart illustrates that the global debt overhang continues to grow led by the world’s 2 biggest economies. Since 2012 China and the U.S. have annually added a total of about $5 trillion to their debts.

So where are oil prices headed?

With oil prices at $100/b, oil companies leveraged up with debt, expecting this to be the new normal. The collapse in oil in 2014 presented them with a new reality, with many now struggling to understand what it means for the future price formation of oil.

I have written several times that oil prices have very much been a function of monetary and fiscal policies and thus provide an important part of the foundations for how its demand develops. Oil is no longer priced for the utilities it provides for societies, but just as another commodity. Oil demand developments still appear to be the variable that remains poorly understood.

If, as present EIA data suggests, crude oil demand in non OECD is in decline with oil prices below $50/b, there may be a shift in structural affordability which (with some time lag) will also affect the OECD.

Affordability is more related to price than costs. The median household has experienced little or no growth in purchasing power relative to developments in other expenses like debt service/rent and health care. This is important as this suggests that the affordability threshold for higher priced oil is likely in decline. This may be hard to verify with oil prices below $50/b, but (if I am right) will materialize in a decline in consumption as oil prices start to move up.

This is where I expect that, for some time, oil prices will enter affordability dynamics as prices start to move up, causing consumption/demand to decline, thus curbing any price growth.

This will create some interesting dynamics as oil companies had bet their futures on sustained higher oil prices and the current “lower for longer” environment prolongs the time it takes to heal their balance sheets and defers necessary CAPEX in exploration and developments to meet projected future demand.

The continued stock build (in petroleum) suggests that there is still some way to go before supplies reach a level where oil prices regain fundamental support for growth. One of the parameters I keep an eye on is how petroleum stocks develop, and I am not thinking about movements from one week to another, but more considering when commercial stock drawdowns over time (and seasonally adjusted) decline and permanently remain 5 percent (or more) below present levels.

On the supply side there is potential for growth of several OPEC members like Iran, Libya and Nigeria.

Bringing on additional supplies (wherever from) will prolong suppressed price growth.

For anyone out there trying to predict the future oil price trajectory, you must consider to what extent several key variables have been factored in. These variables include the effects (or lack of) of future central bank’s policies, governments’ fiscal policies, bank leverage and risks to financial stability, the state of Chinese banks and monetary policies, Chinese oil demand, including the filling of their SPR [Strategic Petroleum Reserve] and developments in world trade.

By Fractional Flow

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  • Charles Hall on October 08 2016 said:
    Good post, but you focus only on potential increases in supply from e.g. Nigeria, Libya and Iran. But you also need to consider the fact that the majority of oil producers (many smaller, it is true, ) have actually reached a peak in the past decade or so and are declining, actually pretty much following a Hubbert curve with low EUR (total resource) estimates:
    (e.g. Hallock Jr., John L., Wei Wu, Charles A.S. Hall, Michael Jefferson (2014), “Forecasting the limits to the availability and diversity of global conventional oil supply: Validation.” Energy 64: 130-153. Also empirical work of Nashawi, I. S., A. Malallah and M. Al-Bisharah (2010), Forecasting World Crude Oil Production Using Multicyclic Hubbert Model. Energy Fuels 24: 1788-1800. ).

    In the longer perspective it would seem that we are at about peak conventional and perhaps all oil :
    Maggio, G. and G. Cacciola (2012), “When will oil, natural gas, and coal peak?” Fuel. 98:111-123.

    Mohr, S.H., J. Wang, G. Ellem, J. Ward and D. Giurco (2015), Projection of world fossil fuels by country. Fuel 141: 120–135.

    In my perspective peak oil has been delayed, but not but to rest. Meanwhile, apparently EROI (Energy Return on Investment silently but steadily seems to be declining. Lufkin's post does a good job at analyzing the factors that will operate in the shorter term.
    Charlie Hall

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