Cracks In OPEC Production Visible

Friday, January 22, 2016

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. LNG demand is weak

- LNG demand slowed to a halt in 2015. Asia is the largest market for LNG - Japan alone accounts for one-third of all LNG imports.
- Japan restarted two nuclear reactors, which cut out some need for LNG. The economy is also flat. As a result Japan's LNG demand fell by 4 percent in 2015 to 85 million tonnes (mtpa), according to Wood Mackenzie.
- China is far behind Japan in terms of LNG demand, but China is supposed to be the biggest driver of future growth. However, LNG consumption fell by 1 percent to 19.5 mtpa in 2015.
- Meanwhile, a wave of new supply is coming online in a bit of unfortunate timing.
- Spot LNG cargoes saw prices drop to below $7 per million Btu (MMBtu) in 2015, nearly one-third of the levels seen in early 2014.
- The LNG market is heading into what is likely to be a prolonged period of oversupply and the massive buildout of new export capacity seen over the past few years is over.

2. Refining margins falling

- Refining margins around the world fell by 34 percent in the fourth quarter of 2015 to just $13.20 per barrel, cutting into the one sector in which integrated oil companies had enjoyed strong profits. Downstream assets cushioned the blow of low oil prices. The margin decline was the largest in eight years.
- Every $1 drop in refining margins cuts down on BP's (NYSE: BP) adjusted earnings by $500 million.
- Refining margins shrank as maintenance period subsided and more refineries ran at full speed.
- 2015 saw record high demand for refined products, helping support margins. But demand has softened in recent months, helping to push down margins.
- In the U.S., the lifting of the crude oil export ban will shrink refining margins, although that will be partially offset by more favorable tax treatment.
- In short, shrinking margins downstream will take away the one bright spot for integrated oil companies.

3. OPEC oil production set to fall

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- OPEC ramped up output since November 2014 when it decided to pursue market share. It has since added over 1 million barrels per day (mb/d).
- But the gains from this 'no-restraint' period are over. There is little room on the upside except from Iran.
- The IEA sees OPEC oil production falling by 600,000 barrels per day this year.
- OPEC's output fell by 210,000 barrels per day in December, with losses coming from Saudi Arabia (-57,000 bpd), Nigeria (-77,000 bpd), Iraq (-31,000 bpd), Kuwait (-22,000 bpd), Venezuela (-20,000 bpd), and Angola (-17,000 bpd).
- Iran says it will immediately ramp up output by 500,000 bpd. IEA largely concurs, expecting +300,000 from Iran in Q1, and +600,000 bpd by mid-year.

4. Iran will fight for market share

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- Iran made its triumphant return to the oil markets this week, with the oil ministry ordering for the immediate increase of 500,000 barrels per day.
- Iran was already selling oil to Asian countries - China, India, Japan, etc. - who were exempt from sanctions. Iran expects to add a modest 200,000 bpd in exports to Asia.
- But Iran will have to fight to claw back customers in Europe, where Russia, Saudi Arabia, and Iraq largely benefited from Iran's absence. Iran exported 1 mb/d to Europe prior to sanctions.
- Iran recently discounted its exports to Northwest Europe in an effort to undercut the competition (Saudi Arabia and Russia) there. An extra competitor could deepen the price war, and further discounts could push down global oil prices.
- Iran is targeting a 1 mb/d increase this year, which would bring it close to 4 mb/d. But the IEA sees that increase as too ambitious. The IEA expects Iran to only achieve 4 mb/d by 2020.

5. China's oil demand slows sharply

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- Despite all the analysis about oil supply and how quickly high-cost production will fall off, this chart could upend those predictions.
- China's oil demand growth plummeted in October and November, the latest months for which data is available.
- Absolute demand dipped by 0.15 mb/d in November. Diesel demand was down 8 percent year-on-year due to slowing manufacturing and construction.
- This points to a possible slowdown in the economy. The stock market turmoil also raise questions of economic stability.
- Overall, China's oil demand grew by just 0.37 mb/d in 2015, and that is expected to slow to 0.29 mb/d in 2016.

6. Canada's oil production will still rise

- One of the reasons that the oil bust has persisted for so long is that supply has been resilient. No place is that more true than in Canada.
- Canada's oil sands are long-term projects, a very different proposition than shale. Shale wells fizzle out after two years. Oil sands can last for decades.
- Moreover, upfront capital costs for oil sands are steep, whereas shale wells are relatively inexpensive. Therefore, if an oil sands project can get up and running, it will continue to operate even during a downturn. Most projects will even operate at a loss once they are online. As such, very little production declines should be expected from Canada.
- Many oil sands projects planned when oil prices were $100 per barrel are set to come online. Canada's oil production could grow at a 4 percent compound rate through 2017, according to Morgan Stanley, despite the crash in prices.

7. Saudi Arabia rapidly losing foreign exchange

- Saudi Arabia has a massive war chest of foreign exchange, which peaked at $737 billion in August 2014. But the Saudi reserves are rapidly depleting as the government defends the currency peg, which has not changed in years.
- The markets are wondering if Riyadh will continue to defend the peg as Saudi Arabia has already burned through $100 billion in reserves. It is now depleting reserves at a rate of $7 billion per month to keep the currency stable.
- It can continue at this pace for several years, but would not ever let cash reserves go to zero. So at some point, something has to give. The Saudis hope that oil prices will rebound before it has to make a choice.
- Most economists believe they will continue to shovel more cash out the door to maintain the peg. A devaluation is an option (which would reduce the burden on cash reserves), but it would raise inflation, increase import costs, shatter confidence, and create uncertainty. Saudi Arabia prizes stability over most other priorities, so for now, it will continue to burn through foreign exchange and hope for a rebound in oil prices.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.