Oil Prices Set To Rise In 2017 On Balancing Markets

Friday December 23, 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. Dollar rally at a turning point?

(Click to enlarge)

- The U.S. dollar has rallied to its strongest level in more than a decade in recent weeks, as the uncertainty surrounding the presidential election disappeared and the Federal Reserve hiked interest rates. The Fed also suggested that the strong labor market could warrant further rate tightening in the quarters ahead.
- At the same time, economic weakness, political uncertainty, and a spate of terrorist attacks in Europe are all weighing on the euro.
- The strong dollar is putting downward pressure on crude oil prices, making oil more expensive for much of the world and thereby pushing down demand. The dollar is offsetting strength in the oil market stemming from the OPEC deal.
- The dollar rally came to a halt in mid-December, reversing somewhat.
- The big question mark will be U.S. policy in the Trump administration. Businesses are confident about prospective tax cuts, but excessive spending could fuel inflation.

2. China's LNG imports spike

(Click to enlarge)

- China imported a record level of LNG in November - 2.66 million tonnes - up 46.6 percent from a year earlier. BMI Research expects the country to hit another import record in December as importers scramble to supply enough gas for winter heating.
- China is the third largest LNG importer in the world, but unlike Japan and South Korea, its imports are growing very quickly.
- Global LNG markets have entered a state of oversupply and weak prices, as the market has been slammed by too much supply and falling oil prices, which affect oil-linked LNG contracts.
- However, the market has tightened in the latter half of 2016. Spot LNG prices in northeast Asia hit a two-year high at $9.40/MMBtu in December, and have doubled since earlier this year.

3. Vehicle sales slow down

(Click to enlarge)

- U.S. automakers are starting to see demand for vehicles slow, leaving them with much higher levels of inventory compared to last year.
- The three major U.S. car companies announce that they would idle some factories for a few weeks in order to clear inventory, an unusual move that points to oversupply.
- GM (NYSE: GM) had 873,000 vehicles on hand at dealer lots, up 26 percent from this time last year and the highest level in a decade.
- That is a bad sign for gasoline demand, which has hovered at record levels throughout 2016.
- On the other hand, while automakers are seeing demand for smaller compact vehicles slow, interest in heavier SUVs remains robust.
- Consumer interest in heavier vehicles could reverse if gasoline prices start to rise again.

4. Fracking only accounts for half of U.S. oil production

(Click to enlarge)

- Although fracking has been used for decades, it only came into prominence over the past ten years.
- In 2000, the industry fracked 23,000 wells, which produced 102,000 bpd, less than 2 percent of U.S. output. That has skyrocketed to 300,000 wells in 2015, producing 4.3 mb/d.
- Oil produced using fracking has surged from virtually nothing to 51 percent of all U.S. oil produced in 2015. However, despite the headlines, conventional oil still accounts for the other half.
- Moving forward, hydraulically fractured wells will account for a growing share of the drilling in the U.S.

5. Oil volatility plummets

(Click to enlarge)

- Oil volatility has plunged to its lowest level in more than two years in recent days.
- The CBOE Crude Oil Volatility Index, which measures volatility of crude oil prices, dropped to 28.39 on Dec. 19, a level not seen since late 2014.
- Coincidentally, it was the OPEC meeting in November 2014 that sparked a surge in volatility in crude oil prices for the next two years, and it was the OPEC meeting in November of this year that has eased the volatility significantly.
- In fact, volatility spiked in the lead up to the latest meeting in Vienna, as oil traders positioned themselves for an expected meltdown in prices on a failed deal from OPEC.
- However, OPEC has surprised many, and has succeeded in smoothing out some of the volatile movements in prices.

6. SPR sales set to rise

(Click to enlarge)

- Since the 1970s, the U.S. has stockpiled oil in its strategic petroleum reserve to protect the economy from a potential supply outage. The SPR holds roughly 695 million barrels.
- But the surge in domestic oil production in recent years has calmed fears over energy security, and the U.S. Congress has authorized sales of oil from the SPR in various pieces of legislation (see chart).
- Between 2017 and 2025 the U.S. could sell 190 million barrels.
- DOE says the sales could begin as soon as January. The proceeds from the sale will go to updating the infrastructure of the SPR for the long-term, as well as for the U.S. treasury.
- Although the sales are expected to be relatively small and spread out, they could affect global supplies in the near-term.

7. Brent futures points to balance next year

(Click to enlarge)

- Brent futures show wide disparity in timespreads over the next few years, as Reuters depicts.
- The market is in a contango, in which near-term contracts trade at a discount to futures further out, a sign of short-term oversupply.
- The February 2017-June 2017 discount is trading between $2.00 and $2.50 per barrel. But the differential between June 2017 and December 2017 has narrowed to just about nothing.
- That indicates that the markets believe that global inventories will keep the market oversupplied for the first half of the year, but they are growing much more bullish about the second half of 2017.
- In short, Brent futures prices are acting as if the oil market will reach balance by the third and fourth quarters of 2017.

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