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Oil and the dead cat bounce

October 18th, 2012 by Andrew McKillop, Former Expert-Policy & Programming, DG XVII Energy, European Commission

What crisis? Nymex and ICE oil price movement shows how oil prices can be moved anywhere as long as its up, except of course when its down, where fundamentals point with stubborn determination.Recent weeks, especially the last show that sometimes the oil bulls can get dispirited and run out of news support, and be forced to take a cut in their boundless optimism which says we really can have $130 a barrel for Brent and $125 for WTI like Goldman Sachs tells us we can – this year, in 2012. When the markets take an especially hard hit, like the recent loss of $10 off the barrel price, the dead cat bounce can take the shape of a Goldman tiger bounce – paper tiger of course.


The real underlying fundamentals are market fundamentals: oil, other commodities, currencies and government debt, equities, any “negotiable security” is now an asset play. And assets have to move up, of course except when their nominal playtime value goes down. Why oil should be specially stuck with the role of lead player in the commodity asset domain is a long story, but what counts is that energy fundamentals are a side dish. What’s supply and demand got to do with it?

The European debt and Eurozone finance crises, so long running that they are now antique, can be used to prop oil prices anytime the ECB seems to have its hand near the QE faucet or Germany seems like it might open its purse strings, but with the wrong signals oil prices can plunge on European news: this week WTI crude plunged as Spanish and Greek protestors took to the streets. On the other hand, Brent stayed strong – that is weakened less than WTI – as President Obama told the world “The US will do what we must to prevent Iran from obtaining a nuclear weapon”. Oil bulls were also heartened by Benyamin Netanyahu’s not so new hard-line posture on Iran at the UN general assembly.

FUNDAMENTALS ARE NEGATIVE
Every so often market players have to take a peek at what are called energy fundamentals, although this is a dangerous thing for the bulls. Recent and ongoing oil demand and supply news is bad for them; upcoming news is bad, also.

Take an old saw so old that its even more antique than Eurozone crisis. It says that “the USA is dangerously dependent on imported energy”. Meaning oil, only, and vastly less than the straight majority of other OECD oil and energy importer countries. Also, shrinkingly less than other major oil and energy importers. Bloomberg News tells us that US oil production last week hit its highest level since January 1997, and the EIA says the US in Q1 2012 met 83 percent of its total energy needs from domestic production. Achieving that also means we take a trip Back to the Past, that is the highest level of energy self-sufficiency since 1991. Soon, the US will be exporting natural gas from its booming shale gas-spurred gas production: in 2006, the so-called “expert community” opined the US was at the edge of a Gas Cliff and was doomed to permanently import gas – at prices running up to, or above $16 per million BTU, equivalent to oil at $92 per barrel. So much for “crippling import dependence”.
But who cares about that when Benyamin Netanyahu is thundering at the UN and Spanish or Greek protestors take to the street, one day, and the ECB hints it will buy even more Eurozone sovereign debt, the next day? Thats fundamental oil trader logic, with a lifetime of milliseconds.

Fundamentals say some awful things about 100-dollar oil, let alone Goldman’s Nice Price of $130 a barrel. US natural gas prices averaged a little more than $2.50 per million BTU in Q2 2012: that prices the stuff at around $14 per barrel equivalent. Expensive energy! US coal prices, in a now languishing industry are as low as $1.60 per barrel equivalent for the cheapest black stuff. Although wind turbines are expensive, but getting less so, and solar PV arrays are expensive but getting less so very fast, the “fuel” they run on is 100% free. Expensive energy!

To be sure that is only one half of the story – the energy supply side. The demand side is also dark and threatening for overpriced oil, very threatening. World oil demand, this year, may achieve a scary feat for the oil bulls: two straight years of near perfect stagnation of global demand. The EU27 countries are now in their sixth straight year of oil demand shrinkage, recession aiding, but they are now far from the only countries where oil demand shrinks – and shrinks. The scariest threat for the cozy, almost automatic Goldman Tiger price bounce, anytime oil falls, comes from the so-called Asian Locomotive, that is China and India. Like we know this runs mainly on coal, like an old time railway loco should, but its rising oil demand was always good for the price bulls, anytime they shifted away from quantitative easing, Eurozone debt bailouts, Iran bombing or a boost to dollar depreciation as a nice set of reasons to bid up oil just as much as they can.

Oil demand growth in China and India is a lot more threatened species than Arctic polar bears. China’s long-term growth rate of oil imports, which hit an average of more than 9 percent a year for 1999-2009 has been slashed in half. Indian oil demand growth, these days, is close to 3.5 percent per year, not the previous 5.5 percent average,

AND WHAT IS OPEC DOING?
Opec alway overproduces, except of course when it underproduces. Most important of all, the figures on supposed national production and export supply never tally, allowing huge margins of creative interpretation, for the oil bulls. At present and for sure, however, Opec and Nopec are overproducing.

Data for Q2 2012 form the EIA shows the US imported 30 percent more crude from the Persian Gulf than a year previous, raising these imports higher than imports of Canadian crude. Alarming stuff, right? In fact EIA data also shows US domestic oil production is at a 14-year high, near 6.3 million barrels a day, and growing, while the USA’s final consumption is back to 1evels of before 2005, at about 18.4 million barrels a day, and shrinking, but these numbers hide a mega shift.

The US is now a large, ever growing net exporter of refined oil products. Domestic refiners are taking crude from wherever available and turning it into diesel, gasoline and other oil products for growing demand from Latin America, Asia, Africa and even Europe, where Europe’s outdated, high cost, oversupplied and mismatched refinery output – relative to European refined product demand – creates a growing market for US exports. Like we know, importing crude and refining it can yield impressive netbacks, easily covering the cost of the imports. Whether it is Opec, meaning Saudi Arabia, or Nopec meaning Russia, crude oil producers are flat out and proud of it, as long as prices stay high.

This is fine for refiners and traders as long as demand holds up. It is also good for oil producers as long as they can benefit from oil energy being priced at 5 or 7 times the price of any other energy, but all good things have to end, one day. Oil production is growing fast, outside Opec, and global oil demand is set to shrink. This is the only possible readout from present and upcoming global economic trends, and oil demand can shrink even faster than first-cut analyses might suggest. In other words the current and effected “global cap” on oil demand is most likely heading for an impossible-to-hide contraction.

When this happens is however hard to predict. It may take 3 months, and will be shaded by winter-time fuel demand growth, and it may take longer but this writing is on the wall.

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