140828 Energy Monitor Sep.docx

Energy Monitor September
Group Economics
Commodity Research
Postponed stress
28 August 2014
• Oil prices decline despite geopolitical tensions
• Nevertheless, geopolitical tensions do have an effect on oil prices
• Current overproduction and possible future production difficulties lead to changes in the forward curve
Figure 1: Price of Brent crude versus WTI (in USD/bbl)
160
140
120
100
80
60
40
20
0
-20
2009
2010
Brent
2011
2012
WTI
2013
2014
Brent-WTI Spread
Oil prices decline
Following the advance of ISIS in Iraq, oil prices rallied to levels above
USD 115/bbl in June. Not long after, it seemed that oil production
would remain unaffected and the market calmed down. This triggered
the start of a declining trend in oil prices. Weak demand, combined
with more than enough oil production, caused the Brent oil price to
drop below USD 100/bbl – the lowest level in fourteen months. Iraqi
Kurdistan increased oil production and Libya also reported higher oil
exports. As a result, OPEC oil production ultimately reached 29.91
million barrels per day (mb/d) in July. This, together with increased oil
production in non-OPEC countries, such as the US and Canada,
created sufficient oil supply. The price of West Texas Intermediate
(WTI) declined as well. However, this decline was not as strong, given
the significant drop in inventories in Cushing, Oklahoma in recent
months. These inventories were partly transported via recently opened
pipelines to the US refineries in the Gulf of Mexico region for
processing. Because this could lead to shortages in other parts of the
US, prices did not decline as much as one would expect. The price
difference between Brent and WTI (the Brent/WTI spread) dropped to
the lowest level since September 2013.
Source: ABN AMRO Group Economics, Thomson Reuters
Geopolitical tensions do have an effect
Many investors wonder why oil prices failed to rally as a result of all
the geopolitical tensions around the globe. There are tensions all
widespread, and many large oil producers are directly or indirectly
involved. Still, fear that political decisions may lead to oil production
shortages have eased. As a result, oil prices have not appreciated
much, and the impact of these geopolitical tensions therefore seems
limited. However, in a normal situation, the effects of oversupply would
have resulted in a much stronger price decline. We believe that
geopolitical tensions are having an impact. Prices may not be
increasing, but nor are they declining.
Table 1: ABN AMRO oil and gas price forecast
(Oil: USD/barrel, HH: USD/mmBtu, TTF: EUR/MWh)
Price
Q3 2014
Q4 2014
Brent
105
105
WTI
100
95
HH**
4.50
4.50
21
21
TTF***
Q1 2015
2014*
2015*
100
105
100
100
100
95
4.75
4.50
4.75
20
21
19
Source: ABN AMRO Group Economics
* year average ** Natural Gas Henry Hub *** Title Transfer Facility
(Please see our Quarterly Commodity Outlook for details regarding
our longer term forecast)
Oil price forecast
Geopolitical tensions are hard to predict. However, normal supply and
demand ratios can be fairly accurately forecasted. The effects of
geopolitical unrest are included in risk scenarios. Lower tensions could
result in increased oil production and, therefore, a lower risk premium.
This could trigger a faster and further decline in oil prices. At the same
time, increased geopolitical tensions could lead to limitations in oil
production and/or oil exports. Still, we largely ignore this in our base
case scenario for future oil price developments. This scenario of a
moderate decline in oil prices (table 1) over the next two years is
based on several arguments. We expect that demand for oil will rise at
a moderate pace. Meanwhile, the oil supply will increase at a similar
pace, mainly due to increased production in non-OPEC countries and
despite the oil production potential in some OPEC countries. Finally,
we expect the US dollar to appreciate, which would have a negative
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Energy Monitor September - Postponed stress
28 August 2014
impact on USD-denominated commodities, including oil.
Figure 2: Development Brent Forward Curve
(xUSD/bbl)
Stress postponed
In the previous paragraph, we talked about the downward pressure
on oil prices. This concerns oil for delivery in the near term, for
instance in September or October (figure 2, arrow 1). While
tensions in oil producing countries do have a supportive effect on
oil prices, the greatest impact is on oil with delivery in the longer
term (figure 2, arrow 2). Until recently, prices for delivery in the near
term (short end of the curve) were significantly higher than those
for delivery in the longer term (back end of the curve). This was the
result of temporary uncertainty regarding oil production due to
increasing violence in oil producing countries. However, since oil
prices at the front end of the curve declined, and oil prices at the
back end of the curve rallied, the price difference narrowed. In
other words, the forward curve (series of oil prices with delivery at
different time horizons) has flattened compared to six months ago.
115
110
105
100
1.
95
2.
90
jan-14 mrt-15 mei-16 jul-17 sep-18 nov-19 jan-21
19-aug
6 month ago
Source: Bloomberg, ABN AMRO Group Economics
Figure 3: Brent Forward Curve – Contango and
Near-term contango
The fact that the price of oil with delivery in two to six months is
higher than the spot oil price (contango, figure 3) is, we believe, the
result of lower tensions. This has led to the closure of many
speculative long positions (speculating on price increases). Trade
volumes of Brent oil declined by more than 40% compared to three
months ago. Nevertheless, investors remain somewhat cautious.
They are keeping open the possibility that there will be some type
of escalation after all, and/or Russian sanctions on the EU. This is
part of the reason why oil prices are higher for delivery in 2-6
months. How long this situation will continue is uncertain. Some
investors will try to benefit from this contango by buying oil now,
storing it, and hoping for higher prices in the future. Too many of
these speculative positions would result in a higher spot price,
which would wipe out the contango.
Backwardation (xUSD/bbl)
105
104
backwardation
103
102
101
100
contango
99
98
97
96
95
Jun-14
Feb-15
Oct-15
Jun-16
Feb-17
forward curve brent olie
Source: Bloomberg, ABN AMRO Group Economics
Oct-17
Long-term backwardation
For now, oil prices with delivery in the near term are down as a
result of weak demand and oversupply. In addition, prices with
delivery after six months are in backwardation (future price below
current price (figure 3)). It seems that the market expects the
demand for oil will be balanced out by the amount of oil produced in
the next few years. However, in the longer term (> 2 years), the
effects of the crisis in Iraq as well as the sanctions against Russia
could lead to significant problems. The uncertainties investors
perceived for the near term appear to have been postponed and
now could emerge at the back end of the curve. Iraq had the
ambition of tripling its oil production in the coming years. To meet
the rise in global oil demand, Iraq needs to double its oil production
over the next five years. Due to the recent emergence of ISIS, oil
production has not yet been affected. However, uncertainty about
realising the needed significant increase in Iraqi oil production has
risen. Iraqi oil production would have to double to help meet the
rise in global oil demand, which is not fully covered by the oil
production potential (spare production capacity) of Saudi Arabia
and the expected increase in non-OPEC production. Besides, a
situation in which Saudi Arabia needed to use all of its oil
production capacity would be unwelcome. This would mean that
Saudi Arabia could no longer fulfil its role as swing producer. As a
result, the market, and therefore oil prices, would be left to the
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Energy Monitor September - Postponed stress
28 August 2014
whims of geopolitical tensions and temporary oil production
disruptions.
In addition, the sanctions imposed on Russia by the EU and the US
will hurt investments in the Russian energy sector. The energy
infrastructure is already outdated and overdue for maintenance and
the funds needed to cover these costs are not available.
Meanwhile, large investments are needed to increase knowledge
for exploring new oil and gas production wells in untapped areas
(for instance at sea, or in the Arctic). The fact that these
investments are also lacking could hurt Russian oil production in
the future.
Based on the current situation, a U-shaped forward curve would
seem to be the most likely scenario. This means that the market
should price in lower oil prices in the near term, mainly as a result
of overproduction. However, in the longer term (>2 years) the curve
should start to point upwards due to possible production shortages.
For now, the price at the front end of the curve may be too high,
and the contango could disappear in the coming weeks.
Furthermore, prices at the back end of the curve seem to have
some upside potential. However, the lack of liquidity for long-dated
Brent oil contracts will likely prevent such a rally.
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Energy Monitor September - Postponed stress
28 August 2014
Group Economics | Commodity Research
Hans van Cleef
Senior Energy Economist
tel: +31 (0) 20 343 4679
[email protected]
Group Economics
Commodity Research team
Marijke Zewuster (Head)
tel: +31 20 383 0518
[email protected]
Hans van Cleef (Energy)
tel: +31 20 343 4679
[email protected]
Casper Burgering (Ferrous, Base metals)
Georgette Boele (Precious metals)
tel: +31 20 383 2693
tel: +31 20 629 7789
[email protected]
[email protected]
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