These are some short notes taken from a presentation I gave last week:
Supply side issues
- Global oversupply is only likely to ease by the end of this year. Peak oversupply will be in 2Q2015;
- Despite the various contributions of Iraq, Libya and other countries, about 60% of the oversupply is coming from the US;
- Just four countries commercially produce shale oil, and the vast majority of it is from the US;
- But this production is expected to peak by 2020;
- Bottom line: global oversupply is really a US story, and it will persist for the next half decade.
Demand side issues
- All the BRICs are in the top 10 oil consuming nations, but only India is seeing faster growth;
- Energy efficiency of growth is increasing. For example, despite growth in size and numbers, US government energy needs are 40% below what they were in the 1970s;
- Overall global demand for oil will be flat this year, and only likely to recover in 2H2016.
- Shale oil is light and sweet crude, but most major US refineries are built for heavy and sour crude;
- In addition, no major new refinery has been built in the US since 1976. Shale oil production took refiners by surprise;
- Geographical dislocation: Most tight oil production is in the interior or on the Gulf Coast, but light sweet refineries mainly on the East coast;
- US government has a ban on crude oil exports. That means US crude demand (and prices) depends critically on refinery demand;
- Worker strikes beginning in February have taken 10% of US refining capacity offline. Further work stoppages this week has doubled that number;
- Insufficient refining capacity, storage at full capacity and worker strikes means heavy downward pressure on US crude prices, driving a wedge between WTI and Brent.
Monetary policy and FX trends
- USD in the middle of a 5-6 year appreciation phase;
- Pending Fed tightening will boost USD valuation vis-a-vis other currencies;
- Approximately 20% of Brent and 25% of WTI movements explained by USD movements (our estimates).
- US rig count decreasing, but rig efficiency is up;
- Economics of shale oil (heavy continuous investment, max production for a very short period) means incentives to maximise production from existing wells irrespective of current prices;
- Current EIA projections puts max production surplus in 2Q2015;
- Refinery constraints only likely to ease in 2016 (new facilities, expansion of old ones);
- Monetary policy divergence means USD strength likely to continue;
- Bottom line: Despite the recent rebound in prices, crude oil will remain under pressure, but market players are beginning to differentiate between US prices and international prices.