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November 6th brought the U.S. election and a glimpse into the effect that Washington will have on the energy markets. It may offer a negative impact as opposed to China which picked new leadership on November 8th, and Europe which worked out a framework for common banking regulation on December 13th. The U.S. should be bogged down with headwinds caused by continued slow-growth conditions, quantitative ease, uncertainty about taxes, the debt ceiling, and ongoing Washington partisanship. Economic growth is expected to improve slightly from 2012's 2.1% average. The fiscal cliff negotiations and the lack of progress in them in late-2012 showed that lawmakers are still unable to reach across the aisle. Corporate spending decisions are being delayed due to uncertainty about tax rates, and could be duplicated in late-February when the debt ceiling will need to be raised. The last battle in July-August 2011 resulted in S&P cutting the U.S.'s AAA credit rating and oil prices falling 25% in just a few weeks.
The composition of the Fed may become more dovish, as the hawkish loyal dissenter Jeffrey Lacker won't hold a vote. Fed Presidents Evans and Rosengren will vote this year and are both considered doves. Both argued for the 6.5% unemployment threshold adopted by the Fed at its December 12th meeting. KC's George will replace the hawkish President Hoenig, but she's been less critical of easy Fed policy than Hoenig has. President Bullard could be hawkish too, but he did not dissent at any time during his previous votes in 2010. A dovish Fed hasn't necessarily been good for oil prices like it has for markets like gold and equities (chart below). Oil may focus more on the Fed's adverse economic outlooks such as promises to keep rates low through 2015 than where easy money will be invested.
Europe is improving, with leaders there showing commitment to debt problems in Greece and Spain. Their resolve is unlikely to waiver, and the euro now appears likely to make it through this crisis without breaking up. China is a bright spot as well, and is showing improvement from a slowdown in FH '12. On May 24th, it said that banks would not meet their 2012 lending goals due to the slow economy.
Manufacturing PMI data reached a bottom in November 2011, but stagnated until a second bottom made in August 2012. Several injections of cash were made into the economy over the summer, and a $150B infrastructure project was announced on September 7th. The official measure of PMI has increased 1.4 points since its August low, while the HSBC measure has gained 3.3 points. Oil demand correlates to the HSBC measure as seen in 2009 when demand recovered as manufacturing activity bounced back (chart).
Production Gains Change Oil Supply/Demand Dynamic
Peak oil was a main factor cited in offering support to oil prices in 2007 and 2008 as WTI went from a low of $50/bbl in January '07 to a high of $147/bbl in July '08. Growth in Chinese demand had outstripped most of the excess supply and OPEC's spare capacity began to dwindle as producers ramped up output to meet demand. The financial crisis in 2008 and the losses in oil demand that it caused forced prices from $147/bbl to $32/bbl in the second half of 2008, but oil has never recovered more than the $115/bbl price level in the four years since. Part of the reason is that the economy is still struggling to regain pre-2008 strength, but it is also explained by growth in supply and OPEC spare capacity.
The growth rate of Chinese imports soared in the early-2000's and was still a relatively high 10.6% y/y in 2007 & 2008. The inability of supply to keep up with the new demand growth was a feature of the price surge in 2008, and essentially created an element of "growing pains" in the market at that time. Producers just couldn't keep up with the extra demand, and prices had to rise. That doesn't seem to be the case as much now, as the rate of Chinese import growth has slowed to 6.8%. Despite the slowdown in the growth rate since 2007 & 2008, the overall level of imports is much higher and yet global oil supplies are more plentiful. China's level of imports has increased to 5.26 mb/d in 2011 & 2012 compared to 3.43 mb/d in 2007 & 2008. Despite higher demand, suppliers are better able to cope with it and stocks are building globally. Oil stocks that are able to be measured such as OECD stocks fell to 53.2 days of demand cover in 2007. The level of cover increased sharply in 2008 and has averaged a steady 59.0 days in the last four years. Oil stocks in the U.S. are the highest above their five-year average since April '09 and are close to moving to the highest since at least 1990.
In addition to elevated inventories and high demand cover, the supply/demand balance and OPEC spare capacity also show the market loosening. The first chart below shows that prior to early-2008, the EIA's supply/demand balance ranged from -2.7 mb/d to +1.2 mb/d with an average 1.1 mb/d deficit. Between 2008 & 2011, the average was a 0.55 mb/d deficit largely because of Libya's civil war in 2011. In 2012, however, the balance averaged a surplus of 0.2 mb/d. The second chart below shows another comparison to the 2007-2008 period, where OPEC spare capacity has grown to 6.0 mb/d in late-2012 from a low of 2.2 mb/d seen in mid-2008 at the peak in prices. From 2007 to 2012, global demand has increased 4.3 mb/d while non-OPEC output has gained 3.2 mb/d and OPEC 2.9 mb/d for 6.1 mb/d combined. The EIA's forecast for 2013 demand growth is 0.96 mb/d while supply is expected to grow 0.85 mb/d. OPEC will play a deciding role in balancing the market again, but may have to cut production sometime in 2013. The bottom line is that supply growth has outpaced demand growth since 2007, which should add pressure to prices.
The increase in non-OPEC production of 3.2 mb/d since 2007 has seen 1.5 mb/d come from the U.S. Rig counts in North Dakota's Bakken shale formation have surged from 33 in May 2009 to over 200 in 2012 (chart 1). As a result, production from the region has increased from 100 kb/d at the start of 2009 to nearly 700 kb/d in 2012 (chart 2). Imports from Canada are still averaging around 2.4 mb/d. However, the increase in domestic output may call into question the need for the Keystone XL pipeline given environmentalists opposition to the rerouting of the pipeline over the Ogallala Aquifer in Nebraska. A decision on the pipeline is expected sometime in early-2013 and meanwhile, the rail trade from North Dakota continues to grow. Increasing discussion regarding oil exports may help to get oil out of the landlocked Midwest, but won't help the pipeline's cause.
Demand Growth Slowing
The EIA's prediction of 0.96 mb/d in global demand growth equates to a 1.08% increase and compares to 1.2% growth in 2011 and a 3.0% increase in 2010. The 2000-2007 pre-recession average was 1.6%. The first chart below shows the oil market's response to the overall level of crude oil demand, while the second chart illustrates the effect of the growth rate of demand vs. the y/y change in prices. A regression since 1993 implies that a 1.08% growth rate in 2013 would equate to around a 10.86% increase in oil prices. Given 2012's average through Dec 24th, it would suggest that a gain of $10.22/bbl is possible, which would put WTI at an average of $104.19. That's a bit high in our view, as we expect the global economy to be slower than the 1993-2011 average, and we also anticipate less commodity index investment than what was seen in the 2000's.
Tom is the director of market research for EOXLive, a wholly owned subsidiary of leading independent interdealer broker OTC Global Holdings (OTCGH). At EOXLive he has developed an energy research product focused on finding opportunities and creating trading strategies in the over-the-counter, futures and options markets which is distributed across OTCGH's trading firms and via the web. The product aims to grow the availability of quality information and analysis available to clients through the company's broking/trading platform, EOXLive. Before joining the EOXLive team, Pawlicki spent nearly two decades as a research analyst including, most recently, five years as an energy and precious metals analyst at MF Global. In addition, Pawlicki worked for nearly 12 years as a financial futures technical analyst at REFCO, analyzing Treasury bond, stock index, and currency futures markets from both technical and fundamental perspectives, after spending a brief stint as runner on CBOT Bond Floor for the company. Pawlicki is a graduate from the University of Illinois at Chicago.
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