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Saturday's
Lagniappe

JUNO Oil Outlook - Feb 2007

By: Andrew McKillop

The first full year of Peak Oil, that is structural undersupply simultaneously affecting markets in different world locations, is at minimum possible, and increasingly probable for June 2007-June 2008.

This may be an on-again/off-again phenomenon, but will surely add more power to oil price volatility. Volatility, and downside risk for the near-term oil price is due to many factors, notably the following/

Through late 2007-mid 2008 there is some potential for a ‘bulge’ in new supply capacity, mostly unconventional and condensate/NGL, arriving on world market. This can or might extend an approximative supply/demand equilibrium into 2008, preventing structural undersupply

Forward oil price sentiment is weakened by this

Extreme oil price spikes, beyond about 90 USD/bbl, can trigger defensive interest rate hikes and a fast ‘hard landing’ of the world economy, also driven by equities underperformance – rapidly cutting oil demand, restoring supply/demand balance, and also cutting oil prices

Renewable energy and energy-saving programs through 2007-2008 may start significantly affecting world hydrocarbon fuel supply/demand balances

Supply increments for the arrival of new non-oil hydrocarbons supply show significant seasonal variation in supply (eg. due to biocrop harvesting seasons)

Increasingly opaque and unrealistic data on real oil stockpiles, claimed to represent about 53 days of OECD country consumption by the OECD IEA in late January, may in fact be closer to the reverse sequence of these numbers, that is 35 days of real demand

WORLD OIL DEMAND VARIATION – SEASONAL CHANGE

Very large seasonal demand variation is now ‘structural’, as proven by world oil demand slumping about 2% or around 1.75 Mbd against climate-normal in Dec 2006-Jan 2007. This was due to climate-changed extreme warm early winter in US, Europe and Japan. The resulting large falls of heating oil demand, well noted by analysts and the media, was quite largely compensated by less well-noted but real increases in motor fuels consumption, running at about 2.5% or 3% up on climate-normal. In other words, during warm winter conditions drivers use their cars more, and their heating furnaces less.

Large seasonal variation of world oil demand generates confused market signals, translated by high or even ‘structural’ volatility of daily prices. This volatility can be increased or decreased by the geopolitical risk context, and risk premium, currently below 7 USD/barrel. This risk premium can very rapidly advance to beyond 10 – 15 USD/bbl, but is likely incompressible below 5 USD/bbl.

UNDERLYING GROWTH OF WORLD OIL DEMAND: CLOSE TO 2 MBD PER YEAR

Convergent data from many countries and different world regions indicates that, as ever, forward estimates of world oil demand growth on a day-average basis, made by institutional players such as the OECD IEA and US EIA, are under-reported. Day-average world demand growth in calendar year 2006 was likely well above 1.85 Mbd (beyond 2%-per-year). Specially strong growth, again as ever, was recorded by China and India, with combined oil import demand of solely these two countries likely increasing by very close to 1 Mbd in 2006 (0.65 Mbd China, 0.35 Mbd India).

Continued and sustained oil demand growth inside OPEC and NOPEC exporter countries, specially Russia, Saudi Arabia, UAE, Iran, Kuwait, Venezuela, Mexico, Algeria combined with physical depletion and erosion of oil production capacities in the majority of these countries, ensures a tight supply context. This is despite the potential and hypothetical ‘bulge’ in new supply through late 2007-2008 that is argued by some analysts. In the majority of these key exporter countries, domestic oil demand is growing at more than 5%-per-year.

World depletion rates vary; by nature depletion loss of oil production capacities is erratic and variable from year to year. For some major exporter countries, eg. Norway, transparent data is available from national authorities – in this case official forecasts for Norway’s oil depletion 2007-2035 are about 6.75%-per-year. Worldwide average rates are at least 4%-per-year, but many estimates of world average rate go above 5%-per-year (around 3 Mbd/year loss of ‘conventional’ capacity).

OIL PRICE RANGE FOR 2007

Forward estimates, or guesstimates of the oil price range for traded WTI and Brent grades have been heavily modified, that is downgraded through January 2007, due to factors noted above.

Extreme ranges of 2007 price forecasts extend from around 30 USD/bbl to 105 USD/bbl, with year average estimates downgraded from above 60 USD/bbl to below 55 USD/bbl. My own forecast range is itself very large – from 49 USD/bbl to 85 USD/bbl – but can be provisionally maintained, with a year average value closer to 63-67 USD/bbl than to 50 or 55 USD/bbl for WTI.

KEY DETERMINANT FOR PRICE SPIKES : PHYSICAL UNDERSUPPLY

World oil demand on an ‘all liquids’ base likely attained 87 Mbd in the July summer demand peak, 2006. With the geopolitical risk premium (GRP), this produced traded price peaks around 78 USD/bbl. Price trends and levels since Sept 2006 enable us to fix the average 2006 GRP at close to 18 USD/bbl. This is below some claimed numbers for the GRP, but is now far above the current early-2007 GRP, likely well below 10 USD/bbl. This context provides upward strength for oil price outbreaks.

World ‘conventional oil’ production is likely not above 66 Mbd. Since about 1998-2000 it does not respond to market price signals. At least 90% of supply growth has come from ‘secondary’ and ‘tertiary’ production. World biofuels output in late 2006, specially Brazil and US ethanol, is only running at about 0.45 Mbd oil equivalent, but the biofuels have a powerful market sentiment impact, if not decisive practical impact on world hydrocarbon fuels supply/demand balances.

Through 2004-2006 world ‘all liquids’ demand has increased at least 6.5 Mbd (3 years). Net supply growth in that period is well behind, perhaps less than 5.75 Mbd. These considerations reinforce comments, above, to the effect that 2007-2008 may be the first year of true Peak Oil, signalled by structural undersupply of world oil markets.

CONVERSELY - NO CRUDE OIL SUPPLY PINCH IN NEXT 3 MONTHS

Taking the period Feb 2007-April 2007, we can easily forecast short-term physical oversupply of markets, perhaps attaining 1.25-1.5 Mbd oversupply, until and unless OPEC production restraint translate to real world supply cuts realistically similar to stated, claimed or announced measures. Due to buoyant demand, and over-reported stockpiles, it is in fact eminently feasible for OPEC + NOPEC exporters to control the supply/demand context, if the real political will existed.

This outlook of course excludes unpredictable, but always possible geopolitical supply constraints, the existence of which would make ‘voluntary restraint’ much easier.

Real world trends suggest that world oil markets can tilt to structural oversupply by March 2007. In this context, signalled by strong and repeated falls in day close and forward prices, perhaps below 49 USD/bbl, there is rational potential for prices falling to ‘unprecedented’ lows, well below 45 USD/bbl.

Again for numerous reasons, including buoyant oil demand for all forms of transport (land, air, marine), over-reported real stockpiles, and tight refinery capacities worldwide the downstream petroleum products market can likely show significant upside price performance through Feb-Apr 2007. This will focus price tensions for gasoline and distillate fuels in major markets, rather than crude.

PRICE BREAKOUT

In the forecasting period to Apr 2007, as argued, day traded oil prices for Brent and WTI can experience extreme volatility to 49 USD/bbl but may settle in a 55-63 USD/bbl range on a week-average daily closing price basis. Price breakout, exclusively on the upside we note, is not excluded.

The Summer peak of world oil demand (July-August) is identified as a key period for oil price movement. Prices may explosively grow in the run-up to this peak, starting from April-May 2007.

Price breakout in the Summer 2007 world demand peak will be set by physical demand. On a wide ‘all liquids’ base this may exceed 88.5 Mbd, including the biofuels (close to 0.5 Mbd). At this time, we may be facing a de facto undersupply context.

 

Andrew McKillop is Senior Energy Strategist in Juno Mother Earth Asset Management. Petroleumworld not necessarily share these views.

Editor's Note: This commentary was originally published by Juno Mother Earth Asset Management, on eb 2007. Petroleumworld reprint this article in the interest of our readers.

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Petroleumworld 03/24/07

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