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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.
