Saudi Arabia

In a recent post we looked at the state of the crude oil market, how demand has been weak as a result of refinery maintenance closures in Europe and lower domestic consumption in China. Even though China is buying more crude, it has increased exports of refined oil products depressing prices in the Asian market and hurting regional refinery utilization rates.

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A Crude Situation

The solution would be for crude oil producers to limit output, but with OPEC only controlling a third of world supply and no appetite among any of its member nations to reduce revenue streams, it seems voluntary reductions of any significance are unlikely. Saudi Arabia as the main swing producer is the most likely to adjust output and a report this week in the FT states output was reduced by 400,000 barrels per day in August from 10 million barrels per day to 9.6 m b/d, the fourth-largest one month drop on record.

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Don’t you just love stories of intrigue?

Well, sure, when they are just stories – but if there is the possibility that they are a fair reflection of real events and that there is the possibility the consequences could affect us all, they become less curiosity and more a source of alarm.

So portends an article in the Telegraph this week, reporting a meeting said to have taken place between Russia’s Vladimir Putin and Saudi Prince Bandar bin Sultan, head of Saudi intelligence, three weeks ago in Mr. Putin’s dacha outside Moscow. The gist of the story is the Saudis are seeking support from Russia in pressuring Syria’s President Assad to stand down in return for a Saudi-Russian pact on the oil price and agreement on “managing” the European market for oil and natural gas/LNG.

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A combination of factors has come together to depress not just the price of oil, but a wide swath of commodity prices this year. According to the FT, the benchmark Reuters-Jefferies CRB index, a basket of commodities from wheat to copper, fell to a 20-month low of 281.13 points.

The index is down 10 percent for the year to date and roughly 40 percent below the all-time high set in mid-2008. ICE July Brent, the global benchmark for oil prices, fell $2.76 a barrel last week to a 5-month low of $105.65 from a peak of $128 a barrel in early March, while US oil prices fell through the $90 key support level, with Nymex July West Texas Intermediate falling $2.14 to $89.71 a barrel.

So what has engineered such a fall? Is it just a reflection of a depressed global economy?

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Never, it would seem, has the oil market been in such a state of disarray.

Brent crude, the global benchmark, hit US$117 per barrel this week for the first time since August. The spot price has been rising on concerns over where the showdown with Iran is leading. European consumers have begun to cut back on purchases ahead of an outright ban when sanctions are introduced.

Meanwhile the Chinese, usually buyers of some 20 percent of Iran’s output (or about 550,000 barrels a day) are said to have cut back by 285,000 barrels in January and February, and are now extending this to March. This has less to do with supporting the Western embargo and more to do with slowing domestic demand and possibly some gamesmanship in applying pressure on the Iranians for bargain-basement prices.

Likewise, while India, Iran’s second-largest customer at an average 341,000 barrels per day, continues to buy, they too are applying pressure for discounts. Saudi Arabia has increased production, as has Russia, and both Iraq and Libya are increasing output every month.

No Worries, We Still Got Texas Tea

In fact, the world is not short of oil yet, to the irritation of North American producers (and the delight of North American consumers.) West Texas intermediate crude prices are at a record discount to Brent.

For a number of reasons, including outages at Midwest refineries causing a drop in demand, tight pipeline and storage capacity and a rise in supply (notably from the Canadian oil sands and from the Bakken shale oil region of North Dakota), the US is awash with oil, forcing not only WTI to trade at a widening discount to Brent, but Canadian synthetic crude to trade at a discount to WTI. From a discount of $31.25 per barrel a month ago, Western Canadian select heavy crude is at a $31.25-per-barrel discount to WTI this week, about 50 percent of the spot Brent price, according to the FT.

Spread ‘Em

Maybe the most interesting disconnect in the market is the forward spread curve for Brent crude. Throughout the boom period of 2004-08, Reuters reports the spot and forward oil prices moved in tandem, but now forward prices for 2015 are at a $19-per-barrel discount and have remained remarkably steady even as the spot price has risen in the wake of rising tensions with Iran.

While the forward price curve is not a prediction of the price of oil in the years ahead, it is often taken as an indication of where the market expects supply and demand to balance out. The paper postulates that the rise of oil shale fracking will have a similar (if less pronounced) impact on the oil market that gas fracking had on the natural gas market.

They also suggest rising conventional supplies from Libya, Iraq, Brazil and elsewhere will supplement current supplies, and point to Saudi Aramco’s decision to cancel investments planned to lift the kingdom’s production from 12.5 to 15.0 million barrels per day as evidence of that. Lastly, although much demand growth is predicated on the rise of an emerging market middle class, a combination of greater efficiency in the use of oil and falling Western demand will diminish the impact of that effect.

One element that does seem likely to persist (for the medium term, at least) is North America’s energy advantage globally. Neither lower natural gas nor lower oil prices are likely to equalize with the rest of the world anytime soon and while no one is suggesting it will lead to long-term energy-intensive investments like aluminum smelters, it will provide a welcome boost to more energy-dependent industries in North America relative to many other parts of the world for some time to come.