ASEAS Singapore Crisis

Is The Oil Market In Crisis?: 

Is The Oil Market In Crisis? December 10, 2004 Institute of Southeast Asian Studies Singapore

Oil in Crisis: Agenda: 

Oil in Crisis: Agenda What is a crisis? Is oil in crisis now?? The road ahead…

Oil in Crisis: Agenda: 

What is a crisis? Is oil in crisis now?? The road ahead… Oil in Crisis: Agenda

What is a crisis?: 

What is a crisis? crisis • n. (pl. crises) 1 a time of intense difficulty or danger. 2 the turning point of a disease when an important change takes place, indicating either recovery or death ORIGIN ME: medical L., from Gk krisis ‘decision’, from krinein ‘decide’ Oxford English Dictionary

Classic oil crises: 

Classic oil crises THE BOOM Dramatic and sustained curtailment in supply Dramatic and sustained demand growth Sharply higher oil prices THE BUST Dramatic and sustained increase in production Dramatic and sustained demand collapse Sharply lower oil prices

Classic oil crises: times of intense difficulty: 

Classic oil crises: times of intense difficulty THE BOOM 1947-1948: US car on road rise from 26-million to 50-million 1973-1974: “First Oil Shock” US Embargo during Arab-Israeli War 1978-1979: “Second Oil Shock” Iranian revolution cuts exports 2002-2004: Second Gulf War/Rise of China THE BUST 1901-1902: Spindletop discovered at Beaumont, Texas 1985-1986: “Third Oil Shock” OPEC claims back market share 1997-1999: Asian economic crisis

Classic oil crises: “recovery or death”: 

Classic oil crises: “recovery or death” THE BOOM 1947-1948: US replaces Britain in determining Middle East oil policies 1973-1974: US exploration opens Alaska, North Sea “discovered” 1978-1979: Birth of the spot markets: Rotterdam, Houston and Singapore 2002-2004: ? THE BUST 1901-1902: Establishment of global production “coordination” 1985-1986: Quota philosophy holds for next 20 years 1997-1999: Awakening of China as global energy power

Classic oil crises: the key ingredient: 

Classic oil crises: the key ingredient Oil crises most often occur when producers lose the ability to “regulate” prices Most often because of over-production Sometimes because of under-production Occasionally because benchmarks get broken OSP system breakdown in 1960s led to birth of OPEC

Classic oil crises: the key symptom is price: 

Classic oil crises: the key symptom is price THE BOOM 1947-1948: Prices rise from $1.50 to $4 1973-1974: Prices rise from $5 to $22 1978-1979: Prices rise from $13 to $34 2002-2004: Prices rise from $27 to $56 THE BUST 1901-1902: Prices fall from 25cts to 3cts 1985-1986: Prices fall from $32 to $10 1997-1999: Prices fall from $25 to $11

20 years of WTI futures: several crises: 

20 years of WTI futures: several crises

Outlook for Oil Prices: 

What is a crisis? Is oil in crisis now?? The road ahead… Outlook for Oil Prices

The historical range: 

The historical range

Reversion to the mean?: 

Reversion to the mean?

2004: Bulls were in charge: 

2004: Bulls were in charge

2004: What happened??: 

2004: What happened??

A Word on Speculation: 

A Word on Speculation “Speculators” a popular, and soft, target for blame Widely blamed for record highs seen in 2004 Speculators “adding $7 to price of oil” Algeria energy minister Chakib Khelil, September 8, Sydney (WEC) A common remark heard throughout 2004

Role of Speculation: 

Role of Speculation But US “speculators” have sold into 2004 rally “Speculators” most commonly defined as “non-Commercials” for US regulatory reporting Non-Commercials have cut reported positions strongly since end of 2003 Long crude positions down 44.7% to 27,964 contracts Long gasoline down 76% to 9,412 contracts Long heating oil down 95.4% to 463 contracts Crude futures rose 35.27% over the same period Oil is worth whatever someone will pay for it Blaming “speculators” alone has slowed the industry’s recovery

Spare capacity at 1% of demand: 

Spare capacity at 1% of demand

Capacity On The Margin Under Pressure: 

Capacity On The Margin Under Pressure Assumes non-OPEC adds of 1.2mb/d in 2005, and total demand growth of 2% in 2005

Not all crude oil was made alike: 

Not all crude oil was made alike

Sweet and crudes are NOT the same price: 

Sweet and crudes are NOT the same price

Spare capacity is heavy and sour: 

Spare capacity is heavy and sour

So, is this a crisis?: 

So, is this a crisis? Dramatic and sustained growth in demand Producers lost control over prices Prices rose dramatically Some classic benchmarks may be broken

Why is it happening?: 

Why is it happening? Demand growth was seriously underestimated Both countries accounted for demand surge Neither country likely to significantly slow demand China protects consumers with price controls Americans evidently have too much money Both are engines of the global economic order Spare crude production capacity ran desperately low Stocks were low at start of the year Demand growth could not be met efficiently China hungry for medium-sweet crude US hungry for light-sweet crude World churned out heavy-sour crude to feed them

Outlook for Oil Prices: 

What is a crisis? Is oil in crisis now?? The road ahead… Outlook for Oil Prices

Short term: Importance of Capacity: 

Short term: Importance of Capacity All producers (not just OPEC) swimming fast to tread water Supply and demand tightly matched Forcing bulls and bears to hedge against anticipated moves in supply and demand Neither supply, nor demand, are readily responsive to price signals In recent years, supply has simply shown itself to be more vulnerable Bulls have held sway

Importance of Capacity: Complications : 

Importance of Capacity: Complications Bullish developments act as accelerators Influence of bearish signals muffled Volatility acts like “noise” Price signals being “discounted” by both consumers and producers New supplies don’t correlate to light, sweet benchmarks Sour crudes trade at growing discounts to benchmarks Supply shortages “overstated” in sweet benchmarks?

Short-term: OPEC to remain in focus: 

Short-term: OPEC to remain in focus OPEC “no longer in the driving seat,” will work hard to regain effective control over prices Quota and price band currently “irrelevant,” will continue to seriously rethink as credibility of both mechanisms remains low Market focus in 2005 will be on OPEC efforts to build spare capacity How to regain influence over a distant benchmark? Success (or otherwise) will be the key to 2005’s landscape

Short-term: A bull’s perspective: 

Short-term: A bull’s perspective Who would bet against more supply shocks? Iraq (2-3mbd) Russia (9mbd) Nigeria (2-2.5mbd) Venezuela (2-2.5mbd) Saudi Arabia (maxed out at 9.5-10mbd) Another tough USGC hurricane season? (1mbd)

Short-term: A bull’s perspective: 

Short-term: A bull’s perspective Sweet crude running out/perceived refining bottlenecks Most new crude capacity will be sour and heavy, doing little to redress perceived shortfalls in gasoline Light, sweet benchmarks will stay under pressure as long as gasoline, distillates cracks remain bullish Structural flaws in US gasoline markets will persist

Short-term: A bull’s perspective: 

Short-term: A bull’s perspective The world seems willing to shoulder $40 crude High oil having only small affect on US GDP growth Record gasoline prices were shrugged off by US consumers until the very end of driving season Many key consuming countries shield consumers through subsidization

Short-term: A bear’s perspective: 

Short-term: A bear’s perspective Almost everyone has bought into the notion of a $8-12 “risk premium” Resolution to any of the key risk areas can shave $5-10 off oil Peace in Iraq (successful elections) Major resolution to any piece of ongoing global terrorism, especially in Saudi Arabia Resolution of Yukos power struggle An easier year in Venezuela, Nigeria

Short-term: A bear’s perspective: 

Short-term: A bear’s perspective Demand growth could shrink US economy “always looks good” in an election year China’s “soft landing” is not guaranteed

Short-term: wildcards: 

Short-term: wildcards Several key issues have power to tilt the balance Taiwan PRC forcible intervention could redraw world politics Significant rebound of US dollar Would give bears more ammunition Ending of price subsidies in Indonesia Nigerian reaction served as a warning to all

Long-term: “recovery or death”?: 

Long-term: “recovery or death”? The prospects for recovery: The world may migrate to new crude benchmarks as existing ones reflect a market in decline Heavy, sour benchmark (and futures) may emerge Dollar may cease to be world’s “gold standard” US addressing import addiction for first time in decades finally attack wasteful consumption? may open up protected Alaska (unthinkable before) will secure access to as much Mid East oil as possible seriously considering refining capacity…. sort of

Long-term: “recovery or death”?: 

Long-term: “recovery or death”? The prospects for recovery: China will dramatically change its oil industry Has already started with WTO commitments Experiments to date in fuel oil very successful Must modernize and upgrade refining industry Refinery expansions to focus on heavy, sour crude oil Must lift price controls on remaining products China will stake new claims as a hungry force in world’s upstream oil Will this lead to a new conflict in the world as US and China redraw the world’s energy status quo?

Long-term: Crisis created paradigm shift: 

Long-term: Crisis created paradigm shift

Thank youDave ErnsbergerEditorial Director, AsiaPlattsdave_ernsberger@platts.comwww.platts.com: 

Thank you Dave Ernsberger Editorial Director, Asia Platts dave_ernsberger@platts.com www.platts.com