China, Iran, Nigeria, and Oil

Last week (June 22-26) I again fielded a ton of questions from several media sources on oil. This is my recollection of what I was asked, how I responded, and some support for my thinking.

Question: I'm seeing at least two reports that said China consumption is up a second month, up much more than a year ago and at record levels. Platts recently reported that China consumed 33.23 million metric tons of oil in May, up 6% from a year earlier.

Answer: Demand from China may be up, however, according to the International Energy Agency, global demand for crude is off 2.9 percent year over year; US demand is down 4.9%. Although it might be popular and trendy to talk about China being the “next big thing” the reality is that the tail cannot wag the dog no matter how much it tries. The United States is still the world’s largest consumer of oil by far and should hold this position for the foreseeable future. Unfortunately for China, at least for now, the laws of nature will not be rewritten.

According to the most recent CIA Fact Book figures on Oil consumption the United States currently consumes nearly as much oil per year as the entire European Union and China combined. As a result, based on these figures, when demand from the US is off nearly 5% China’s increases don’t mean much. When looking at the math, a 4.9% decrease in US consumption equates to 1,013,320 (BBL/Day) lost. When that figure is contrasted against China’s consumption gain of 6%, an increase of 472,800 (BBL/Day), the disparity is easily recognizable.

Question: Can Chinese consumption, if it continues to increase, boost oil prices in the near term? Make them significantly higher? Why / why not?

Answer: China is not “really” increasing consumption, and as a result will not be able to affect oil prices indefinitely. Over the past several months (since March) China has been attempting to hoard commodity resources through speculative buying. This heavy buying is being led by Chinese stimulus money which has been flowing into its banking system. Once at the banks, due to lending law differences, this stimulus money is able to be lent out for use within the broad commodities markets. More specifically, Chinese banks are able to book physical commodities as allowable collateral assets and can lend on commodity purchases with physical delivery; this cannot be done by many other places in the world.

Since lending on commodity investment is allowable, Chinese banks and investors have little reason to pour money into expanding export infrastructure which is already far too large for current global demand. As a result, the standard in Chinese lending has changed for the time being. With nowhere else to lend, this type of commodity borrowing has become lucrative for struggling banks and investors alike. To put it quite simply: What is the point in developing more export infrastructure that’s not needed? The recession will eventually end, so rather than increase capacity, existing exporters are trying to deal with the prospects of future; increased input costs and / or inflation.

Besides artificial Chinese demand, it is also important to remember that as a net exporter China still needs the European Union, the United States, and all other industrialized nations to drive its expansion. Therefore, if oil prices were to increase beyond what these economies can currently handle, demand from China would drop off even more significantly.

This phenomenon is very similar to what I wrote about previously in “Oil, OPEC, and Super Contango.” To get back to your question I think demand from China can only grow if the global economy comes back online. At some point speculative purchasing in China will end as stimulus money runs dry and commodity stockpiles grow too high. It’s a global economy now and no one country can efficiently exist without transacting with outside nations. China must know this and I would guess will be very aware of its impact on global oil prices.

Question: What does all of that mean for the oil market? Why is oil still below $70 or just not able to get past $75

Answer: Weak underlying fundamentals for oil and excessive speculation suggest to me that crude may be ready to turn hard between now and July. Around mid summer to early fall I expect to see oil trade between $40 and $55 per barrel. Again, for a more detailed discussion of my long term forecasts please see "Oil at $25 a Barrel? Gas $1.50? The Time Is Coming Soon". From the date of that material we are at the “Medium Term Forecast” point and I don’t see any reason to materially revise my estimates at this time.

Question: Even with all the turmoil in Iran and Nigeria of late?

Answer: The turmoil in Iran and Nigeria are unlikely to materially affect oil prices in my opinion. I feel this way as current global supply, capacity, and demand all suggest that oil production is nowhere near “maxed out”. Since we aren’t at maximum production I feel that small disruptions are unlikely to materially damage current pricing.

When considering the two situations, the unrest in Nigeria is more likely to hurt supply in the near term due to the militaristic nature of those events. However, Nigeria as a global player is less significant to the oil market than Iran. In addition, Nigeria is less likely to get involved in a global conflict as its situation is primarily a civil one. Further, since supplies from Nigeria are unlikely to be completely wiped out, it is probable that other producers will be able to pick up the slack if a Nigerian supply disruption were to occur.

When looking at Iran, although political protesting has been borderline revolutionary, I do not see it resulting in a destruction of oil infrastructure. Iran, as the second largest OPEC nation, would certainly damage global supply more significantly than Nigeria if it went offline. It also has a significantly higher probability of creating a global conflict due to its political positioning. However, since the protesting in that nation is now subsiding, it is unlikely things will escalate further without provocation from the Iranian government.

To summarize, since neither country looks like it will go completely offline as a result of its respective problems and the world is not running at full oil capacity; it is not likely that supply and demand will be materially affected. This of course should hold unless an all out war were to break out in Iran or Nigeria which had global implications.

Disclosure: No positions

Comments

[one eye:]

My, my.

You've combined estimates from 18 months ago with ongoing estimates without blinking an eye.(one or the other).

You do not have a clue as to what Chinese consumption was in 2008 and The Chinese figures do not include ongoing additions to their SPR. You do not Include the Increases in consumption by Mid-Eastern countries. I have seen recent estimates that this consumption has almost doubled from 7 to 13 mil. brls daily since 2006.

Meanwhile, in addition to whatever unrest is going on, I have seen estimates of 6 million brls./day in surplus Capacity which, at least to me, Means that Opec has reduced production by 6 million brls/day. This is far above the estimated decline in Global demand.

In addition to increased usage in China, you can add Australia, Indonesia, and South Korea all of which now have Positive GDP. India can be expected to join in on the demand side as well as the UK and USA within the next 6 to 9 months.

The Chinese demand is not artificial. Even GM acknowledged a 75% increase in car sales in China. An estimated annual sales amount of 11 million of which around 8 million are New Owners. Meanwhile Chinese consumers have begun Buying Chinese, since better quality items are not being exported. Chinese consumption figures are higher than export decline figures.

All in all, Figures don't lie but using Estimated, Outdated demand figures without Including Actual Supply Cuts seems rather farfetched. The Presumption that Demand Will Not Increase outside of China is equally absurd.

Jun 28 07:33 AM

[kaoo:]

no one knows what impatcs can the hurricanes bring to the crude oil production and refinery industry in mexico bay this year, although some predicts that there would be fewer hurricanes and storms than last year.

Jun 28 08:25 AM

[tresspass:]

This is one guy who is out of touch or just being disingenuous.

Another " minor " point to add to one eye's very astute observations---this one will get ya'---the world bank just revised China;s GNP from 6.5 to 7.2%. The author's commits the worst sin in journalism or column writing and, certainly reporting. And that is the sin of omission.

Jun 28 09:02 AM

[Ferdinand E...:]

I wonder if the decision makers in OPEC and Russia are dumb enough to allow the oil price to decline at the present time. My guess is that they are not, however I have been wrong about that a few times. Of course, the decision makers in Norway and the UK were criminally stupid on the subject of oil a few years ago, but that was because they wanted to be loved by their colleagues in Washington.

Personally, I think that it is a mistake to convince or try to convince ignoramuses in the media and in governments that oil prices could tank.

Jun 28 09:48 AM

[The Greates...:]

If the over all global economy contuines, oil will drop, more supply then demand today. People with out jobs do not buy.

Jun 28 11:23 AM

[The Greates...:]

China is a large exporting country for goods and services, their economy will suffer until the worlds economy turns around. (which will not be soon)

Jun 28 12:01 PM

[one eye:]

Tough Twinkies.

Read My Lips, hell Read Chinese Lips: Chinese Consumption Is China's current Policy. The Industrialization/Export driven Policy is Dead.

They have the Will and the Means to implement this. They DO NOT give a Damn about the US/EU.

The World Economy? What a load, The US/EU is totally dependent on their Economic growth not the other way around.

Jun 28 02:50 PM

[forzagrifo:]

Oil at $25? Let me ask you one simple question: will OPEC let oil prices drop to $25?

Jun 29 01:38 AM

[one eye:]

IEA data? No problem. BUT:

Who in their right mind gets their Info from the CIA

Jun 29 03:12 AM

[James Bibbings:]

Regarding the CIA Fact Book reference

The reason for it's inclusion (that most failed to recognize) is that the figures are from the period of global peak consumption 2007. They (CIA) also have the most comprehensive and easy to reference figures to compare across countries. In my illustration I was showing the disparity between Chinese consumption and US consumption at the peak. We know that peak consumption occurred in 2007 from the IEA's current figures; a more reasonable source no doubt. Those same figures indicate that from 07' until now, global consumption has fallen more than 7.1%, the steepest fall in 60 years. So showing the gap at the peak was intended to make the China/US disparity look even more pronounced today in a period of lower consumption.

Sure oil demand is up in China according to figures from the IEA; I reconcile this with my thoughts on speculative lending on commodities by the Chinese and resource stockpiling. Although that may be true, the IEA gives no discerment to genuine demand increases and what I would consider "artificial demand" increases as is the case here with Chinese speculative buying. Certainly an increase in purchasing indicates a rise in demand, that does not however mean this demand is "real" in the sense that China's increase in purchasing is for near term consumption...this is another conversation and a different article all together.

I hope that clarifies the CIA figures used above.

Jun 29 12:48 PM

[Devon Shire:]

Why do you not discuss the supply side of the supply/demand equation ?

Have a look at the numbers, we are completely at the mercy of OPEC as the rest of the world can't raise production.

Oil demand is down 2.6 million barrels per day this year.

On the supply side we have lost

3.0 million barrels through OPEC cuts (actually more than this)
200,000 to North Sea depletion
200,000 to Norway depletion
200,000 to Mexico depletion
400,000 to Nigeria terrorism
???? to Russia decline, lack of investment elsewhere

Do the math, supply is down 4 million barrels a day. Demand is down much less than this.

How can oil prices not go up as long as OPEC wants them to ? This scenario is how it is going to look going forward. If OPEC wants prices up, they can push them up. And OPEC is not specific enough, it is Saudi Arabia and they have the discipline to do it.


On Jun 29 12:48 PM James Bibbings wrote:

> Regarding the CIA Fact Book reference
>
> The reason for it's inclusion (that most failed to recognize) is
> that the figures are from the period of global peak consumption 2007.
> They (seekingalpha.com/symbo...) also have the most comprehensive
> and easy to reference figures to compare across countries. In my
> illustration I was showing the disparity between Chinese consumption
> and US consumption at the peak. We know that peak consumption occurred
> in 2007 from the IEA's current figures; a more reasonable source
> no doubt. Those same figures indicate that from 07' until now, global
> consumption has fallen more than 7.1%, the steepest fall in 60 years.
> So showing the gap at the peak was intended to make the China/US
> disparity look even more pronounced today in a period of lower consumption.
>
>
> Sure oil demand is up in China according to figures from the IEA;
> I reconcile this with my thoughts on speculative lending on commodities
> by the Chinese and resource stockpiling. Although that may be true,
> the IEA gives no discerment to genuine demand increases and what
> I would consider "artificial demand" increases as is the case here
> with Chinese speculative buying. Certainly an increase in purchasing
> indicates a rise in demand, that does not however mean this demand
> is "real" in the sense that China's increase in purchasing is for
> near term consumption...this is another conversation and a different
> article all together.
>
> I hope that clarifies the CIA figures used above.

Jun 29 02:54 PM

[Brad543:]

While I agree with the author, one 'black swan' that could change things quickly near-term is an Israeli air strike against Iran's nuclear infrastructure resulting in Iran closing the Strait of Hormuz.

Jun 29 08:17 PM