US & EU Oil Demand: The
crude oil demand picture in US continues to be mixed and demand remains well below the historical average. GDP is expected to expand by between 2.7 percent to 2.9 percent this year, down from April’s forecasts of 3.1 percent to 3.3 percent (median projections). Growth in 2012 will range from 3.3 percent to 3.7 percent, compared with forecasts in April of 3.5 percent to 4.2 percent. Central bankers have raised their forecast range for the unemployment rate after the June jobs report showed broad disappointment, with the unemployment rate ticking up to 9.2 percent. On the upside, consumer spending, which was lacklustre in H1 2011, is likely to improve before the end of Q3 2011. We expect consumer confidence to remain below expectations till August 2011, which will keep driving below the seasonal average. The recent drop in fuel costs will result in improvement in consumer spending & confidence, with a lag, which we estimate will be up by August's end. Positive momentum in unemployment, retail sales, ISM, PMI, consumer confidence and payrolls may increase the market’s expectation of
crude oil demand, and hence add more demand related
crude oil risk premium to the
crude oil price by the end of Q3 2011.
Crude oil traders will tend to remain focused on the demand side of the equation until the end of Q3 2011, as the US economic picture looks weaker than expected, and the EU is still mired in periphery debt problems. EU Oil Consumption will decline in H2 2011 because of strict austerity measures in peripheral Europe and the potential of spread of some of the debt-related problems to the core countries like France.
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China’s economic growth At current levels, China PMI, input purchase orders, new orders, delivery delays and new export orders are low, raw material and finished goods inventories are high, electricity demand growth has decelerated 22 percent year-over-year (yoy) in H1 2011, and buying for China SPR (marginal 170 million barrels) has slowed. China’s net imports of crude oil fell to an eight-month low in June (19.73 million m tons; 4.5 million bbls per day, -10 percent month over month & -12 percent yoy) after a record net crude imports of roughly 5.3 million bbls per day in Q1 2011, and imports made up roughly 55 percent of its total oil consumption this year. With the consumer price index hitting a three-year high 6.4 percent last month, this give additional worry to oil traders. This will prompt some speculation that China may again crack down on inflation by raising bank reserve requirements as well as interest rates. A slowdown will have a short term impact on China’s marginal crude oil consumption and crude oil prices. Click to enlarge Click to enlarge Click to enlarge
Japan Effect: Japan may need additional consumption to help repair the damage, as percentage of GDP, and will need to replace current electricity generation using hydrocarbon based fuels. Based on previous periods when Japanese nuclear power has gone offline, Japan’s energy demand could increase by somewhere between 0.4 -0.75 million bbl of OE per day. Besides, if 4 percent of GDP is what needs to be produced to repair quake damages, required marginal level of GDP will be around US$200 billion over say 2 years, which with an estimated energy intensity of US$1600 GDP per barrel of oil, may require an additional energy input of 125 million bbls of OE.
Spread Between Cushing and Brent: The spread reached historic levels in Q2 2011 on growing volumes of Canadian crude oil imported into the United States, Libyan and Nigerian Supply disruptions and higher demand from China. Brent-WTI Oil Spread has narrowed as China Crude imports are seen slowing and Euro debt problems persist. The current gap is “unsustainable” and it will narrow further as a trend of declining Chinese imports (in June) increased speculation that demand for Europe’s oil may decline. However it may not completely disappear due to transportation bottlenecks restricting the movement of mid-continent crude oil to the Gulf Coast, supply issues in some North Sea facilities, growing tensions in Nigeria, and the possibility that IEA being offset by less accommodative Saudi.
Refining & Crack Spreads: The gasoline price has corrected by +20 percent in the last five trading sessions – still staying +US$3.65 / gallon. We see the gasoline price sliding to US$3.5 per gallon to be sustainable. This implies contraction of gasoline refining margins by another 15 percent in Q3 2011, before demand comes back.
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Non-OPEC Supply: EIA projects that non-OPEC
crude oil and liquid fuels production will increase by 540 thousand bbl/d in 2011 and by 740 thousand bbl/d in 2012. The greatest increases in non-OPEC oil production during 2011 occured in Canada (170 thousand bbl/d), China (140 thousand bbl/d), the United States (140 thousand bbl/d), Brazil (120 thousand bbl/d), and Colombia (120 thousand bbl/d). EIA has lowered the rate of production declines in the North Sea and Europe compared with the last Outlook. At the same time, the EIA now expects that Azerbaijan's production will be lower compared with the previous Outlook. In Russia, a lack in reform of the tax regime will likely dampen any increase in oil production
OPEC Supply Forecast: OPEC
crude oil production is expected to decline by about 300 thousand bbl/d in 2011, but increase by 560 thousand bbl/d in 2012. The EIA assumes that about one-half of Libya's pre-disruption production will resume by the end of 2012. OPEC produced an estimated 29.2 million bbl/d of
crude oil in the Q2 of 2011 and the EIA expects that its production will increase to an average 29.6 million bbl/d in the third quarter, which may not be possible. The EIA projects that OPEC surplus capacity will fall from 4.0 million bbl/d at the end of 2010 to 3.5 million bbl/d at the end of 2011, followed by a further decline to 3.1 million bbl/d by the end of 2012. Click to enlarge
OECD Petroleum Inventories:
Crude oil inventories in the US are still running above historical averages, which have capped oil prices. But broad US dollar weakness and gradually improving risk appetite should support oil. The EIA expects that OECD commercial inventories will decline in both 2011, and 2012. Because of the IEA release of emergency stocks, the projected commercial stock declines are not as large as those in last month's Outlook. Projected onshore OECD stocks fall by about 78 million barrels in 2011, compared with 118 million barrels in last month's Outlook. Days' supply (total inventories divided by average daily consumption) drop from a relatively high 58.1 days during the fourth quarter of 2010 to 55.7 days in 2011 and 54.6 days of supply in 2012.
Trade Weighted US Dollar May Weaken: The US dollar may remain strong until August 2011, because of safe heaven demand on account of economic growth uncertainty and EU periphery debt problems. US trade, weighted to the dollar, will keep facing cyclical and structural decline. We expect the trend to continue after August 2011, which may result in a further upside to crude oil price Click to enlarge
Draining global liquidity: China needs to raise interest rates even further to curb inflation, given existing excess liquidity. Although the government has implemented a series of measures, including increasing interest rates, RRR and raising margins for certain commodity futures, the impacts on inflation are not significant. Although
crude oil consumption in China is less sensitive to oil shocks due to the lower per capita use, interest rate hikes can be negative for the
crude oil price in the short term. In the US, loose monetary policies may continue in Q3 2011, which is positive for commodity prices in general and for
crude oil in particular.
Click to enlarge Click to enlarge Paper barrels May Remain Intact in Short Term: Click to enlarge Click to enlarge Click to enlarge
Disclosure: I am long USO, OIL, OILC, CRUD, UGA.