Year to date, Brent oil is down only 3.5%. Given the falls seen across other commodities, why has it held up so well?
This past week market has dug up all sorts of acronyms like BAN LGIV SPV etc. responsible for the demise of Copper and Iron ore. Does anyone even know what half of them stand for? Sure the unwind of commodity financing deals and prospects of China reigning in Shadow banking presents a real risk to some of the commodities held in warehouses as collateral, but I think I know my limits if I were to build my case for lower prices specifically on this angle. What I do know is that the two markets, Copper and Iron ore, have been battling with rising supply prospects since the start of this year and the market is only now trying to find a new equilibrium for prices. Sometimes the simplest of explanations are usually the best ones. Believe it or not, Commodity markets have been behaving rationally.
Now lets look at oil specifically…
Despite the Ukraine/Russia crisis, oil price action has been rather muted. The threat of sanctions is a risk, but one that will hurt not only the Russian economy but seriously hinder German GDP growth as well. 36% of Russian revenues in 2013 came from the Oil & Gas sector via taxes and export duties forming 10% of its GDP, and 40% of German gas imports came from Russia. There will be a serious rethink if any thing was to be imposed.
Where is oil demand really coming from?
In 2013 the global oil market growth trend was dominated by a pick up in Developed Markets offset by weakness in Emerging Markets. For the first time, US oil demand growth was higher than China on an absolute level, +400k bpd vs. +110k bpd respectively.
No doubt the oil markets were tight heading into 2014. Q413 saw a substantial stock draw keeping OECD inventories tight. Even January saw a notable drop of 13.2 million barrels unusual for the time of year, exacerbated by the harsh winter in US and Canada. However, February saw a big jump in global oil supply, rising more than 600k bpd from January to reach 92.87mln bpd. The reason for this boom was not the onshore oil boom in the US that the markets have gotten accustomed to, but the culprit was Iraq. Despite ongoing political instability, the country managed to boost production to 3.62mln bpd in February, up 500k bpd from the previous month (highest level since 1979!). With such an injection from Iraq, total Opec supply last month jumped by 500k bpd to reach 30.49 mln bpd.
According to IEA, the latest demand estimates leaves 2014 global oil demand at 92.68mln bpd (+1.35mln bpd from 2013). Non Opec supply is expected to rise 1.7mln bpd outpacing demand because of relentless growth in US and Canadian supplies. Even without the lifting of sanctions in Iran and the possible recovery of Libyan and Iraqi production levels, the "call on OPEC" in 2014 is severely reduced at 29.7mln bpd in 2014 which is significantly below current production rates.
Iraq and Liyba are two unknowns this year. Market expects 2014 y-o-y Iraq production growth of 440k bpd but risks of infrastructure sabotage and uncertainty of oil sharing revenues between Iraqi and Kurdish regional government can keep a lid on that number. Libya is producing 230k bpd, but with protests seen across the country, market forecasts of 500k bpd production growth in 2014 could be at risk as well.
With the call on OPEC lower and refineries now entering their seasonal maintenance period in Q2 (a.k.a. "shoulder period"), supplies can start to rise. With the jury still out on whether the US slowdown is a weather related phenomenon or not, the oil market clearly faces risks to the downside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.