Tuesday, October 04, 2011

Sucden to Soc Gen: The fortnight’s crude chatter

The last two weeks have been tumultuous for the oil market to say the least. This morning, the ICE Brent crude forward month futures price successfully resisted the US$100 level, while WTI’s resistance to US$80 level has long since crumbled. Obviously, the price of crude cannot divorce itself from the global macroeconomic picture which looks pretty grim as it stands, with equity markets plummeting to fresh new lows.

Bearish sentiments will persist as long as there is uncertainty or rather the "Greek tragedy" is playing in the Eurozone. Additionally, there is a lack of consensus about Greece among EU ministers and their next meeting - slated for Oct 13th - has been cancelled even though attempts are afoot to allay fear about a Greek default which hasn’t yet happened on paper.

Sucden Financial Research’s Myrto Sokou notes that following these fragile economic conditions across the Eurozone and weak global equity markets, the energy market is under quite a bit of pressure.

“The stronger US dollar weighs further to the market, while investors remain cautious and are prompted to some profit-taking to lock-in recent gains. We know that there is so much uncertainty and nervous trading across the markets at the moment, as the situation in the Eurozone looks daunting, “ready for an explosion”. So, we expect crude oil prices to remain on a downside momentum for the short-term, with WTI crude oil retesting the US$70-$75 range, while Brent consolidating around the US$98-$100 per barrel,” Sokou adds.

Many in the City opine that some commodities are currently trading below long term total costs, with crude oil being among them. However, in the short-run, operating costs (the short run marginal costs) are more important because they determine when producers might cut supply. Analysts at Société Générale believe costs should not restrict prices from dropping, complementing their current bearish view on the cyclical commodities.

In a note to clients on Sep 29th, they noted that the highest costs of production are associated with the Canadian oil sands projects, which remain the most expensive source of significant new supply in the medium to long term (US$90 represents the full-cycle production costs).

“However global oil supply is also influenced by political factors. It should also be noted that while key Middle East countries have very low long term production costs, social costs also need to be added to these costs. These costs, in total, influence production decisions; consequently, this may cause OPEC countries cutting production first when, in fact textbook economics says they should be the last to do so,” they noted further.

Furthermore, as the Oilholic observed in July – citing a Jadwa Investment report – it is commonly accepted by Société Générale and others in the wider market that Saudi Arabia needs US$90-$100 prices to meet its national budget; and this is particularly true now because of large spending plans put in place earlier this year to pre-empt and counter public discontent as the Arab Spring unfolded.

Therefore, in a declining market, Société Générale expects long-dated crude prices to show resilience around that level but prices are still significantly higher than the short-run marginal costs so their analysts see room for further declines.

Concurrently, in its September monthly oil market report, the International Energy Agency (IEA) cut its forecast for global oil demand by 200,000 barrels per day (bpd) to 89.3 million bpd in 2011, and by 400,000 bpd to 90.7 million bpd in 2012. Factoring in the current macroeconomic malaise and its impact on demand as we’ve commenced the final quarter of 2011, the Oilholic does not need a crystal ball to figure out that IOCs will be in choppy waters for H1 2012 with slower than expected earnings growth.

In fact ratings agency Moody’s changed its outlook for the integrated oil & gas sector from positive to stable in an announcement last week. Francois Lauras, Vice President & Senior Credit Officer - Corporate Finance Group at Moody’s feels that the weakening global macroeconomic conditions will lead to slower growth in oil consumption and an easing in current market tightness over the coming quarters, as Libyan production gradually comes back onto the market.

The Oilholic is particularly keen to stress Mr. Lauras’ latter assertion about Libya and that he is not alone in thinking that earnings growth is likely to slow across the sector in 2012. Moody’s notes that as crude oil prices ease and pressure persists on refining margins and downstream activities slower earnings are all but inevitable. This lends credence to the opinions of those who advocate against the integrated model. After all, dipping prices are not likely to be enjoyed by IOCs in general but among them integrated and R&M players are likely to enjoy the current unwanted screening of the Eurozone “Greek tragedy” the least.

© Gaurav Sharma 2011. Photo: Alaska Pipeline, Brooks Range, USA © Michael S. Quinton / National Geographic

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