From Global Risk Management
The Oil Market Annual Outlook Jan'18
From Global Risk Management
It is sometimes difficult to imagine that the next year in the oil business can possibly be as interesting as the last year. But 2017 proved to be full of events and developments which impacted the oil market, some more anticipated than others. Like OPEC and non-OPEC oil producers walking the talk and complying with the oil production agreement of cutting 1.8 mio. barrels of oil per day. Or extreme weather conditions in the U.S. halting production and refineries for weeks along with end-of-year huge pipeline outages in the North Sea.
The list is long, but let's focus on the year to come. OPEC and some non-OPEC oil producers will continue operating under the limits of the current oil production cut deal of a total of 32.5 mio. barrels per day, at least until their meeting in June where the deal will likely be up for review. Estimates of the U.S. oil production are that the shale oil producers will likely expand production to around 10 mio. barrels per day this year. The current geopolitical risk premium seems elevated and could potentially cause increased oil price volatility should the situation in e.g. Iran, Venezuela or Libya escalate. All in all, the likelihood of elevated oil prices this year seems imminent. Read why on the following pages.
GOSI is the Global Oil Strength Index - an index created to evaluate important issues and the effect on oil prices. It answers the basic question: “Are oil prices going up or down from here?”
A high rating is bullish for oil prices and a low rating is bearish. In other words, the index is a lot of information boiled down to one number that indicates whether prices should go up or down.
|Oct. 17||Jan. 18||Comments|
|Fundamentals||52||55||OPEC and some non-OPEC oil producers continue the oil production cuts, but increased U.S. production could offset the cuts. However, we could see demand picking up as global growth seems to be on the rise and global crude oil inventories are heading lower.|
|Financials||50||50||U.S. and Chinese growth data is improving while India is still struggling. The U.S. interest rate path is expected to impact oil prices, but as the Fed did not stick to their own projections last year, this year's developments remain mixed. Further, a new FEd chairman will be appointed next month (February 2018) which could spur even more uncertainty.|
|Geopolitics||60||60||Iran/Saudi Arabia tensions and Venezuela balancing on the verge of bankruptcy contribute to the elevated geopolitical risk premium.|
|GOSI||54||55||GOSI is above the 50 level - indicating that our oil price expectation is bullish.|
Keeping fuel costs within a predictable range protects you from unexpected changes in the price of fuel. Changes that could otherwise seriously impact your budget and profit margin.
OPEC cut, US production
Oil prices recovered considerably in 2017 compared to 2016. Brent crude oil price started the 2017 in the mid 50’s as an effect of OPEC and a row of non-OPEC oil producers announcing a production cut in late 2016. The parties agreed to cut oil production by a total of 1.8 mio. barrels per day. Since then, another huge oil producer, the U.S., which does not participate in the current oil production cut, has tried to profit from OPEC’s cuts by ramping up production, reaching output levels not seen since the 1970’s. Oil price plummeted to mid-40’s on concerns that OPEC was not compliant and global demand was not very strong. But the decline was clearly rejected, sending prices surging through H2 on top of decent OPEC compliance and strong global demand growth.
Potentially bullish factors
The oil market looks a lot like it did in 2015, oil prices have recovered from a low 40$ level and surged to above 60$. OPECs intensions to stabilise the oil market were further consolidated as they in end of November extended their production cut to include the rest of 2018 but with a meeting in June, with the possibility of a revision of the deal.
Below are 4 graphs showing some of the world’s most crucial oil inventories, especially the U.S. crude inventories are followed closely by the market. In 2017 most of them saw a drop likely as an effect of the OPEC and non-OPEC allies’ production cut. As the cut is expected to last through 2018 we could likely see this trend continue.
Global oil inventories
Potential bearish factors
Oil prices have been in an uptrend since mid-June 2017, and so has U.S. production. Not only has the U.S. production increased, but the exports have increased as well. The number of drilled uncompleted wells (DUCs) have increased further leaving room for more crude oil production. As the WTI price reached 50$ in August-September we have seen the U.S. production pick up, indicating that this is a level where the shale producers are making money, - a level we are well above at time of writing. Question is if global demand can hold up and if shale oil producers will invest more, and extract more oil, or if they are going to concentrate on positive cashflows and shareholders thereby keeping production constant.
Please note that the two dips in the U.S. production, shown in the graph, below is caused by the two hurricane incidents shutting down off-shore production and limiting refining capacity.
US crude oil production
Demand did not really pick up until after Q1-17, and did seem to not affect prices before H2-17.
By looking at the 3 majors (China, USA and India), demand seems to be steadily increasing for at least U.S. and especially China. India has had a rough time getting back on the feet after major tax and monetary changes depressed spending.
In Q3-17 U.S. saw a remarkable increase in exports of both crude oil as well as gasoline and middle distillates. This increase is in terms of demand an indication of either decreased supply from other exporters or a general increase in demand, but most likely a combination. As OPEC has cut production their exports have decreased as well. Additionally, growth has in general been positive on a global scale.
During 2017, the two main forces which have been driving global oil supply, have been the OPEC and a row of non-OPEC production cut and the increasing U.S. production. As regards demand, when looking at imports and inventory data. U.S. supply is unlikely to decrease this year, especially if OPEC/non-OPEC oil producers continue to comply with the oil production cut deal.
H1-18 is likely going to be affected by the same dynamics (OPEC-cut, shale production) as in 2017. For H2-2018 prices are likely going to increase as macroeconomic effects kicks in. The dark horse being the outcome of the OPEC / non-OPEC review of the oil production cut agreement in June.
In our last quarterly report, we called for gasoil cracks and time spreads to remain elevated. We also said the gasoil East-West would retrace upwards. Both of these have happened and we expect them to continue as we enter the first quarter of 2018.
On the demand side, global trade indicators continue to suggest robust economic activity, particularly in the OECD countries. For example, net tonnage transiting key shipping lanes like the Panama and Suez canals have seen year-on-year growth soaring into double digit percentage figures. We also expect India demand to pick up in Q1 2018 and outpace domestic supply growth.
On the supply side, there will be heavy Middle Eastern turnarounds occurring in the first quarter of this year. Additionally, any fears of a deluge of Chinese exports into Asia due to several new Chinese refineries are being curtailed as these projects have been delayed.
The LS Gas Oil curve remains largely in backwardation with the exception of the front months. The Jan18/Dec18 spread for example has been well supported and trading in the +8/mt to +17/mt range, before breaking to the upside and trading more than double the previous high by the end of 2017. We had similar price action on the LS Gas Oil crack, with the Q1 18 crack trading largely in the +12.5/bbl to +13.5/bbl range for most of Q4 17 before breaking to the upside by approximately 10% as we approached the end of 2017.
On the East-West, the front month 500ppm East-West swap-swap touched its low in September 2017 but has subsequently retraced around 10/mt to trade at -18/mt levels at time of writing. We expect further move upwards, particularly as IE Singapore last week revealed that Middle Distillates stocks in Singapore have tumbled to near 5 year lows. In the physical window, we have also seen major players jumping over to the buy side having largely been on the sell side previously. Do take note that as of 1st Jan 2018, the main benchmark for Singapore gasoil is the 10ppm instead of the 500ppm.
Fuel oil cracks weakened over the course of last quarter as we expected, with the front month crack against Brent falling from approximately -7/mt to around -9/mt currently. This was mainly due to strong crude flat price which has jumped by more than 10/bbl since the end of last quarter. This weakening of the crack however juxtaposed against what is otherwise a supported fuel oil market.
Renewed nuclear power disruptions in South Korea mean that Fuel Oil needs to be used as a power generation alternative. A jet fuel supply crunch in Pakistan resulted in the government authorising local power plants to reverse a shutdown of local oil-fired power plants, diverting supplies away from Singapore. Finally, global bunker demand remains solid on the back of robust economic activity, evident from the increase in net tonnage passing through the Panama and Suez canals.
The elephant in the room for the room for Fuel Oil cracks, however, remains crude flat price which we believe has more upside in 2018. Arguably, Fuel Oil cracks would have been much weaker without the healthy demand so in the case of any flat price weakness, expect that cracks would strengthen more on a relative basis compared to the weakening of crude and vice versa for as long as this favourable supply and demand picture remains.
Middle distillates and fuel oil stocks
The U.S. economy was expected to get a boost when Trump was elected president. Though many financial figures have been mostly positive during the year, the U.S. dollar took quite a beating in 2017. A strong dollar theoretically means cheaper oil, and vice versa.
Furthermore, 2017 was the year the FED raised interest rates for the first time in years. At the start of 2017 the interest rate was 0.75% and December 2017 it was raised to 1.5%. Higher interest rates can be associated with lower growth as capital gets more expensive. But as the interest rate is below 2% it is still relatively low.
The U.S. GDP Q-o-Q in 2017 looked better than that of 2016 (see below table), indicating an improvement of the U.S. economy. For every quarter, the GDP growth is higher than in 2016 as the table below shows.
The PMI, Purchaser Managers’ Index, has been quite healthy over the past year as well, see below graph. The highest level in 2017 was equal to the highest level of 2016, but the lowest level was much higher this year. Please note that a PMI above 50 is suggesting economic expansion which is bullish.
The most significant event last year on the Chinese financial front was that the credit rating was lowered one grade. The concern was rising interest rates meaning that capital would get more expensive which could decrease growth rates. But it looks like this effect never manifested. At least not by looking at the oil demand, which has been increasing.
Looking further into Chinese financials, GDP has seen quite large fluctuations in 2017 from 1.4% to 1.8% Q-o-Q. Though the Chinese GDP growth has decreased considerably during the last 5 years, it is still high bearing the size of the economy in mind.
The PMI has on average increased steadily as well. In 2015 it was 49.91, 2016: 50.32, 2017: 51.61.
Chinese growth is likely to continue at about the same pace as we have seen through 2017 next year, which most likely will spill over to the oil market and increase their oil demand.
Therefore, Chinese financials are set to slightly bullish for oil prices.
Throughout 2017 India has been struggling with the new monetary system and new tax system. The implementation of the two came as a shock to the economy, and expenditure fell which directly affected GDP and GDP growth. Even though GDP growth has slowed downit is still relatively high, and is likely not to slow down any further as India has a huge potential for growth.
The question is, if India will be able to increase growth figures and if so, will it spill over to the oil market? It seems possible for India to increase growth, but as there typically is a lag before such trends spill over to the oil market, Indian financials are less likely to affect the oil market, at least through H1 2018.
Therefore Indian financials are assessed neutral.
The most important dynamic to look out for in 2018 is the relative strength of the USD. Either way its moves will affect the crude oil price in the longer term, and next year it looks like the dollar is more likely to lose strength which could contribute to supporting oil prices.
If India can somehow turn growth figures to increase during next year we could possibly see effects on the oil market in the end of 2018. But most likely the focus in Asia will be on China as their growth seem steady and likely affecting the oil market quite a bit.
Tensions in Saudi Arabia and Iran
Saudi Crown price Mohammad Bin Salman launched a corruption crackdown on 4 November 2017. This led to the arrests of eleven princes, four ministers and several former ministers. This provided the launchpad for the rally in crude oil prices into the $60s.
Shortly after, Houthi rebels in Yemen launched a missile targeted at a Saudi airport in Riyadh. The missile was intercepted. However, Saudi Arabia and the United States have accused Iran of supplying the Yemeni rebels with missiles. A similar incident happened in December 2017. Saudi Arabia continues with airstrikes against Houthi rebels in the capital. The disputes are ongoing but the issue is that it is difficult to predict and quantify where it could be heading.
Since the last few days of December 2017, demonstrations in Iran have been ongoing. These started in the city of Mashhad but have since spread to other areas. The Iranian economy, much higher food prices, a roll back in cash subsidies, 50% increase in gasoline prices have been cited as the protestors’ motives. Again, the issue here is that it is unprecedented and no one knows where it will head.
The geopolitical uncertainty is bullish for oil prices.
Saudi Arabian oil production
In response to the freezing of former President Chavez’s personal assets and the prohibition of dealings in new debt or equity by the state oil firm PDVSA or the government, Venezuela suspended trading in US dollars and publishes the country’s oil basket price in Chinese Yuan. PDVSA also underwent major changes after arrests and firings. The oil infrastructures are in dire need of upgrading and this has not changed. Production levels have plummeted with severe shortages of diluents. The country has the largest proven oil reserves in the world. PDVSA ended the year operating at only 20 percent capacity with 76 of 84 plants out of action. Oil production has fallen to below 2m barrels per day and is dropping around 50k bpd each day.
Venezuela owes billions to Russia and China. $3.1b of debt owed to Russia was restructured during Q4 2017 and in return, Rosneft was given the right to new ventures and two gas fields in the country. The state-owned oil company fell back on its debt payments which amounts to $27b in unsecured bonds and $60b to oil service companies. During December, it was announced that a national cryptocurrency called the Petro would be launched. It would be backed by the country’s five billion barrels of oil and gold and diamond deposits. Some view this as an attempt to sidestep the restrictions in using the US dollar.
With the increasing decline of the state of affairs in the country, one cannot rule out a complete paralysis of the country and that would mean for oil production to fall even more drastically.
This is supportive for oil prices.
Oil price forecast (average)
Brent forecast and prices (USD per barrel)
How is the report structured?
The report is divided into three parts – each part elaborates on three main topics which are influencing the oil prices:
The GOSI is the background for the medium term forecast on oil prices. The last pages in the report are our forecast and company news.
Global research team
About Global Risk Management:
Global Risk Management is a leading provider of customised hedging solutions for the management of price risk on fuel expenses. Combining in-depth knowledge of the oil market, finance and transport, we help clients protect their margins from the risk posed by notoriously volatile fuel prices.
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In 2017 the U.S. rig count increased from about 500 to just below 750. This has provoked a huge increase in production to around 30-year highs. The main reason for this large increase in production after the price plummeted in 2014 is the development of the fracking technology making it financially feasible to extract oil from shale formations.
In 2015 the technology really proved its worth and showed what is was able to do as the production reached levels above 9.5 mbpd.
But then came 2016 where prices plummeted and so did production. The number of rigs dropped as well. But the amount each well produced increased remarkably, which suggests that there is no linear relationship between the U.S. rig count and U.S. production. The picture looks like this:
So, what is causing this picture and why is it important?
The U.S. rig count released by Baker Hughes is closely watched all over the oil market as it says something about how the U.S. oil production is behaving. Drops in active rigs are a bullish signal, and vice versa.
But if the relationship between production and number of rigs is not linear, producers will be able to keep production at elevated levels even though they are trimming costs and closing rigs making the effect less bullish as they are still able to meet demand.
It is tempting to think that the U.S. producers are just turning on valves and producing more on the rigs they left active. But over time this would imply wells depleting faster with total amount of oil recovered decreased.
But this is likely not the entire story.
The first effect to account for is the off-shore rigs. One offshore platform is counted as 1 rig in the Baker Hughes rig count. But an offshore rig produces on average about 100 kbpd, where on shore rigs produce about 10-12 kbpd on average. So, if a few of the off-shore rigs are closed the production could drop remarkably. (which is seen in the two 2017 production spikes).
When leaving the off-shore rigs out of the equation the picture is the same as in the first graph presented. So, what is going on with the on-shore rigs?
By looking at the graphs below it shows that there are relatively fewer vertical rigs now compared to earlier. Additionally, there have been an increase in the number of horizontal- and directional rigs, this is a sign of drillers trying to streamline their business and cutting costs, as the conventional vertical wells produces less.
In 2015 the production per rig was a little higher than through 2017, this is likely due to the larger number of off-shore rigs back then. There was a relatively larger number of vertical rigs, but most likely they are offset by the off-shore rigs, and could potentially be pumping at increased pace. What is remarkable is that in 2015 the 2 spots where production per rig was down was when the number of vertical rigs was highest (marked with red lines in the graph below). As the vertical rig count drops to 35, the production per rig reaches its highest. What we are seeing now is that production per rig has been reduced, but that seems as a natural effect of increased rig count.
Assessing the graphs below:
From April 2015 to May 2016 the production per rig increased from about 11 kbpd to just below 24 kbpd. during that same period number of vertical wells dropped by 67%. The number of horizontal wells dropped by 56% and the number of directional wells dropped by 61%. This suggests that the verticals are the least productive.
Furthermore, by looking at the dip in production per rig in August 2015 versus the peak in June 2015, it is observed that vertical rigs in August counts for 17.5% of total active drills, horizontal for 79.5% and directional for 3%. In June, the figures are Verticals: 14,5%, Horizontals: 80,5% and directional 5%.
So as the production pr. rig increases so does the part of horizontals and directional drills, but the opposite is true for the vertical drills.
Vertical drilling rigs are traditional rigs drilling straight down and are known for in most cases producing less than directional and horizontal drilling rigs.
Global Risk Management obtains license as investment firm
After thorough preparation Global Risk Management has obtained license as investment firm with the Danish FSA.
Managing Director, Hans Erik Christensen, states: “With the new status as investment firm, we are ready for the coming MiFID II regulation which takes effect from 3 January 2018 and among other things impacts the commodity derivatives business in which Global Risk Management operates. By receiving the license we have not only secured the basis for our existing business, we have also gained new opportunities to expand our services to our clients. As part of the preparation we have been working with the entire value chain. The process has matured us as organisation and has led to improvements on IT systems as well as further additions to our staff of skilled and specialised professionals.”
Christensen adds: “The decision to apply for a license has been underway for a while, and it supports our strategy to grow via both geographical and product expansion. Main purpose of the MiFID regulation is to protect investors; i.e. our clients and we fully support this objective.”
The license as investment firm means that the company will change registration number as well as add the Danish word for investment firm, Fondsmaeglerselskab to the name in all legally binding documents. Management and employees remain the same.
New Board of Directors
In connection with the recently obtained license with the Danish FSA to become an investment firm, Denmark-based Global Risk Management has formed a new Board of Directors effective as of 8 December 2017. The Board consists of experienced professionals with skills in board services as well as financial markets.
The Board consists of:
Keld Rosenbæk Demant, 51, Chairman of the Board and CEO of Bunker Holding A/S
Keld has more than 20 years of experience from leading positions in international companies as well as Executive Management and Board Programme at INSEAD supplemented by shipping training at Oxford University and Lorange Institute. Keld has been Chairman of the Board in Global Risk Management since 2015 prior to which he was Board Member from 2010.
Jesper Klokker Hansen, 53, Board Member and CFO of Bunker Holding A/S
Jesper holds a Diploma in Business Administration and Economics supplemented by Executive Management Programme at INSEAD and Columbia Business School. In addition, he has extensive experience as CFO and Finance Director with international companies. Jesper has been Board Member in Global Risk Management since 2010.
Jacob Bro Eriksen, 52, Board Member, CEO and owner of Omni Group 2000
Jacob is an MSc in Economics and Business Administration and has worked in investment firms for over 30 years, both in management positions as well as Board Member.
Kaj Damgaard, 63, Board Member, owner of KD Management and long-serving manager in Danish banks.
Kaj has worked for many years with board services in financial businesses. Furthermore, Kaj has a diploma in business administration.
Hans Erik Christensen will remain Managing Director in the company which will change VAT number and add the Danish term for investment firm, Fondsmaeglerselskab, to the name in legally binding documents.
Ahead of the formation of the new Board of Directors, the entire Board as well as the Managing Director, Hans Erik Christensen, have over the fall attended extensive education at Copenhagen Business School to ensure compliance with the FSA as being “fit and proper”.
Chairman Keld Demant comments on the new Board of Directors: “Along with the license as investment firm, we welcome two new highly skilled Board Members to the Board of Directors. We all have different strengths and hence we complement each other, forming an extremely strong team which will contribute to the continued success and progress of the company.”
New hire in Global Risk Management - Camilla Skovsbo Erichsen
We are pleased to inform you about the employment of Camilla Skovsbo Erichsen at our headoffice in Denmark.
Camilla Skovsbo Erichsen, 34, works as Management Assistant in Global Risk Management and comes from a position as Project Consultant in a large Danish bank.
Camilla is a CFA charterholder as well as MSc in Economics and has several years of experience within the financial markets both as Senior Analyst and Portfolio Manager.
In her new position as Management Assistant Camilla will focus on implementing management overview tools and reports as well as strategy development together with the management team in Global Risk Management.
Managing Director, Hans Erik Christensen, comments on the employment: “Camilla is highly skilled and has in-depth knowledge of our line of business and I am confident that she will be a huge asset to our company and our management team”.