From Global Risk Management

The Oil Market Quarterly Outlook July 17

The outlook in less than 60 seconds....

The oil production cut agreed by both OPEC and a row of non-OPEC oil producers has been extended into Q1-2018. Compliance to the deal is high, but increasing production by shale oil producer U.S. could outweigh the reduced production. Two of the world's fastest-growing countries, India and China, could face economic growth slowdown for very different reasons.

On the product fundamental side, the Asian gasoil and fuel oil markets are very strong, read more details in the report. Two of three economic majors, U.S. and China, could face increasing interest rates while the third, India, traditionally the fastest growing major economy in the world, goes through demonetisation. Dark horse in the geopolitical arena is the Qatari diplomatic crisis - though not our base case scenario, fears are that the diplomatic crisis could extend or spread and potentially affect oil production in the Middle East.

GOSI - Global Oil Strength Index

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.

From Global Risk Management

The Oil Market Annual Outlook July'17


As a new initiative, we include both crude oil fundamentals and product fundamentals in our analysis.

Crude oil fundamentals summary

  • Rising OPEC and non-OPEC compliance to oil production cut agreement
  • However, so is U.S. shale oil production, making it harder to get global crude oil inventories back to 2014 levels.

Crude oil fundamentals

On 25 May, OPEC decided to extend the deal to cut oil production by approximately 1.2mbpd  for another 9 months (starting 1 July). Compliance for the previous deal was a surprising 106%, with Saudi Arabia carrying most of the load and offsetting more than the missing volume from non-compliant members.

The group benefitted greatly from scheduling fields into maintenance and “low-season” Q2. Looking forward it will be a lot harder to comply in the high demand quarters of Q3 and Q4, therefore we expect compliance to come in below 100% for this period. However, there is a possibility that heavy maintenance will be scheduled again in Q1-18, so the average compliance rate can inch towards 100%. The goal is to bring down global inventory levels to a 5-year average. When looking at the data (see chart), it is not an easy task.

The scaled back production from OPEC leaves the door wide open for shale oil producers in the U.S. which now acts as the de facto swing producer due to the technical possibilities in shale production. For example, it is possible to drill the wells without completing them and leave them idle until higher prices warrant an activation. As can be seen from the graph, there is now a record amount of almost 6,000 drilled but uncompleted (DUC) shale oil wells.

 The 6,000 DUC will act as a natural lid on prices and keep Sisyphus busy – at least in the short term. It obviously becomes easier to get to the 5-year average as time passes (as the average will increase). It would be a lot harder if the mission statement was: “Get inventories back to 2014 levels”.

We set crude fundamentals to Neutral

Product fundamentals summary:

  • Strong Asian Gasoil market in Q2’17 due to heavier than usual refinery maintenance and high demand
  • Strong Fuel Oil cracks in the past month not just due to falling crude oil prices but also fundamental reasons
  • Gasoil East-West spread and fuel oil cracks are expected to stay supported in the near term.

 Middle Distillates

Very strong Asian gasoil market

The East of Suez Gasoil market has been strong due to a combination of supply (heavier than usual refinery maintenance) and demand side factors which have outdone seasonal factors that were supposed to weigh on the gasoil market.  

In China, diesel demand reached a record in Q2’17 on underlying demand from heavy industry and freight and is expected to be stronger in Q3’17 despite China implementing a fishing ban this year that began earlier and is tougher than normal years. Unusually low diesel exports from China have also supported the Asian gasoil market in recent weeks, although additional diesel export quotas awarded to Chinese refiners and additional refining capacity soon coming online will soon change this.

In India, delays in refineries returning from maintenance has seen the country’s refiners increase buying of ULSD to comply with the tighter Bharat IV fuel standards which stipulate that diesel import must contain no more than 50ppm sulphur. This is despite the monsoon season in South Asia which should have weighed on gasoil demand from reduced economic activity. As a result, India’s diesel imports have reached a 13 month high, with diesel being pulled from the Middle East, the Mediterranean and Northwest Europe, an unusual turn of events considering that India typically supplies up to 0.3 million tonnes of diesel to Europe each month. There has also been strong buying elsewhere in Asia with Indonesia and Thailand buying more than their usual allotment.

To compound the strong demand side picture in Asia, unusually high temperatures in South Asia and the Middle East have resulted in droughts and low water levels which has in turn resulted in reduced availability of hydroelectric generation in countries such as India and Pakistan. Middle distillates imports/demand have duly risen due to its role as substitute for power generation.

Supported European middle distillates complex

In the west of Suez, ULSD is pricing strongly due to good demand for road fuels in Europe, longer than expected refinery outages and emptying stocks. Refinery problems in Latin America are also pulling molecules from the U.S. Gulf Coast away from Europe, exacerbating the tight diesel situation already caused by Asia. As a result of these near term bullish factors, the Jul17/Aug17 ULSD-ARA Futures spread have gone into backwardation and is trading at +0.50 at time of writing.

Looking ahead to Q3 2017

Looking to Q3’17, however, a large supply of distillates is expected to hit Europe and U.S. this summer as refineries ramp up to their seasonal peaks. And while European diesel demand is expected to remain strong, dropping Rhine levels will reduce barge loadings to 60-70% of capacity, hence making it challenging to supply inland where demand is the strongest.  The big economies in Latin America are also struggling to grow, reducing the possibility that demand from Latin America can absorb the increased distillate supplies from U.S. Gulf Coast. These supplies would inevitably end up in Europe and together with the aforementioned factors, lead to a build of ARA stocks and a weaker European distillates complex as we head into the next quarter.

Asian refineries are also expected to start ramping up output. Together with increased Chinese refinery capacity (if China do not cut refinery runs) and exports from additional diesel export quota, the tightness in the Asian gasoil market could ease. That said, we expect the additional supplies into Europe to hit first and the East-West arbitrage spreads in gasoil to remain strong for the better part of Q3’17. 

Fuel oil

Fundamental reasons behind fuel oil’s strength

At first glance, fuel oil’s strength can be attributed to lower crude prices as the former is a relatively inelastic product. Beneath the surface however, there lies very strong fundamental reasons for why fuel oil cracks have strengthened so much.

Years of declining medium and heavy crude have raised the prices of more sour crudes, forcing refiners to process sweeter and less fuel oil rich crudes. This situation was exacerbated by the OPEC cuts which focused mainly on sour crudes against a backdrop of increasing shale oil production from the U.S. which produces mainly sweet crudes. The Brent-Dubai crude spread has therefore tumbled to historical lows, with Brent crude the marker for sweet crudes and the Dubai crude for sour. The Bren-Dubai EFS averaged +0.72 in June. In comparison, it averaged +2.97 in 2016.

Furthermore, there have been refinery problems in Mexico and Latin America which traditionally supplies fuel oil to the Asian market. This comes at a time when demand for fuel oil in Asia is robust. Bunker demand is strong in the Asian region with demand in Singapore being supported by the ongoing diplomatic dispute between Qatar and the Gulf Cooperation members complicating refueling at Qatari ports.

Weather playing its hand

Soaring temperatures in Saudi Arabia and Pakistan are also boosting utility demand, with the latter requiring fuel oil for power generation as a substitute to reduced hydroelectric power caused by a heat wave and drought. A widespread nuclear outage in Taiwan where 5 of the country’s 6 reactors are out of service has also boosted the demand of fuel oil for power generation. Finally, Chinese and Russian domestic fuel oil demand have both performed well of late, the latter due to an emergence from a recent recession.

Increasing upcoming fuel oil supplies

Looking forward, higher fuel oil prices will no doubt result in higher production and supply, especially with turnarounds winding down in most markets. In Europe for example, fuel oil output is expected to rise with Belgian and Turkish fuel oil yields already up significantly and Greek and Italian fuel oil yields expected to gain this summer. FSU fuel oil output may also rise as crude oil export margins in June and July are expected to be sharply negative, meaning that it would be more profitable to process crude oil at home and export the products than to export the crude oil.

Pressure from utilities will also ease with the end of Ramadan and the return of one of Taiwan’s nuclear reactors. The joker in this deck of cards, however, remains the weather as demand for fuel oil will not reduce significantly as long as the heat wave persists. Until then, we expect fuel oil and its cracks to remain relatively strong even if there is a strengthening of crude oil prices.  

From Global Risk Management

The Oil Market Quarterly Outlook July'17


Financials summary:

  • U.S. could be heading for increasing interest rates
  • Rating agencies downgrade Chinese credit rating - consequenses could be increasing interst rates --> less growth ahead?
  • India - the world's fastest growing major economy - turns to demonetisation to reduce the underground economy

US increasing interest rates

The Fed agreed to raise the U.S. interest rates in mid-June from 1% to 1.25% while also seeking  to decrease the balance sheet. The minutes from the Fed March meeting did, however, state that the process of balance sheet reduction would not begin until end 2017. Which could be in September.

The direct effect of an interest rate on oil prices is questionable and likely not significant as there is a lag tied to the implications of such an action. Hence, an interest rate hike is likely not going to affect the oil prices directly in the coming quarter. Expectations are for one more hike in 2017.

Moody’s downgraded Chinese credit rating

Credit rating agency Moody’s downgraded the Chinese credit rating due to the high amount of government debt and an expected decline in growth. Both Moody’s and Fitch have similar ratings on China, while Standard & Poor’s rating is one notch above. The lower credit rating could result in higher interest rates and thereby declining growth rates. Currently, there are no signs of increasing interest rates.

India is going through demonetisation

India remains the fastest growing major economy in the world, but lately the country made some drastic decisions with the demonetisation as the largest factor. The demonetisation has caused reduced money supply and ultimately less spending, suggesting slowed growth in the short run. Longer term, the demonetisation is expected to shrink the underground economy and bring in more tax revenue. Additionally with new tax arrangements such as the Goods and Service Tax, growth is expected to pick up in the longer run.

We set financials to slightly bearish.

From Global Risk Management

The Oil Market Annual Outlook July'17


Geopolitics summary:

  • The Qatar crisis is still unfolding and could have different effects on crude oil and products prices depending on how it evolves. The net effect on both crude and product prices is leaning towards being bullish
  • A shift in the energy directive of the US by the Trump Administration to Energy Dominance is bearish in the long term but is likely to roil market sentiment in the short term and could decouple historical relationships between asset prices
  • Saudi Arabia recently underwent a restructuring of top brass. The new Crown Prince is aggressive when it comes to asserting Saudi Arabia’s position in the Middle East. The IPO of the state owned oil company is also a key event to keep in your sights. Bullish effects likely
  • Libya, Nigeria and Iraq continue to be wildcards in the crude oil demand and supply balance

Qatar diplomatic crisis

During June 2017, several countries severed economic ties with Qatar. The nine countries are Bahrain, Comoros, Egypt, Maldives, Mauritania, Saudi Arabia, Senegal, United Arab Emirates and Yemen. Five other countries namely Chad, Djibouti, Eritrea, Jordan and Niger have reduced ties. The official reason appears to be linked to terrorism.

A variety of actions were taken by the countries and these include the withdrawal of ambassadors, a purging of Qatari visitors and residents, closure of ports and airspace to Qatari vessels and planes, closure of borders and the restriction of trade.

Qatar has been given a list of thirteen non-negotiable demands that it needs to accept, with further sanctions to follow if it does not comply.

Qatar is the second richest nation as measured by per capita GDP and it is the world’s largest LNG exporter. On the oil front, it is the 17th largest crude oil producer in the world. While the effects on crude oil do not seem to be meaningful due to the small quantum, the unfolding of the crisis has had some effects on both crude oil and products prices.

The effect on crude oil is bullish with any further worsening of current affairs. In terms of products prices, the ban on Qatari vessels from entering UAE and Fujairah have locked out Qatar from the largest fuel export hub in the Middle East. Qatari vessels have also lost a key refueling stop. We saw fuel oil prices in Fujairah fall dramatically with inventory levels rising. At other ports such as Singapore and Gibraltar, we have seen the opposite effect. As such, the effects on the different parts of the oil complex are different. But the net effect is bullish.

United States

The current energy directive for the U.S. under the Trump administration is Energy Dominance, no longer Energy Independence. After crude oil prices were lifted following OPEC and Non-OPEC curtailments in December 2016, this provided the ideal conditions for U.S. producers to hedge out future production (into 2018). What followed was a resurgence of U.S. oil into the global markets – oil production has risen by 500,000 barrels per day (bpd) so far and is set to hit the 10 million bpd mark by 2018. The Trump administration is currently rewriting a five year drilling plan and will expand drilling into the Arctic and the Atlantic Ocean. The target is for the U.S. to be an energy exporter by 2026, but the current administration has stated that 2020 is feasible.

The U.S. is also heavily intertwined with the rest of the world and this could complicate matters. For instance, with reference to the Qatar Crisis, the U.S. has vested interests with parties on both sides. Hence, the net effect of oil prices is not clear.

The fundamental effects are long term but there are effects in the short term as well. The movement of crude oil prices, especially during the months of May and June 2017, has shown that the sentiment of the market sometimes matters more than fundamentals. A prevailing negative sentiment could more than offset U.S. inventory data that is bullish.

Saudi Arabia

Saudi Arabia underwent a power restructuring during June 2017 which saw 31 year old Mohammed bin Salman being elevated to crown prince. The crown prince has already been effectively running the country over the past few years. The crown prince is known to stronglyassert Saudi Arabia’s position in the Middle East. The escalated friction with Iran and the recent Qatar Crisis could be highlighted as examples.

The effect on oil prices depends largely on the price directive set by Saudi Arabia. Previously, prices did not matter but with the fall in prices last year, it marked the return of market management – the restriction of output to manage prices. This comes at a time when the Saudi Aramco IPO is also part of the mix. The decision on which foreign bourse chosen for the listing was supposed to be reached by the end of Ramadan but this date has now since passed. However, it is not expected for the decision to be pushed much further out in time.

 The net effect of Saudi Arabia on oil prices is bullish.

Libya, Nigeria and Iraq

In previous outlooks, these countries have been geopolitical mainstays with oil production levels curtailed and restored due to various issues such as militant actions, oil pipeline leaks, warring factions, ISIS, etc.

The effect of these countries on oil prices are now included under fundamentals but to sum things up, Libya, Nigeria and Iraq have seen stable and increasing oil production levels in recent times. Nigeria and Libya are exempt from the oil cut deals of November 2016 and May 2017.

We set Geopolitics to slightly Bullish

From Global Risk Management

The Oil Market Quarterly Outlook July'17

Oil Price Forecast

About the report and the authors

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:

  • Fundamentals – covering the supply and demand balance
  • Financials – covering speculators’ interest and the development of the financial market
  • Geopolitics – covering the situation in unstable oil producing regions of the world.

 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.


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.

5 good reasons to manage your fuel price risk

Book a meeting with an oil risk manager

This publication has been published by the research department of Global Risk Management for information purposes only. Global Risk Management is not liable for its content and disclaim liability if it is used for trading or other purposes. The publication is protected by copyright and may not be reproduced in whole or in part without a proper source description.

News from Global Risk Management

Annual report shows all-time high financial result

The 2016/17 annual report from Global Risk Management shows an all-time high financial result of over 12 mio. USD, 75% above last year’s result, and a gross profit for the year of 20.37 mio. USD. Trading activities increased along with the number of clients wishing to secure their fuel price exposure.

Read more

Photo: Managing Director, Hans Erik Christensen

New hires in Global Risk Management

We are pleased to inform you about the employment of Eugene Yuliang Yeo in our Singapore Team and Trine Nytofte in our Back Office Team in Denmark. We are pleased to inform you about the employment of Eugene Yuliang Yeo in our Singapore Team and Trine Nytofte in our Back Office Team in Denmark. Also, Christoffer Rask will be our new student analyst, working from the head office in Middelfart, Denmark.

Eugene Yuliang Yeo, Oil Risk Manager, Singapore team

Trine Nytofte, Accountant

Christoffer Rask, Student Analyst

Global Risk Management is searching for Financial Controller

Read more about the position here.