Today’s collapse of commodity prices has the potential to cause a major financial crisis, as I first suggested back in June. In fact, this would now be my Base Case. But companies and investors have been lulled into complacency by unthinking ‘conventional wisdom’.
This simply ignored the obvious fact that record levels of commodity prices could only be sustained by ever-increasing amounts of stimulus. Now the Great Unwinding of these stimulus policies is underway, reality is appearing once more.
Oil markets are now reaching a very dangerous stage. Conventional wisdom in financial markets is that prices are just about to jump back to $100/bbl – amazingly, speculators keep adding to their upside bets, even as prices fall.
Yet the Executive Summary below from the International Energy Agency’s latest Monthly Report tells a completely different story (my emphasis in bold).
“As oil prices keep plunging, projections of short-term supply and demand balances stay the same – more or less – in the wake of OPEC’s decision last month to leave its production target unchanged. Since the last Report, futures benchmark prices fell by another $15/barrel, with Brent last trading near $65/barrel and WTI in the low $60s, 40% below their June highs. Several years of record high prices have induced the root cause of today’s rout: a surge in non-OPEC supply to its highest growth ever and a contraction in demand growth to five-year lows.
“Barring a disorderly production response, it may well take some time for supply and demand to respond to the price rout. Here’s why.
“When it comes to supply, lower oil prices are already slashing producers’ spending, but this is more likely to affect medium- and long-term output than short-term supplies. So long is the lead of oil projects that price swings can take time to work their way through to supply. Projects that have already been funded will for the most part go on. Non-OPEC supply growth for 2015 will not come close to its 2014 record, but prices have little to do with it – as things stand now. The short-term outlook for US light tight oil production remains unchanged at current prices as long as producers maintain access to financing. Only in Russia is oil’s plunge, along with sanctions and a collapsing currency, likely to trim 2015 production plans. A lower forecast of Russian supply is offset, however, by upward revisions to North American projections in view of the latest production data.
“As for demand, oil price drops are sometimes described as a “tax cut” and a boon for the economy, but this time round their stimulus effect may be modest. For producer countries, lower prices are a negative: the more dependent on oil revenues they are and the lower their financial reserves, the more adverse the impact on the economy and domestic demand. Russia, along with other oil-dependent but cash-constrained economies, will not only produce less but is likely to consume less next year.
“In oil-importing countries, price effects are asymmetrical: Demand lost to substitution or efficiency gains during prolonged periods of high prices will not come back in a selloff. Several governments are wisely taking advantage of the price drop to cut subsidies. Consumers thus might not see much of the decline. The dollar’s strength and oil sale taxes in some countries will also limit the feed-through from crude oil to retail product prices. In the OECD, a tepid economic recovery, weak wage growth and – last but not least – worrying deflationary pressures will further blunt the stimulus of lower prices.
“Based on current projections of still relatively weak demand growth and robust supply, global oil inventories would notionally build by close to 300 mb in 1H15 in the absence of disruption, shut-ins or cut in OPEC production. If half of this took place in the OECD, stocks there would approach 2 900 mb and possibly bump against storage capacity limits. The resulting downward price pressure would raise the risk of social instability or financial difficulties if producers found it difficult to pay back debt.
“Meanwhile OECD refining margins, which gained from lower feedstock costs in 4Q14, will likely come under downward pressures in 1Q15, as product stocks rebuild in the wake of surprisingly strong runs and as much as 1.4 mb/d of new refining capacity comes online.
“Continued price declines would for some countries and companies make an already difficult situation even worse. Today’s oil spending cuts will dent supply – just not right now.”
We can only imagine what will happen when markets finally realise that oil prices are going to stay at today’s level, or lower.
Our 13th annual World Aromatics & Derivatives Conference takes place in Berlin next week. Jointly organised as always by International eChem and ICIS, it features a must-hear list of speakers:
- ExxonMobil: Europe Business Director Tim Stedman will give a global market overview
- Dow Chemical: Global Business Director Pieter Platteeuw will discuss the future for benzene
- BASF: Business Manager Klaus Ries will look at the styrene value chain
- Shell: General Manager Elise Nowee will ask the question, “What about Europe?”
In addition, we will benefit from expert presentations on key issues:
- International Energy Agency: Analyst Fabian Kesicki will present the IEA’s energy outlook to 2035
- BMW: Senior Researcher Peter Phleps will look at how Mobility trends will impact car markets
- Nexant: Global Manager Stewart Hardy will focus on the outlook for paraxylene and polyester
- VCI: Senior Economist Christian Buenger will analyse global economic megatrends
- Biorizon: Business Development manager Florian Graichen will look at opportunities in the bio area
- ICIS price reporters Rhian O’Connor and Rob Peacock will highlight toluene and phenol/acetone developments
I will also be giving a presentation discussing the likely impact of the Great Unwinding of policymaker stimulus on the industry.
As the chart above highlights, chemical markets suggest a major economic slowdown is underway, caused by China’s new policies. We are therefore in the New Normal world of slow demand growth and deflation. How can companies create new markets for the future?
Full details of the agenda and registration details can be found by clicking here.
Yesterday’s post described how OPEC oil producers are seeing their export sales to the US start to disappear. But this, of course, is only one side of the story. As the chart from the Wall Street Journal shows, Saudi needs a $93/bbl oil price to balance its budget. Most of OPEC needs a higher price. Only Kuwait, UAE and Qatar need less.
Most analysts choose to focus on this question. But important though it is, it is not the key concern. We are in the New Normal – where demand growth may no longer exist, and suppliers have to fight for market share. As the International Energy Agency has warned recently, “the recent slowdown in demand growth is nothing short of remarkable.”
A moment’s thought, after all, reveals that there is no point in having a high price if it becomes purely nominal. OPEC countries will have no income if they cannot sell their oil barrels.
The coal market provides a vivid example of the problem. 50 years ago, it was common to assume the world was running out of coal. Today, however, coal is being left in the ground, as it is no longer needed.
ASIAN OIL DEMAND IS NO LONGER ON A GROWTH PATH
Developments outside the US provide a vivid wake-up call. Already Asia has become unable to accept cargoes of Russia’s highly valuable Sokol oil. The economic slowdown, and increasing African competition, means the market is over-supplied. So it has been forced to travel to California to find a home.
Even worse, from the producer viewpoint, is that Asian governments are being forced to cut back on fuel subsidies.
China has been doing this for some time, and now indexes domestic prices to world levels. India began cutting them last year, and the new Modi government is now increasing them to world levels. Indonesia will have to follow and increase them by 23%, as the end of the commodities boom makes it impossible to fund subsidies.
Already the subsidy cuts have slowed India’s growth in diesel sales to zero, from up to 11%/year growth in the past. Clearly the pattern is now being repeated across Asia.
And one immediate result is that Indian refiners are demanding better terms from Saudi and Iraq. Bloomberg reports payment terms are likely to be extended to 60 days – essentially a price cut by another name.
Global oil consumption growth had already slowed to 1.2%/year before these changes, as the blog discussed back in July. Western oil consumption has been falling for some years, with even US consumption falling 0.6%/year since 2008. And this trend is likely to continue:
- US Dept of Transport data highlights that “as we age, we drive fewer miles“
- Similarly, the world is now entering its “peak car” moment, where sales will start to decline
- High prices have also spurred moves to gas, and to increased fuel efficiency
Thus oil producers are now effectively in a battle for market share. This is not only between themselves, but also against other forms of energy such as gas and renewables. Those who lose, like coal producers in the past, will have to shutdown.
Saudi Arabia knows this. And its reliance on the US for its defence needs means it has to be amongst the winners.
Tomorrow the blog will look at the key question of what these changes in supply and demand balances will likely mean for prices.
A blog reader has kindly forwarded an important new study ‘Golden rules for a Golden Age of Gas’, produced by the International Energy Agency (IEA). It sets out what needs to be done to maintain public confidence in ‘fracking’ and the other techniques used to extract unconventional gas.
It is clearly a vital piece of work. US developments have already shown, as the IEA notes, that:
“Natural gas is poised to enter a golden age, but will do so only if a significant proportion of the world’s vast resources of unconventional gas – shale gas, tight gas and coalbed methane – can be developed profitably and in an environmentally acceptable manner.”
The good news, as they add, is that:
“The technologies and know-how exist for unconventional gas to be produced in a way that satisfactorily meets these challenges, but a continuous drive from governments and industry to improve performance is required if public confidence is to be maintained or earned.”
The issue is that success is far from assured. The states of New York, New Jersey and Maryland have already put in place temporary bans on fracking. Similar actions have been taken in other parts of the world, such as France. Ignoring legitimate concerns will only lead to a sense that the industry has something to hide – silence, as we all know, indicates guilt.
The chart above, from the report, highlights some key areas of concern. All of these can, and should be addressed as a matter of urgency. As the IEA note, the main need is for companies to act responsibly and transparently. Governments also need to develop the appropriate regulatory regimes, based on sound science and high quality data.
Equally, companies and governments need to guarantee public access to the data, so that it can be properly debated and understood by the communities affected, and by the wider public. Regulatory regimes also need to be properly enforced, in order to build public confidence.
The IEA report is an important step forward in this vital area. The blog can only hope that its conclusions are widely accepted and implemented.