Oil prices flag recession risk as Iranian geopolitical tensions rise

Today, we have “lies, fake news and statistics” rather than the old phrase “lies, damned lies and statistics”. But the general principle is still the same.  Cynical players simply focus on the numbers that promote their argument, and ignore or challenge everything else.

The easiest way for them to manipulate the statistics is to ignore the wider context and focus on a single “shock, horror” story.  So the chart above instead combines 5 “shock, horror”  stories, showing quarterly oil production since 2015:

  • Iran is in the news following President Trump’s decision to abandon the nuclear agreement, which began in July 2015.  OPEC data shows its output has since risen from 2.9mbd in Q2 2015 to 3.8mbd in April – ‘shock, horror’!
  • Russia has also been much in the news since joining the OPEC output agreement in November 2016.  But in reality, it has done little.  Its production was 11mbd in Q3 2016 and was 11.1mbd in April- ‘shock, horror’!
  • Saudi Arabia leads OPEC: its production has fallen from 10.6mbd in Q3 2016 to 9.9mbd in April- ‘shock, horror’!
  • Venezuela is an OPEC member, but its production decline began long before the OPEC deal.  The country’s economic collapse has seen oil output fall from 2.4mbd in Q4 2015 to just 1.5mbd in April- ‘shock, horror’!
  • The USA, along with Iran, has been the big winner over the past 2 years.  Its output initially fell from 9.5mbd in Q1 2015 to 8.7mbd in Q3 2016, but has since soared by nearly 2mbd to 10.6mbd in April- ‘shock, horror’!

But overall, output in these 5 key countries rose from 35.5mbd in Q1 2015 to 36.9mbd in April.  Not much “shock, horror” there over a 3 year period.  More a New Normal story of “Winners and Losers”.

So why, you might ask, has the oil price rocketed from $27/bbl in January 2016 to $45/bbl in June last year and $78/bbl last Friday?  Its a good question, as there have been no physical shortages reported anywhere in the world to cause prices to nearly treble.  The answer lies in the second chart from John Kemp at Reuters:

  • It shows combined speculative purchases in futures markets by hedge funds since 2013
  • These hit a low of around 200mbbls in January 2016 (2 days supply)
  • They then more than trebled to around 700mbbls by December 2016 (7 days supply)
  • After halving to around 400mbbls in June 2017, they have now trebled to 1.4mbbls today (14 days supply)

Speculative buying, by definition, isn’t connected with the physical market, as OPEC’s Secretary General noted after meeting the major funds recently:  “Several of them had little or no experience or even a basic understanding of how the physical market works.”

This critical point is confirmed by Citi analyst Ed Morse:  “There are large investors in energy, and they don’t care about talking to people who deal with fundamentals. They have no interest in it.

Their concern instead is with movements in currencies or interest rates – or with the shape of the oil futures curve itself. As the head of the $8bn Aspect fund has confirmed:

“The majority of our inputs, the vast majority, are price-driven. And the overwhelming factor we capitalise on is the tendency of crowd behaviour to drive medium-term trends in the market.” (my emphasis).

OIL PRICES ARE NOW AT LEVELS THAT USUALLY LEAD TO RECESSION

The hedge funds have been the real winners from all the “shock, horror” stories.  These created the essential changes in “crowd behaviour”, from which they could profit.  But now they are leaving the party – and the rest of will suffer the hangover, as the 3rd chart warns:

  • Oil prices now represent 3.1% of global GDP, based on latest IMF data and 2018 forecasts
  • This level has been linked with a US recession on almost every occasion since 1970
  • The only exception was post-2009 when China and the Western central banks ramped up stimulus
  • The stimulus simply created a debt-financed bubble

The reason is simple.  People only have so much cash to spend.  If they have to spend it on gasoline and heating their home, they can’t spend it on all the other things that drive the wider economy.  Chemical markets are already confirming that demand destruction is taking place.:

  • Companies have completely failed to pass through today’s high energy costs.  For example:
  • European prices for the major plastic, low density polyethylene, averaged $1767/t in April with Brent at $72/bbl
  • They averaged $1763/t in May 2016 when Brent was $47/bbl (based on ICIS pricing data)

Even worse news may be around the corner.  Last week saw President Trump decide to withdraw from the Iran deal.  His daughter also opened the new US embassy to Jerusalem.  Those with long memories are already wondering whether we could now see a return to the geopolitical crisis in summer 2008.

As I noted in July 2008, the skies over Greece were then “filled with planes” as Israel practised for an attack on Iran’s nuclear facilities.  Had the attack gone ahead, Iran would almost certainly have closed the Strait of Hormuz.  It is just 21 miles wide (34km)  at its narrowest point, and carries 35% of all seaborne oil exports, 17mb/d.

As Mark Twain wisely noted, “history doesn’t repeat itself, but it often rhymes”.  Prudent companies and investors need now to look beyond the “market-moving, shock, horror” headlines in today’s oil markets.  We must all learn to form our own judgments about the real risks that might lie ahead.

 

Given the geopolitical factors raised by President Trump’s decision on Iran, I am pausing the current oil forecast.

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Oil prices remain at pre-2005 levels as inventories rise

Brent Feb16Its mid-winter in Russia, and the snow is deep in some parts of Moscow.  Meanwhile in Venezuela the economy is close to meltdown, and its hard to find even essentials in Caracas.  So it is no real surprise that this month saw their Oil Ministers head for “important discussions” in the warmer climate of the Middle East.  Similarly, the Gulf States were happy to provide hospitality:

  • Decades of bitter experience have proved that neither country ever delivers on its promises to restrain oil output
  • But just news of the meeting led credulous investors to bid up oil prices, making the discussions worthwhile

US oil and gas producers were even more delighted.   Hopes of higher prices have enabled them to sell $5bn of new equity since the New Year – a welcome boost to their balance sheets.  And prices on the forward curve for future delivery moved up to $45/bbl, triggering a surge of hedging interest from companies keen to lock in profitable economics for another few months.  As the head of Pioneer Natural Resources told his investors:

“You’ve got to use events like that to put hedges in the marketplace

Plus, of course, the high-frequency traders, who now dominate energy markets, were delighted.  Prices have raced up and down by several percent, providing them with effortless profitability.

Back in the real world of supply and demand fundamentals, nothing has really changed.

Russia has already denied that it actually agreed to a production freeze, and also denied that it intended to put pressure on Iran to agree,  Instead, it is finalising a $5bn loan to kick-start Iranian purchases from Russia, to support its collapsing economy.  And even news that the US rig count is back at 1999 levels has failed to show any major link as yet with declining production.

Thus the key to the outlook continues to focus on the price chart above:

  • It first signalled the coming collapse in August 2014, when the 5-year “flag shape” finally broke down
  • This led to the expected freefall in prices, as the bulls lost the power to sustain higher prices
  • Then prices went below the 200-day exponential moving average, confirming a bear market
  • Next, they dropped back below the $36.20/bbl level, and returned to the pre-2005 price era

The events of the past few weeks have provided an opportunity to test this level again.  And, so far at least, it has acted as resistance to higher prices.  This is typical of such moves, where traders understand that major change has taken place in the fundamentals, and that previous support levels have turned negative.

No doubt Saudi Oil Minister, Ali Al-Naimi, will be happy to continue talking up prices tomorrow, when he speaks in Houston.  But markets continue to suggest that the collapse has not yet hit bottom.  US inventories have reached new record levels, and current supply/demand balances continue to support the International Energy Agency’s suggestion that the recent rally was “a false dawn”.

$30/bbl was always my forecast price for oil in today’s New Normal world.  So I am not arguing that any further fall would be sustainable on a longer-term basis.  But it would certainly be unusual, to say the least, for prices to bottom at today’s level, whilst there are still so many players who believe they “must” go higher.

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 70%
Naphtha Europe, down 66%. “Crack spread sinks deeper into negative territory”
Benzene Europe, down 58%. “There are several downstream turnarounds on the horizon from March into May, which could lead to an excess of benzene.”
PTA China, down 46%. “Downstream end-users in the polyester industry are not expected to increase their consumption rates until after the 15th day of the first month of the lunar new year”
HDPE US export, down 42%. “Domestic prices for export moved up a little during the week on sentiment that producers might have a chance for obtaining some increase domestically in March”
¥:$, down 11%
S&P 500 stock market index, down 5%

 

 

Brazil – still ‘The country of tomorrow?’

Brazil Dec15

I am just back from Sao Paulo, Brazil, where I was giving a keynote presentation alongside Brazil’s Finance Minister and other senior figures at the 20th Annual Meeting of the Brazilian chemical industry association, ABIQUIM.

As we all know, Brazil is facing difficult times.  I lost count of the number of times the word “crisis” was mentioned during the meeting – the economy is in recession following the collapse of its commodity exports to China; major corruption scandals circulate around the state-owned oil company, Petrobras; and the country’s President, Dilma Rousseff, is threatened with impeachment.  Ordinary life also remains difficult for the majority of Brazilians:

  • GDP/capita at $6k is just 47% of the global average, despite rising 35% as the economy boomed due to China
  • It peaked in 2013, and may well fall now that the economy has hit problems
  • The core problem is that GDP/capita had stagnated at around $4k from 1980 – 2000

A key issue for today, as I discussed in my presentation, is that Brazil is now seeing its former ‘demographic dividend’ turn into a ‘demographic deficit’:

  • Brazil’s population rose 70% from 122m in 1980 to 208m this year, but will rise just 10% to 229m by 2030
  • The reason is shown in the slide – its high fertility rate in 1950 has now fallen 70%, from 6 babies/woman to just 1.75 babies/woman
  • At the same time, life expectancy has risen by 40%, so the average Brazilian can now expect to live a further 18 years at age 65 – fantastic news for individuals, but a major strain for the country’s finances

As a result, Brazil’s median age is set to nearly double from 19 years in 1950 to 37 years by 2030.

In the past, Brazil always had the reputation of being ‘the country of tomorrow’.  Brazilians would all agree that things weren’t perfect “at the moment”, but believed they were about to improve.  And for a period, during the China boom decade, it seemed as though this confidence was well-founded.  Today, however, the picture is not so rosy.

The good news, however, is that Brazil’s chemical industry – like other key parts of the economy – is run by people with plenty of energy and vision.  If the dead-weight of corruption and political cronyism could be removed, then it could move ahead very strongly.  Brazil is, after all, the 6th largest chemical industry in the world, with a domestic market of over 200m people.

In addition, I heard very positive comments from senior executives on the new administration in Argentina.  President Macri has only been in power a few days, but is already moving fast to try and clear up the mess he has inherited. And elsewhere in the region, the opposition victory in Venezuela’s parliamentary elections is spurring hope that political change might finally be underway – although political crisis is likely to be the immediate result.

It is no exaggeration to say that a continuation of the status quo would be a disaster for Brazil.  But real and sustainable change is possible if leaders come forward who focus on sensible policies rather than slogans.  Such a change would also make a major difference in the rest of the continent, and support those in Argentina, Venezuela and elsewhere who are trying to change the failed policies of the past.