The 200 day moving average price for Brent crude oil set a record last month as concerns about global crude oil supply and demand continue to grow (see chart, courtesy of the Economist). Even as Brent crude appreciates towards 5 a barrel Vitol, the world’s largest independent energy trader, warned that prices may rise to 0 or higher based on rising global demand and threats to supply.
In the last month we have seen several factors push prices upward, including the following:
- South Sudan has stopped pumping nearly 300,000 barrels a day (b/d) of sought-after low-sulfur crude. Political unrest and strikes have removed about 250,000 b/d of supply from Yemen. Libya is pumping roughly 1 million b/d, well below the pre-civil war level of 1.6 million b/d. Syrian output has dropped by about 200,000 b/d due to the turmoil there. Barclays Capital estimates that the problems in Sudan, Yemen and Syria alone could together curtail over 1 million barrels a day of output – the Economist puts the figure closer to 1.25 million b/d – more than 1 per cent of global supply.
- Demand in Asia has picked up in part because Japanese power generators are turning to oil as an alternative to atomic power in the aftermath of last year’s Fukushima nuclear disaster. Only two of Japan’s fleet of 54 reactors are operating, forcing the country to consume more fuel oil and crude for electrical generation. JBC Energy, a consulting firm, claims Japan consumed 635,000 b/d of crude and fuel oil for power generation last month, more than double the amount used a year ago.
The supply disruptions and low spare capacity come at a time of historically low stock levels. Most analysts had expected that strong Saudi production and recovering Libyan output would push up global stocks of oil. But the opposite is true: at the end of January, total crude oil and refined products inventories in the OECD club of developed nations were at their lowest levels since 2008. Inventories are at the lowest in 15 years in Europe
The International Energy Agency (IEA) said that in December OECD stocks came in below the historical average for a sixth consecutive month. Those trends have continued into this year. The IEA said preliminary figures for January showed an 11.4 million barrel climb in inventories, much lower than the five-year average increase of 43.2 million barrels. The figures were particularly striking considering the much warmer-than-normal winter weather in the US and Western Europe. Chart courtesy Financial Times.
- Adding to global demand, European governments including France and Germany have bought oil and refined products for their strategic stockpiles since the start of the year as the market braces for a possible disruption of supplies from Iran. The timing of the purchases has surprised traders as oil and refined products prices are surging. Analysts said that the fact that European agencies had chosen to buy at a time of record high prices suggested a degree of urgency – some say panic – due to the supply and demand situation.
- Even with Saudi Arabia producing at 30-year highs, OPEC spare capacity is “approaching dangerously low levels” according to a report from Goldman Sachs. This is occurring “just as world economic growth is beginning to strengthen. This leaves the world oil market increasingly vulnerable to sharply rising prices in 2012,” the bank said in a research note.
- Two big cushions that had been counted on to stem a price increase appear to be elusive. Saudi Arabia’s oil minister, in an effort to calm markets, publicly detailed Saudi spare capacity. According to the Financial Times it turns out to be far less robust than the market thought. Of the 12.5 million barrels per day of declared capacity, 700,000 b/d falls outside the widely agreed definition of spare capacity – it won’t be available for three months. The kingdom is currently producing 10 million b/d – some say this is their maximum rate of output. The Financial Times points out the immediately available capacity might be a paltry 1.5 million b/d, “far less than the safety valve needed to convince markets that prices won’t rise”.
- The US Strategic Petroleum Reserve (SPR) – the other cushion against rising prices - also may be less viable than expected. The US claims it can draw down the SPR at a rate of 4.4 million b/d. But the Financial Times reports the most recent test – last summer in response to the Libyan disruption – saw a rate of less than 500,000 b/d because the logistical pipeline system of the US has changed.
The SPR was designed to pull inventory directly into pipeline systems moving oil from the US Gulf Coast inland. Over the last decade the direction of flow in many of the lines has been reversed. The latest data show less than 800,000 b/d flowing inland due to the growth of Canadian oil sands and US shale oil output in North Dakota and Montana. Logistics now require mostly seaborne exports from the SPR and port congestion impedes tanker loadings at SPR terminals. As a result the Financial Times reports the oil cannot be brought out at any more than one seventh of the projected rate.
- Oil prices have risen partly in response to lack of spare capacity, partly in response to an anticipated dislocation of Iranian crude oil and the bidding up of available incremental supplies. The Financial Times notes “one stunning problem is that on average the International Energy Agency is projecting 2 million barrels a day of more refinery demand for crude oil in the second quarter than in the first quarter. Where is the oil going to come from?”Add to the problem the fact that gasoline supplies needed on the US East Coast may fall short as 2 million b/d of Northeastern refinery capacity has recently been shut down. This raises the probability we will see gasoline prices in the Northeast this summer.
- The three leading energy demand forecasting agencies - the International Energy Agency (IEA), the Organization of the Petroleum Exporting Counties (OPEC) and the U.S. government's Energy Information Administration (EIA) – all project higher crude oil demand in 2012. The IEA projects a gain of 0.8 million barrels per day. OPEC estimates demand will grow by 0.94 million b/d, and the EIA raised its forecast to 1.32 million b/d saying the oil market has grown “increasingly tight” in 2012. Chart courtesy Reuters.
- The IEA notes that global oil demand has grown almost every year during the last decade even as global prices have increased. The ongoing development and “westernization” of global economies means that crude oil demand should continue to grow well into the future.
- Russia has been breaking oil production records, pushing its oil production to post-Soviet highs. In January output increased to 10.7 million b/d, 1.5 per cent higher than a year previously. But despite the increase, overall exports from the former Soviet Union have fallen – largely due to growing consumption of oil in the domestic market.
- Oil field depletion probably means that Saudi Arabia’s maximum pumping capacity has dropped to 11.9 million b/d according to a report by the IEA. The supply cushion has fallen to 2 million b/d according to that agency from more than twice that level 18 months ago. Some analysts see the spare capacity much lower – more in the 1.5 million b/d range or less.
- To counter the impact of sanctions on Iran and other supply shortages some forecast an additional 500,000 b/d of global production is needed, which would leave very little excess capacity. Internal consumption in Saudi Arabia increases by 0.6 million b/d in the summer to generate electricity for air conditioning. To meet the strong domestic and global demand the IEA projects Saudi production might be pushed above 11 million b/d, a production level that a number of analysts think is unsustainable.
