Oil prices – one more perspective for 2012

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This post is a guest contribution by Asha Bangalore, vice president and economist of The Northern Trust  Company.

Crude oil prices lost ground in today’s trading (down around $1.31 for Brent crude and decline of $1.21 for U.S crude oil, data points stop at quotes for February 24 in Chart 1.) Needless to say, the impact of rising oil prices is one of the pressing economic issues in the past few days. Here is one more perspective.

A good place to start is gasoline prices in the United States. Gasoline prices (excluding taxes) closed at $3.16 on February 24, which is higher than readings seen a year ago and it is close to the peak ($3.22) registered in 2011 (see Chart 2). At the same time, natural gas prices show a significant decline in the past year. Natural gas prices stood at $2.60 on February 24 vs. a peak of $4.91 in 2011 (see Chart 2). Here is an important partial offset that should soften the blow from higher gasoline prices to consumers.

In addition, employment conditions in 2012 show an improvement in last few months vs. early 2011. The unemployment rate in January 2012 was 8.3% vs. 9.1% in January 2011 (see Chart 3) and initial jobless claims show a noticeable downward trend (see Chart 4). Putting these pieces of information from the demand side, purchase of gasoline in the United States is not likely to show a rapid decline in the near term. At the same time, the higher price of gasoline should translate into a jump in profits of oil producing companies. At the margin, if higher oil prices reduce discretionary consumer spending, profits of oil companies could make their way into economy through other conduits – increased investment expenditures of oil companies, larger dividends to shareholders of oil firms, and buying back of equities.

From a global standpoint, the eurozone is most likely to experience a recession in 2012. The IMF/World Bank projections show advanced nations growing at a 1.2% pace in 2012 vs. 1.6% in 2011, while emerging economies are predicted to grow 5.4% in 2012 compared with a 6.3% increase in 2011. China, an economic juggernaut, is likely to advance 8.2% in 2012 vs. 9.2% in 2011. These forecasts imply near term demand pressures on oil prices are likely to be more benign in the months ahead compared with the first-half of 2011

Moving on to the supply side of the equation, the 2011 Arab Spring led to higher oil prices temporarily in 2011. This time around, the Iran situation is the not the only source of supply pressures. The Economist (Oil markets: High drama | The Economist) notes that supply disruptions of oil are occurring from a pipeline dispute in Sudan, striking workers in Yemen, and repairs in the North Sea; all of which are transitory setbacks that have led to recent gains in oil prices. The bottom line is that demand and supply both determine the price of oil. The recent shortage of oil is a passing event in 2012 which is likely to be overshadowed by soft economic conditions in 2012, particularly in Europe, until world GDP growth gains momentum. That said, a sustained increase in oil prices due to geopolitical tensions is a legitimate risk to bear in mind for the economic outlook of 2012.

Source: Asha Bangalore, Northern Trust – Daily Economic Commentary, February 27, 2012.

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Crude oil vs. Iran: Who blinks first?

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This post is a guest contribution by Dian Chu, market analyst, trader and author of the EconMatters blog.

Oil futures spiked more than 2% in one day to their highest level in nine months on Tuesday Feb. 21. WTI front month contract closed at $105.84, while Brent ended at $121.66 on ICE, primarily on investors fear of potential conflict over the escalating tensions between the US, Europe, Israel, and Iran. A second Greek bailout deal of €130bn (£110bn; $170bn) also helped to inject some optimism into the market (which would seem totally mis-placed as we may need to relive this Greek drama in two years). Nevertheless, the fact remains crude oil market supply and demand has not changed a bit to warrant a 2%+ price jump in one day.

The U.S. and its allies believe Iran is building nuclear weapons, which Tehran has vehemently denied. Last week, the European Union (EU) imposed a ban on Iran oil imports effective July 1, and froze the assets of its central bank. In December, the U.S. said it would “blacklist” companies in the U.S. market if they do business with Iran’s central bank.

In retaliation, over the weekend, Iran announced that it halted oil exports to France and the United Kingdom and warned European companies that it would halt their supplies unless they sign long-term contracts. However, France and UK do not import a significant portion of crude oil from Iran, and Europe could most likely still get alternative crude supplies from other sources like Saudi, or Russia.

Despite Iran oil ministry spokesman Alireza Nikzad’s statement that “we will sell our oil to new customers,” according to Financial Times, Tehran is “struggling” to find a new buyer for the estimated 500,000 barrels of oil per day left as surplus from its decision to halt sales to France and the UK. And another Reuters report quoting commodities traders that

“Iran is turning to barter – offering gold bullion in overseas vaults or tankerloads of oil – in return for food as new financial sanctions have hurt its ability to import basic staples for its 74 million people….Difficulty paying for urgent import needs has contributed to sharp rises in the prices of basic foodstuffs, causing hardship for Iranians.”

Earlier report from AP suggested that Iran still had support from its major Asian buyers as India has joined China in saying it will not cut back on oil imports from Iran. But the latest development, according to Reuters, is that China, India and Japan are now planning cuts of at least 10% in Iranian crude imports as tightening U.S. sanctions make it difficult to keep doing business with Iran. China, India and Japan together buy about 45% of Iran’s crude exports. So the cut-back on Iranian oil imports from these three big clients will be yet another serious blow to Iran.

Iran is OPEC’s second-largest producer after Saudi Arabia, and exports 2.5 million barrels of oil per day, about 3% of world supplies. About 500,000 barrels go to Europe and most of the rest goes to China, India, Japan and South Korea.

Earlier this month, the International Energy Agency cut its 2012 oil-demand growth forecast for the second time in just a few weeks and said the decrease in demand would leave the oil market with enough flexibility to adjust to any loss of Iranian crude exports when sanctions take effect in July. So similar to the “Libyan sweet crude supply crisis” of last year, even if oil exports from Iran goes completely off line, the shortfall would not be such a crisis as priced in right now by investor’s fear.

However, the reality remains that crude oil prices get disproportionately distorted and detached from supply and demand fundamentals whenever there’s a whiff of geopolitical tension and conflict.

Right now, it seems Iran could be the one blinks first (war or peace) with multiple sanctions putting mounting pressure on the country’s basic necessity imports, while hurting its oil revenue. But with Iran still a volatile unknown, analysts say oil could continue to rise and expect to see gasoline at $4 a gallon, and some even see $5, heading into the summer driving season.

If the analysts were right, $4 or $5 gasoline by summer time would certainly be detrimental to the nascent U.S. recovery, and debt-troubled Europe, which could bring demand destruction pushing oil prices back down.

Crude oil prices or Iran, no matter who blinks first, one thing for certain is that consumers most likely will end up footing the bill of higher fuel costs, and world economy would suffer as a whole in the process as well.

Source: Dian Chu, EconMatters, February 21, 2012.

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Case for a sustained $100 oil price

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The article below is a guest contribution by Frank Holmes, CEO and Chief Investment Officer of U.S. Global Investors.

In 2011, oil was one of the top performing commodities among those we track, with Brent rising more than 13 percent. Geopolitical risk and unexpected non-OPEC supply losses caused oil to rise significantly in early 2011. By October, we saw the black gold sink to a low of $80 per barrel before rising to its current level of nearly $108 a barrel.

This year’s unrest demonstrated how major oil-producing regions can significantly affect oil prices. As I’ve previously stated, according to PIRA, the Middle East accounts for over 70 percent of OPEC oil production and, along with North Africa, more than 95 percent of the cartel’s capacity growth.

A disruption of the supply chain can also influence oil prices. One of the largest chokepoints along the global oil supply chain is the Strait of Hormuz, which roughly 90 percent of all Persian Gulf oil tankers—some 18 million barrels per day—pass through, according to Barclays. With Iran controlling the entire northern border of the strait, there is a significant chance for disruptions should the country fall into conflict or war.

The story will likely continue into the new year, as “sanctions against Iran, including a possible European Union oil embargo, and fear of an Israeli attack on Iran’s nuclear facilities led 2011 to close on a bullish note” for oil, said PIRA Energy Group in its new report today. Additionally, there’s new political uncertainty in Iraq that may keep oil elevated.

The chart below sums it up: With more than 40 percent of the world’s oil controlled under autocratic rule, oil supply in democratic nations likely depends on the state of autocratic nations.

China Rises to Top of Energy Pyramid
Another significant development in 2011 was that China surpassed the U.S. to become the world’s largest energy consumer. BP’s Statistical Review of World Energy report calculated that China’s energy consumption rate grew 11 percent over the previous year, with the country consuming 20 percent of global energy.

Read China is World’s Largest Energy Consumer

Continue reading Case for a sustained $100 oil price

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Oil price to average $80 in 2012, says Tim Guinness

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Tim Guinness, chief investment officer at Guinness Atkinson Asset Management, talks about the outlook for oil prices.

Source: Bloomberg, October 12, 2011.

 

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Oil Market: Rectifying the broken paper pricing model

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This post is a guest contribution by Dian Chu, market analyst, trader and author of the EconMatters blog.

It has become quite apparent that major changes are necessary in the oil futures market after the latest year of volatility which had little relation to the actual fundamentals of supply and demand in the marketplace.

Oil is too an important commodity to have such a large dislocation from the actual physical market of supply and demand. It is used by people all over the world as a necessary commodity for daily transportation, businesses rely on the commodity to produce goods, and economies need a stable price reflective of fundamentals to flourish in an efficient matter.

In short, speculators have no business in the oil market, they distort prices, and sure helped slow global growth during the past year by running up prices well beyond the fundamentals based upon actual inventory levels of the commodity.

WTI & Cushing Inventory – A Curious Correlation
Let us look at WTI, it was trading at $115 a barrel while US inventory levels at Cushing were at record levels of over 40 million barrels in storage, in contrast WTI was trading at $76 a barrel when Cushing inventories were actually only 36 million barrels. (Back in May, when WTI was at $100/bbl, we wrote this piece predicitng oil would drop to $80 a barrel by Sept….We probably were too conservative.)


In addition, Libyan oil was offline the entire time, often cited by bullish speculators as a thesis to push up price regardless of the actual market effects of the offline oil which was more than made up for by Saudi Arabia. So now we can empirically validate that oil should never have been $115 a barrel, the market was actually over-supplied based upon inventory levels in relation to their 5-year averages.

Continue reading Oil Market: Rectifying the broken paper pricing model

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Chart du Jour: Oil price spikes in perspective

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With crude oil prices having surged over the past ten days, Chart of the Day has just produced a long-term chart of the inflation-adjusted price of West Texas Intermediate Crude, providing an interesting perspective.

The graph illustrates that most oil price spikes coincided with Middle East crises and often preceded or coincided with a US recession. “The logic behind this is that a Middle East crisis can potentially disrupt an already tight oil supply and thereby drive crude oil prices higher. Also, rising oil / energy prices can, among other things, increase costs within the global economy’s supply / distribution chain and thereby contribute to inflation which can in turn encourage governments to halt or reduce any plans to stimulate the economy,” says the report.

Source: Chart of the Day, July 8, 2011.

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