The oil industry is passing through a very interesting phase. Many myths have broken in the process. Pundits are pointing to the fact that the historical relationship between oil prices and forward stock cover has altered — or at least been suspended for the time being. With the Dated Brent testing $60 a barrel in recent weeks, there seems no letup in the market’s pursuit of higher oil prices. And this is happening despite the supply and demand figures pointing to a significant stock build up in 2Q05, says the Monthly Oil Report of the London based Center for Global Energy Studies. Hence despite the forward cover rising — there are no signals of softening of the crude markets.
The last time the global stock cover was at 74 days’ worth of forward demand in 4Q02, oil prices in sharp contrast to today, were hovering at below $30 a barrel. In an environment of relatively low commercial inventories and lack of spare oil and refining capacity, which has been the hallmark of the today’s crude market, prices are higher than they would have been in past in the given circumstances.
Crude supply from the region is also on increase. Saudi Aramco is reported to have hired additional VLCCs to deliver crude to the United States. As per press reports, Saudi Arabia has reportedly hired two more very large crude carriers to the United States in August, swelling spot oil exports to 11.3 million barrels. Saudi Aramco’s chartering arm Vela International Marine had chartered the Sylt to ferry 275,000 tons of crude to the US Gulf from Ras Tanura on Aug. 12 and a Chevron VLCC to carry up to 290,000 tons to the US Gulf on Aug. 2-3. According to some reports Saudi Aramco has also booked the Al-Awdha spot to carry 275,000 tons from Ras Tanura to Red Sea on Aug. 9.
Saudi Arabia booked five VLCCs spot to carry 10.5 million barrels of crude to the US in July. The Kingdom hires an average of up to eight VLCCs on the spot market every month to the US. These reports of an overall surge in the VLCC chartering from the region for July and August loading suggest that OPEC production has been raised further — apparently contributing to the stock build up. Revisions to both historical and future oil demand growth figures published in the July issue of the IEA’s Monthly Oil Report are also reinforcing the emerging pricing scenario. The IEA has cut down its demand forecast growth for 2005 by 200,000 barrels per day. However, despite this slowdown, prices are not reacting in the manner they would have done in past.
OPEC has, in the meantime, also trimmed down its demand forecast. It puts its revised demand estimate down by 150,000 bpd, putting total annual growth for the year at 2.0 percent, or an extra 1.62 million barrels per day compared to 2004. The current outlook for global oil demand will have a huge impact on the market. Although the IEA projects demand growth rebounding in 2006, led by a revival in the Chinese growth, yet the CGES says that there are indications that the higher than normal oil prices could finally be starting to hit end-users and that could trigger a reaction.
However, supply side uncertainties are still there to keep the markets on the edge. The IEA sees non-OPEC output growing by 1.4 million barrels per day in 2006; well up on additions in recent years. However, first production from BP’s 250,000 bpd Thunder Horse field in the Gulf of Mexico may be delayed from 4Q05. In Russia, Shell is scheduled to commence year round production from Sakhalin 2 in 2006, but it may also be delayed by the environmental difficulties the project has been facing.
In view of all this the industry wants to maintain a higher than normal forward cover cushion and that in part explains the disassociation between the market prices and the forward stock cover. The CGES and the IEA thus seem to differ on their view for 2006. The CGES view of oil demand growth in 2006 is of an ongoing slowdown. The world oil demand according to the CGES was expected to grow by 1.54 million bpd on average or 1.9% year on year, slowing up further in 2006 to 1.34 million bpd or 1.6 percent.
The CGES growth forecasts of non-OPEC supply over the coming year are not particularly optimistic either. Yet due to stocks overhang, the prices are to weaken in 2006 - however, not as much as they did in 2002, when stocks reached similar levels of cover.
Hence it projects the Dated Brent to fall from the $56 a barrel level expected in 4Q05 to $51/barrel in 1Q06 and then all the way down to $38/barrel in 3Q06 before the delayed effect of an anticipated OPEC output cut reverses this fall and send the oil prices to $44 a barrel in the last quarter of 2006. This is indeed in sharp contrast to what Mat Simmons is projecting. However, the IEA in its latest Oil Market Report presents a much more optimistic picture in 2006 of both oil demand, which they envisage increasing by 1.75 million bpd and non-OPEC supply, which they see growing by 1.4 million bpd.