Global Oil set to Fall

Phil Flynn (Price Futures Group) writes, 20 September: “Oil is all of a sudden getting hit on all of the bearish fronts and….more bearish demand fundamentals seem to be developing every few minutes”.

To be sure, that’s a good moment for day traders to play counterintuitive, and grab the dead cat bounce – but oil’s fundamentals have rarely been so awful. And are set to stay that way.

The pincer on oil operates from both sides: supply and demand, meaning both energy and oil supply and demand. Even a mostly-symbolic but impressive and continuing growth in windpower and solar power production capacity is bad news for oil. According to the European Wind Energy Association, over the next three years, 18 more offshore wind projects will become operational, lifting Europe’s total offshore capacity to 9 000 MW. By 2020 on present plans the EU (+Norway) will have an offshore wind power capacity of 40 000 MW, and by 2030 this could reach 140 000 MW. In other words: the equivalent of one hundred and forty 1000 MW conventional power stations. This will only concern offshore wind, but in itself is a project of Apollo-like proportions. As we know, Germany’s surfeit of solar power capacity (about 28 000 MW able to attain about 24 000 MW peak output), combined with Germany’s near-30 000 MW of windpower capacity can on some days of low demand, like weekends, cover the country’s entire electric power needs.

Who would have expected that, about year 2000? For oil-fired electric power generation, which outside the OECD countries still has a major role consuming about 2 billion barrels a year (around 6.5% of world total demand), the writing is on the wall. Where oil-fired power can’t be replaced by renewables, shale and stranded gas supplies are set to grow very rapidly, as gas prices spiral downward. For those still interested in limiting CO2 emissions, gas-fired power is a lot cleaner than coal-fired, and in the US is already cheaper than coal. Oil-fired generation in the US accounts for about 1% of US power.

OIL DEMAND GROWTH?
Taking the recession and debt-deficit wracked EU27 countries – but well before the Lehman Bros and subprime moment – oil demand has fallen every year since 2006: this year marks the sixth straight year of European oil demand decline. To be sure there is always China and India, but even here the oil boomers now have serious problems spinning their tale of “runaway oil demand gowth”. China’s economic growth, and the sectors of China’s economy that are still growing set a growing number of question marks on the future rate of national oil demand growth. In the short-term which we can define as the next 12 months, worries about China’s growth are the only possible analysis.

The most recent HSBC China factory index, but with declining amounts of surprise came in below majority analyst expectations, for the 11th month of contraction, the longest losing streak in the eight years that HSBC has run this index. Normally and until recently, this news when linked with recent Chinese electricity demand data indicating a near-perfect year-on-year zero growth trend, should have quickly resulted in the Chinese government acting to reinforce its various stimulus measures but both China’s internal, as well as external politics are highly different from normal. A change in China’s leadership just around the corner and the rising tension with Japan over the disputed islands in the east China sea are very bad news for oil demand growth, and likely indicators of demand destruction.

Japan’s oil demand is still bolstered by post-Fukushima utilisation of oil-fired power plants, but this is already tapering down as gas-fired plant replaces oil, for subsituting nuclear capacity. In addition, Japan is now running large monthly trade deficits, the most recent hitting 754.1 billion yen in August, of which oil is a major element. Japan’s potential for QE measures is low or zero, indicating that further economic decline, even contraction is upcoming, with an inevitable knock-on and knock-down of oil demand. In the EU27 countries, and especially the Eurozone-17 recent manufacturing index numbers are worse than ever, making any possibility of European oil demand recovery even more unlikely.

India has now shifted back to trade deficit status, and capital account deficit, with the Indian economy even harder hit than China’s by global slowdown. India’s potential for raising its oil demand in any significant multi-percent way, in the short-term, is low. The basic question is set: where is the growth in oil demand supposed  to come from? Humorists can suggest the USA, but the read-out from stocks tells a different story.

ONLY WHEN HIS MOUTH MOVES
Saudi Arabia’s oil minister al Naimi has over the years polished an almost perfect act of only lying when his mouth moves, now featuring his repeated calls for a nice price, for oil, of 75 dolllars a barrel, but of course having no ethical problems with selling it at over $100. The 75-dollar price level is however no number snatched from the air, and not on the demand side. Global oil production growth now needs prices nearing $75 a barrel, as shown by the struggling fortunes of all the “historic oil majors”, whose oil production struggle gets more difficult each day. Without prices near $75 their E&P spending and production will slip even faster than it did following the 2008-2009 oil price crash.

Al-Naimi might imagine that Saudi and other OPEC state production can handle the demand, in a global downturn of oil production following the global decline of oil demand – if there is an end to the decline – but the upward pressure on oil prices following any kind of “classic economic recovery” would quickly price oil out of the global energy equation. The process would be very fast, this time.

Present US natural gas prices struggling to reach $3 per million BTU price gas energy at $17 per barrel equivalent. Global traded coal, including marine and local transport is struggling, but failing to hold $25 – $30 per barrel equivalent of energy. In the lowest-cost coal producer countries and regions, prices are now below $10 per barrel equivalent: why should oil energy be priced 3 to 5 times higher and get away with it ?  As analysts from far and wide, for example at Credit Suisse have recently noted, the real present state of the global economy is not so different from early 2009: at the time oil changed hands at $39 per barrel. For the “historic oil majors”, and a host of NOCs, this would be a disaster price.

THE NEAR TERM
Oil price boomers, who (surprisingly to some) now include Goldman Sachs and the entire hedge fund community, can be counted on to beat the drum – but with declining conviction. Daily price falls on oil markets are now likely to outpace the weakening rallies, of course unless and until the geopolitical scene permits “robust price growth”. The problem is that, even here, the global geopolitical conflict scene now includes the China-Japan standoff, which is unremittingly bad for oil. The boomers’ hope is therefore that enough geopolitical stress will magically produce more QE in the US, Europe and Japan.

Their hopes ignore the real impact of major geopolitical stress, including a hike in the value of the US dollar – again bad for oil prices in dollars – and a sure and certain decline in economic activity. Conflict in the Middle Est, now widened to Mahomet caricatures and its blowback, is either unlikely or impossible to do anything for oil demand, but could or might impact oil supply. The use by Saudi Arabia, Qatar or any other defender of the faith, of “the oil weapon” against the West, meaning oil consumers outside the Muslim world, is highly unlikely given the almost instant energy policy and economic impacts that $150-oil would produce.