Andreoli on Oil and Fuel: The top oil and fuel stories of the past year
January 01, 2013
By far, the top story of 2012 was that world oil markets tightened throughout the year despite slow growth in advanced economies and slower than expected growth in emerging economies. While the media, whose attention was focused on the shale revolution, largely ignored the tightening of the world oil market, yet this tightening was and continues to be the driving force underlying persistently high fuel prices.
The best barometer of tightness in the world oil market is surplus oil production capacity, which is the amount of oil that could be produced if all taps were running at full volume. Surplus capacity has been declining since 2010, at which point it was equivalent to 5 percent of total consumption. By November 2012, which is the most recent data point available, surplus capacity had declined to just over 2 percent.
In absolute terms, 2 percent equates to less than 2 million barrels per day. With surplus production capacity so low, an uprising like that which occurred in Libya or another bad hurricane in the Gulf of Mexico could potentially knock surplus capacity toward zero. As a consequence of persistently low surplus capacity, a significant risk premium was priced into the market.
Runner Up: The shale oil revolution and energy independence
A close runner up to the top story was the news that on the back of growing shale oil production and declining consumption, the U.S. is on track to be energy independent in the next decade or so.
A closer look at these trends in domestic production and consumption, however, indicates that though the situation has improved and will continue to improve, forecasts of energy independence are overly optimistic.
Second Runner Up: Diesel exports
Another story that was underreported, if not entirely missed by the media, is the fact that diesel exports climbed to an all-time high and remained at this level.
Historically, the U.S. has been a net diesel importer. Between 1998 and 2008, U.S. net imports of diesel averaged between 3 percent and 5 percent of domestic diesel consumption. In late 2007, the U.S. became a net exporter, and by the end of 2011, net diesel exports climbed to nearly 1 million barrels per day.
In terms relative to domestic diesel consumption, for every four gallons of diesel consumed domestically, one gallon was exported in 2012. If you were wondering why diesel prices remained high while gasoline prices eased, this is a big part of the answer. The other big part is that corn ethanol is a substitute that is blended with gasoline.
Third Runner Up: Brent-WTI price spread
As shale oil production in the Midwest ramped up, a “relative glut” emerged at the delivery point in Cushing, Okla., which is also where the West Texas Intermediate crude stream (WTI) is delivered. In 2011, this relative glut pushed the price spread between WTI and Brent blend, a similar crude stream that’s delivered from the North Sea to Europe. The spread grew from just a dollar or two per barrel to over $25 in September of that year.
It seemed clear to me that such a wide price differential would eventually be solved through physical arbitrage where a third party that is able to figure out the logistics side of the equation and align the appropriate capital and equipment would buy cheap oil in the U.S. and sell it as expensive oil to some other market. So, as the price differential yawned, as I forecasted in 2012, it would converge.
By January 2012, the differential had declined to just over $10 per barrel for a variety of reasons, and Enbridge announced that in the summer of 2012, they would reverse the flow of the Seaway Pipeline that historically carried crude from Houston to Cushing.
It was understood by many analysts, including myself, that this reversal would significantly alleviate the glut and therefore the price differential. But we were wrong.
Though the price differential rose from January through March, the differential dropped more than 30 percent by June.
It soon became clear, however, that the pipeline that carries 150,000 barrels per day from Cushing to Houston, did not have enough capacity to alleviate the glut because production in North Dakota continued to climb exponentially. Between June and November, the spread increased from just over $12 per barrel to just over $22 per barrel.
U.S. oil production
Domestic liquid petroleum production surged in 2012, rising by 0.65 million barrels per day (mbd). In relative terms, this increase from 10.8 mbd to 11.4 mbd pencils out to a domestic growth rate of 6 percent. Of course, you don’t need an analyst to tell you that liquids production surged, but there is more to this story than is commonly reported.
The ratio of crude oil production to total liquids production has been steadily declining, while the biofuels and natural gas liquids component has been increasing.
From a transportation perspective this is problematic because the fractions that are growing as a percentage of the total are not diesel substitutes, and from an aggregate perspective, alternative fuel vehicles (e.g. LNG) do not comprise a significant portion of the total, while accelerated adoption of these technologies will not have any meaningful impact of the total.
U.S. oil consumption
In January 2008, domestic consumption was over 20.2 million barrels per day. As of October 2012, consumption was just over 18.8 million barrels per day. While consumption declined by roughly 7 percent over this period, nearly the entire decline occurred as a result of the great recession which drove down consumption of everything including oil and fuel.
Since the first quarter of 2009, consumption has essentially been flat. The latest available data indicates that 18.84 mbd of oil were consumed in October 2012. By comparison, 18.80 mbd were consumed in October 2009. That equates to a compound annual growth rate of just 0.06%, which is a far cry from the average decline rate of 7% which has been employed by the more optimistic energy independence forecasters.
What’s ahead in 2013?
On the supply side, domestic oil production is expected to continue to increase, though the pace of increase is likely to slow as production rates from an increasing number of fracked shale oil wells go into decline. Outside the U.S., oil supply depends to a great deal on the politics of two Persian Gulf countries: Iraq and Iran.
Production from Iraq has consistently posted strong growth, and the biggest challenges that the country faces moving forward are rooted in the chaos of that country’s domestic politics. While production in Iraq is expected to continue to increase, the output from Iran is expected to stagnate as a consequence of oil sanctions imposed by the West. On the demand side, the U.S. remains the largest single consumer, and as reviewed earlier consumption has been flat.
Looking forward, while domestic petro-efficiency is on the rise, domestic consumption will likely remain flat if the economy continues to grow at a subdued rate. The story is largely the same across Europe. Though European consumption has fallen as Portugal, Italy, Greece, and Spain still struggle with high debt and low productivity, across the whole of Europe demand has been flat.
Looking forward, European demand is likely to remain flat unless the EU can satisfactorily resolve the debt crises, in which case consumption will rise.
Asian demand has risen at a compound annual rate of 9 percent since 1985, but slow economic growth in advanced economies combined with structural changes in the Chinese economy suggest that the rate of growth will slow somewhat over the coming year. Demand among the oil exporters of the world is expected to continue to grow at a robust rate.
In all, uncertainty on both the supply and demand sides of the equation suggests that there is an equal probability of markets tightening or loosening in 2013. In the event that they loosen, it is unlikely that oil prices will drop much below $90. In short, supply chain managers will likely be challenged by high and volatile fuel prices, and competitive advantage will be bestowed on those that minimize their exposure to fuel price volatility.
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