By Neil Hume, Commodities Editor

Workers with Raven Drilling line up pipe while drilling for oil in the Bakken shale formation on July 23, 2013 outside Watford City, North Dakota
©Getty

Canada is exploiting shale resources and Mexico could follow

For a third year, international oil prices have gone nowhere. Brent, the global marker, has averaged more than $108 a barrel in 2013 – like it did in 2012 and 2011 – as feared oversupply from the US shale revolution failed to materialise because of production setbacks in other parts of the world.

For many investors who track commodities, and hedge funds who bet on volatility, this has meant poor returns. For investment banks, it has meant a lack of business as consumers see less need to hedge. Only Opec, the producers’ cartel, has been happy, with consistently high revenues.

So is it time for investors to throw in the towel on Brent, or will 2014 bring anything different? Analysts are divided.

Many believe 2014 will be the year in which rising output finally overwhelms modest demand growth, sending prices lower and testing Opec’s resolve to balance the market and keep prices stable.

“The US shale revolution, coming on top of the maturation of deepwater production, paints a robust supply picture,” says Ed Morse, head of commodities research at Citi. His bank expects Brent to average $98 a barrel in 2014.

Others, though, argue supply will disappoint, providing a powerful prop for Brent.

“The patterns of recent years are likely to repeat themselves because nothing has really changed,” says Michael Dei-Michei of JBC Energy, a consultant which is forecasting an average Brent price of $110 a barrel next year.

Why the opposing forecasts? The main reason is differing views on the risk of more supply disruptions within Opec .

While the US shale revolution has grabbed attention, headline prices have arguably been influenced as much by production disruptions from Libya’s civil war to oil sanctions against Iran to discourage the country’s nuclear programme. Many analysts see Opec output as a wild card once again.

Barclays, for example, expects non-Opec supply growth to exceed global demand growth by about 500,000 barrels in 2014. But analyst Miswin Mahesh says this will only translate into modest downside pressure on crude prices because of uncertainty surrounding output in many Opec countries.

In Libya, militias continue to block oil exports from major ports. A comprehensive deal to lift sanctions against Iran may prove elusive. In Venezuela traders are increasingly concerned that political unrest could affect the oil industry.

There are concerns about decline rates and also doubts about whether non-Opec supply growth can meet ambitious expectations. Production from the giant Kashagan oilfield in Kazakhstan, for example, was recently halted because of gas leaks and will not restart until at least the spring.

“In eight of the last ten years the International Energy Agency [the developed world’s energy body] has overestimated non-Opec supply growth,” says Tom Nelson, co-portfolio manager of Investec Asset Management’s Global Energy Fund.

With the prospects for supplies hard to predict, a more fruitful way for investors to assess the oil market may be to look at demand growth, where more clear-cut shifts are discernible.

Indeed, the IEA recently raised its forecasts for global oil consumption amid the strongest US demand growth in a decade. It is now forecasting global oil demand growth of 1.2m b/d in 2014.

“Should the current momentum in global oil demand continue, 2014 could hold a few surprises,” says Amrita Sen of Energy Aspects, a consultancy. She thinks Chinese and Indian demand is also likely to remain robust despite the possibly dulling impact of tighter US monetary policy on economic growth in those countries.

But Mr Morse argues that stronger US economic growth may not translate neatly into more global demand for oil, as the US economy is less skewed towards energy intensive manufacturing and industry than China’s.

One thing on which everyone appears to agree is that US oil prices will remain volatile in 2014. Surging shale oil production along with severe restrictions on exports has led the North America oil market to diverge from the global market in recent years.

And a build-out of pipeline infrastructure has allowed the glut of oil produced in shale rock formations such as the Bakken in North Dakota and Eagle Ford in Texas to move to markets on the US Gulf Coast.

Absent changes to crude-export restrictions, prices at the Gulf Coast, the world’s largest refining centre, are likely to trade at a “structural” discount to Brent throughout the year, say analysts. This has important implications for US refiners, who can buy cheap domestic crude below global prices and sell their output at international levels.

Ms Sen expects Louisiana Light Sweet, the Gulf Coast benchmark, to trade $6-$8 below Brent and West Texas Intermediate, the US marker, around $12 below but to exhibit considerable volatility.

“Beyond a reduction in foreign imports, clearing the North American market will be dependent on extremely high capacity utilisation at most refineries,” says Ms Sen. “And the risk is that aggressive utilisation results in unplanned shutdowns for maintenance.”

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