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Izabella Kaminska
As we alluded to earlier, there is a battle taking place in the oil markets at the moment.
On one side there are conventional oil producers like Opec members desperate to stop oil prices from following the declining trajectory of the wider commodity complex. On the other side there are the new US shale oil producers, who — due to the US export ban — are unable to capture the full earnings potential of their production (on account of an inability to tap foreign bids directly).
The problem for Opec types is that the break-even rates they seek to defend are now too high to prevent the new class of producer from being incentivised to keep producing. This despite the fact that the export bottleneck only ends up transferring much of the profitability to the refining sector instead of the US producer.
As pressures mount, it’s fair to presume that at some point something will have to give. One group will be forced by to scale back production, whether they like it or not.
Ending the US export ban would of course serve the interests of the US producers. Global prices would be equalised with US levels, the WTI-Brent spread would reconnect, and Opec would be pressured to cut supply to offset. What was lost by Opec would be America’s gain.
At the same time, however, ending the export ban would see the US lose its competitive advantage on crude processing grounds, jeopardise the US refining industry and with it a whole bunch of domestic jobs.
All of which leads us to something of a supply-side standoff.
As BNP Paribas’ Harry Tchilinguirian and Gareth Lewis-Davies observe on that front (our emphasis):
" Looking forward, we anticipate that 2014 will be a repeat of the end of 2013. The oil market will be in a holding pattern, unable to sustainably break out of a trading range, absent a geopolitical flare-up. Global economic growth in 2014 and 2015 is benign and the market’s ability to supply the resulting oil demand growth is unlikely to be materially challenged.
Given the above, we expect supply trends to take on greater importance in shaping the oil price. In 2014, the market will be caught in the crossfire of strong growth in US oil supply on the one hand and supply risk allied to OPEC supply management on the other. This is likely to result in another year of sideways movement in prices. With non-OPEC oil supply growth centred in the US, more swings in the WTI/Brent spread, driven by WTI, can be expected.
Sustained convergence between the light-sweet benchmarks towards cost of transport will be delayed well into 2015. With little directional conviction in 2014 and a flatter price profile for our quarterly Brent forecast relative to WTI, being short 85/115 Brent option strangles for the entire 2014 calendar year to capture time value is our preferred trade, even if this implies selling volatility at historically lower levels. In terms of price spreads, large downside risk to WTI on strong US oil supply growth in H1’14, and moderate downside to Brent suggests a short WTI/Brent position for April 2014 delivery when planned refinery outages in the US peak.
And as they further pinpoint:
" The US accounts for the bulk of non-Opec supply growth with growth coming in tight light oil, courtesy of the shale revolution. Yet, the US cannot export its crude oil (with the exception of Canada) and this is unlikely to change in 2014/15. As such, to support WTI, elevated refinery utilisation and the displacement of foreign oil is required. Even if high refinery runs were to be maintained and more refining spare capacity utilised, it is unlikely that the US will witness a full displacement of foreign crude imports — this is due to long term contracts in procurement or specific quality requirements by refiners. Given the sizeable annual rise in US supply in H1 ‘ 14 (of circa 1.3 mb/d) and spring refinery maintenance lowering refinery throughputs, we see near-term downside risk for WTI. This risk arises even as connectivity from the Midcontinent to US Gulf Coast expands to allow the shifting surplus light oil away from Cushing, the delivery hub of the NYMEX WTI contract.
The critical point here is that even though the world is facing a positive supply-side oil shock, a stand-off between international and US domestic vested interests is preventing that supply shock from being passed down to end consumers in the form of lower prices.
That in other words means the market is happier to squeeze itself silly — for the sake of protecting national revenue streams and incumbent industrial players — than allow market dynamics to reset to a lower equilibrium.
Is this situation sustainable over the longer-term? At a global economic level, a mis–priced oil price means lots of other things are being mis priced as well!
