The American "counter-revolution" and the oil recovery

The American "counter-revolution" and the oil recovery

Demostenes Floros
In the first two months of 2016, oil prices reached their lowest levels since November 2003. Since then, oil prices have almost doubled, despite the negative outcomes of the Doha meeting and Brexit
The #Leave victory in the #British referendum led to an immediate reduction in #oil prices by almost $3.5

During the first half of 2016, North Sea Brent Crude and West Texas Intermediate reached their lowest levels, respectively, on January 20 at $27.81 per barrel and February 11 at $27.23 per barrel. The highest levels, on the other hand, were reached on June 8: The European benchmark reached $52.72, while the North American benchmark reached $52.08. In April alone, prices increased by approximately 20%, recording the greatest monthly increase compared with the same period of the previous year. This upward trend has indeed characterized the entire month, both prior to the Doha meeting and in the days following the failure of the summit between the main oil producers, held in the capital of Qatar. In the wake of an increase of approximately $4 for both grades that occurred in May, not even the inability to reach an agreement regarding the freezing of production or, at least, the restoring of a production ceiling by OPEC member countries reversed the trend of oil prices. On the contrary, prices reached the highest levels since the beginning of 2016, precisely in the days following the Vienna conference on June 2. The Leave victory in the British referendum led to an immediate reduction in oil prices by almost $3.5, which was almost completely reabsorbed by the end of the month.The fall in oil prices that occurred, on the other hand, during July seems to be the direct result of the accumulation of refined products in the US rather than crude oil, in addition to the role played by speculation: In fact, on the NYMEX in particular, where WTI is traded, short positions (selling) have almost tripled compared with the end of May, from 53 to 141 million barrels. According to the IEA’s Oil Market Report, the global oil supply was at $95.4 million per day in May, down by 590,000 barrels compared with the same period last year. This is the first significant drop in production since the beginning of 2013. That mainly concerned the output of non-OPEC countries, starting with Canada - the fourth largest extractor in the world with approximately 4 million barrels per day, of which 2.2 million of oil sands, and the United States' top supplier, with 3,169 million barrels per day in 2015 - which was struggling with severe forest fires. Secondly, the decline has affected the production of US crude oil which, after having reached its peak of 9.7 million barrels in April 2015, currently stands at around 8.622 million. With regards to the OPEC member countries, in May, supply fell slightly by 110,000 barrels per day to 32.61 million. Nigeria’s significant losses due to continuous sabotages and, more generally, the political instability that the country is facing, were substantially offset by the constant, and unexpected, increase in Iran’s production, of around 3.8 million barrels per day (+700,000 since the start of 2016). The latter figure partly contradicts the claims made in March by the Vice President of Lukoil, Leonid Fedun. ''Iran,'' he said ''will not be able to significantly increase its output without more foreign investment. Also, Iran’s domestic demand is very high given its large population. Consequently, the country may place 300,000-400,000 more barrels on the market: a marginal amount''. On an annual basis, while OPEC’s output has increased by 500,000 barrels per day, non-OPEC output, despite the Russian Federation having increased its extractions, has fallen by 1.3 million barrels. In 2016, it is estimated that the latter will drop by 0.9 million barrels per day, of which 500,000 barrels are due to US tight oil. In the first half of 2016, demand grew by approximately 1.6 million barrels per day, increasing from 93.62 million to 95.17 million, mainly as a result of the greater energy demand of the emerging economies. In the whole of 2016, it is expected that global demand will increase by 1.3 million barrels per day. In 2017, it will reach 97.4 million. These figures confirm the slow, but steady, decline in excess supply: from the 1.5 million barrels per day in January 2016, the excess is estimated at around 800,000 barrels per day as a combined effect of an initial slowdown in output - which then turned into a decline in May - and a more robust increase in demand for black gold. If the next estimates confirm the tendential rebalancing of the oil market, this will no doubt act as a supporting factor for prices during the second half of the year. Currently, June forecasts show an increase in global oil supply amounting to 600,000 b/d for an overall output which reached 96 million b/d while, in the second quarter of 2016, demand increased by 1.4 million b/d compared with the same period last year.

The American dream of energy independence is fading

In 2015 alone, forty US companies resorted to 'Chapter 11' bankruptcy proceedings, despite American frackers being able, at the same time, to reduce extraction costs by 40% and increase the productivity of wells by 48%. According to the forecasts of Wolfe Research, approximately one third of US companies involved in the extraction of crude oil by means of the unconventional method could resort to Chapter 11 by the middle of 2017 if per-barrel prices do not remain at around at least $50. Other analysts, however, believe this threshold to be too low to continue to pump. For instance, Fadel Gheit, Senior Oil and Gas Analyst at Oppenheimer & Co, told the CNBC that "half of the current producers need the barrel to be at $70 to survive and, therefore, have no legitimate right to remain in a business where the price forecasts, albeit recovering, fluctuate between $50 and $60". According to a report by Goldman Sachs, although "limited storage capacity and a still significant excess supply will continue to fuel the volatility and instability of prices over the coming months", the oil market is slowly rebalancing in parallel to the decrease in non-OPEC production and, specifically, that of the U.S. "No matter what OPEC does, supply will fall due to the decline in US production. The latter will not stop the fall provided prices stand at around $45-50 per barrel, and at that point it will only stabilize", Roland Morris, Commodities Strategist at the VanEck center, told the Wall Street Journal. On May 24, the price of WTI reached $49.04 per barrel, temporarily exceeding that of Brent (at $49.01) for the first time since September 2010. According to the U.S. Energy Information Administration, during this period of time, the spread between the two grades of crude oil incorporated the excess supply at the Cushing terminal, in turn due to the fracking revolution and to Canadian Oil Sands, in addition to the dollar trend and the geopolitical instability of North Africa and the Middle East which had influenced Brent more than WTI. The current fall in American unconventional production has significantly limited this spread. According to Bloomberg, US oil & gas producers will announce losses totaling over $15 billion in 2015 alone. If this is the case, the hope is that Nouriel Roubini was wrong when he said that the new global financial crisis could arise from the bankruptcies of companies involved in extracting oil and gas from shale. The impression, however, is that the dream of energy independence founded on the technical revolution of fracking is slowly fading, and not only due to the problems of water pollution and the increase in earthquakes. It is quite likely that the next president of the United States will have to implement a future policy strategy in a national energy context that is no longer as favorable as it was in the last decade.

In 2015 alone, forty U.S. companies resorted to ‘Chapter 11' bankruptcy proceedings, despite American frackers being able, at the same time, to reduce extraction costs by 40 percent and increase the productivity of wells by 48 percent

The oil market should achieve a stable equilibrium towards the middle of 2017. The growth in demand and declining production are helping to reduce the excess supply recorded since 2014.


Monetary policy, the dollar and the euro

The euro/dollar exchange rate opened 2016 at 1.086. On June 23, the euro stood at $1.142. As a result of the electoral outcome regarding Brexit, the common European currency immediately depreciated on the dollar to drop below 1.10, while the British pound reached its lowest level since September 1985 at $1.32. The euro/dollar exchange rate therefore closed the first half at 1.11 (1.108 €/$ at the end of July). During this period, the dollar then partially depreciated against the euro (lowest level at 1.1569 €/$ on May 3) despite, on March 10, the European Central Bank having cut the entire trilateral structure of interest rates, having increased the so-called corridor, and brought the amount of its Quantitative Easing program from €60 billion to €80 billion. In view of the inverse relationship that usually exists between the performance of the dollar and the price of the barrel, the weakening of the former could, to a certain degree, support the increase of the latter. Previously, on December 16, 2015, the Federal Reserve had already decided to increase interest rates by 25 basis points for the first time since the start of the financial crisis. The latter, in fact, stood at 0-0.25% from December 16, 2008. In addition to the end of the Quantitative Easing program, many analysts - wrongly believed that this option would be the first of a long series of rate increases by the FED that would have led to a phase characterized by an appreciation of the dollar. In fact, in the days following the decision of the Central Institute, the dollar reached its highest level over the euro at 1.0742 (January 6, 2016). Why did the Federal Reserve stop the launch of a generally restrictive monetary policy, despite the position taken by the Presidents of the FED of Atlanta, Dennis Lockhart, and of San Francisco, John Williams? In actual fact, Janet Yellen, head of the US Federal Reserve, subsequently decided not to increase rates, both during the meeting of the Federal Open Market Committee (FOMC) of March 16, and during the meeting of June 15, although market expectations were that they would increase as demonstrated by the temporary appreciation of the dollar in February and, especially, in May. It is worth noting that during these 2 months, there was no corresponding fall in the cost of the barrel. The main reason for the interruption to the new monetary course of the FED lies in the data derived from the US labor market, which have not been entirely comforting. In April, only 160,000 new jobs were created, much less than the 200,000 plus expected on average by analysts, while the Labor Department revised downwards the number of newly employed recorded in the previous month. Despite an unemployment rate remaining unchanged at 5 percent, the expanded unemployment rate - which includes the underemployed and forced part-time employed - is at 9.7%, although down from 9.8% in March, while the rate of participation in the workforce fell again to 62.8% (from 63%), the lowest levels in almost forty years. The first estimates for May, however, only indicate 38,000 new jobs, the lowest level in six years and against expectations for 160,000. Therefore, one should not be misled by the fall in the unemployment rate to 4.7%, given the simultaneous further decrease in the rate of participation in workforce at 62.6%. In truth, the possibility that the Federal Reserve should review the monetary policy program - which initially included four increases in interest rates during 2016 - was already clearly explained by the Vice President of the FED directorate, William Dudley, who had justified this by referring to the worsening of the US macroeconomic context. Some macroeconomic data that seem to support the concerns of W. Dudley are outlined below. According to estimates recorded by the Bureau of Economic Analysis, the second reading of the real U.S. Gross Domestic Product showed a 0.8% growth in the first quarter of 2016, up from the 0.5% previously calculated. In 2015, overall growth stood at 2.4%, identical to 2014 and next to the disappointing average of 2.1 percent recorded in the entire post-recession phase, from 2009 to date. Undoubtedly, these figures are more positive than those of the Eurozone, but they cast some shadows. On November 13, 2015, the U.S. Department of Commerce stated that the relationship between stocks and sales was at its highest level since 2009, precisely at 1.38: against warehouse goods amounting to $1,800 billion, something that, in itself, could overestimate the calculation of the GDP, sales until October amounted to $1,300 billion. Is the United States also facing another crisis of over-production? According to the data provided by the US Treasury Department, the Federal government debt - estimated at around $10.6 trillion when Barack Obama assumed the office of President - officially reached $19 trillion. Considering that the 2015 output was at 17.9 trillion, the Public Debt/GDP has currently exceeded 106%. According to the estimates of the Congressional Budget Office, the $8 trillion record of further debt is likely to continue to increase in the near future. After the war (1952), $1.3 of debt created $1 of GDP, while in 2014 the ratio increased to 3.5:1. That is, the United States creates $3.5 of debt for $1 of additional gross domestic product. The deficit of US current accounts further increased by $13 billion during the third quarter of 2015, reaching a total of $124.1 billion. Finally, however, we cannot rule out that during the meeting in Shanghai in February, the main Central Banks worldwide did not secretly decide to avoid a sharp appreciation in the dollar given the negative consequences that this would cause the global economy, mitigating that currency war which saw the FED as the temporary winner, a fact that also benefitted China’s economy. The impression is that the euro/dollar exchange rate is moving away from that equally assumed as imminent in November 2015. Moreover, as regards the future prospects of the U.S. monetary policies, J. Yellen herself took a partial backward direction with respect to her statements of May 27, in which she defined a move by the FED as early as in the following months as "likely," arguing, just 10 days later, that interest rates will rise only gradually, avoiding any reference to a possible date. The monetary policies outlined and the effects that they could have on the dollar, suggest that they may take on a beneficial role in maintaining current per-barrel prices. That said, it can certainly not be ruled out, in the medium term, that the effects that Brexit may assume, conversely, a countertrend role.

As for monetary policies, even all of these geopolitical considerations lead us to believe that it is unlikely, in the second half of 2016, that the barrel will sink back to the low levels of January

The geopolitics of energy between strategies and negotiations

On April 17, the negotiations underway between major oil producers, with the aim of freezing production, failed after Saudi Arabia, Qatar and the United Arab Emirates refused to reach an agreement that did not include Iran. In fact, Tehran had expressed its intention to increase its production up to same level as prior to the start of the sanctions, equivalent to 4 million barrels per day well before the meeting, in order to be able to gain an advantage from the lifting of the same following the agreement on the nuclear issue. The reasons for oil price increases during the second half of April could be as follows:
The Russian Federation, Saudi Arabia and Iraq, the second largest OPEC producer, were producing at a very high speed, both in January 2016 and in the first quarter of this year. Had an agreement been reached in Qatar, the Russians would have had to freeze their output at 10.99 million barrels per day (record level since the end of the Soviet Union), the Saudis at 9.95 million and the Iraqis at 4.46 million, one of the highest levels since the post-Saddam Hussein era. Financial investments from hedge funds, whose total exposure of speculative buying conditions, both on Brent and WTI, had reached 656 million barrels per day, approximately 7 times the global daily oil production, have meant that paper bets on barrels would promote the rise of the real barrel. The maintenance of interest rates at 0.25-0.50% announced by the Federal Reserve on April 27, which followed the weak growth of US GDP during the first quarter of 2016 (+0.5%) as well as the decline in North American unconventional production, did not promote the strengthening of the dollar. In contrast, Chinese demand - reaching 7.7 million barrels per day in March, up by 22% compared to the same month the preceding year - has driven prices up. The strategy of Saudi Arabia and its allies within OPEC - Kuwait, Qatar, and the United Arab Emirates - to push prices down and to defend their own market share thanks to lower production costs, certainly obtained significant results: data reported on non-OPEC output speak clearly. This risky strategy also acted explicitly against the interests of one part of the Cartel, but without succeeding in the main goal to weaken Iran. It also had serious consequences on the national budgets of all OPEC members, who suffered the first substantial losses for 18 years, as demonstrated by the Current Account deficit of $99.6 billion compared with the surplus of $238.1 billion in 2014. This leads us to believe that Riyadh is reaching only a part of its goals and not as fast as previously thought.
From a strictly military point of view, we cannot help but observe that in Syria, the Saudis and their allies - except for Turkey - are the same OPEC member states that are succumbing against the loyalist army of the Arab Republic, the Russian Federation, Iran and Hezbollah.
Sooner or later, will the Wahhabi and Shiite Iran petro-monarchy have to come to an agreement? Tehran - which, if it actually comes out the winner of the conflict in Syria, would increase its political and economic influence in the entire Middle East - is not far from reaching 4 million barrels per day. As suggested by Davide Tabarelli, President of Nomisma Energia, "at the next meeting on November 30, 2016, the Iranians might actually accept a limit to production, while the Saudis, having found that production outside of the Cartel is falling, might renounce the market share strategy at all costs to damage Iran, rather as happened as of June 2014."
In March 2016, US crude oil imports reached 8.042 million barrels per day compared with 7.910 million in February and 7.675 million b/d in January. The last time the United States had imported more than 8 million barrels per day was in August 2013. Taking into account that, in 2015, US crude oil imports stood at 7.351 million barrels (7.344 million b/d in 2014), the real risk is that the trend in demand is rising and that therefore the United States will need more crude oil imports from abroad, despite the figures for April indicating a decrease in imports to 7.637 million b/d (although higher than the 2015 average). As for monetary policies, even all of these geopolitical considerations lead us to believe that it is unlikely, in the second half of 2016, that the barrel will sink back to the low levels of January. However, during the OPEC summit of June 2 in Vienna, the member states failed to reach an agreement on the freezing of production and on the return to a production ceiling. Brexit, therefore, dollar and speculation permitting.