the 2010 outlook for oil markets and impact on economic activity new york energy forum william h....

The 2010 Outlook For Oil Markets The 2010 Outlook For Oil Markets and Impact On Economic Activityand Impact On Economic Activity

New York Energy ForumNew York Energy Forum

William H. Brown IIIWilliam H. Brown IIIPresidentPresident

WHB Energy Research LLCWHB Energy Research LLC

January 13, 2010January 13, 2010

Outline of PresentationOutline of Presentation

Fundamentals 2010:Fundamentals 2010:World oil balanceWorld oil balanceU.S. refinery balanceU.S. refinery balance

Financials 2010:Financials 2010:Non-commercial participationNon-commercial participationThe equity marketThe equity marketThe dollarThe dollarInterest ratesInterest rates

Price components in a recovery yearPrice components in a recovery yearBroad fundamental viewBroad fundamental viewNon-commercial influenceNon-commercial influenceSeasonalitySeasonalityOverlay all factors into a price forecastOverlay all factors into a price forecast

Potential price impact on economic growthPotential price impact on economic growth

FundamentalsFundamentals20102010

World oil demand forecast to rise by 1.9% in 2010, World oil demand forecast to rise by 1.9% in 2010, assuming real GDP growth of 2.5%-3.0%assuming real GDP growth of 2.5%-3.0%

OECD oil demand expected to gain by 0.7%OECD oil demand expected to gain by 0.7%

Non-OECD oil demand forecast to rise by 3.2%, paced by Non-OECD oil demand forecast to rise by 3.2%, paced by ChinaChina

Refined product demand strength will be derived primarily Refined product demand strength will be derived primarily from middle distillates in both the OECD and non-OECDfrom middle distillates in both the OECD and non-OECD

Gasoline demand growth is expected to be moderate in the Gasoline demand growth is expected to be moderate in the United States, reflecting rising average fleet fuel efficiencyUnited States, reflecting rising average fleet fuel efficiency

FundamentalsFundamentals20102010

Non-OPEC supply forecast to rise by 430 MB/D, with FSU Non-OPEC supply forecast to rise by 430 MB/D, with FSU accounting for healthy share of total accounting for healthy share of total

OPEC “11” crude oil deliveries expected to average 27.1 OPEC “11” crude oil deliveries expected to average 27.1 MMB/DMMB/D

Saudi Arabia crude oil deliveries forecast to average 8.3 Saudi Arabia crude oil deliveries forecast to average 8.3 MMB/DMMB/D

Iraq oil production expected to average 2.6 MMB/DIraq oil production expected to average 2.6 MMB/D

Balances imply little net change in global stocks for the Balances imply little net change in global stocks for the year, and thus the market will remain adequately supplied year, and thus the market will remain adequately supplied and competitiveand competitive

Geopolitical Factors Include:Geopolitical Factors Include:

IranIran

-We believe an attack by Israel or the United States against -We believe an attack by Israel or the United States against Iran nuclear facilities carries odds of less than 50%Iran nuclear facilities carries odds of less than 50%

-There may be greater odds of an internal revolution and -There may be greater odds of an internal revolution and attempted overthrow of President Ahmadinejadattempted overthrow of President Ahmadinejad

-If this occurs, there may likely be a greater impact on oil -If this occurs, there may likely be a greater impact on oil prices than if an outside attack were to occur, i.e. 1979-prices than if an outside attack were to occur, i.e. 1979-type scenario type scenario

-However, we should assume that supply uncertainty could -However, we should assume that supply uncertainty could be mitigated via a release of strategic stockpiles and higher be mitigated via a release of strategic stockpiles and higher Saudi productionSaudi production

Geopolitical Factors Include:Geopolitical Factors Include:

NigeriaNigeria-Despite periodic cease fires and efforts to resolve the Niger -Despite periodic cease fires and efforts to resolve the Niger Delta disputes and violence, we believe Nigerian oil Delta disputes and violence, we believe Nigerian oil production in calendar 2010 will average around 2.1 MB/D, production in calendar 2010 will average around 2.1 MB/D, below effective capacitybelow effective capacity

-We believe major oil companies will continue to operate in -We believe major oil companies will continue to operate in Nigeria, despite the uncertainty Nigeria, despite the uncertainty

U.S. Refinery BalancesU.S. Refinery Balances20102010

Crude oil inventory forecastCrude oil inventory forecast

-Runs should remain relatively restrained; excess refining -Runs should remain relatively restrained; excess refining capacity to remain until 2012 capacity to remain until 2012

-Stocks should build seasonally from here-Stocks should build seasonally from here-Peak in the spring should fall well short of 2009-Peak in the spring should fall well short of 2009

Gasoline inventory forecastGasoline inventory forecast

-Little growth in 2010 demand-Little growth in 2010 demand-Refiners must continue to micro manage output-Refiners must continue to micro manage output-Stocks will be more than adequate this year-Stocks will be more than adequate this year

Distillate inventory forecastDistillate inventory forecast

-A recovery in manufacturing output leads to higher -A recovery in manufacturing output leads to higher demanddemand

-Global demand growth will help moderate import potential-Global demand growth will help moderate import potential-Stock surplus will end by spring-Stock surplus will end by spring

FinancialsFinancials20102010

Non-commercial participationNon-commercial participationThere is clear evidence of early 2010 allocation of capital to oil, There is clear evidence of early 2010 allocation of capital to oil, consistent with our thesis. Many funds believe 2010 will be a boom yearconsistent with our thesis. Many funds believe 2010 will be a boom year

This was also evident in early 2009, leading us to believe, contrary to theThis was also evident in early 2009, leading us to believe, contrary to theconsensus, that WTI would exceed $70.00 per barrel by Augustconsensus, that WTI would exceed $70.00 per barrel by August

The dollarThe dollarThe greenback has exhibited a tight, not continuous, but periodic inverse The greenback has exhibited a tight, not continuous, but periodic inverse correlation with crude oil over the last few years. The reason is the trade correlation with crude oil over the last few years. The reason is the trade periodically “worked” for hedge funds, and not due to any sophisticated periodically “worked” for hedge funds, and not due to any sophisticated fundamental rationale. In 2010 we assume a dollar/euro trading range of fundamental rationale. In 2010 we assume a dollar/euro trading range of $1.40-$1.50$1.40-$1.50

Interest ratesInterest ratesThe Fed and central banks will verbally prepare markets for rate hikes down The Fed and central banks will verbally prepare markets for rate hikes down the road. The oil market will discount this phenomenon in 2010.the road. The oil market will discount this phenomenon in 2010.

Financials:Financials:Non-Commercial ParticipationNon-Commercial Participation

CFTC data: one, imperfect way to gauge the CFTC data: one, imperfect way to gauge the influenceinfluence

The CFTC now provides a long-overdue The CFTC now provides a long-overdue disaggregation of the weekly Commitments of disaggregation of the weekly Commitments of Traders ReportTraders Report

The categories are:The categories are:

-Producer/Merchant/Processor/User-Producer/Merchant/Processor/User

-Swap Dealer-Swap Dealer

-Money Manager-Money Manager

-Other Reportables-Other Reportables

FinancialsFinancialsCFTC Data: Who is What?CFTC Data: Who is What?

Producer/Merchant/Processor/UserProducer/Merchant/Processor/User-An entity that predominantly engages in the production, processing, packing -An entity that predominantly engages in the production, processing, packing

or handling or handling of a physical commodity and uses the futures market to manage or of a physical commodity and uses the futures market to manage or hedge risks associated hedge risks associated with those activitieswith those activities

Swap DealerSwap Dealer-An entity that deals primarily in swaps for a commodity and uses the futures -An entity that deals primarily in swaps for a commodity and uses the futures

market to market to manage or hedge the risk associated with those swaps manage or hedge the risk associated with those swaps transactions. The swap dealer’s transactions. The swap dealer’s counterparties may be speculative traders, like counterparties may be speculative traders, like hedge funds, or traditional commercial hedge funds, or traditional commercial clients that are managing risk arising from clients that are managing risk arising from their dealings in the physical commoditytheir dealings in the physical commodity

Money ManagerMoney Manager-A registered commodity trading advisor (CTA), a commodity pool operator -A registered commodity trading advisor (CTA), a commodity pool operator

(CPO), or an (CPO), or an unregistered fund identified by the CFTC (e.g. hedge fund)unregistered fund identified by the CFTC (e.g. hedge fund)

Other ReportablesOther Reportables-Every other reportable trader that is not placed into one of the other three -Every other reportable trader that is not placed into one of the other three

categories is categories is placed into the “other reportables” categoryplaced into the “other reportables” category

Financials:Financials:CFTC Data: Explanatory or Not?CFTC Data: Explanatory or Not?

Correlation, Net Position vs. Prompt CL,Correlation, Net Position vs. Prompt CL,

June 2006-2009June 2006-2009

Swap DealerSwap Dealer 0.280.28

Money ManagerMoney Manager 0.170.17

Producer/MerchantProducer/Merchant 0.170.17

Other ReportablesOther Reportables 0.140.14


Correlations: A Look by YearCorrelations: A Look by Year

Swap DealerSwap Dealer Money ManagerMoney Manager

20072007 0.190.19 0.420.42

20082008 0.380.38 0.410.41

20092009 0.250.25 0.720.72


Our point with the CFTC disaggregation is the same as we made in the Our point with the CFTC disaggregation is the same as we made in the “olden days” pre 2004 when there was only a split between commercials “olden days” pre 2004 when there was only a split between commercials and non-commercials: the non-commercial categories have strong and non-commercials: the non-commercial categories have strong explanatory power regarding NYMEX crude oil, but only during explanatory power regarding NYMEX crude oil, but only during discretediscrete periods periods withinwithin a given year. a given year.

Money Manager and Swap Dealer Net Positions vs. Prompt NYMEX CL

-50,000

0

50,000

100,000

150,000

200,000

250,000

300,000

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

$140.00

$160.00

SDNET

MMNET

PCL


Let’s look at an example where there were too few data points to Let’s look at an example where there were too few data points to statistically verify, but where the relationship appeared fairly statistically verify, but where the relationship appeared fairly “tight” based on observation:“tight” based on observation:

September 29, 2009 through January 5, 2010September 29, 2009 through January 5, 2010

Over this time period prompt NYMEX CL on a settlement basis Over this time period prompt NYMEX CL on a settlement basis rose from $66.71 to $81.77 per barrelrose from $66.71 to $81.77 per barrel

Over the same period net length held by money managers rose Over the same period net length held by money managers rose from 60,002 contracts to 154,775 contracts, implying a $1.59 from 60,002 contracts to 154,775 contracts, implying a $1.59 per barrel price gain for each 10,000 contract rise in net lengthper barrel price gain for each 10,000 contract rise in net length

Purely hypothetically, based on the most recent relationships, if Purely hypothetically, based on the most recent relationships, if money managers went “flat” crude oil, all else equal prompt money managers went “flat” crude oil, all else equal prompt NYMEX crude oil would be trading at around $57.00 per barrelNYMEX crude oil would be trading at around $57.00 per barrel

Financials:Financials:The Equity MarketThe Equity Market

Correlation, S&P 500 vs. NYMEX CL:Correlation, S&P 500 vs. NYMEX CL:

2004-20092004-2009 0.180.18

20042004 0.000.00 20052005 0.250.25

20062006 0.400.40

20072007 0.150.15

20082008 0.660.66

20092009 0.760.76

Financials:Financials:The DollarThe Dollar

Correlation, Dollar/Euro vs. NYMEX CL:Correlation, Dollar/Euro vs. NYMEX CL:

2004-20092004-2009 0.600.60

20042004 0.040.04 20052005 0.430.43

20062006 0.020.02

20072007 0.930.93

20082008 0.730.73

20092009 0.870.87

Financials:Financials:Interest RatesInterest Rates

Fed Funds vs. Prompt NYMEX CLFed Funds vs. Prompt NYMEX CL-It is clear that cheap money has helped fuel the commodity -It is clear that cheap money has helped fuel the commodity

boom boom over the last few yearsover the last few years

-There have been periods since 2004 where there has been -There have been periods since 2004 where there has been a close a close inverse correlation between Fed Funds and prompt NYMEX inverse correlation between Fed Funds and prompt NYMEX CLCL

-However, eventually the relationship obviously breaks -However, eventually the relationship obviously breaks down because down because money does not get any “cheaper” but oil prices money does not get any “cheaper” but oil prices continue to rise.continue to rise.

-We therefore can only make a judgment as to the impact -We therefore can only make a judgment as to the impact on crude on crude oil prices of higher rates. We suggest it will oil prices of higher rates. We suggest it will limit limit gainsgains under the under the expectations of more moderate economic expectations of more moderate economic growth, but not directly and growth, but not directly and adversely impact oil prices as a adversely impact oil prices as a hedge fund “trade”, like the dollar hedge fund “trade”, like the dollar periodically has periodically has

Price Components in a Recovery Year:Price Components in a Recovery Year:SeasonalitySeasonality

With very few exceptions, crude oil prices tend to rise in With very few exceptions, crude oil prices tend to rise in the second quarter from a first quarter troughthe second quarter from a first quarter trough

Factors include:Factors include:In Q1, lower refiner demand for crude in Atlantic In Q1, lower refiner demand for crude in Atlantic

BasinBasinIn Q1, market discounts end of winterIn Q1, market discounts end of winter

Consensus invariably “mis-correlates” the first to Consensus invariably “mis-correlates” the first to second quarter downturn in global refined product second quarter downturn in global refined product demand with crude oil pricesdemand with crude oil prices

In Q2, refiner crude oil demand recoversIn Q2, refiner crude oil demand recoversIn Q2, North Sea production begins to fall In Q2, North Sea production begins to fall

seasonallyseasonallyIn Q2, funds buy gasoline, always believing the In Q2, funds buy gasoline, always believing the

U.S. gasoline U.S. gasoline season will be strongseason will be strong

Price Components in the Recovery Price Components in the Recovery Year:Year:

SeasonalitySeasonalityMonthly Crude Oil Price Seasonality Since 2004: Monthly Crude Oil Price Seasonality Since 2004:

Year=1.00Year=1.002004-

2004 2005 2006 2007 2008 2008 2009

January 0.83 0.83 0.99 0.75 0.93 0.87 0.68February 0.84 0.85 0.93 0.83 0.95 0.88 0.64March 0.88 0.97 0.95 0.84 1.05 0.94 0.78April 0.89 0.94 1.06 0.88 1.13 0.98 0.81May 0.97 0.88 1.07 0.88 1.25 1.01 0.96June 0.91 1.00 1.07 0.94 1.34 1.05 1.13July 1.00 1.04 1.12 1.03 1.34 1.11 1.04August 1.08 1.15 1.10 1.00 1.17 1.10 1.15September 1.12 1.15 0.96 1.10 0.98 1.06 1.12October 1.27 1.10 0.89 1.19 0.78 1.05 1.23November 1.15 1.03 0.90 1.31 0.58 0.99 1.26December 1.04 1.05 0.94 1.27 0.42 0.94 1.21

Price Components in the Recovery YearPrice Components in the Recovery Year2010:2010:

Adding It All UpAdding It All Up2010 NYMEX crude oil prices will once again be determined by a 2010 NYMEX crude oil prices will once again be determined by a

combination of fundamental and financial variables:combination of fundamental and financial variables:

Fundamental factors:Fundamental factors:--Growth in world oil demandGrowth in world oil demand-Growth in non-OPEC supply-Growth in non-OPEC supply-Geopolitical influences on supply-Geopolitical influences on supply

--Global days supply of crude oil and product inventories influenced by:Global days supply of crude oil and product inventories influenced by:-Excess refining capacity-Excess refining capacity-Excess producing capacity, primarily Arabian Gulf sour grades-Excess producing capacity, primarily Arabian Gulf sour grades

Financial factors:Financial factors:--Need/desire by financial institutions to diversify invested assetsNeed/desire by financial institutions to diversify invested assets--Global equity market strength/weaknessGlobal equity market strength/weakness-Value of the dollar-Value of the dollar-Interest rates and interest rate expectations-Interest rates and interest rate expectations


Adding It All UpAdding It All Up

Fundamental factors are “straightforward”, but there is a critical Fundamental factors are “straightforward”, but there is a critical need to appreciate the importance of the financial factors and the need to appreciate the importance of the financial factors and the “non-commercial” price influence “non-commercial” price influence

Ever since 2004, the non-commercial influence on crude oil prices Ever since 2004, the non-commercial influence on crude oil prices has been increasing, and has had a major impact, even during the has been increasing, and has had a major impact, even during the global recession. We have tried various approaches to quantify global recession. We have tried various approaches to quantify the impact for the last four years. In our view, those who argued the impact for the last four years. In our view, those who argued that fundamentals were primarily, if not exclusively, responsible that fundamentals were primarily, if not exclusively, responsible for the price run up were guilty of the logical fallacy:for the price run up were guilty of the logical fallacy:

Argumentum ad ignorantiamArgumentum ad ignorantiam Non-commercial participation in oil will continue in 2010 and Non-commercial participation in oil will continue in 2010 and

beyond. This is fact of life, there is no one to “blame”, and Wall beyond. This is fact of life, there is no one to “blame”, and Wall Street should not be afraid or paranoid. Short of banning ETFs Street should not be afraid or paranoid. Short of banning ETFs and prohibiting OTC activity, there is little the Obama and prohibiting OTC activity, there is little the Obama Administration can or will do to limit “speculation”Administration can or will do to limit “speculation”


Laying It All Out Laying It All Out Adding up fundamentals, financials, early-2010 asset allocation impacts, overall non-commercial influence, and seasonality yield Adding up fundamentals, financials, early-2010 asset allocation impacts, overall non-commercial influence, and seasonality yield this potential monthly price path for prompt NYMEX crude oil:this potential monthly price path for prompt NYMEX crude oil:

However, the potential second half fundamental response to However, the potential second half fundamental response to higher prices in a recovery year and the potential for higher prices in a recovery year and the potential for

rate hikes rate hikes suggests a greater weakening off the summer peak: suggests a greater weakening off the summer peak:

JanJan $80.00$80.00 JanJan $80.00$80.00FebFeb $81.35$81.35 FebFeb $81.35$81.35MarMar $86.80$86.80 MarMar $86.80$86.80AprApr $88.70$88.70 AprApr $88.70$88.70MayMay $90.75$90.75 MayMay $90.75$90.75JunJun $94.30$94.30 JunJun $94.30$94.30Jul Jul $97.20$97.20 JulJul $97.20$97.20AugAug $97.65$97.65 AugAug $97.65$97.65SepSep $96.30$96.30 SepSep $92.50$92.50OctOct $96.90$96.90 OctOct $88.50$88.50NovNov $91.75$91.75 NovNov $84.25$84.25DecDec $87.15$87.15 DecDec $78.50$78.50

Year Year $90.75$90.75 YearYear $88.35$88.35

Price Components in the Recovery YearPrice Components in the Recovery Year2010: 2010:

ConclusionsConclusions The overall fundamental global balance should remain The overall fundamental global balance should remain

competitive in 2010 with excess producing and refining competitive in 2010 with excess producing and refining capacity suggesting much lower prices than $80.00 per capacity suggesting much lower prices than $80.00 per barrel barrel

However, early 2010 market behavior and anecdotal However, early 2010 market behavior and anecdotal evidence suggests funds and other non-commercials are evidence suggests funds and other non-commercials are intent upon allocating more capital to oil this year, given intent upon allocating more capital to oil this year, given bullish economic expectationsbullish economic expectations

Thus, a higher price “bar” has been established from which Thus, a higher price “bar” has been established from which prices will rise seasonally as we move through the next prices will rise seasonally as we move through the next couple quarterscouple quarters

Price elasticity of demand still “exists”, however, suggesting Price elasticity of demand still “exists”, however, suggesting that crude oil price strength in 2010 will be “front loaded” in that crude oil price strength in 2010 will be “front loaded” in the first half of the year. Later on, fundamentals and the the first half of the year. Later on, fundamentals and the prospect of higher rates will exert a sufficient influence so prospect of higher rates will exert a sufficient influence so as to weaken prices more than the “normalized” seasonal as to weaken prices more than the “normalized” seasonal pattern would imply, setting the stage for 2011 pattern would imply, setting the stage for 2011

the 2010 outlook for oil markets and impact on economic activity new york energy forum william h....

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