Oil Prices and the Market Outlook

Source: ZE

Oil markets have seen a lot of fluctuations in the past few months as the continued tensions in the Middle East and other disruptions kept market participants on their toes. However, the market prices shaped by the economic principles of supply and demand are beginning to look less tight as U.S. crude oil production averaged 7.7 million barrels per day (Mbpd) in October 2013(EIA). By the end of October, U.S. oil stockpiles were more than 10 percent above their five-year average, which pushed down prices due to the abundant supply. For the first time since February 1995, monthly domestic crude oil production exceeded crude oil imports whereas total petroleum net imports were the lowest since February 1991. Despite the supply disruption in Iraq and Libya, tepid demand along with increased U.S. production and Saudi’s effort to produce at the maximum capacity restrain the oil prices. Here is a quick look at the recent developments in the oil market:

Supply Disruptions and Change in Production

EIA reported that the unanticipated global petroleum disruptions reached above 3 Mbpd in the beginning of November due to unplanned outages in Libya and Iraq, but higher production in North America and Saudi Arabia along with seasonally lower demand in October due to refinery maintenance contained the prices (EIA). Libyan production was down by 1.3 Mbpd in the middle of November as series of political crises caused major swings in output and exports: total Libyan production reduced to 0.25 Mbpd while exports dropped to less than 0.1 Mbpd. In Iraq, a series of attacks on the Kirkuk-Ceyhan pipeline contributed to loss of 0.34 Mbpd productions while upgrades to southern petroleum export terminals reduced Iraqi crude oil output by another 0.4 Mbpd for the total supply outage of 0.74 Mbpd since September 2013.

On the other hand, non-OPEC production grew by 1.6 Mbpd where 1.5 Mbpd came from North America. Furthermore, Saudi Arabia operated at almost full capacity level by maintaining production around 10 Mbpd to help neutralize the supply shortage. This led to the reduction of global spare capacity from 1.7 Mbpd to 1.4 Mbpd.

Changes in production and unplanned disruptions in 2013 compared to December 2012

Figure 1: Changes in production and unplanned disruptions in 2013 compared to December 2012 | Data Source: EIA

According to the International Energy Agency (IEA), global refiner crude throughput dropped by 2 Mbpd to 76 Mbpd in October due to seasonal refinery maintenance outages. For the week ending November 15, 2013, EIA reported that U.S. crude oil refinery inputs average 15.4 Mbpd while refineries operated at 88.6% of their throughput (EIA). U.S. commercial crude oil stocks were reported at 388.5 million barrels, well above the upper limit of the average range for this time of year. Now that maintenance season is over, refineries are back in action to supply the market while the strong stockpiles reduce the effect of unplanned disruptions.

Consumption and the Market Outlook           

Based on the EIA Short-Term Energy Outlook, global consumption-which averaged 89.2 Mbpd in 2012- will increase moderately to 90.3 Mbpd in 2013 and 91.4 Mbpd in 2014 (EIA). While China, Central & South American countries, and the Middle Eastern countries outside of the Organization for Economic Cooperation and Development (OECD) are responsible for the growth, OECD liquid fuels consumption is projected to decline by 0.1 Mbpd in 2013 and 0.2 Mbpd in 2014 due to lower consumption mostly caused by weaker economic prospects in Europe and Japan. Among the non-OECD countries, China is the largest contributor to the global consumption.

World Liquid Fuels Consumption

Figure 2: World Liquid Fuels Consumption | Data Source: EIA

Market Prices and Volatility                    

Brent crude oil spot prices dropped by $3 USD/bbl in October 2013 to an average of $109 USD/bbl from the previous month. EIA projected that the Brent crude spot price continues to fall as non-OPEC supply growth surpasses growth in world consumption. The Brent crude oil price is estimated to average $103 USD/bbl in the next year whereas WTI is estimated to average $95 USD/bbl during 2014. The discount of WTI crude oil to Brent is projected to average $10 USD/bbl in the fourth quarter of 2013 and $8 USD/bbl during 2014. However, EIA warns that energy price forecasts are highly uncertain while the current values of futures and options contracts suggest that prices could differ significantly from the forecast levels.

On November 7, 2013, implied volatility for the prompt month Brent and WTI futures contracts settled at 18.3% and 20%, respectively, both declining slightly from their October 1 prices (Figure 3).

EIA stated: “With lower refinery runs largely offsetting reductions in global crude oil supplied from unplanned outages, implied volatility for both benchmarks moved lower as the market became less tight.” The lower and upper limits of 95% confidence interval for the market’s expectations of WTI monthly average prices for delivery in February 2014 was set at $80 USD/bbl and $112 USD/bbl, respectively.

Same time last year, WTI for February 2013 delivery had the implied volatility of 31% with the lower and upper limits of the 95% confidence interval at $66 USD/bbl and $115 USD/bbl. The declining volatility of WTI signals growing confidence in the market stability.

Crude Oil Implied Volatility

Figure 3: Crude Oil Implied Volatility | Data Source: EIA

In November 2013, oil prices fell as an unexpected rate cut by the European Central Bank strengthened the dollar and OPEC reported abundant global supplies of oil. Due to high production levels and secured stockpiles in U.S., WTI dived more than Brent to settle around $92 USD/bbl on NYMEX.

Created in ZEMA, the graph below shows the settlement prices of NYMEX Prompt-Month Contract for Brent vs. WTI, as well as the Brent-WTI Spread since October 2012:

NYMEX Future Settlements Prompt-Month Brent vs. WTI

Figure 4: NYMEX Future Settlements Prompt-Month Brent vs. WTI |Data Source: NYMEX

Final Words                                                                                                             

Strong crude oil inventories in U.S. have secured oil prices mostly due to rising domestic production in the past few weeks. In its November Short-Term Energy Outlook, EIA predicted growth in petroleum production and reduction in the level of supply disruptions, putting downward pressure on prices through the last weeks of 2013 and into the next year. Meanwhile, Iran resumes promising negotiations in Geneva with six world powers over its controversial atomic program, which previously led to economic sanctions. Relief from the sanctions could potentially translate into supply of more crude oil to the market, keeping the market well-supplied.

Low crude oil price volatility, strong supply, and slight increase in the world’s appetite for the petroleum products in the upcoming year curb the oil prices for now.

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