Black Gold Eases on Supply and Demand Concerns

Oil prices are down again today, and have dropped for five of the past six sessions.   The proximate cause for today's drop was news that OPEC had cut its demand forecasts through 2035, except for next year.   In addition, Libya indicated that it would soon resume operations of its largest oil field. 

The demand side had been the initial focus.  The slowing of the world economy, especially China,  the world's largest importer of oil, was widely cited.  However, supply side variables seemed to be the driver.  Hydraulic fracturing (fracking) and horizontal drilling in the US, and the fact that Saudi Arabia was not acting as it traditionally has, as the swing producer, pulled the rug under prices. 

Reports that a deal may be in the works that will lead to greater Iranian oil sales surfaced earlier this week.  The idea is that Iranian nuclear material may be sent to Russia, where it will be fashioned into bars, used for nuclear power and more difficult to weaponize. 

It appears that many Asian countries, including China, stepped up their purchase last month, when Saudi Arabia and other OPEC producers cut price.  This month, Asian buying is said to be drying up. 

Of note, the nearly one dollar fall in the December light crude oil control has not weighed on oil stocks as much as one might expect.  Oil/gas refining and marketing issues up 0.9%  in early NY afternoon activity.  Integrated oil/gas shares are up about 0.4%, while the explorers are up slightly.  The storage and transportation sector is off about 0.15%. 

Many investors are trying to get their head around the legislation that could be forthcoming from the US Congress, where Republicans enjoy a majority in both chambers.  Lifting or modifying the ban on oil exports is one such initiative.  However, it appears that not every is waiting for the ban to be lifted.  US crude oil exports has risen by more than five-fold since May, or from 75k barrels a day to more than 400k.  There are exceptions to the US ban, especially for Alaskan and Californian output and Canada as a destination. 

Earlier this week, as some folks were cutting the ballots of the mid-term election, BHP Billiton reportedly announced its intention to sell 650k barrel of ultralight sweet Texas oil to an undisclosed foreign buyers in a deal worth around $50 mln.  As we noted previously,
 in June the US Commerce Department granted permission to two US companies to export their condensate (an oil that is unusually light with minimal processing).

Some officials have argued that increased oil exports will boost the price of gasoline in the US.  In the middle of October, the Government Accountability Office (GAO) said this claim was wrong.  The argument is predicated on the recognition that oil, like steel, is not a homogeneous market.  Much of the US refining capacity has been retrofitted to process the heavy, sour, crude that comes from the Middle East and South America.  

Yet much of the new oil being produced in the US is light sweet, and by produced, we mean that oil output is up some 70% since 2008. The refinery mismatch means that many US producers are eager to sell their light sweet oil offshore.    According to the EIA, US gasoline prices track international benchmarks (Brent) closer than West Texas Intermediate Crude.  Those refiners that can process the light sweet and sell gasoline are in the most advantageous position.  

The GAO concluded that lifting the ban on oil exports would tend to lower the price of gasoline.  The additional supply that US producers would make available to sell at the higher international prices could put downward pressure on global prices.   This, in turn would push down gasoline prices on the margin.  GAO estimates a 1.3 to 13 cent decline per gallon.  However, that assumes that other producers would not cut back on output to offset the increased supply. 

There has been some talk that one or more countries are considering beginning proceedings at the WTO to challenge the US ban on crude exports.  The ban was approved in the early 1970s, and does seem to violate the spirit, if not the letter of the treaty, as much as China's attempt to curtail its export of rare earths. 

Lastly, we note that OPEC has not invited non-OPEC countries to its November 27 ministerial meeting.   Given that 1) the surfeit of light sweet crude and 2) that OPEC produces mostly heavy sour crude, there is not much OPEC can do by itself to put a floor under light sweet crude prices.  Moreover, US output is expected to rise further next year to nearly 10 mln barrels a day. 

Meanwhile the December light crude futures contract is hugging the bottom of its Bollinger Band (~$77.31), and although today is the second session of higher lows, the tone remains heavy.  OPEC's Secretary General argued that price drop has been excessive given supply and demand fundamentals; blaming infamous speculators (as if they are not responding to anticipated supply and demand fundamentals).   Ironically, the latest Commitment of Traders showed the speculators in the futures market were net long a little more than 267k contracts.  The gross long position has been cut from 548k contracts in late-June to 428k as of October 28.  While the net position is the smallest since June 2013, the gross position  suggests there are still significant stale longs that have yet to capitulate.