July Crude Oil. Quarterly Outlook. KCTL Research Reports also available on Bloomberg with key KCTL <GO> & Reuters Knowledge

Transcription

1 July 2008 Crude Oil Quarterly Outlook

2 Preface No wonder crude oil is referred as the Black gold. The ascending prices indeed support this alias of the hydrocarbon of a precious commodity status. The dependence of the world on this fossil fuel explains the attention or the public interest drawn towards the pricing of the commodity. The pricing of any commodity scales back to the never-ending human wants and the scarcity of resources. Hence the need arises in detailing the fundamentals of demand and supply. Apart from these reasons prices have been continuously influenced by various factors like the political constraints. Oil time line Historically many events have been factored into the movement in oil prices. With the reserves being concentrated in the few nation factors affecting these nations are regarded as potential threat to the supplies thereby creating a risk premium in prices. The crude oil prices timeline shows the effect of the world events (force majeure) on the oil prices. First in line are the geopolitical tensions (gulf war, Iran-Iraq), devastating hurricanes like Katrina and Rita, PDVSA strike and the Asian crisis to name a few. Apart from demand supply these factors have a higher impact on prices in the short term. However any of these factors leading to major supply disruption have long term bearing on the prices. Fundamental snapshot Demand: The demand for the fossil fuel is to be discussed in focus to depleting condition in the world s largest consumer US and the expected growth in the developing nations. The energy consumption can be scaled to the industrial performance of the nations. The demand from the nations is discussed in view of the nations attributing to the highest consumption and the developing countries. In million barrels per day The world total demand and supply Supply World Oil Balance Demand Source: Data compiled from Energy Information Administration.

3 The demand growth in the nation is classified into OECD and the Non OECD. The US by far is the largest consumer of energy, and its control on the oil politics is phenomenal. The ongoing economic slowdown is affecting the demand prospects in the world largest consumer. The increase in the demand from the developing nations has been seen to offset the decline in the demand in US. The growth in the demand has taken a setback in the first two quarters of the current year. Growth in US Crude oil Demand Source: Data compiled from Energy Information Administration. The demand is broadly discussed into two major groups constituting the OECD nations and the Non OECD pact. in million bpd Growth in Oil demand by region Q Q Q Q Q Q3 2008(E) OECD Non OECD Q4 2008(E) The Q1 and Q2 have witnessed negative growth in the region mainly affected by the US, Japanese and the European nations. The Non OECD recorded a growth consecutively in all the quarters contributed by the Chinese and other Asian economies. The Chinese have accounted for a QoQ growth of 2.81% in Q According to the EIA estimates the demand from both the regions is likely to post an increase. Nevertheless the slowdown witnessed in the industrialized nations is likely to dampen the demand in these nations. Supply The supply concerns have been leading to haywire movement in prices in the recent past. Crude oil supply dynamics need to be examined from the point of view of the OPEC and Non

4 OPEC supplies. The OPEC contributes to more than 40% of the total world s supplies. Hence the cartel has a significant impact on the world oil prices. The pace and the timing of the non OPEC supplies is major determining factor given the contribution of the region to the total global supplies. The poor growth in the Non Opec supplies due to the delays in projects was one of the factors leading to the uptrend in prices in the Q1 and Q2 of the year. Nevertheless in the Q3 region s supplies are estimated to project an increase of 1.3% with gains recording from the Brazil, Russia, and Azerbaijan offsetting the depletion in Norway and Mexico. 1.5 QoQ grwoth in Non OPEC Supplies 1 OPEC spare capacity The spare capacity is the difference between the production capacity and the actual production of the nation. All the nations in the OPEC are currently running at their full capacity excluding Saudi Arabia and Kuwait. OPEC Surplus Production Capacity Q o Q inmillion bpd Q1'03 Q2'03 Q3'03 Q4'03 Q1'04 Q2'04 Q3'04 Q4'04 Q1'05 Q2'05 Q3'05 Q4'05 Q1'06 Q2'06 Q3'06 Q4'06 Q1'07 Q2'07 Q3'07 Q4'07 Q1'08 Q2'08 Q3'08 E Q4'08E OPEC Total Saudi Arabia Source: Data compiled from Energy Information Administration in million bpd Q Q Q Q Q Q3 2008(E) Q4 2008(E) From the figure it is evident that the most of the Spare capacity is concentrated in the world s largest producer Saudi Arabia. The surplus capacity is forecasted to increase in the near term thereby adding up to the supply sources of oil. The OPEC spare 1 capacity is forecasted to increase from 1.17 million Q3 08 barrels per day (mbpd) to 2.14 mbpd in Q4 08.

5 OPEC production Out of the total global supplies OPEC contributes to approximately 40%. With more than three quarters of the total world reserves being concentrated in the OPEC this makes up the cartel the largest holder of assets of crude oil. OPEC Crude oil Production Q o Q in million barrels Source: Data compiled from Energy Information Administration In consortium the other price influencing factors are Geopolitical Tensions: Historically various events on the geopolitical front had their significant impact on oil prices. The Iran Iraq war in has resulted in prices hitting a high of above $70 per barrel. With these nations being a part of the OPEC cartel and among the top producing nations any potential supply disruption in these nations acts as a risk premium leading to price surge. In the recent past the Iran s standoff against the West and Israel of the uranium enrichment program, has furthered prices to touch a lifetime high of $ The continuous attacks by militants in Nigeria have now led to the country to surrender its position as a largest African to Angola according to the April figure from OPEC. The attacks by militants on various oil fields have lessened supplies hence becoming a factor resulting in run up in prices. Depreciating US dollar: The depreciating U S dollar in comparison to the other majors has instigated buying as it makes dollar priced commodity cheaper for the consuming nations. The ongoing credit turmoil and the housing slump in the US have weakened the economy thereby leading to the depreciation of the US dollar. The increasing downside risk in the economy has led to the dollar hitting new lows against the majors. The dollar hit a low o f $ on back of the deepening financial turmoil. The chart below depicts the relationship of oil and the US dollar.

6 Oil vs Dollar Index Crude oil prices Dollar Index Investment Demand: The run down in the returns in other asset classes like the equities, currencies have reflected in higher participation in the commodity arena resulting in prices hitting record high levels. Commodities are mostly negatively correlated with that of the other asset classes hence driving excessive participation into the oil futures. The depreciating dollar also prompted investment into the commodity as it makes cheaper for investment. Instrument Avg. Returns from April 2000 (%) Annualized Returns (%) Gold Silver Crude S&P GSCI Dow Jones NIFTY US Treasury Bills Reuters CRB CFTC Report The non commercial longs reflect the speculators positions unlike the hedgers in the market. The graph below depicts the increasing participation in the long position by the speculators in the market thereby resulting in the rise in prices. CFTC data Vs Oil Price in contracts /06/ /06/ /06/2008 Crude oil Prices Non Commercial Longs Alternate Effect Crude oil being the essential commodity for energy consumption the record high prices is having serious repercussion on world economy. The high rise in prices will also lead to use of alternative fuels hence reducing the dependence on crude oil. This is likely to influence the consumption pattern in the fossil fuel. The figure below is a in $ per barrel

7 comparison of the crude oil demand and that of biofuel in the US. monetary policies globally and higher interest rate are not conducive for higher oil prices. In mbpd Demand of Biofuel Vs Crude oil In US Q o Q Q1'07 Q2'07 Q3'07 Q4'07 Q1'08 Q2'08 Q3'08 E Q4'08E Crude oil demand Biofuels Interest rate effect The aftermath of the rise in crude oil prices is witnessed in the double digit inflationary numbers posted by the developing countries. The IMF has projected the global inflation is a serious concern and has urged the nations to take stringent monetary policies. It raised its forecasts for inflation in the emerging and developing economies by 1.7 percentage points, to 9.1 percent in 2008 and 7.4 percent in With the rising inflation forecasts there is likely chance of revising the In Quadrillion btu Policy factors The record high oil prices are in the limelight and are driving legislative measures to check the participation in the market. The rising concerns globally and within the nation have urged the US democrats to instigate a legislation to limit the oil speculation in the futures market. The bill was introduced by Senate Majority Leader Harry Reid of Nevada. This legislation requires the Commodity Futures Trading Commission (CFTC) to impose limits on speculative trading in oil and natural gas futures markets. It also requires more reporting in energy markets to prevent market manipulation. Though not approved we anticipate these legislation will hamper the participation in the market leading to lower prices. Global Growth Rate The IMF raised its 2008 global growth forecast to 4.1 percent from 3.7 percent and its 2009 forecast to 3.9 percent from 3.8 percent.this revision provides an optimism which is indicating

8 a lesser than anticipated global economic slowdown. Nevertheless the ongoing slowdowns in the major economies and the higher inflations number are likely to underplay the growth in the developing nations. Subsidies The Asian economies namely China, India, Malaysia provides oil products at subsidized rate to the consumers. With the rise in crude oil prices the burden is now unbearable on the government hence they have been off late passing these costs on to the consumers. The recent hike in petroleum products by 10% in India has seen serious agitation by the truckers especially. China also in tandem has increased its retail product prices by nearly 18%.These price hikes are likely to some degree dent the oil demand growth in these regions. Hurricane Season The NOAA predicts a 65% chance of higher than normal hurricane season and activity in the ongoing Atlantic hurricane season. The odds against the US oil supplies are likely to rise. This is important to be tracked as the Gulf of Mexico concentrates the oil refinery activity and the supplies of US. When Hurricanes Katrina and Rita struck the U.S. Gulf Coast in 2005, they combined to impart record damage to offshore Gulf of Mexico oil and gas production and facilities, which helped push oil and gas prices to record levels by January 2006 and increased fears about oil and gas supply shortages. Hence there is potential risk attached to the supplies thereby leading to short term spikes in prices. GOLD/Crude relationship Gold crude oil ratio simply put is the multiplying factor that equates prices of gold and crude. The ratio climbed down to recent quarterly lows of 6.63X and in daily it has posted a low of 6.19X. Over the past 20 years it has been observed that the average ratio works out to be 15.9X. Nevertheless presently the ratio is slightly above the lower levels at 7.4X. Past 20 years data(quaterly) Last Mean Off Avg Median StDev Off Avg StDev Percentile 0 High 09/30/ Low 06/30/

9 Correlation The gold and oil were seen to be more related due to the high correlation stated by the prices. Hence they are often termed in consortium while studying price influencing factors for both these commodities. The correlation between prices posted as high as 0.95 taking the quarterly time period of five years. Fundamental View recent peak of levels. In 1990, Monthly RSI (14) tested a high of 81 and moved lower along with US recession which started from July 1990 and lasted to March The present situation is more or less similar with rise in the unemployment rate, falling home prices and decline in industrial activity in US. (Chart 1) Prices are forecasted to trade lower on back of the rising Non OPEC supplies and OPEC spare capacity in contrast to the dwindling demand prospects. In communion factors like the Interest rate effect, policy factors, use of alternatives etc are pointing towards lower prices. However the hurdles for the view remain in the form of hurricane season and the supply disrupting geopolitical tensions. Technical Analysis (Nymex WTI Crude Oil) NYMEX WTI prices have entered into a corrective phase after testing a fresh historic top of $ Oil prices fell towards $124 a barrel recently after breaching the crucial support of $135 levels. Market was at highly overbought level in the Monthly Charts with RSI (14) is now trending down with Coming back to technicals, oil prices have breached the short trend channel support of $135 which is the first signal of a correction. The medium term trend channel support is seen at $120 levels and breach of the same may see market correcting

10 (Chart 3) towards $110 levels which is 38.2% retracement level of move. Weekly RSI is trending down and presently trading at levels after it peaked at 80 levels. Daily RSI is at now at oversold area and the recent steep fall from $ $ may see some recovery. (Chart 2) The Wave analysis gives a picture of a short term bearish market. Market seems to be in the fifth wave of the long term move started from $10. As per our counting, the first wave started from $10 in 1999 and lasted to mid 2002 with peak at $37.80 and market took correction to $16.70 in Dec 2001.The 3 rd larger wave started from the bottom made at $16.70 on Dec 2001 and peaked at $78.40 in July Prices moved downward from the high and saw the second leg at $49.90 in January The talk of the town is the rally started from $49.90 which as per our counting is the fifth wave of the larger

11 wave. The fifth wave has been broken down in minor wave for short term outlook. The wave structure in the fifth larger wave, 1 st wave = nd wave = rd wave = th wave = th wave= (Chart 4) The larger fifth wave has extended and this move from $ $ is equal to % of the third larger wave. The fifth wave in the fifth larger wave has also seen an extension. The move from $86.11-$ is 138.2% of the 3 rd wave in the fifth larger wave. The recent take off from $ to $ is likely to take an A-B-C correction. Prices are likely to take support at medium term trend channel pegged at $120 levels and a daily close below that may see a further fall towards the next channel support pegged at $110 levels. $110 is also 38.2% retracement support in the fifth larger wave. If market does not breach $110 then it is likely to move slightly higher to form a probable B. It will be crucial to see how the B pullback rally lasts and market if turning downside from the B the final fall in the market is likely to be vicious. The break of $110 may be the vicious fall in the market which may drag down towards $90-$87 levels in the long term. There are many indications for the reversal in the market. The trending down of the Monthly RSI from oversold area, Daily close below 50 Day s EMA and breakout of the short term trend channel support of $135 is supportive factor for a correction. The risk factor at present is the likely formation of a falling wedge in the daily charts shown in Chart 2. As market

12 has already breached the trend channel support of $135 after a long time we may see a pullback towards the $135 - $138 or so only if it does not beach the support of $120 levels. Technical Indicators Current Values Indications Major Support and Resistance levels Support Support Resistance (Long Term) (Short (Short term) term) Resistance (Long term) RSI (weekly, Daily) 54, 38 Daily RSI is at oversold region, Weekly is neutral zone and monthly 123,120,116,110, ,110, ,135,14 0, ,140,148, 154 RSI is at oversold territory. EMA 50, 100, 200 Daily 132,123, 110 Prices are below 50 Days EMA and near to the 100 days EMA support of WE EXPECT PRICES TO MOVE LOWER TOWARDS $90 IN THE MEDIUM TERM PERSPECTIVE Daily close below $123 may signal further weak signal. Short term traders can sell on a pullback towards $135-$140 targeting $110 and $100, $90 with stop loss above $150 levels. Bollinger Band Market is near to lower band in the (Daily Daily Charts and near to the moving,weekly) average support of 20 Days in weekly Charts. The indicators are suggesting there may be a pullback in the short term. The crucial level for the short term is $123-$120 and $110.

13 Disclaimer The report contains the opinions of the author, which are not to be construed as investment advices. The author, directors and other employees of Karvy and its affiliates cannot be held responsible for the accuracy of the information presented herein or for the results of the positions taken based on the opinions expressed above. The above mentioned opinions are based on the information which is believed to be accurate and no assurance can be given for the accuracy of this information. There is risk of loss in trading in derivatives. The author, directors and other employees of Karvy and its affiliates cannot be held responsible for any losses in trading. Commodity derivatives trading involve substantial risk. The valuation of underlying may fluctuate, and as a result, clients may lose entire of their original investment. In no event should the content of this research report be construed as an express or an implied promise, guarantee or implication by or from Karvy Comtrade that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. Information provided on this report is intended solely for informative purposes and is obtained from sources believed to be reliable. Information is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted. We do not offer any sort of portfolio advisory, portfolio management or investment advisory services. The reports are only for information purpose and not to be construed as investment advices. For Detailed disclaimer please go to following URL's: