Oil Strategy: In Pursuit of Equilibrium

Transcription

1 Oil Strategy: In Pursuit of Equilibrium October 2017, LLC Michael Tran (Director, Energy Strategist) (212)

2 What s Next For Oil Markets? Signs of improving global oil fundamentals are apparent, but the market remains dogged by constant reminders that the rebalancing act is a lengthy and tumultuous process rather than a linear one. The $50-55/bbl level in WTI will act as a short term ceiling over the coming months given increased producer hedging activity and elastic US production. We see longer term prices near $60/bbl, but the recovery will be long and protracted. Global balances will, on average, ebb in constructive fashion alongside the passage of time, and while our core West to East rebalancing thesis is developing, global stock draws have accelerated since the beginning of the year. The long road back to full market equilibrium entails returning global stocks to seasonally normal levels. This feat will remain elusive until early Premature backwardation is an exercise in futility given that the US will be the last major region to rebalance, but refined product exports are reconfiguring how we think about oil balances. Our medium-term constructive trajectory remains intact, but the dynamic between uninspiring global demand growth and the implications of an undervalued forward curve will dictate the shape and the tenor of the next cycle. 1

3 Tale of The Tourist Trader The evolution of the oil market has attracted significant participation from noncommodity, tourist type traders. This increases the knowledge gap for a growing group who can inadvertently crowd trades, alter sentiment and increase volatility. Volumes traded are occurring at a higher notional level, turning over at a faster pace by a growing number of traders who are less informed than previously was the case. Unearthing gems from intellectually rigorous fundamental analysis can often lead one to arrive early on a market call. Bloomberg s street consensus estimate for weekly US crude stock change is inherently flawed due to ridiculously low participation rates and tremendous skew risk. An absurdly low number of individuals set consensus for an entire market. API storage numbers often diverge from the EIA. The Cushing stock change number is often the only API data point that is credible while issues with sample size cloud the rest. Is the back end of the forward curve lying to us? Liquidity gaps and poor price discovery has outsized implications for the next cycle. 2

4 Investor Beware Choppy Markets Ahead NYMEX & ICE Managed Money WTI Short Positioning '000 contracts Source:, CFTC

5 The Financialization of the Oil Market Volumes Traded Per Month - WTI Contracts/Mo 18,000,000 15,000,000 12,000,000 9,000,000 6,000,000 3,000, Source:

6 Who Owns Consensus? Bloomberg Storage Surveys Flawed Participants in Weekly Cushing Survey Participants in Weekly US Crude Survey 4% 9% 4% 5% 21% 26% 34% 24% 41% 33% Less than 4 Estimates 4 Estimates 5 Estimates 6 Estimates Greater than 6 Estimates 8 Estimates 9 Estimates 10 Estimates 11 Estimates 12 Estimates Source:, Bloomberg 5

7 Long Dated Portion of Curve Anchors at the Marginal Cost Barrel WTI Spot Price & Forward Curve* $/bbl Long dated portion of curve anchored '95 '96 '97 '99 '00 '01 '03 '04 '05 '07 '08 '09 '11 '12 '13 '15 '16 '17 '19 '20 6 Source: *Forward strip as of Jan 1 of each year

8 Is The Back End of the Forward Curve Lying To Us? Liquidity for December WTI Contract in Five Years Leading to Expiry* Contracts/Mo 450, , , , , , , ,000 Source: *Week 1 denotes volume traded for December contract 60 months out. Ie. Week 1 volume for the Dec 2020 contract is Jan ,000 0 Average ' Week #

9 Fundamentals Point To Tighter Markets Ahead Following several years of over supply, the market reverted back to a position where daily supply and demand were balanced in Q2, we see significant stock draws to follow. Global Supply & Demand Balance mb/d Q1 Q2 Q3 Q4 YoY Q1 Q2 Q3 Q4 YoY Q1 Q2 Q3 Q4 YoY Demand OECD Non-OECD Total Demand Supply OPEC Crude OPEC Other Liquids Non-OPEC Crude & Biofuels & Proc Gain Total Supply Stock Change Call on OPEC Price Forecast ($/bbl) '16 Avg '17 Avg '18 Avg WTI $33.63 $45.64 $44.94 $49.29 $43.47 $51.78 $48.15 $48.20 $51.50 $49.36 $53.00 $51.75 $53.75 $54.50 $52.67 Brent $35.21 $47.03 $46.99 $51.06 $45.13 $54.61 $50.79 $52.17 $54.75 $52.50 $56.25 $54.75 $56.25 $57.00 $55.45 WTI-Brent Spread -$1.58 -$1.39 -$2.05 -$1.77 -$1.66 -$2.83 -$2.64 -$3.97 -$3.25 -$3.14 -$3.25 -$3.00 -$2.50 -$2.50 -$ Source:, Petro-Logistics SA, IEA, EIA, JODI, company and government sources

10 OPEC s Cuts Have Kick Started a String of Global Stock Draws Global Oil Supply and Demand Balance mb/d 2.5 Oversupplied Q Q3 Q Q3 Q Q3 Q Q3 Undersupplied Q Q3 9 Source:, Petro-Logistics SA, IEA, EIA, JODI, company and government sources

11 OPEC - What Does Winning Look Like? Slow and steady wins the sustainable recovery but the $50/bbl mark only buys breathing room for some sovereign producers. OPEC is a low cost marginal producer, but fiscal break evens remain much higher. Most OPEC nations are heavily reliant on energy revenue to fund social programs and military campaigns. As such, much higher oil prices are required. In the context of many pegging OPEC s decision to cut production as a watershed moment, in our view, Saudi Arabia shifted gears and abandoned the strategy of prioritizing market share simply because it proved ineffective. Simply put, the Saudis had a difficult time increasing market share in any of the key demand centers. OPEC cuts are proving effective, but the type of crude taken offline is also important. Production cuts, whether voluntary or not, to global heavy crudes from both within and outside of OPEC means that available barrels globally are trending lighter and sweeter. This is exacerbated given that much of the near term global growth stems from the lighter end of the barrel from regions like the US and FSU. We expect heavy crudes to outperform light barrels over the coming years. 10

12 Iran Gabon Kuwait Qatar UAE Ecuador Angola Algeria Weighted Avg Saudi Arabia Iraq Nigeria Libya Venezuela Many OPEC Members Remain On The Hot Seat Even at $50/bbl 2017 Fiscal Breakeven Estimates $/bbl Source:, IMF, government sources 11

13 Saudi Arabia s Market Share Strategy Proved Ineffective Chinese Crude Imports By Key Region % of Chinese Crude Imports 25% 20% 15% 10% 5% 0% Saudi Russia Angola '10 '11 '12 '13 '14 '15 '16 '17 Source:, Chinese Customs General Administration 12

14 Saudi Arabia Boxed Out in the Battle For Barrels in Beijing Chinese Crude Oil Imports, YoY Chg Crude Exports to China, Top Gainers, YoY kb/d kb/d ,200 Russia Brazil 1,000 Angola 800 United States 600 Malaysia UK 400 Iraq Venezuela Libya Egypt Source:, Chinese Customs General Administration, Country & Gov t Sources 13

15 Saudi Arabia s Strategies Have Left Money on The Table Saudi Share of Chinese Crude Imports kb/d 1,800 1,500 Actual Saudi Market Share Saudi Share Left on Table (had share remained at 19%) 1, Source:, Bloomberg, Chinese Customs General Administration 14

16 Supply Will Rebalance The Market With Non-OPEC In Focus Global balances have achieved a delicate state of equilibrium but the market remains in a fragile state in which minor changes at the margin could tip balances in either direction, resulting in large asymmetric shifts in both sentiment and price. We remain in a supply driven market. Recent hedging activity helps US producers become increasingly price agnostic as hedges are shored up. Other non-opec countries will be counted on to rebalance the market to a long term equilibrium level in the coming years. The over arching theme of slowing investment in costly multi-year cycle projects have planted the seeds for a sustainable push higher given that the commissioning of short cycle, steep decline projects will be insufficient to offset supply disruptions alongside natural declines. The lack of commissioning of additional high cost, low decline projects like the oil sands or deepwater projects will steepen the treadmill of global decline rates as the market moves towards a supply gap later in the decade. 15

17 US Production has Become Anti-Fragile US Crude Growth/Decline By Key Region kb/d 1,250 1, Permian Eagle Ford Bakken -750 Q1'15 Q4'15 Q3'16 Q2'17 Q1'18 Q4'18 US Drilled but Uncompleted Wells # Wells 7,000 Permian US ex Permian 6,000 5,000 4,000 3,000 2,000 1, Source:, EIA 16

18 Is The EIA Production Data Lying to Us? US Crude Production Estimation Error kb/d 9,600 9,400 9,200 9,000 8,800 8,600 Monthly Weekly 8,400 Jan'16 May'16 Sep'16 Jan'17 May'17 Source:, EIA 17

19 Producer Hedging Pressure will Continue to Pressure Prices Calendar 2018 WTI Price and Producer Hedging Window $/bbl WTI Spot Price Producer Hedging Sweet Spot 45 Oct'16 Dec'16 Feb'17 Apr'17 Jun'17 Aug'17 Oct'17 Source:, Bloomberg 18

20 US, Canada and Brazil Growth Slow The Rebalancing Act Non-OPEC Oil Production, YoY Chg kb/d 2,500 2,000 1,500 1, ,000-1,500 RBC Forecast Africa & Mideast Asia Europe Latin America North America FSU Source:, IEA, EIA, Company and Government Sources 19

21 Recency and Locational Biases Muddle Global Storage Picture The path to running down inventories has been bumpy rather than linear, but what started as a slow chip at the iceberg has accelerated visibly over recent months. Running down the remaining surplus of oil inventories is a multi-step process. We anticipate that refined products will lead the rebalancing and that firm refining margins, particularly in the Atlantic Basin will entice further drawdown of crude stocks. Achieving daily supply and demand balance was the first step to rebalancing the market. This was achieved in Q2 17. Second, the long road back to full market equilibrium entails returning global stocks to seasonally normal levels. This feat will remain elusive until early Stocks are drawing in several key parts of the world, but US inventories remain elevated. As such, recency and locational bias often lead industry participants to draw false parallels, particularly if the abundance of US oil data and ensuing media coverage is being extrapolated and used to draw similarities to the rest of the world, where data is often lagged or less visible. 20

22 The Pursuit of Equilibrium Runs Through the US OECD Oil Stocks: +/- to Five Year Avg mb 0 OECD Europe OECD APAC OECD Americas Source:, EIA, IEA, Euroilstock, PAJ, country and government sources US Net Imports of Refinery Production kb/d 5,000 4,000 3,000 2,000 1, ,000-2,000-3,000 Distillate Gasoline Total Products -4,000 '00 '02 '04 '06 '08 '10 '12 '14 '16

23 Backwardation Explained WTI and Brent are experiencing backwardation to varying degrees, but the two forward curves are sending very different signals to the market. Improving fundamentals have physically led Brent into backwardation, while WTI has been financially pushed. Brent has shed its contango and we expect the steepness of the term structure to sustain given that Atlantic Basin fundamentals have improved materially over recent months. WTI has lagged and the current mullet-like term structure reflects loose near term fundamentals while the term is backwardated due to producer hedging pressure. US exports are the global equalizer and the WTI discount to Brent should narrow as the call on exports evens the playing field, but premature backwardation does not come without risk given that an untimely move destroys storage economics and proves selfdefeating. Producers will continue to prudently layer in the insurance policy given that the market currently resides in such a critical pricing corridor where a $5/bbl move in either direction could be the difference between feast and famine. The ability for WTI to rally over the near term will be determined by the producer hedging ceiling. 22

24 How To Achieve Backwardation WTI & Brent Term Structure $/bbl WTI - Mullet-like structure: Contango front, Backwardated term Brent (LHS) WTI (RHS) $/bbl Brent - Clean Backwardation Month 49 Source:, Bloomberg 23

25 Backwardation on Hold Until Further Stockdraws Emerge Cushing Storage Utilization vs WTI Spread (1 vs 6 Mo) $/bbl Past 10 Years (Monthly) Recent Month % 40% 50% 60% 70% 80% 90% 100% Cushing Crude Storage Utilization Source:, EIA 24

26 US Exports Are The Key Balancing Factor US Crude Oil Exports kb/d 2,000 1,750 US Crude Exports Four Week Rolling Avg 1,500 1,250 1, Oct'15 Apr'16 Oct'16 Apr'17 Oct'17 Source:, EIA 25

27 All Aboard The Export Express Key US Gulf Crude Export Ports Houston: Current Nameplate Capacity: 1.7 mb/d Fit VLCC: No Port depth: 45 feet Crude Types: Various US Crudes, Canadian Heavies Beaumont/Port Arthur: Current Nameplate Capacity: ~480 kb/d Fit VLCC: No Port depth: Both ~40 feet Crude Types: Various US crudes Texas Louisiana Corpus Christi: Current Nameplate Capacity: 960 kb/d Capacity under construction: 1.8 mb/d Fit VLCC: In progress Port depth: 45 feet, expanding to 54 feet Crude Types: Eagle Ford, Permian Louisiana Offshore Oil Port: Currently Operational? No Planned Initial Nameplate Capacity: 300 kb/d Fit VLCC: Yes Port depth: 115 feet Crude Types: Various US crudes including Thunder Horse, Southern Green Canyon, Bakken, as well as Canadian Heavies Source:, Company Reports 26

28 Global Demand Outlook Steady Rather Than Slow or Spectacular Global oil demand growth will remain steady rather than spectacular or slow but the story is a tale of two regions. OECD demand peaked before the recession and has been trending lower in the years since. Aside from the past few years, Emerging markets have singlehandedly carried global oil demand growth since the recession. Emerging Asia alone has accounted for 60-70% of total global oil demand growth over the past several years. Concentration risk is rarely a friend of Wall Street. The massive growth days for China are over, but the trend remains steadfast as the Asian giant transitions towards a consumer based economy. India will be a major driver of global oil demand growth for many years to come. With the upcoming supply gap not as wide as many initially forecasted, the pendulum of importance shifts back to the demand side to determine the gap of the shortfall. While supply has dictated the market of late, the upside price potential over the next cycle is contingent on the demand growth trajectory. 27

29 Emerging Markets Have Carried Global Demand Since The Recession Demand Change Since 2008 kb/d 14,000 12,000 OECD Non-OECD 10,000 8,000 6,000 4,000 2, ,000-4, Source:, EIA, IEA, company and government sources 28

30 OECD Oil Demand In Structural Decline OECD Oil Demand mb/d 58 OECD Demand Pre-Recession Trend US Avg Sales Weighted Fuel Economy mpg Source:, EIA, IEA, UMTRI, Country & Gov t Reports 29

31 Cheap Oil Prices Are Spurring Large Vehicle Purchases US Vehicle Sales By Type units/mo 1,100,000 1,000, , , , , , ,000 Trucks & SUV Cars 300, Source:, UMTRI, Ward s Automotive Group 30

32 Global Demand Has Been Steady But Concentration Risk Remains Global Oil Demand Growth By Region kb/d 4,000 Rest of World Emerging Asia 3,000 2,000 1, % 76% 100% 100% 54% 98% 62% 62% 63% 62% 70% 73% -1,000-2, Source:, EIA, IEA, JODI, company and government sources 31

33 Macro Spill Over To Physical Chinese Oil Demand Will Be Limited Chinese Gasoline Demand kb/d 2,900 2,700 2,500 2,300 2,100 1,900 Chinese Crude Imports (3 Mo Moving Avg) kb/d 8,500 7,500 6,500 5,500 4,500 3,500 1,700 2,500 1, , Source:, Chinese Customs General Administration 32

34 Gasoline Carries Chinese Demand While Diesel Growth Slows Chinese Demand Growth By Key Refined Product, YoY kb/d Gasoline Diesel Source:, Chinese Customs General Administration 33

35 Expansion of Chinese Vehicle Fleet Drives Gasoline Consumption 2016 Chinese Vehicle Sales By Type Vehicles/Mo 3,000,000 2,500,000 Commercial Vehicles SUV Trucks Basic Passenger Car 2,000,000 1,500,000 1,000, , Source:, China Automotive Information, China Association of Automobile Manufacturers 34

36 SUVs Spearhead Another Banner Year For Chinese Auto Sales 2016 Chinese Auto Sales By Type SUV as % of Total Vehicle Sales 35% 13% 33% 30% 25% 20% 45% 9% 15% 10% SUV Trucks Basic Passenger Car Commercial Vehicles 5% 0% Source:, Chinese Customs General Administration 35

37 India Will Be The Key Demand Growth Center of The Future Indian Oil Demand By Product, YoY Chg kb/d YTD LPG Naphtha Gasoline Jet Fuel Diesel Fuel Oil Other Source:, India PPAC 36

38 Indian Vehicle Penetration Potential Remains Tremendous Composition of New Vehicle Sales 90% 80% 70% 60% 50% 40% 30% 20% 10% Source:, Indian Automobile Manufacturers 37 0% Two Wheelers Passenger Vehicles Commercial Vehicles Three Wheelers

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