The Petroleum Economics Monthly

Transcription

1 The Petroleum Economics Monthly Philip K. Verleger, Jr. Volume XXVIII, No. 5 May 2011 Better Late than Never Thousand Barrels per Day 2,000 Libyan Monthly Crude Oil Production, ,500 1, Source: EIG. (Publication Date: 6/29/2011) 2011, PKVerleger LLC. All rights reserved. ISSN Reproduction of The Petroleum Economics Monthly in any form (photostatically, electronically, or via facsimile), including via local- and wide-area networks, is strictly forbidden without direct licensed permission from PKVerleger LLC. Contact Dr. Verleger at 2000 E. 12 th Ave, Unit 32, Denver, CO 80206; 540 Fox Run Dr, Carbondale, CO 81623; or phil@pkverlegerllc.com.

2 Better Late than Never Philip K. Verleger, Jr. PKVerleger LLC Disclaimer: Although the statements of fact in this report have been obtained from and are based upon sources that PKVerleger LLC believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions and estimates included in this report constitute the judgment of PKVerleger LLC as of the date of this report and are subject to change without notice.

3 Table of Contents Summary Better Late than Never... 1 I. The IEA s Strategic Stock Release Better Late than Never... 4 II. Privatizing the Strategic Petroleum Reserve III. The Economic Benefits of Selling Refining Capacity IV. Short-Term Price Outlook Glossary Statistical Appendix List of Figures Figure 1. Libyan Monthly Crude Oil Production, Figure 2. Monthly Projections of 2011 and 2012 US GDP Growth Issued from January 2010 to June Figure 3. Refining Margins for Urals Crude at Mediterranean Refineries, Monthly, Figure 4. Crude Stocks Held in the US Strategic Petroleum Reserve Figure 5. Change in WTI Price vs. Change in Net Position of Investors in WTI Futures, June 2009 to April List of Tables Table 1. Differentials Offered by Saudi Arabia for Different Crude Oil Grades Delivered to Various Markets... 7 Table 2. Crude and Product Volumes to be Released from Strategic Stocks Following the IEA s June 23 Announcement... 9 Table 3. Calculation of the US Petroleum Dependency Ratios for the Nation as a Whole and Excluding West Coast Table 4. Price Forecast i

4 Summary Better Late than Never The title of the May issue of The Petroleum Economics Monthly, Better Late than Never, was also used by Argus Global Markets for its June 27 report. The statement is appropriate for the action it describes the IEA decision to release 60 million barrels from strategic reserves and this publication. Our May report is late again. Publication was delayed in part by the IEA s June 23 announcement. The strategic stock release will have important implications for oil price movements going forward. We chose to hold back publication to provide analysis of this event. Here we tackle three subjects: 1) the impact of the strategic stock release, 2) a proposal to privatize strategic reserves, and 3) the manner in which integrated oil companies are raising their profits significantly by selling refineries. The first section examines the release of crude from reserves. Better Late than Never captures our view of this occurrence. Consuming nations created these stocks more than thirty years ago to protect against supply disruptions. The creators (this author played a very small role in the process) believed that stock releases could moderate the economic impact of market disruptions such as the Libyan crude cutoff. Immediately after that incident, US gasoline prices jumped, rising twenty percent (from $3.40 to $4 per gallon) in two months. Consumer confidence in the United States plunged, and the modest economic recovery came to a stop. Some of these economic dislocations could have been avoided by a stock release on March 1, 2011, that is, when the magnitude of the Libyan problem became clear. Precious time was lost, however, before the IEA acted. Hence the title: Better Late than Never. Section I examines the stock release s impact and the possible need for further action. As noted, the IEA announced that 60 million barrels of oil would be sold. The crude will be distributed over time, with European countries pushing oil into the market in July and the US oil arriving in August. (The total released may be less than 60 million barrels if all bids for US volumes are not accepted.) The price effect of this action will also develop over time. The evidence from recent releases of heating oil from the US Strategic Petroleum Reserve (SPR) in February and March suggests the effect would be substantial if large volumes were offered at one time. However, it appears more likely that the oil sales will be spread out and that some of the fuels produced from reserve oil will be shifted to storage. The release s impact will also depend on the oil industry s response and the willingness of IEA members to repeat the action. The industry s early reaction was negative. Given this view, the oil release could have minimal impact if the oil sector refuses to accept the crude. Such a ploy, though, would risk potentially permanent intervention by various governments. We expect the current release to produce declines of five and fifteen percent in wholesale prices for low-sulfur distillates (diesel fuel) and gasoline, respectively. These in turn will lead to a thirteen-percent decline in crude oil prices. Combined with slower economic growth, prices will be lower through the end of the year. Any increases at that time will be moderated by the greater inventories accumulated thanks to the strategic stock release. Another release of strategic stocks or, alternatively, increased sales by OPEC countries could further depress prices. Kuwait called on OPEC countries to boost production following the IEA action. Increased output from Kuwait, if priced correctly, could lead to further price declines going forward. Otherwise, the oil will sit in tanks or on ships. 1

5 Finally, we explain that further sales of strategic reserves can be expected in 2011 because the sales will benefit consumers and Saudi Arabia. As noted in Section I, Saudi Arabia will probably realize higher income levels with the sales than it would in their absence, assuming in the latter case that the Saudis and other Persian Gulf countries increase production and sales in an effort to contain crude price rises. Such sales would require exporting countries to boost discounts offered for heavy sour crude substantially. Under these circumstances, their income would be lower than it would be with the strategic stock release even though they would sell more oil. This peculiar economic situation gives Saudi Arabia every incentive to encourage further sales. The discussion of the strategic release, Better Late than Never, begins on page 4. The chaos surrounding the strategic stock release offers yet another reminder that governments are generally not good at managing markets. The disruption of Libyan supplies should have brought an automatic release on March 1, The actual release came 126 days later and only after myriad discussions among officials from consuming countries, as well as between oilexporting country and consumer representatives. The sale probably would not have occurred had Iran agreed to an OPEC quota increase at the June meeting, even though such an agreement would have been meaningless. As noted, precious time was lost between March and June. Retail product price increases in the United States and Europe cut into fragile growth, and the impact of the decision to release stocks was muted. These effects could have been avoided had stocks been sold immediately. Unfortunately, governments cannot move quickly. Thus we suggest here that strategic stocks be privatized. Specifically, the United States should promote the creation of one or more private enterprises to buy and manage strategic stocks in an entrepreneurial fashion. The enterprise should have the authority to purchase or sell oil at any time. Sales will tend to be made when prices jump and purchases when prices fall if the enterprise owners are, as we propose, pension funds and/or other organizations seeking commodities exposure to diversify portfolios. We note that these market participants have established a record of buying low and selling high. They would undoubtedly do the same with the SPR reserves. Privatizing reserves offers two other important advantages. First, the sale of these resources might raise $100 billion for the US government, something Congress and the Obama administration would find helpful as they struggle to cut $4 trillion from the deficit. Second, a private manager of reserves would move more rapidly and more discreetly, buying and selling frequently in smaller lots. Such actions would likely dampen price fluctuations. Details on the proposal to privatize the reserve begin on page 14. Section III (page 21) focuses on sales of refining capacity by integrated oil companies. We base the discussion on a long interview that Mark Williams, director of Royal Dutch Shell s downstream business, did with Petroleum Intelligence Weekly. In it, he celebrated Shell s disposal of 35 percent of the company s refining capacity. Using the best Harvard Business School speak, he explained that Shell could obtain any required products through supply-chain partners. Speaking between the lines, Williams made clear that, in selling refining capacity, Shell identified or blundered into a way to increase profits substantially. Its gains rise not because the company has unloaded costly low-return businesses but because, in selling or closing refining capacity, it found a way to boost crude prices higher than they would otherwise be. 2

6 Shell s success in raising crude prices occurs because those who bought the facilities require more time to construct hydrocrackers. These are the units vitally needed across the globe to convert unwanted heavy high-sulfur residual fuel oil into the ultra-low-sulfur diesel fuel coveted by consumers. The Shell program works in conjunction with OPEC s strategy, identified in the IEA s 2011 Medium Term Oil Market Report, of limiting sales of heavy sour crude to support prices. Although Williams does not say it, Shell recognized that light product supplies will be restricted and crude prices pushed higher by its refinery sales. Other large companies seem to have noticed this unacknowledged strategy, and this may explain the rise in refineries being offered for sale. The strategy is unobjectionable, although some may complain that companies should not boost crude prices. Consuming nations can respond by offering subsidies or other incentives to build the needed hydrocrackers. Alternatively, new policies that allow continued use of higher-sulfur product might be considered. The report concludes with a price forecast (page 23). We expect additional sales to be made from strategic stocks. This will hold Brent prices at $110 per barrel. 3