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Trading Lessons

Troubled Times for World Oil

Commodities / Crude Oil May 31, 2012 - 01:06 PM GMT

By: Andrew_McKillop

Commodities

Best Financial Markets Analysis ArticleMajor energy monitoring entities, including the US EIA and the OECD group's energy watchdog the IEA are forced to report that for the developed nation OECD group, and increasingly even for energy outlooks in Emerging economy giants China and India, energy demand is stagnant or falling. For the G20 group, including the largest Emerging economies, demand forecasts are presently set at growth for all types of energy being at most 2% in 2012. For oil, taking account of continuing shrinkage, or at best fractional growth of OECD demand and constantly revised-down demand growth in China and India, the year forecast is now well below 1% growth for global demand and can easily go lower.


This is the current outlook, but these current forecasts may turn out to have been "optimistic": for oil this will be very easy to measure, as rising stocks and falling prices, but with a special turn of the vice on the downside.

This can be set as follows: since 2010 there has been no recovery in oil demand in many countries, not only in the OECD group where many trends and policy economic issues give an easy explanation for no recovery, but also in a range of countries outside the OECD group. In these non-OECD developing economies, including the Emerging giants, the energy and oil demand compression that has happened in the developed OECD group through as long as 25 years since about 1985, has been short-circuited to a 10-year process of energy transition. Previous typical growth rates for the leading forms of energy - oil and electricity - have been cut from as high as 6% to 12% every year, to as little as 2% to 3.5%.

In the OECD group this energy transition process has only accelerated with recession and following a near-decade of energy policy action and energy communication aimed at cutting energy demand and shifting supply to renewable sources. The EU27 group, in the case of several leading economies, have cut their nationl demand by 20% since 2006. In 2011 no recovery was easy to forecast, and no recovery occurred. The change to "energy lean" in the emerging and developing economies is however the surprise factor, due to this type of transition being forecast by the IEA and other entities as likely by "about 2025-2030" in studies and reports as recently published as mid-2011.

PEAK OIL - ALTERNATE ENERGY

Investment and spending on global oil and gas exploration and production (E&P) is estimated by analysts like Citibank's energy group to be running at a rate of around $275 bn per year as of Q1 2012. The results of this spending are easy to compare with very similar spending, around $300 billion including state subsidies (of about $65 bn), on global alternate and renewable energy, as estimated by the IEA and sector specialists like Bloomberg New Energy Finance.  While shale gas is a clear winner, and stranded gas/LNG development may also be highly profitable both by energy yield and by forcast future earnings, oil investment returns trail well behind leading cleantech/green energy opportunities on both these criteria: that is energy yield and future earnings performance.

Oil is priced out on the production upstream as well as the end-use downstream, for a widening number of reasons, that include but no longer feature the decline of conventional oil resources, called "Peak Oil". This factor is now only one of several, all of them leading to a faster-than-expected wind down for oil in the global energy economy. The 2011 split for the global energy mix, using BP Statistical Review data, gives about 37.5% for oil's share: this is almost surely and certainly its most recent high. Mounting numbers of factors suggest oil's share in the global energy mix can shrink to 30%, and then steadily go on shrinking, by 2020-2025, in a global energy picture where annual growth stays riveted down at no more than about 2% a year.

The near-term impacts of this future shock will be shown in the usually speculative, usually frenetic oil trading arena, where a price fall to the Saudi and Russian "reaction price" of around $75/b can happen very soon, but oil priced down nearer its real market value will do little to stimulate demand, this time around, as in 2010, for the reasons we have started to cover in this article.

Like anybody who cares to read the numbers will find out rapidly, trends through 2000-2010 in world energy were relativelt predictable, at least until 2009-10. Oil demand growth trailed behind gas demand growth which itself trailed behind coal demand growth, as King Coal made a remarkable comeback in world energy. By 2010, using real world coal data as supplied by China's NEA, India's Ministry of Coal, Platts, Argus McCloskey, rather than undercounted data from BP, coal's share in global energy was close to 27.5% of total. This however was in a demand system and structure where global energy demand continued to grow at close to the long-run average of about 4% a year.

The simplest, most basic reason for why coal and gas demand grew so much faster than oil was as we stated above: oil was already too expensive. To this and growing exponentially since the 2000-2005 period we have the "uncoventional renewables", that is windpower and solar PV. Their mega-difference with fossil energy is these "fuels" are entirely and 100% free. Any conceivable end use application which can subsitute oil-coal-gas by renewables is now the daily work and task of tens of thousands of energy managers, strategists and planners worldwide. The impact of this mega-shift in world energy has now burst onto the scene, and will not be quitting it.

ALTERNATE ENERGY ISNT CHEAP

Bankruptcy protection now applies to many of the world's biggest solar photovoltaic and wind energy equipment producers - the same way it applies to a string of big name airlines - which keep on flying the same way alternate energy industrialists keep on producing. Consolidation in the alternate energy sector is now in full force, but for buyers and users of alternate energy equipment the good times are here, as prices cascade down.

Upstream of this, governments in most OECD countries, and in China and India are only lightly taking their feet off the gas pedal, for a host of reasons including simple and straight job creation: a key example is Germany with its 'Energiewende" transformation plan, which has already resulted in "free power Sundays", as in late May. With a combined wind + solar power capacity now above 55 000 MW, and growing, the nation's need for power on a windy and sunny day of low demand, as at weekends in May, is only about 37 000 MW. So the power is free because neighboring countries cannot or will not handle that much cheap supply. But Germany AG keeps on producing the equipment !

How long Germany keeps on that course is difficult to say: logic says there has to be pause in its expansion programme, but Energiewende was conceived, rationalized and planned with many different strands of logic - including the belief that the planet is burning, due to CO2 and global warming, making an emergency programme of shifting to non-fossil energy the only way to save Humanity. Also in Germany however, but rarely placed on the high ground the understanding that most renewable energy sources (excluding biofuels) are entirely free "fuels" was given the No 1 importance it merits. Using IEA data and to be sure, global subsidies to alternate and renewable energy were estimated at about $65 bn in 2011, but IEA figures on state subsidies to not-free fossil fuels show these ran at about $409 bn a year in 2011. 

Alternate energy is not cheap - it is free - has powerful but until recently slow-moving impacts across the energy planning, project analysis, project financing and downstream energy using sectors.

Already for Germany, on free power Sundays the theoretical (if not practical) need for fossil-fuelled power capacity is zero, but in the Emerging economies where fossil-fuelled generating capacity is still high and rising, the impact of ever lower costs of rapidly maturing renewable energy-based power production will grow very fast. Not only coal and gas demand growth will be impacted, but especially oil demand growth, and these effects are now able to be seen in country data, on an upward path for alternate energy, and downward path for oil and other fossil fuels that has heavy implications for oil not only in the mid-term but also the short-term.

While in Europe the unexpectedly fast, almost unplanned massive surge in renewable energy supply is taking place in some countries, like Spain, that are in deep recession, alternate energy spending in China and India is also in high gear, but unlike the OECD countries this growth (for China the NEA target is 1000% growth of solar power capacity by 2016) can and will particularly shave their growing oil demand. Unlike the OECD countries, oil-fired power production still features in the Emerging economies, and is sometimes a large slab of national capacities: against oil-based power using oil at nearly $100 a barrel (or even $75 a barrel), wind, solar and other new and conventional renewables (like hydro) are often so competitive they do not need feed-in tariffs: the fuel is free, and that counts!

OIL'S DOWNWARD SPIRAL 

Coming cuts in global oil demand's outlook not only include the supply side: through energy saving and efficiency raising, and straight fuel substitution using natural gas to power almost all forms and types of transport except airlines. Perhaps not surprisingly, due to latecomer-innovator status the Emerging economies already have a lead on nearly all OECD countries in shifting their road transport to operate on natural gas, starting with minicipal city transport and heavy truck transport, but also moving into taxi fleets and individual private car users.

Global bulk and container shipping, rarely identified as a massive "resource" for global oil saving, had a regular trend of 7%-a-year oil demand growth until 2010, racking up global marine oil demand to around 2 billion barrels-a-year, about 5.4 million barrels per day or 20% more than the total oil demand of Japan, the world's third-biggest economy. Gas fuel substitution, clean coal fuel substitution, and currently small but increasing applications of new and emerging alternate and renewable energy for the marine sector can easily trim oil demand growth for bulk shipping to near zero - the sector already practicing "slow steaming" to trim the massive oil demand of 100 000 horsepower behemoth container ships, resulting in these ships now often sailing at around 18 - 20 mph (15 knots), the same as 100% wind-driven fast clippers of the 19thC !

In the US, still the OECD's most oil swilling economy, higher gasoline prices are today what they were not as recently as 2008: today they trigger car buyers to crowd into car showrooms and buy a new car, always using less fuel, instead of triggering them to give up all intention of buying a car. US car fleet oil needs are now forecast at mostly flat, and may even fall - especially if the fleet dieselizes as has happened en masse in Europe, where some leading economies, like Germany and France now have around 75% of their car fleet running on diesel.

The global energy shift away from oil, on the supply side, not only features runaway growth of alternate and renewable energy, but will surely also include the gas boom. Like we know, there are 'historical impediments' to replacing oil with gas in the transport sector and for car fleets, but as mentioned above this sectoral energy shift likely will start with heavy road transport and possibly marine transport. With the outlook for oil demand growth cut back to fractions of 1%-a-year, unless an unlikely global economy surge happens, the smallest increments of new supply, now including rising perspectives for Brazilian deep offshore, east African output and to be sure US shale oil output can and will place serious limits on oil price growth, outside geopolitical crisis windows.

As we know from oil price trends through 2011 and 2012 to date, the biggest fillip to prices was supplied by the Libyan regime change war, Iran nuclear crisis, and a possible Arab Middle East regional civil war triggered by the Syrian crisis. In no case were these fillips due to straight supply-demand issues. While the price downside is never too easy to forecast because market mechanics always and traditionally swings prices to the extremes each way, the energy-economic and financial fundamentals of global oil are now themselves tilting the big picture towards faster and further decline of Black Oil.

Project feasibility in a rising number of key areas like deep offshore oil needs prices north of $75/barrel to see the light of day. Alternate energy, from cheap gas to ever less expensive renewables is operating a pincer on world oil on the finance available to develop upstream supply, as well as the economic rank and merit of oil in the demand downstream. Regarding supply and if the oil simply isn't produced, the new panic-reduced no-sweat response is that folks will find a way of not using it !

How far down oil falls is difficult to set, in a process of oil extinction that is amplifying and feeding on itself. In the short-term we can likely get to $75/b for WTI in relatively short order, on a downswing marked by producers starting to call for supply cuts from as early as $75/b. This however will likely be the floor price, due to the oil sector now being so capital intensive and high cost, unless we get a remake of 2009. In that outlook, which the European debt crisis and Eurozone crisis could hatch, the price spiral can go far lower, and can only be stopped and reversed when serious new "QE" happens - if it happens.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2012 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


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