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Elliott Wave Trading

Crude Oil Price Shakedown

Commodities / Crude Oil Nov 06, 2013 - 02:56 PM GMT

By: Andrew_McKillop

Commodities

BEWARE THE BULLS
As I already noted in several articles, WTI grade oil at less than $100 a barrel is something of a revolution and an open incitation for Wall street's “heavy lift brigade” to plunge protect and lift prices back up to what they think is the right level. The leading member of the heavy lift brigade, Goldman Sachs, has until relatively recently bragged that WTI could reach $125 a barrel by Dec 31st or early in the new year.


Their oil pricing mythology is at best only lightly flavored with supply-demand-stocks fundamentals. Their interest in, even knowledge of energy-economics is close to zero, therefore it is useless to ask why there is such a fantastic energy price premium for oil. US natural gas, trading today (Nov 6) at $3.55 per million BTU offers clean, easy-to-use energy at a barrel equivalent price of $20.59, but oil commands more than $94 a barrel. Brent, to be sure, is even more expensive, with a premium added to the premium but geopolitical risk factors weighing on Brent, supposedly, explain its added premium. Also adding more to the Brent price, both European and Asian or “eastern hemisphere oil” is pushed higher against US WTI due to competing energy sources and supplies being so high priced in the eastern hemisphere.  Natural gas prices in Europe and Asia, for example, are 3 - 4 times US prices.

Only coal has a truly world-based pricing system. Using Indexmundi data, the average monthly price in September for South African export coal to any destination was $73 per metric ton, pricing this coal energy at around $14.50 per barrel equivalent of energy on a FOB basis.

Stripping oil out of the commodity space, leading tradable non-energy commodity indices show the real world trend for commodities, for example the TR/Jefferies CRB ex-energy index, below. Indices including energy are for the moment supported by high oil prices, due to oil being almost always overweighted in these indices. One example is the World Bank energy index, which is 84.6% oil weighted. (see end of article).

AS IF FUNDAMENTALS MATTERED
Certainly since 2009-2010, it is impossible to ignore the fact that US oil import dependence is on a wipeout curve, due to rising shale gas, shale gas-liquids, and light shale oil production. Simply due to the US re-approaching energy independence, it could be argued, there is a rationale for the Brent premium on WTI, due to Europe and Asia remaining very heavily oil-import dependent, but this argument can easily be opposed.

Whatever the Brent/WTI premium, however, the true basis of actual production cost of oil has to enter the pricing formula, sooner or later. On this basis, the production cost of eastern hemisphere oil, dominated by the Middle East, Russia and rising African output, is lower than western hemisphere oil, especially US oil, meaning that Brent should run at a discount to WTI. US oil production costs are on aggregate probably below $70 per barrel for light oil, and on aggregate they are probably below $50 in the eastern hemisphere.

These can be taken as current highest-average production cost levels in the two hemispheres.

Oil demand, today, is however the prime price-setting variable over and above short-run geopolitical factors, industrial and transport accidents, weather variables and other short-life factors.

Unexpectedly perhaps, the main energy watchdog agency of the OECD, the IEA, continues to forecast unrealistically high oil demand trends going forward. In its October monthly oil report, the IEA said it expected global oil demand to grow by 1 million barrels a day this year, an increase of 100,000 barrels a day above its previous estimate. It maintained its 2014 outlook for demand growth at 1.1 million barrels a day. These growth rates are well above 1%, and approach 1.3% a year.

Real rates of global oil demand growth based on world refinery output and refined product stocks, and refined product price trends are probably in the range 0.4% - 0.6%. In October, the IEA raised its forecast for demand growth in 2012 on the base of what it claimed were “signs of improvement” in the European economy and “higher-than-expected” oil fired power production in other world regions.

Concerning the “signs of improvement” in the European economy, we can take the Eurostat report of October 31 stating that the number of unemployed in the 17-nation eurozone reached a record high in September as the bloc's “nascent recovery” failed to generate jobs. Jobless ranks in the eurozone countries swelled by 60,000 to a record 19.45 million. Eurostat also said annual inflation fell to 0.7 per cent in October from 1.1 per cent a month earlier, marking its lowest annual rate in four years. The ECB is tasked with “keeping inflation close to 2 per cent” and currently faces something of a crisis due to the rising outlook of intensified economic downturn in Europe – which can only depress oil demand.

The ECB, in late June, said euro area activity still lacks a functioning engine for growth. Private demand is still adversely affected by an ongoing deleveraging process, and public sector demand despite some recent austerity relaxation, remains geared towards austerity. External demand for EU exports has been subdued as the euro remains overvalued and emerging economies have slowed down, and the US and Japanese recoveries remain timid. The leading economies inside the euro area have suffered from this gloomy environment, most recently Germany. The ECB concluded that the end of recession in Europe “was possible but sustained recovery is unlikely”. The exact same applies to the outlook for oil demand recovery in Europe.

Concerning world electricity demand, around 70% of all demand growth in 2012, Enerdata.net reports, was due to China which overtook the US in power consumption in 2011. With the three other original BRIC countries, and four others including South Africa from 2010, this levered BRICS power demand to equal the G7's power demand of about 6800 terawatthours (billion kWh) in 2012. The BRICS' power demand growth, driven by Chinese demand, was an average 4.6% a year in 2000-2011, according to Enerdata, but since then BRICS power growth rates have slipped. Since 2008 several G7 countries have recorded an average annual decline of up to 1.6% in power demand. Since 2006 total EU power demand has fallen, on average at about 1% a year. In the US, since 2008, power demand has fallen 3 years out of 4 and the US EIA long term forecast for electricity sets an average of just 0.6% a year growth for industrial users and 0.7% for households through 2012-2040.

Chinafaqs.org reports that in 2012 close to 80% of Chinese electricity was coal-origin despite official government plans to firstly cap, then reduce electricity output from coal. Other major Asian power producers, for example India, also produce mainly coal-based power and very low amounts from oil.
According to the IEA, global electricity generation from oil fell to 5% of total in 2009 and the role of oil-fired power will continue to decline, both in developed and emerging economies. European data shows that about 0.8% of total power production was oil-fired in 2012. For the US, oil-fired plants supplied about 1% of total electricity in 2012.

OIL AND TRANSPORT
Outside of petrochemicals, plastics and fertilizers which take about 4.75 million barrels a day (5.2% of world total oil demand) the main prop to overpriced oil is its supposedly “not substitutable” role in transport. Outside of air transport (which takes about 4.5 Mbd), the real prop to global oil demand is road transport (goods + private) taking about 24.6 Mbd but road transport oil demand is increasingly substitutable – as admitted even by the IEA!

 The IEA's web sites say the agency conducts transport research and analysis focusing ways in which countries can reduce the energy and greenhouse gas intensity of their transport sectors. Policy advice is given to the 30 member governments of the IEA on implementing advanced transport technologies, improving fuel efficiency and shifting to low carbon fuels and transport modes. The agency also says the major goal of its transport-sector policy is to reduce dependence on oil.

Among the national policy shifts it recommends, the IEA supports development of urban transport systems and infrastructures using little or no oil and the intensive development of part-electric (hybrid) and all-electric cars. The IEA claims that by 2035 about 70% of global car sales (possibly 80-85 million per year at that date) will need to be advanced vehicles including hybrids, plug-in hybrids and all-electrics. This however is not advanced as an oil-saving strategy, but to meet the IEA's goal of not exceeding 450 ppm (parts per million) CO2 in the atmosphere and less than a 2 degC rise in world average temperatures by 2045.

Related to its anti-CO2 policy, the IEA gives no firm support to natural gas-fueled transport, both of heavy and light road transport, shipping and rail, all of which are in any case increasingly focused by the global transport energy shift away from oil, whether or not the IEA supports it. The IEA however actively supports the rapid global development of “new gas” resources, including deep offshore and onshore stranded gas reserves, shale fracture gas, coalbed methane and biomethane. The agency currently forecasts that due to fast-growing world gas supply, global prices may fall about 25%-33% from current price levels by 2017 while US gas prices may rise to about $5 - $6 per million BTU (about $33 per barrel equivalent).

Two reports from the IEA in 2012 “Technology Roadmap: Fuel Economy for Road Vehicles” and “Policy Pathway: Improving the Fuel Economy of Road Vehicles,” describe the technologies needed and the policy packages that can help improve fuel economy. As the reports said, about 92% of world road transport is presently oil-dependent, but the IEA sets a target of a 50% cut in fuel demand-per-vehicle by or before 2050. This would be able, the IEA claimed in these two reports, to substitute as much as “four fifths of current annual global oil consumption”.

To be sure, this depends on nation-by-nation totals for transport oil demand relative to total oil demand, but transport oil demand dominates all other oil demand in all countries. In the emerging economies, oil demand for the transport sector often takes more than 75% of national total oil demand. Cutting transport oil demand will have a much bigger “bang for the buck” than cutting electricity demand.

 The transport sector is therefore the largest unknown for estimating future oil demand, and oil demand growth – or decline – profiles for major regions and countries. The “proxy” for transport sector oil consumption by road vehicles is however well covered by refinery runs, stocks, and prices. Recent IEA data on global refinery runs suggests that outside specific and local market and technology issues, especially in the US, global refining output is currently growing at a very low rate (well below 0.6% a year). Linked with car sales, and just as important actual yearly mileage-per-car utilization trends, the major car fuel markets of the US, Europe, Japan and emerging Asia currently do not offer prospects for major oil demand growth.

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.

© 2013 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 advisor.

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