By Ole Hansen
(Head of Commodity Strategy,
Saxo Bank)
Brent Crude oil has, despite times of elevated uncertainty, been trading within a relative stable trading range during the last couple of years, especially compared with previous years where extreme peaks and troughs appeared. Looking ahead to 2013, we believe that this range trading will continue, as Brent Crude is currently sandwiched between several equal important factors, the combined sum of which should keep the price boxed in between $90 and $125 during the next couple of years.
During these past two years Brent Crude Oil has become the global benchmark for a majority of physical oil transactions, and also increasingly the preferred crude oil commodity in investment portfolios. Just recently we have seen two of the world’s most followed commodity indices, the S&P GSCI and DJ-UBS, both announce another percentage point weight increase of Brent in their portfolio for 2013 at the expense of WTI Crude, which still carries the highest weight but is sharply reduced from previous years.
The major spikes in Brent Crude during 2010 and 2011 were primarily triggered by both major and minor fears of supply disruptions, especially the Libyan civil war in early 2011 and the announcement of Iran sanctions due to uncertainties over its nuclear intentions in early 2012. Minor disruptions to production in Sudan, Nigeria, Syria and the North Sea also helped to support the price.
Up against these fears of supply disruptions, the global economy has been bumping along at a relative slow pace, resulting in only a small increase in global demand for oil. At times worries about recession, now realised in Europe, and other regions of the world has helped offset the above mentioned supply worries, resulting in minor (and a few major) downside corrections.
As a result the average price of Brent Crude has remained almost unchanged for the past two years at 110.75 $/barrel in 2011 and 111.70 $/barrel so far in 2012. Almost nine percent of all volume during the last two years has taken place between 110 and 111 while 54 percent of all traded volume has occurred within a narrow $9 range between $106 and $115.
The downside tail, as also seen below, is somewhat longer than the upside one. This can among other things be explained by the presence of speculative investors such as hedge funds and traders. Speculative traders react to market movements by either by adding or reducing exposure and the two peaks in oil price were both followed by one minor and a major sell-off as they were forced to reduce loss making positions . During such times of long liquidation we often find that the move gets extended much beyond what is warranted by the underlying fundamentals.
Now that we have determined two of the major drivers behind the price of oil, geopolitical concerns and speculative investment flows, let us take a look at some of the other reasons why we believe that the price of oil will remain range bound for the foreseeable future.
During the early parts of 2012 when the price of Brent Crude was elevated we often heard verbal intervention from Saudi Arabia’s Minister of Petroleum Al-Naimi in order to bring the price lower. As the Kingdom is one the world’s largest producer of oil and the only one with any available spare capacity, the world take notice when he speaks.
Following the embargo on Iranian oil they increased their production close to 10 million barrels per day in order to make good on his intention to help bring the price of oil back towards 100 USD/barrel, a level which is acceptable to both producer and consumer. With the global economy still in a fragile state of recovery high oil prices act as a deterrent for growth and thereby demand.
Rising prices due to geopolitical tensions also carries the risk of OECD nations stepping in to calm markets by releasing oil or products from its Strategic Reserves. Members of the International Energy Agency are obligated to hold an emergency reserve that would cover 90 days of imports and with the US the largest consumer, they currently hold nearly 700 million barrels, according to the US Department of Energy. Although the release in June 2011 - due to the loss of Libyan production - had a limited longer term impact, the threat of a release is sometimes enough to deter speculative investors from getting too involved, thereby preventing the price from moving even higher.
Outside OPEC the main growth in production in 2013 will come from US shale. This growth has already resulted in a dramatic reduction in net crude oil imports over the last five years.
The US Energy Information Administration (EIA) in their Annual Energy Outlook 2013 said that “The advent and continuing improvement of advanced crude oil production technologies continued to lift projected domestic supply” and they see production reaching 7.5 million barrel per day by 2019.
This paradigm shift in global oil markets over the coming decade could eventually, according to the International Energy Agency, see US production surpass Saudi Arabia.
Such an increase should help increase the buffer between demand and available supply, thereby reducing the risk of price spikes during periods of supply disruptions.
While global oil prices continue to be exposed to sudden sharp moves, primarily to the upside, caused by supply disruptions, the recent changes especially in new production methods should leave the market in better and less volatile place than in previous years. While the worry about peak oil may not have gone away, it has at least been postponed for a number of years. This will buy the world additional time to continue to improve production methods through new technology. This will increase the demand for natural gas – and the world has plenty of natural gas.
Meanwhile, the automobile industry will continue to improve the effectiveness of engines, something that is already making an impact on US gasoline consumption. It’s truly a paradigm shift and one we feel will be the biggest positive input to growth and markets over the next ten years. The fact that one of the byproducts is reduced carbon footprint does not make this a less appealing case. We see the price of Brent Crude remaining within the $90 to $125 range in 2013 with an average price around $111. The Peninsula
