World Crude Oil Markets: Crude Oil Price Forecast Update July ...
1100, 311 - 6 Avenue SW Calgary, Alberta T2P 3H2
WWW.FIRSTENERGY.COM
World Crude Oil Markets: Crude Oil Price Forecast Update
Time to Wade In. For the oil and the oil-levered equity
FirstEnergy Crude Oil Price Outlook West Texas Old NEW $99.75 $99.75
Old $98.52
NEW $98.52
Q1 Q2 Q3 est. Q4 est. Average est.
$43.31 $52.83 $58.00 $65.87 $55.00
$43.31 $59.79 $62.33 $66.58 $58.00
$45.72 $53.83 $58.00 $64.87 $55.61
$45.72 $59.90 $61.33 $65.58 $58.13
Q1 est. Q2 est. Q3 est. Q4 est. Average est.
$70.00 $75.00 $80.00 $75.00 $75.00
$70.00 $75.00 $80.00 $75.00 $75.00
$69.50 $74.50 $79.50 $74.50 $74.50
$69.50 $74.50 $79.50 $74.50 $74.50
2011 Average est.
$85.00
$85.00
$86.00
$86.00
2012 Average est.
$95.00
$95.00
$96.00
$96.00
2008 2009
2010
US $/BBL Average
July 13, 2009
Brent
investor we think the recent pull back in crude oil prices is the right opportunity to consider or reconsider the crude oil sector. If you are currently long, then hold to your position or add to it. If you are not yet participating, then wade into the space now. We see the latest pullback in crude oil prices (Figure 1) as a healthy correction in what is otherwise a slowly evolving return to the secular bull market that was in place up to the late stages of 2007. The 2008 price surge was more a function of runaway risk taking, U.S. dollar depreciation, and investor fund flow that thoroughly disconnected prices from the fundamentals, and ultimately led to the demise of prices by the end of 2008. Figure 1: Nymex WTI Crude Oil Futures Price
Notes: All historical averages computed using weekday data only.
US $/BBL $150.00
$150.00
Source: FirstEnergy Capital Corp., Bloomberg; est. refers to forecasted value.
$140.00
$140.00
$130.00
$130.00
We have chosen to make little modification to our outlook for crude oil prices. We have raised our average WTI price expectation for 2009 by US $3 per barrel to US $58 per barrel. For all remaining years of our forecast we have made no change, still expecting US $75 per barrel in 2010, US $85 per barrel in 2011, with the longer term price target still being US $120 per barrel after 2013. Key conclusions from this price forecast update include: • The recent pullback in crude oil prices provides another opportunity for investors to further go long the oil space or to freshly enter the space. • We do not expect a further deterioration in crude oil prices from current levels and anticipate a more gradual and fundamentally supported crude oil price environment for the second half of 2009. • With cumulative supply reductions still outpacing demand losses, it is a simple matter of waiting for further erosion in crude oil and, eventually, refined product inventories, to generate additional price upside. • Gradual demand improvement in the emerging economies and declining spare capacity will be the hallmark of the crude oil market after 2010, setting the stage for a return in crude oil prices to the triple digit level. • We anticipate that Canadian light-heavy crude oil price differentials will remain snug for the remainder of 2009, followed by a modest widening in 2010. On a percentage basis we expect the differential will be much tighter than recent historic averages.
$120.00
$120.00
$110.00 $100.00 $90.00 $80.00
2007 Avg: $72.41 2008 Avg: $99.75 2009 YTD: $52.30
$110.00
(to July 10, 2009)
$80.00
$100.00 $90.00
$70.00
$70.00
$60.00
$60.00
$50.00
$50.00
$40.00
$40.00
2007
$30.00
2008
2009
$30.00
$20.00
$20.00 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
Source: FirstEnergy Capital Corp., Bloomberg.
The most recent run in crude oil prices from the US $50s per barrel in March 2009 to over US $70 per barrel in June 2009 was also driven more by non-fundamental factors than fundamental ones. With the price pullback, the current price range for WTI in the high US $50s to low US $60s per barrel we think is now more indicative of constructive and slowly improving fundamentals and that the market is not setting up for a correction back to the US $30s or US $40s per barrel. Why do we think this? Six months ago the world crude oil market was characterized by free falling demand, rising inventories, relentlessly negative headlines in global finance, and OPEC supply cuts that had yet to take much of a bite and over which the market was expressing skepticism. Fast forward six months to today and demand has stabilized, inventories of crude oil are falling, financial conditions have stabilized to improved, and OPEC’s supply cuts have looked very credible, though eroding a bit
Analyst: Martin King 403-262-0625 • [email protected]
Page 1 of 10 The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. While the accuracy or completeness of the information contained in this document cannot be guaranteed by FirstEnergy Capital Corp., it was obtained from sources believed to be reliable. FirstEnergy Capital Corp. and/or its affiliates may have acted as financial adviser and/or underwriter during the past twelve months for certain of the issues mentioned herein and may have received remuneration for such services. FirstEnergy Capital Corp. and/or its officers, directors and employees may from time to time acquire, hold or sell positions in the securities mentioned herein as principal or agent. FirstEnergy Capital (USA) Corp., a member of the National Association of Securities Dealers Inc., is a wholly owned subsidiary of FirstEnergy Capital Corp. and operates as a Broker-Dealer in the United States.
World Crude Oil Markets: Crude Oil Price Forecast Update
July 13, 2009
of late, but have clearly begun to take a significant bite from supplies.
from the supply side first, with the demand side providing additional support and lift once we enter 2010.
In other words, the fundamentals at present are not that great, but they are nowhere near as bad as they were six months ago. Prices can hold into this recently corrected range and a revisit of the crude oil price lows at the start of this year in the US $30s and US $40s per barrel is very unlikely.
Moderate Gains for H2 2009. We see prices as generating some modest upside from the corrected levels of 2009 driven by several factors:
For the oil investor going forward, this will remain more of a supply driven story into Q1 and Q2 2010. Since we do not expect much in the way of oil demand improvement in many of the major economies until some point next year, and then, not even that much, relying on scattered and premature positive demand headlines in the oil sector as a cue to invest may well prove to be unwise. We will definitely take positive demand headlines as supportive for the sector, we just think that there will not be that many of these headlines for some time. Indeed, the latest price pullback has been partly and refreshingly driven by the realization that demand fundamentals still look stagnant despite market euphoria for claiming that a demand rebound was imminent. Overall, expect a more gradual and fundamentally driven push for crude oil prices into the second half of 2009. A move back into the US $70s per barrel will happen again toward the end of this year and will have more cumulative supply effects and inventory reductions to back it up. Once arriving at 2010, the demand side of the story should also show some small promise and prices may take a run at the US $80s per barrel range over the course of the year. Whether it be the fundamentals or the fundamentals augmented by other factors, the crude oil sector is going to remain attractive and relatively outperforming of the rest of the market for the remainder of 2009 and well into 2010. The waters may not seem that inviting at the moment, but it is time to wade in if you have not already done so.
1. Demand trends in the major consuming nations have stabilized, but little else (Figure 2). Despite the market’s seemingly early insistence that macroeconomic trends are improving from the financial implosion of 2008, there is little evidence yet that oil demand has been turning up. At best, we expect that demand can hold steady, with some slight improvement into the late stages of this year, and with year-over-year comparisons that will become much easier when compared to very weak levels of late 2008. Figure 2: Year-over-Year Change in OECD Monthly Demand Thousand B/d 1,000 500 0 (500) (1,000) (1,500) (2,000) (2,500) (3,000) (3,500) (4,000) Jan-07
These fundamentals are improving, but they certainly do not involve a tremendous improvement in demand, as has been the wont of the market to date. In general, our view has been that steady price improvement would emanate
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
2. There is still plenty of inventory, whether it be crude oil or refined product. Although inventories of crude oil have been coming down thanks to OPEC’s supply reductions, crude stocks are still high by historical standards (Figure 3). Compounding this problem is that stocks of refined products are even more bloated as end user demand has finally stopped falling, but has failed to make a sustained push to higher levels. Aside from the
It Still Adds Up. The simple reason for little change to
our price outlook is that we feel that the fundamentals have been evolving in a fashion that we have been forecasting and that this is a market simply not quite ready to make a major move to the upside in terms of price. The strong run in prices of May and June was just not supported by the fundamentals, and the price correction that has been witnessed in early July is a return to levels that are more reasonable given the current set of fundamentals.
Jul-07
Source: FirstEnergy Capital Corp., IEA.
Figure 3: OECD Inventories of Crude Oil Million Barrels 1,050
1,050
1,030
1,030
1,010
1,010
990
990
970
970
950
950
930
930
910
910
890
890
870
5 Yr. High-Low Range
2007
2008
2009
850 Jan
870 850
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Source: FirstEnergy Capital Corp., IEA.
Page 2 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update problem of high inventories on land is the still looming issue of unwinding all of the crude oil and refined product that is still being held in floating storage. 3. Supply trends, as mentioned earlier, are the one factor where there has been significant change over the first half of 2009. This remains the single biggest reason as to why crude prices have stabilized and have improved since early 2009. Obviously, most of this supply reduction is due to the efforts of OPEC in terms of getting barrels off the market (Figure 4). This has been the source of crude oil inventories coming off their highs and looking destined to move to steadily lower levels for the second half of 2009. Though the cartel has been leaking more barrels of late, helping prices to moderate, we do not expect that there will be a flood of new supply from the cartel for some time. Figure 4: OPEC Production Levels Versus Quota Thousand B/d 31,000 30,000 29,000 28,000 27,000 26,000 25,000 24,000 23,000
OPEC 11 Quota
22,000
OPEC 11 Production
21,000 Jan00
Jan01
Jan02
Jan03
Jan04
Jan05
Jan06
Jan07
Jan08
Jan09
July 13, 2009
only in response to encouraging positive trends developing in demand. For now, it is a matter of sitting back and waiting for the supply reductions to continue to impact the market. The end result will be a steady, but gradual improvement in pricing for the remainder of 2009 until some measure of demand growth can return in 2010. Price Pressure in 2010 and Beyond. It is upon reaching 2010 where we think prices will have a much firmer base to hold the US $70+ per barrel range that we are forecasting and perhaps make a move into the US $80s per barrel. However, we do not expect run away prices as there will still be structural elements in place that should hold prices back, until these become tighter in 2011 and 2012. 1. Upon reaching 2010, demand trends should start to improve, with most of the growth coming from the emerging economies of the Non-OECD. Although widely expected with a projected increase in global GDP growth, some modest signs of demand growth in the developed economies will further provide a better base for firm pricing (Figure 6). An additional factor between now and the first half of 2010 is that the market will be seeing some improving economic trends, but will also pass through the next heating season in the Northern Hemisphere which could help further boost demand and draw down refined product stocks depending on the severity of the winter weather. Figure 6: World GDP Growth versus Crude Oil Demand Growth
Jan10
12.0%
Oil Demand Growth
10.0%
Source: FirstEnergy Capital Corp., Bloomberg.
This is a market that is still being fundamentally driven to gradually higher prices more as a result of supply changes than demand changes. As such, our view that the cumulative effects of the supply reductions to date have begun to overtake the cumulative negative demand impacts still holds and remains the primary driver of the market in the short-term (Figure 5). Supply will only move significantly higher when OPEC allows it to happen, and
World GDP Growth
8.0%
Forecast
6.0% 4.0% 2.0% 0.0% -2.0% -4.0%
Figure 5: World Oil Demand Versus Supply 5.0 4.0 3.0
-6.0% 1970
Million B/d
5.0
Non-OPEC OPEC Supply Demand
Forecast
4.0 3.0
2.0
2.0
1.0
1.0
0.0
0.0
(1.0)
(1.0)
(2.0)
(2.0)
(3.0)
(3.0)
(4.0) (4.0) 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1
1974
1978
1982
1986
1990
1994
1998
2002
2006
2010
Source: FirstEnergy Capital Corp., IEA, IMF.
2. Inventories should be returning to more reasonable and historically average levels by the middle stages of 2010 (Figure 7). By that time, OPEC supply reductions will have had a full chance to work through their inventory levels of crude oil, through the refinery processing level, and eventually impacting refined product inventories. With more than a year of inventory reduction in hand from early 2009 into mid-2010, this should be plenty of time to unwind that immense stock overhang that has been established, even when compared against a modest demand recovery.
Source: FirstEnergy Capital Corp., IEA.
Page 3 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update Figure 7: OECD Monthly Days of Forward Cover Days 64 62
64
5 Year Hi-Lo
62
Days of Cover
60
60
58
58
56
56
54
54
52
52
50
50
Forecast
48 46 Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
12,000 20%
Spare Capacity as % of World Supply
10,000
Forecast
All spare capacity is centered in OPEC.
8,000 6,000
15%
10%
4,000 5%
46
0
0% 1980
1985
1990
1995
2000
2005
2010
2015
Source: FirstEnergy Capital Corp., IEA, US DOE/EIA, Pennwell.
Figure 8: OPEC Crude Oil Production
33.0
Forecast
32.0 31.0 30.0 29.0 28.0 27.0 26.0 25.0 24.0 2006 Q1
25%
Spare Capacity
Jan-10
Million B/d 34.0
2005 Q1
Thousand B/d 14,000
2,000
3. OPEC will only begin to make deliberate and large additions to supply in the second half of 2010, making sure that demand has begun to recover first (Figure 8). When combined with our view of further deterioration in Non-OPEC supplies, then the market will be in a far better position to begin bidding for barrels with higher prices.
2004 Q1
Figure 9: Estimated Global Spare Crude Oil Wellhead Productive Capacity
48
Source: FirstEnergy Capital Corp., IEA.
July 13, 2009
2007 Q1
2008 Q1
2009 Q1
2010 Q1
less supply than demand and letting that combination work its way through global inventory levels this year and next.
Demand. Our outlook for global crude oil demand has
not changed that materially since our previous outlook (Figure 10). We estimate that demand will post a second consecutive year of decline in 2009 in the range of 2.1 million B/d, followed by growth in 2010 and 2011 in the range of 0.9 million B/d. Though the first back-to-back years of oil demand decline since the early 1980s, our demand outlook remains far more optimistic than the latest outlook from IEA in which it is calling for a 2009 demand decline of 2.5 million B/d. This also underscores what we believe has been a negative headline driven trend that has been clouding the demand outlook of the major forecasting agencies. We believe that the low crude oil prices that marked the end of 2008 and start of 2009, though partly undone at the mid-point of this year, are still encouraging a return of demand, especially in those countries where it will matter the most: the emerging economies.
2011 Q1
Figure 10: Change in World Petroleum Demand
Source: FirstEnergy Capital Corp., IEA.
4. Spare capacity inside OPEC is currently at one of its highest levels seen in many years, but will begin to steadily erode over the next few years (Figure 9). The major wellhead capacity additions seen at mid-year 2009 are essentially the bulk of what had been expected out of the cartel, and there will not be much in the way of capacity adds, at least for crude oil, in the next few years. Though acting as damper on prices for 2009 and 2010, and keeping the market under US $100 per barrel, a lack of spare capacity will start to become more of an issue in the post2011 timeframe. Combined with what will be close to a million barrels per day of supply loss from the Non-OPEC nations by that time, then we feel that prices will begin to make the move back to the triple digit range.
Million B/d 3.5
2.97
3.0 2.5
Forecast
2.0
1.65
1.5 1.0
0.75 0.67 0.72
0.5
1.38
1.05
1.26 0.96 0.90 0.92 (0.28)(2.13)
0.0 (0.5) (1.0) (1.5) (2.0) (2.5)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: FirstEnergy Capital Corp., IEA.
All, in the fundamentals have improved off the very miserable looking conditions of late 2008 and early 2009. For now it is a simple matter of trusting the arithmetic of Page 4 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update It is these emerging economies of the Non-OECD where we expect that demand will move back into positive territory before the end of this year. The unstoppable demographics of many of these nations and what is a gradual return to the positive in per capita income growth, all assure that oil demand is returning to the positive after a short lull in the past six months. Overall, it is these nations that will provide the growth story for world oil demand going forward, a theme that we have been pursuing for several years (Figure 11).
July 13, 2009
healing such as improving consumer balance sheets, better financial stability, shaky, but rising consumer confidence, and signs that some industries are starting to see additional activity as the inventory backlog has been depleted. However, demand growth trends, especially in the developed economies, will remain very slow.
Supply. We continue to believe that most market
0.0
watchers remain overly optimistic on Non-OPEC supplies. Despite the potential for improving trends in some regions such as Russia, the overall direction for NonOPEC supply is downward for the next several years. Indeed, our current outlook for Non-OPEC supply declines may still actually be too conservative and provides the potential for price upside (Figure 13).
(0.5)
Figure 13: Change in Non-OPEC Petroleum Supply
Figure 11: OECD Oil Demand Growth Million B/d 0.5
(Incl. FSU, Indonesia; Excl. Angola, Ecuador)
(1.0)
Thousand B/d 1,400
(1.5)
1,200
1,165
1,000
(2.0)
Forecast
(2.5)
800 600
1,183 845 872
Forecast
649
577 445
400
(3.0)
200 (3.5)
(201)
0 2007 Q1 2007 Q3 2008 Q1 2008 Q3 2009 Q1 2009 Q3 2010 Q1 2010 Q3
Source: FirstEnergy Capital Corp., IEA.
On the other hand, the developed economies of the OECD are likely to be looking to get demand back to flat, at best, by the end of this year or early in 2010. This is about all that we expect to come from these nations as energy efficiency gains, slow income growth and environmental restrictions will likely begin a steady erosion of demand going forward. For the foreseeable future, after a possible bout of small positive growth in 2010, we expect that oil demand in these nations will be in steady decline well into the next decade and beyond (Figure 12). Figure 11: OECD Oil Demand Growth Million B/d 0.5 0.0 (0.5) (1.0) (1.5) (2.0)
Forecast
(2.5) (3.0) (3.5)
2007 Q1 2007 Q3 2008 Q1 2008 Q3 2009 Q1 2009 Q3 2010 Q1 2010 Q3 Source: FirstEnergy Capital Corp., IEA.
In the very short-term, the next few quarters of demand growth will likely be very uneven and this is what is causing the greatest pause for prices at mid-year 2009. There are some aspects of demand that are showing
(228) (475)(905) (472) (310)
(200) (400) (600) (800) (1,000) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: FirstEnergy Capital Corp., IEA.
We think there is no getting away from the very steep declines that are impacting such regions as Mexico and the North Sea. Moreover, even the previous growth region of the United States in late 2008 and early 2009 is now starting to sputter sooner than expected, despite the several large new producing projects in the Gulf of Mexico. The simple reason that Non-OPEC supply is still losing ground is, aside from natural geology, has been the lack of sufficient capital reinvestment in the producing regions. The sharp price pullback of last year and what has proven to be a wild ride for prices this year, has underscored the need for Producers to maintain capital discipline and keep spending on a tight leash. In addition, even some of the bright future prospects for supply growth such as Brazil and offshore West Africa, have recently run into speed bumps, suggesting that a more conservative growth path, and not a media headline driven one, remains the more prudent course when forecasting future supply growth. As always, OPEC supply trends remain the best friend or enemy of market watchers, depending on which side of the market you may be sitting (see Figure 4). After staging what may be the most impressive production reduction in its history in so short a time in late 2008, OPEC seems to be once again becoming a victim of its own success. With oil Page 5 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update prices having staged a sharp rally since March of this year, OPEC members, especially the non-Persian Gulf core members, have begun to leak more barrels into the marketplace. Quota discipline has been eroding from better than 80% a few months ago to near 70% recently. It is this “leakage” of barrels that we think we may act as a price damper on the market for the second half of 2009 as described earlier, and will also act a catalyst for senior cartel members to crack the whip on other members in terms of dialing back production once again. Our present outlook envisions such an outcome, but we feel that the cartel will not be quite as successful in achieving as much discipline as it saw earlier this year. Beyond the quota problems of 2009, we are forecasting that the cartel will have to steadily put more barrels into the marketplace in 2010 and beyond in order to satisfy even the modest degree of demand growth that we have forecast. With Non-OPEC supplies facing further losses, OPEC will have to be the supplier of last resort for the market, especially once its earlier production cuts are fully felt in 2010 in terms of returning global days of inventory cover back to more normal historical levels (Figure 14). Figure 14: Global Days of Forward Inventory Cover Days 53.0 52.0 51.0
53.0
Days of Cover 4Q Moving Average
52.0
Forecast
51.0
50.0
50.0
49.0
49.0
48.0
48.0
47.0
47.0
46.0
46.0
45.0
45.0
44.0
44.0
43.0 43.0 1995 Q1 1997 Q3 2000 Q1 2002 Q3 2005 Q1 2007 Q3 2010 Q1 2012 Q3 Source: FirstEnergy Capital Corp., IEA.
At this stage, we see the cartel as facing little problem in terms of meeting that production call for the next couple of years. The significant expansion in productive capacity that has been put in place at mid-year 2009 (Figure 15), primarily in Saudi Arabia, should lay to rest the notion that the market will be facing tight productive capacity in the near term for quite some time. It is only once the market starts to see the conditions heading into 2012, that we expect that spare productive capacity will once again start to become a serious issue, contributing to the much higher prices that we are forecasting north of US $100 per barrel by this time. Meanwhile, in the very short run, it is this latest productive capacity expansion that should also alleviate any worries over supply distortions from such volatile suppliers as Nigeria.
July 13, 2009
Figure 15: OPEC Spare Crude Oil Wellhead Productive Capacity
Thousand B/d 8,000 7,000
8,000 7,000
Other OPEC Saudi Arabia Effective
6,000
6,000
5,000
5,000
4,000
4,000
3,000
3,000
2,000
2,000
1,000
1,000
0
0
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08 Jul-08
Jan-09
Jul-09
Jan-10
Source: FirstEnergy Capital Corp., IEA.
Inventories. Solving the inventory overhang for the
global crude oil and refined product markets is the key, as it usually is, to setting the tone for future price direction. We continue to believe that, even in the generally modest demand growth environment that we are forecasting, global inventories will begin to unwind to lower levels over the next few quarters. Earlier, we indicated that the aggregate supply reductions on a cumulative basis, mostly engineered by OPEC, have begun to outpace the cumulative effects of the demand slowdown. The simple arithmetic points to inventory reductions at the primary, or crude oil, level. The fact that crude oil inventories in key markets such as the United States have been steadily dropping (Figure 16), even in light of very slow refinery activity, is very supportive of our view that sufficient barrels have been taken off the market to correct that earlier oversupply and that crude oil inventories will continue to decline to more historic averages. It is at the refined product level where more uneven improvement will be seen over the next few quarters. These inventories currently remain very high by historic Figure 16: U.S. Inventories of Crude Oil Million Barrels 380
(Excluding Strategic Petroleum Reserve)
380
370
370
360
360
347.30
350
350
340
340
330
330
320
320
310
310
300
300
290
290
280
280
270 260
270
5 Yr Hi-Lo
2006
2007
2008
2009
250 Jan-2
260 250
Feb-13 Mar-27
May-8
Jun-19
Jul-31 Sep-11 Oct-23
Dec-4
Source: FirstEnergy Capital Corp. US DOE/EIA.
Page 6 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update
$40 per barrel range seen at the start of this year are diminishing quickly.
Figure 17: OECD Inventories of Refined Products Million Barrels 1,600
1,600
5 Yr. High-Low Range
1,550
2007
2008
2009
1,550
1,500
1,500
1,450
1,450
1,400
1,400
1,350
1,350
1,300
1,300
1,250
1,250
1,200
1,200
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
July 13, 2009
Dec
Source: FirstEnergy Capital Corp., IEA.
standards (Figure 17) especially for the distillates category, likely the most economically sensitive of the refined products. Given the pace of demand recovery that we are seeing in the developed economies, there may be little movement lower in the majority of refined product inventories for the remainder of 2009, and yet another component of our price moderation view for H2 2009. However, there is no getting away from the fact that even in the face of demand stabilization and slow recovery into 2010, the very slow pace of refinery activity will eventually result in a reduction of refined product inventories. It will take time, but by the second half of 2010, inventories should be returning to more historical levels along with days of forward cover for refined products. It is the inventory situation in the emerging economies which we think could provide an inventory wildcard for the market, especially for price upside. Given that inventory data for these countries is very limited or nonexistent, getting a good sense for what is happening can only be determined indirectly. However, we expect refined product inventories in the developed economies may be further run down in the months and quarters ahead at a faster rate than some are thinking as it will be the developing economies which will be staging a faster economic rebound than the developed economies. Even the significant overhang of floating refined product inventories should be undermined as term price structures for refined products flatten out in the months ahead and prior to heading into the Northern Hemisphere’s winter. All in, global days of forward inventory cover will be declining. We see no way to get around the supply and demand math that a sizeable inventory correction is underway. It is the speed of this inventory correction that will partly set the pace for the price recovery. With the worst of the inventory build up now behind us, and crude oil inventories starting to decline globally, the odds of a price reversal back to the low levels in the US $30 and US
Canadian Crude Oil Markets. With the 2009 heavy
crude oil market still looking very snug, we have elected to further tighten our light-heavy crude oil price differentials for 2009 by several dollars compared to our previous outlook. For 2010 and beyond, we have made no change to our price spread outlook and still expect that the price spread on a percentage basis to the WTI marker will remain tighter when compared to recent historical averages. FirstEnergy Crude Oil Price Differential Outlook
2008
$/BBL Average
Ed Light-Bow Cdn$ NEW Old $18.45 $18.45
WTI-WCS US$ Old NEW $20.36 $20.36
2009
Q1 Q2 Q3 est. Q4 est. Average est.
$6.03 $11.00 $10.00 $14.00 $10.26
$6.03 $4.05 $6.67 $12.00 $7.19
$9.03 $11.00 $10.00 $14.00 $11.01
$9.03 $7.94 $9.67 $12.00 $9.66
2010
Q1 est. Q2 est. Q3 est. Q4 est. Average est.
$15.00 $14.00 $13.00 $16.00 $14.50
$15.00 $14.00 $13.00 $16.00 $14.50
$15.00 $14.00 $13.00 $16.00 $14.50
$15.00 $14.00 $13.00 $16.00 $14.50
2011 Average est.
$15.50
$15.50
$15.50
$15.50
2012 Average est.
$19.00
$19.00
$19.00
$19.00
Notes: All historical averages computed using weekday data only. Source: FirstEnergy Capital Corp., Bloomberg; est. refers to forecasted value.
If our global crude oil market discussion sounds a bit on the optimistic side, then it is the heavy crude oil market for Canadian Producers that remains downright positive. Light-heavy crude oil price spreads have remained very tight over the first half of 2009 and we expect only a moderation in this tightness for the remainder of the year. The building blocks for this price spread tightening have been a long time in the making and remain generally consistent with the tighter price spread outlook that we have been expecting for several years. Those building bocks have been very closely aligned during 2009 as the WCS-WTI price spread has generally held under US $10 per barrel (Figure 18). We think that a good part of this tightness is actually more of a demand issue as opposed to a lack of supply in the market. Specifically, the rather mediocre looking crack spreads that refiners have been facing since Q4 2008 have persisted well into the middle of this year, especially for distillate margins. This has led to refiners in North America bidding for the cheapest - i.e. heavier - crude oil barrels that they can find. This bargain hunting, in attempt to pad refining margins, has led to the rather surprisingly tight light-heavy spreads that have been seen so far in 2009. Moreover, we expect that this situation will continue for the remainder of this year at a minimum, as refiners will be facing bloated stocks for numerous refined product Page 7 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update FirstEnergy Canadian Crude Oil Price Outlook Edmonton Light Old NEW $102.70 $102.70
Bow River Stream Old NEW $84.25 $84.25
W. Canada Select Old NEW $82.50 $82.50
Q1 Q2 Q3 est. Q4 est. Average est.
$50.23 $63.04 $68.60 $78.33 $65.05
$50.23 $66.18 $69.47 $74.81 $65.17
$44.20 $52.04 $58.60 $64.33 $54.79
$44.20 $62.13 $62.81 $62.81 $57.98
$42.28 $52.29 $59.26 $63.25 $54.27
$42.28 $60.17 $61.23 $62.98 $56.66
Q1 est. Q2 est. Q3 est. Q4 est. Average est.
$82.34 $87.29 $92.12 $83.23 $86.24
$77.55 $82.27 $87.39 $81.33 $82.13
$67.34 $73.29 $79.12 $67.23 $71.74
$62.55 $68.27 $74.39 $65.33 $67.63
$66.27 $72.62 $78.82 $67.05 $71.19
$62.50 $68.54 $74.86 $65.56 $67.86
2011 Average est.
$89.61
$89.37
$74.11
$73.87
$74.89
$74.70
2012 Average est.
$98.00
$98.00
$79.00
$79.00
$80.00
$80.00
Cdn $/BBL 2008 Average 2009
2010
Notes: All historical averages computed using weekday data only. Source: FirstEnergy Capital Corp., Bloomberg; est. refers to forecasted value.
categories and will continue to seek the cheapest barrels on the market. OPEC production cuts initiated late last year, though looking to be losing some traction of late, have also helped to tighten global light-heavy price spreads. With the OPEC nations taking their heavier and more sour barrels off the market first, this helped to alleviate some of the pressure on global and North American heavy oil markets. On the flipside, it is the gradual erosion of OPEC discipline and the “leakage” of these barrels that partly contributes to our view for some widening in the absolute dollar price spread in the latter stages of this year. Overall heavy oil production has improved in the last few months for Canada, but it is still lagging well behind where many in the marketplace thought it would be just 6 to 12 months ago. Underperformance has dogged some projects, while start-up problems and deferrals have plagued others, but are now starting to become a thing of the past as the enormous pressures have begun to ease on heavy oil and oil sands projects. This supply Figure 18: Canadian Crude Oil Differential WTI Versus Western Canada Select US$/BBL $50.00
2006
$45.00
2007
2008
$35.00
$50.00
2009
$45.00 $40.00 $35.00 $30.00
$25.00
$25.00
$20.00
$20.00
$15.00
$15.00
$10.00
$10.00
$5.00
$5.00
$0.00 Jan-2
$0.00 Feb-20
Apr-10
Source: FirstEnergy Capital Corp., Bloomberg.
May-29 Jul-17 Weekly Average
Sep-4
Oct-23
All seems to be running well for the Southern Access pipeline expansion (400 thousand B/ d), and the Keystone pipeline (435 thousand B/d) into the U.S. Midwest is still scheduled to enter service toward the end of this year. This will effectively create more shipping capability than the market can fill with heavy oil supply, so we anticipate that pipeline constraints will be absent for some time, possibly for next the several years.
All of these factors, combined with our long stated view that Canadian heavy oil is facing declining competition from other heavy oil sources in the Western Hemisphere, keeps us very optimistic that heavy oil prices can remain generally tight on a percentage basis versus the WTI price marker, though perhaps not quite as tight as has been in 2009 (Figure 19). Although our forecast has the absolute dollar price differential rising over time, this is consistent with a generally low percentage price spread versus historical averages (Figure 20). Figure 19: Ratio of the WTI-WCS Price Differential to the Price of WTI 70%
70%
2006 60%
2007
2008
2009 60%
2007 Avg: 32.0% 2008 Avg: 22.7% 2009 YTD: 17.2%
50%
50%
(to Jul 3, 2009)
40%
40%
30%
30%
20%
20%
10%
10%
Jan-2
(to Jul 3, 2009)
$30.00
underperformance has allowed the some aspects of the demand story (i.e. refiners) to get a grip on limited barrels, while at the same time allowing pipeline capacity expansions to catch up and overtake what was thought to be a lagging race against production increases.
0%
2007 Avg: $23.56 2008 Avg: $20.30 2009 YTD: $8.48
$40.00
July 13, 2009
Dec-11
0% Feb-13 Mar-27 May-8 Jun-19 Jul-31 Sep-11 Oct-23
Dec-4
Source: FirstEnergy Capital Corp., Bloomberg.
Depending on the speed at which other countries such as Mexico and Venezuela experience production declines, and the magnitude of future expansions in pipeline access from the U.S. Midwest to the U.S. Gulf Coast, our outlook for light-heavy price spreads on a absolute dollar and percentage basis may still be too conservative. In other words, even tighter price spreads than many thought possible even just a year ago, could be developing for the North American heavy crude oil market going forward, especially in an environment where poor demand trends continue to squeeze refinery margins, necessitating steady and strong bids for heavy oil by refiners. Page 8 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update Figure 20: WTI-WCS Price Spread and % Discount US $/BBL $30.00
WTI-WCS Spread % of WTI
45.0%
$23.57 $21.57 $21.00 $20.36
$25.00 $20.00 $15.00
Forecast
40.0% 35.0%
$19.00 30.0% $15.50 25.0% $14.50
$13.59 $10.58
$10.00
$8.19
20.0%
$8.82
$9.54
15.0%
$6.53
10.0%
$5.00 5.0% $0.00
0.0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: FirstEnergy Capital Corp., Bloomberg, Enerdata.
Conclusions. The wild crude oil price swings in the past
12 months are a testament to what is still one of the world’s most dynamic industries. From a forecasting perspective, we do not expect things to get any easier as there will be periods of time where seemingly inexplicable price swings to the upside and the downside will occur, and likely in a very rapid fashion. This is also a reflection of crude oil becoming a financial instrument beyond the fundamentals. The commodity inflation hedge is now more alive and well than it has been since the late 1970s and early 1980s, the last period of time when the global economy was passing through a period of sustained rising inflation coupled with strong and rising crude oil prices. We expect that financial flows will remain very potent in generating price volatility for the market and that financial capital will be looking for a home against which to protect itself from what will be a rising inflation threat at some point in the next 24 months. In a similar vein, is the story of U.S. dollar effects. In a world of rising inflation and one in which the United States is clearly racking up immense and unsustainable Figure 21: Near Month Nymex Crude Oil Price versus the USD-EUR Exchange Rate US $/BBL $150.00
USD/EUR 1.66
$140.00
1.62
$130.00
1.58
$120.00
1.54
$110.00
1.50
$100.00
1.46
$90.00
1.42
$80.00
1.38
$70.00
1.34
$60.00 $50.00 $40.00 $30.00 Jan-07
1.30
Nymex WTI USD versus EUR (rhs) Jul-07
Jan-08
Jul-08
Source: FirstEnergy Capital Corp., Bloomberg, Pacific Exchange Rate Service.
1.26 1.22 Jan-09
Jul-09
Jan-10
July 13, 2009
budget deficits, these deficits will have to monetize at some point, if not already being done so. The subsequent knockon effects merely add to the broader inverse commodity play against want will be a declining exchange value of the U.S. dollar (Figure 21). Beset by significant shifts in supply and demand factors, the market is now even more keenly aware of these impending financial plays, aside from the usual desire to send money to where it will fetch the best return at a moment’s notice. This alone will generate huge capital inflows and outflows from the commodity space depending on the relative performance of other asset classes, creating additional price volatility. Risk appetite seems to be returning in many investing categories and commodities are no exception. However, we do not see that risk appetite for the rest of this year and 2010 as being anywhere near the hyperactive levels of 2008, when cheap and easy credit drove a levered buying frenzy in crude oil and which rapidly saw prices become completely divorced from the fundamentals. With the average consumer and many industries repairing balance sheets, the flow of easy credit into the commodity and crude oil space should be more limited for some time. As much as we would like to ignore these financially related factors and remain exclusively focused on the fundamentals, these are a fact of life in the increasingly dynamic crude oil market. However, when combining these with the market’s current state of affairs, we think that balance of price risk remains neutral but is definitely tending to the bullish side over the next 6 to 12 months (Table 1).
Table 1: Price Directional Factors Bearish Contango Brent vs. Nymex Crude Inventories Product Inventories Floating Storage Shipping Rates OPEC Supply vs. Demand Crack Spreads U.S. Dollar Equity/Credit Markets Open Interest Summary Sentiment
Price Direction Neutral Bullish X
X X X X X X X X X X X
What has been satisfying has been to see prices generally move in the direction and to the levels that we have been forecasting since the beginning of 2009. Even with the small changes we have made for 2009 expected prices, we generally remain more optimistic than the Street (Figures Page 9 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update 22 and 23) and more optimistic that the Nymex forward curve (Figure 24). Needless to say, we expect that the Street and the forward curve will continue to migrate to our view of the world.
July 13, 2009
Figure 23: Expectations for the Price of WTI in 2010 US $/BBL $95.00
(As of Jun. 25, 2009 survey; Nymex value as of Jul. 10, 2009) (Consensus estimate does not include Nymex value)
FirstEnergy
$90.00
All in, the crude oil market is undergoing a huge healing process from the wrenching financial and fundamental wounds that it suffered in 2008. All wounds take time to heal. This healing process will be measured by a gradual return to higher prices as the world once again comes to grips with what will be a daunting supply challenge.
Consensus
$85.00
Nymex
$80.00 $75.00
$70.87
$70.00
$75.00
$67.20
$65.00 $60.00 $55.00
Figure 22: Expectations for the Price of WTI in 2009
$50.00
(As of Jun 25, 2009 survey; Nymex value as of Jul. 10, 2009) (Consensus estimate does not include Nymex value) US $/BBL $85.00 $80.00
$45.00 $40.00 1
Consensus
$75.00
Nymex
$70.00 $65.00
$55.00
5
7
9
11 13 15 17 19 21 23 25 27 29 31 33 Number of Analysts
FirstEnergy Figure 24: Nymex Crude Oil Futures Strip versus FirstEnergy Crude Oil Price Forecast
$58.00 $56.28 $56.76
$60.00
3
Source: FirstEnergy Capital Corp., Reuters.
US $/BBL $150.00
$150.00
$50.00
$140.00
FCC July Forecast
$140.00
$45.00
$130.00
Nymex Strip as of Jul. 10, 2009
$130.00
$40.00
$120.00
$120.00
$35.00
$110.00
$110.00
$30.00
$100.00
$100.00
$90.00
$90.00
$80.00
$80.00
$70.00
$70.00
$60.00
$60.00
$50.00
$50.00
$40.00
$40.00
1
3
5
7
9
Source: FirstEnergy Capital Corp., Reuters.
11 13 15 17 19 21 23 Number of Analysts
25
27 29
31 33
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: FirstEnergy Capital Corp., Bloomberg.
Page 10 of 10
WWW.FIRSTENERGY.COM
World Crude Oil Markets: Crude Oil Price Forecast Update
Time to Wade In. For the oil and the oil-levered equity
FirstEnergy Crude Oil Price Outlook West Texas Old NEW $99.75 $99.75
Old $98.52
NEW $98.52
Q1 Q2 Q3 est. Q4 est. Average est.
$43.31 $52.83 $58.00 $65.87 $55.00
$43.31 $59.79 $62.33 $66.58 $58.00
$45.72 $53.83 $58.00 $64.87 $55.61
$45.72 $59.90 $61.33 $65.58 $58.13
Q1 est. Q2 est. Q3 est. Q4 est. Average est.
$70.00 $75.00 $80.00 $75.00 $75.00
$70.00 $75.00 $80.00 $75.00 $75.00
$69.50 $74.50 $79.50 $74.50 $74.50
$69.50 $74.50 $79.50 $74.50 $74.50
2011 Average est.
$85.00
$85.00
$86.00
$86.00
2012 Average est.
$95.00
$95.00
$96.00
$96.00
2008 2009
2010
US $/BBL Average
July 13, 2009
Brent
investor we think the recent pull back in crude oil prices is the right opportunity to consider or reconsider the crude oil sector. If you are currently long, then hold to your position or add to it. If you are not yet participating, then wade into the space now. We see the latest pullback in crude oil prices (Figure 1) as a healthy correction in what is otherwise a slowly evolving return to the secular bull market that was in place up to the late stages of 2007. The 2008 price surge was more a function of runaway risk taking, U.S. dollar depreciation, and investor fund flow that thoroughly disconnected prices from the fundamentals, and ultimately led to the demise of prices by the end of 2008. Figure 1: Nymex WTI Crude Oil Futures Price
Notes: All historical averages computed using weekday data only.
US $/BBL $150.00
$150.00
Source: FirstEnergy Capital Corp., Bloomberg; est. refers to forecasted value.
$140.00
$140.00
$130.00
$130.00
We have chosen to make little modification to our outlook for crude oil prices. We have raised our average WTI price expectation for 2009 by US $3 per barrel to US $58 per barrel. For all remaining years of our forecast we have made no change, still expecting US $75 per barrel in 2010, US $85 per barrel in 2011, with the longer term price target still being US $120 per barrel after 2013. Key conclusions from this price forecast update include: • The recent pullback in crude oil prices provides another opportunity for investors to further go long the oil space or to freshly enter the space. • We do not expect a further deterioration in crude oil prices from current levels and anticipate a more gradual and fundamentally supported crude oil price environment for the second half of 2009. • With cumulative supply reductions still outpacing demand losses, it is a simple matter of waiting for further erosion in crude oil and, eventually, refined product inventories, to generate additional price upside. • Gradual demand improvement in the emerging economies and declining spare capacity will be the hallmark of the crude oil market after 2010, setting the stage for a return in crude oil prices to the triple digit level. • We anticipate that Canadian light-heavy crude oil price differentials will remain snug for the remainder of 2009, followed by a modest widening in 2010. On a percentage basis we expect the differential will be much tighter than recent historic averages.
$120.00
$120.00
$110.00 $100.00 $90.00 $80.00
2007 Avg: $72.41 2008 Avg: $99.75 2009 YTD: $52.30
$110.00
(to July 10, 2009)
$80.00
$100.00 $90.00
$70.00
$70.00
$60.00
$60.00
$50.00
$50.00
$40.00
$40.00
2007
$30.00
2008
2009
$30.00
$20.00
$20.00 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
Source: FirstEnergy Capital Corp., Bloomberg.
The most recent run in crude oil prices from the US $50s per barrel in March 2009 to over US $70 per barrel in June 2009 was also driven more by non-fundamental factors than fundamental ones. With the price pullback, the current price range for WTI in the high US $50s to low US $60s per barrel we think is now more indicative of constructive and slowly improving fundamentals and that the market is not setting up for a correction back to the US $30s or US $40s per barrel. Why do we think this? Six months ago the world crude oil market was characterized by free falling demand, rising inventories, relentlessly negative headlines in global finance, and OPEC supply cuts that had yet to take much of a bite and over which the market was expressing skepticism. Fast forward six months to today and demand has stabilized, inventories of crude oil are falling, financial conditions have stabilized to improved, and OPEC’s supply cuts have looked very credible, though eroding a bit
Analyst: Martin King 403-262-0625 • [email protected]
Page 1 of 10 The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. While the accuracy or completeness of the information contained in this document cannot be guaranteed by FirstEnergy Capital Corp., it was obtained from sources believed to be reliable. FirstEnergy Capital Corp. and/or its affiliates may have acted as financial adviser and/or underwriter during the past twelve months for certain of the issues mentioned herein and may have received remuneration for such services. FirstEnergy Capital Corp. and/or its officers, directors and employees may from time to time acquire, hold or sell positions in the securities mentioned herein as principal or agent. FirstEnergy Capital (USA) Corp., a member of the National Association of Securities Dealers Inc., is a wholly owned subsidiary of FirstEnergy Capital Corp. and operates as a Broker-Dealer in the United States.
World Crude Oil Markets: Crude Oil Price Forecast Update
July 13, 2009
of late, but have clearly begun to take a significant bite from supplies.
from the supply side first, with the demand side providing additional support and lift once we enter 2010.
In other words, the fundamentals at present are not that great, but they are nowhere near as bad as they were six months ago. Prices can hold into this recently corrected range and a revisit of the crude oil price lows at the start of this year in the US $30s and US $40s per barrel is very unlikely.
Moderate Gains for H2 2009. We see prices as generating some modest upside from the corrected levels of 2009 driven by several factors:
For the oil investor going forward, this will remain more of a supply driven story into Q1 and Q2 2010. Since we do not expect much in the way of oil demand improvement in many of the major economies until some point next year, and then, not even that much, relying on scattered and premature positive demand headlines in the oil sector as a cue to invest may well prove to be unwise. We will definitely take positive demand headlines as supportive for the sector, we just think that there will not be that many of these headlines for some time. Indeed, the latest price pullback has been partly and refreshingly driven by the realization that demand fundamentals still look stagnant despite market euphoria for claiming that a demand rebound was imminent. Overall, expect a more gradual and fundamentally driven push for crude oil prices into the second half of 2009. A move back into the US $70s per barrel will happen again toward the end of this year and will have more cumulative supply effects and inventory reductions to back it up. Once arriving at 2010, the demand side of the story should also show some small promise and prices may take a run at the US $80s per barrel range over the course of the year. Whether it be the fundamentals or the fundamentals augmented by other factors, the crude oil sector is going to remain attractive and relatively outperforming of the rest of the market for the remainder of 2009 and well into 2010. The waters may not seem that inviting at the moment, but it is time to wade in if you have not already done so.
1. Demand trends in the major consuming nations have stabilized, but little else (Figure 2). Despite the market’s seemingly early insistence that macroeconomic trends are improving from the financial implosion of 2008, there is little evidence yet that oil demand has been turning up. At best, we expect that demand can hold steady, with some slight improvement into the late stages of this year, and with year-over-year comparisons that will become much easier when compared to very weak levels of late 2008. Figure 2: Year-over-Year Change in OECD Monthly Demand Thousand B/d 1,000 500 0 (500) (1,000) (1,500) (2,000) (2,500) (3,000) (3,500) (4,000) Jan-07
These fundamentals are improving, but they certainly do not involve a tremendous improvement in demand, as has been the wont of the market to date. In general, our view has been that steady price improvement would emanate
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
2. There is still plenty of inventory, whether it be crude oil or refined product. Although inventories of crude oil have been coming down thanks to OPEC’s supply reductions, crude stocks are still high by historical standards (Figure 3). Compounding this problem is that stocks of refined products are even more bloated as end user demand has finally stopped falling, but has failed to make a sustained push to higher levels. Aside from the
It Still Adds Up. The simple reason for little change to
our price outlook is that we feel that the fundamentals have been evolving in a fashion that we have been forecasting and that this is a market simply not quite ready to make a major move to the upside in terms of price. The strong run in prices of May and June was just not supported by the fundamentals, and the price correction that has been witnessed in early July is a return to levels that are more reasonable given the current set of fundamentals.
Jul-07
Source: FirstEnergy Capital Corp., IEA.
Figure 3: OECD Inventories of Crude Oil Million Barrels 1,050
1,050
1,030
1,030
1,010
1,010
990
990
970
970
950
950
930
930
910
910
890
890
870
5 Yr. High-Low Range
2007
2008
2009
850 Jan
870 850
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Source: FirstEnergy Capital Corp., IEA.
Page 2 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update problem of high inventories on land is the still looming issue of unwinding all of the crude oil and refined product that is still being held in floating storage. 3. Supply trends, as mentioned earlier, are the one factor where there has been significant change over the first half of 2009. This remains the single biggest reason as to why crude prices have stabilized and have improved since early 2009. Obviously, most of this supply reduction is due to the efforts of OPEC in terms of getting barrels off the market (Figure 4). This has been the source of crude oil inventories coming off their highs and looking destined to move to steadily lower levels for the second half of 2009. Though the cartel has been leaking more barrels of late, helping prices to moderate, we do not expect that there will be a flood of new supply from the cartel for some time. Figure 4: OPEC Production Levels Versus Quota Thousand B/d 31,000 30,000 29,000 28,000 27,000 26,000 25,000 24,000 23,000
OPEC 11 Quota
22,000
OPEC 11 Production
21,000 Jan00
Jan01
Jan02
Jan03
Jan04
Jan05
Jan06
Jan07
Jan08
Jan09
July 13, 2009
only in response to encouraging positive trends developing in demand. For now, it is a matter of sitting back and waiting for the supply reductions to continue to impact the market. The end result will be a steady, but gradual improvement in pricing for the remainder of 2009 until some measure of demand growth can return in 2010. Price Pressure in 2010 and Beyond. It is upon reaching 2010 where we think prices will have a much firmer base to hold the US $70+ per barrel range that we are forecasting and perhaps make a move into the US $80s per barrel. However, we do not expect run away prices as there will still be structural elements in place that should hold prices back, until these become tighter in 2011 and 2012. 1. Upon reaching 2010, demand trends should start to improve, with most of the growth coming from the emerging economies of the Non-OECD. Although widely expected with a projected increase in global GDP growth, some modest signs of demand growth in the developed economies will further provide a better base for firm pricing (Figure 6). An additional factor between now and the first half of 2010 is that the market will be seeing some improving economic trends, but will also pass through the next heating season in the Northern Hemisphere which could help further boost demand and draw down refined product stocks depending on the severity of the winter weather. Figure 6: World GDP Growth versus Crude Oil Demand Growth
Jan10
12.0%
Oil Demand Growth
10.0%
Source: FirstEnergy Capital Corp., Bloomberg.
This is a market that is still being fundamentally driven to gradually higher prices more as a result of supply changes than demand changes. As such, our view that the cumulative effects of the supply reductions to date have begun to overtake the cumulative negative demand impacts still holds and remains the primary driver of the market in the short-term (Figure 5). Supply will only move significantly higher when OPEC allows it to happen, and
World GDP Growth
8.0%
Forecast
6.0% 4.0% 2.0% 0.0% -2.0% -4.0%
Figure 5: World Oil Demand Versus Supply 5.0 4.0 3.0
-6.0% 1970
Million B/d
5.0
Non-OPEC OPEC Supply Demand
Forecast
4.0 3.0
2.0
2.0
1.0
1.0
0.0
0.0
(1.0)
(1.0)
(2.0)
(2.0)
(3.0)
(3.0)
(4.0) (4.0) 2004 Q1 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1
1974
1978
1982
1986
1990
1994
1998
2002
2006
2010
Source: FirstEnergy Capital Corp., IEA, IMF.
2. Inventories should be returning to more reasonable and historically average levels by the middle stages of 2010 (Figure 7). By that time, OPEC supply reductions will have had a full chance to work through their inventory levels of crude oil, through the refinery processing level, and eventually impacting refined product inventories. With more than a year of inventory reduction in hand from early 2009 into mid-2010, this should be plenty of time to unwind that immense stock overhang that has been established, even when compared against a modest demand recovery.
Source: FirstEnergy Capital Corp., IEA.
Page 3 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update Figure 7: OECD Monthly Days of Forward Cover Days 64 62
64
5 Year Hi-Lo
62
Days of Cover
60
60
58
58
56
56
54
54
52
52
50
50
Forecast
48 46 Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
12,000 20%
Spare Capacity as % of World Supply
10,000
Forecast
All spare capacity is centered in OPEC.
8,000 6,000
15%
10%
4,000 5%
46
0
0% 1980
1985
1990
1995
2000
2005
2010
2015
Source: FirstEnergy Capital Corp., IEA, US DOE/EIA, Pennwell.
Figure 8: OPEC Crude Oil Production
33.0
Forecast
32.0 31.0 30.0 29.0 28.0 27.0 26.0 25.0 24.0 2006 Q1
25%
Spare Capacity
Jan-10
Million B/d 34.0
2005 Q1
Thousand B/d 14,000
2,000
3. OPEC will only begin to make deliberate and large additions to supply in the second half of 2010, making sure that demand has begun to recover first (Figure 8). When combined with our view of further deterioration in Non-OPEC supplies, then the market will be in a far better position to begin bidding for barrels with higher prices.
2004 Q1
Figure 9: Estimated Global Spare Crude Oil Wellhead Productive Capacity
48
Source: FirstEnergy Capital Corp., IEA.
July 13, 2009
2007 Q1
2008 Q1
2009 Q1
2010 Q1
less supply than demand and letting that combination work its way through global inventory levels this year and next.
Demand. Our outlook for global crude oil demand has
not changed that materially since our previous outlook (Figure 10). We estimate that demand will post a second consecutive year of decline in 2009 in the range of 2.1 million B/d, followed by growth in 2010 and 2011 in the range of 0.9 million B/d. Though the first back-to-back years of oil demand decline since the early 1980s, our demand outlook remains far more optimistic than the latest outlook from IEA in which it is calling for a 2009 demand decline of 2.5 million B/d. This also underscores what we believe has been a negative headline driven trend that has been clouding the demand outlook of the major forecasting agencies. We believe that the low crude oil prices that marked the end of 2008 and start of 2009, though partly undone at the mid-point of this year, are still encouraging a return of demand, especially in those countries where it will matter the most: the emerging economies.
2011 Q1
Figure 10: Change in World Petroleum Demand
Source: FirstEnergy Capital Corp., IEA.
4. Spare capacity inside OPEC is currently at one of its highest levels seen in many years, but will begin to steadily erode over the next few years (Figure 9). The major wellhead capacity additions seen at mid-year 2009 are essentially the bulk of what had been expected out of the cartel, and there will not be much in the way of capacity adds, at least for crude oil, in the next few years. Though acting as damper on prices for 2009 and 2010, and keeping the market under US $100 per barrel, a lack of spare capacity will start to become more of an issue in the post2011 timeframe. Combined with what will be close to a million barrels per day of supply loss from the Non-OPEC nations by that time, then we feel that prices will begin to make the move back to the triple digit range.
Million B/d 3.5
2.97
3.0 2.5
Forecast
2.0
1.65
1.5 1.0
0.75 0.67 0.72
0.5
1.38
1.05
1.26 0.96 0.90 0.92 (0.28)(2.13)
0.0 (0.5) (1.0) (1.5) (2.0) (2.5)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: FirstEnergy Capital Corp., IEA.
All, in the fundamentals have improved off the very miserable looking conditions of late 2008 and early 2009. For now it is a simple matter of trusting the arithmetic of Page 4 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update It is these emerging economies of the Non-OECD where we expect that demand will move back into positive territory before the end of this year. The unstoppable demographics of many of these nations and what is a gradual return to the positive in per capita income growth, all assure that oil demand is returning to the positive after a short lull in the past six months. Overall, it is these nations that will provide the growth story for world oil demand going forward, a theme that we have been pursuing for several years (Figure 11).
July 13, 2009
healing such as improving consumer balance sheets, better financial stability, shaky, but rising consumer confidence, and signs that some industries are starting to see additional activity as the inventory backlog has been depleted. However, demand growth trends, especially in the developed economies, will remain very slow.
Supply. We continue to believe that most market
0.0
watchers remain overly optimistic on Non-OPEC supplies. Despite the potential for improving trends in some regions such as Russia, the overall direction for NonOPEC supply is downward for the next several years. Indeed, our current outlook for Non-OPEC supply declines may still actually be too conservative and provides the potential for price upside (Figure 13).
(0.5)
Figure 13: Change in Non-OPEC Petroleum Supply
Figure 11: OECD Oil Demand Growth Million B/d 0.5
(Incl. FSU, Indonesia; Excl. Angola, Ecuador)
(1.0)
Thousand B/d 1,400
(1.5)
1,200
1,165
1,000
(2.0)
Forecast
(2.5)
800 600
1,183 845 872
Forecast
649
577 445
400
(3.0)
200 (3.5)
(201)
0 2007 Q1 2007 Q3 2008 Q1 2008 Q3 2009 Q1 2009 Q3 2010 Q1 2010 Q3
Source: FirstEnergy Capital Corp., IEA.
On the other hand, the developed economies of the OECD are likely to be looking to get demand back to flat, at best, by the end of this year or early in 2010. This is about all that we expect to come from these nations as energy efficiency gains, slow income growth and environmental restrictions will likely begin a steady erosion of demand going forward. For the foreseeable future, after a possible bout of small positive growth in 2010, we expect that oil demand in these nations will be in steady decline well into the next decade and beyond (Figure 12). Figure 11: OECD Oil Demand Growth Million B/d 0.5 0.0 (0.5) (1.0) (1.5) (2.0)
Forecast
(2.5) (3.0) (3.5)
2007 Q1 2007 Q3 2008 Q1 2008 Q3 2009 Q1 2009 Q3 2010 Q1 2010 Q3 Source: FirstEnergy Capital Corp., IEA.
In the very short-term, the next few quarters of demand growth will likely be very uneven and this is what is causing the greatest pause for prices at mid-year 2009. There are some aspects of demand that are showing
(228) (475)(905) (472) (310)
(200) (400) (600) (800) (1,000) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: FirstEnergy Capital Corp., IEA.
We think there is no getting away from the very steep declines that are impacting such regions as Mexico and the North Sea. Moreover, even the previous growth region of the United States in late 2008 and early 2009 is now starting to sputter sooner than expected, despite the several large new producing projects in the Gulf of Mexico. The simple reason that Non-OPEC supply is still losing ground is, aside from natural geology, has been the lack of sufficient capital reinvestment in the producing regions. The sharp price pullback of last year and what has proven to be a wild ride for prices this year, has underscored the need for Producers to maintain capital discipline and keep spending on a tight leash. In addition, even some of the bright future prospects for supply growth such as Brazil and offshore West Africa, have recently run into speed bumps, suggesting that a more conservative growth path, and not a media headline driven one, remains the more prudent course when forecasting future supply growth. As always, OPEC supply trends remain the best friend or enemy of market watchers, depending on which side of the market you may be sitting (see Figure 4). After staging what may be the most impressive production reduction in its history in so short a time in late 2008, OPEC seems to be once again becoming a victim of its own success. With oil Page 5 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update prices having staged a sharp rally since March of this year, OPEC members, especially the non-Persian Gulf core members, have begun to leak more barrels into the marketplace. Quota discipline has been eroding from better than 80% a few months ago to near 70% recently. It is this “leakage” of barrels that we think we may act as a price damper on the market for the second half of 2009 as described earlier, and will also act a catalyst for senior cartel members to crack the whip on other members in terms of dialing back production once again. Our present outlook envisions such an outcome, but we feel that the cartel will not be quite as successful in achieving as much discipline as it saw earlier this year. Beyond the quota problems of 2009, we are forecasting that the cartel will have to steadily put more barrels into the marketplace in 2010 and beyond in order to satisfy even the modest degree of demand growth that we have forecast. With Non-OPEC supplies facing further losses, OPEC will have to be the supplier of last resort for the market, especially once its earlier production cuts are fully felt in 2010 in terms of returning global days of inventory cover back to more normal historical levels (Figure 14). Figure 14: Global Days of Forward Inventory Cover Days 53.0 52.0 51.0
53.0
Days of Cover 4Q Moving Average
52.0
Forecast
51.0
50.0
50.0
49.0
49.0
48.0
48.0
47.0
47.0
46.0
46.0
45.0
45.0
44.0
44.0
43.0 43.0 1995 Q1 1997 Q3 2000 Q1 2002 Q3 2005 Q1 2007 Q3 2010 Q1 2012 Q3 Source: FirstEnergy Capital Corp., IEA.
At this stage, we see the cartel as facing little problem in terms of meeting that production call for the next couple of years. The significant expansion in productive capacity that has been put in place at mid-year 2009 (Figure 15), primarily in Saudi Arabia, should lay to rest the notion that the market will be facing tight productive capacity in the near term for quite some time. It is only once the market starts to see the conditions heading into 2012, that we expect that spare productive capacity will once again start to become a serious issue, contributing to the much higher prices that we are forecasting north of US $100 per barrel by this time. Meanwhile, in the very short run, it is this latest productive capacity expansion that should also alleviate any worries over supply distortions from such volatile suppliers as Nigeria.
July 13, 2009
Figure 15: OPEC Spare Crude Oil Wellhead Productive Capacity
Thousand B/d 8,000 7,000
8,000 7,000
Other OPEC Saudi Arabia Effective
6,000
6,000
5,000
5,000
4,000
4,000
3,000
3,000
2,000
2,000
1,000
1,000
0
0
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08 Jul-08
Jan-09
Jul-09
Jan-10
Source: FirstEnergy Capital Corp., IEA.
Inventories. Solving the inventory overhang for the
global crude oil and refined product markets is the key, as it usually is, to setting the tone for future price direction. We continue to believe that, even in the generally modest demand growth environment that we are forecasting, global inventories will begin to unwind to lower levels over the next few quarters. Earlier, we indicated that the aggregate supply reductions on a cumulative basis, mostly engineered by OPEC, have begun to outpace the cumulative effects of the demand slowdown. The simple arithmetic points to inventory reductions at the primary, or crude oil, level. The fact that crude oil inventories in key markets such as the United States have been steadily dropping (Figure 16), even in light of very slow refinery activity, is very supportive of our view that sufficient barrels have been taken off the market to correct that earlier oversupply and that crude oil inventories will continue to decline to more historic averages. It is at the refined product level where more uneven improvement will be seen over the next few quarters. These inventories currently remain very high by historic Figure 16: U.S. Inventories of Crude Oil Million Barrels 380
(Excluding Strategic Petroleum Reserve)
380
370
370
360
360
347.30
350
350
340
340
330
330
320
320
310
310
300
300
290
290
280
280
270 260
270
5 Yr Hi-Lo
2006
2007
2008
2009
250 Jan-2
260 250
Feb-13 Mar-27
May-8
Jun-19
Jul-31 Sep-11 Oct-23
Dec-4
Source: FirstEnergy Capital Corp. US DOE/EIA.
Page 6 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update
$40 per barrel range seen at the start of this year are diminishing quickly.
Figure 17: OECD Inventories of Refined Products Million Barrels 1,600
1,600
5 Yr. High-Low Range
1,550
2007
2008
2009
1,550
1,500
1,500
1,450
1,450
1,400
1,400
1,350
1,350
1,300
1,300
1,250
1,250
1,200
1,200
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
July 13, 2009
Dec
Source: FirstEnergy Capital Corp., IEA.
standards (Figure 17) especially for the distillates category, likely the most economically sensitive of the refined products. Given the pace of demand recovery that we are seeing in the developed economies, there may be little movement lower in the majority of refined product inventories for the remainder of 2009, and yet another component of our price moderation view for H2 2009. However, there is no getting away from the fact that even in the face of demand stabilization and slow recovery into 2010, the very slow pace of refinery activity will eventually result in a reduction of refined product inventories. It will take time, but by the second half of 2010, inventories should be returning to more historical levels along with days of forward cover for refined products. It is the inventory situation in the emerging economies which we think could provide an inventory wildcard for the market, especially for price upside. Given that inventory data for these countries is very limited or nonexistent, getting a good sense for what is happening can only be determined indirectly. However, we expect refined product inventories in the developed economies may be further run down in the months and quarters ahead at a faster rate than some are thinking as it will be the developing economies which will be staging a faster economic rebound than the developed economies. Even the significant overhang of floating refined product inventories should be undermined as term price structures for refined products flatten out in the months ahead and prior to heading into the Northern Hemisphere’s winter. All in, global days of forward inventory cover will be declining. We see no way to get around the supply and demand math that a sizeable inventory correction is underway. It is the speed of this inventory correction that will partly set the pace for the price recovery. With the worst of the inventory build up now behind us, and crude oil inventories starting to decline globally, the odds of a price reversal back to the low levels in the US $30 and US
Canadian Crude Oil Markets. With the 2009 heavy
crude oil market still looking very snug, we have elected to further tighten our light-heavy crude oil price differentials for 2009 by several dollars compared to our previous outlook. For 2010 and beyond, we have made no change to our price spread outlook and still expect that the price spread on a percentage basis to the WTI marker will remain tighter when compared to recent historical averages. FirstEnergy Crude Oil Price Differential Outlook
2008
$/BBL Average
Ed Light-Bow Cdn$ NEW Old $18.45 $18.45
WTI-WCS US$ Old NEW $20.36 $20.36
2009
Q1 Q2 Q3 est. Q4 est. Average est.
$6.03 $11.00 $10.00 $14.00 $10.26
$6.03 $4.05 $6.67 $12.00 $7.19
$9.03 $11.00 $10.00 $14.00 $11.01
$9.03 $7.94 $9.67 $12.00 $9.66
2010
Q1 est. Q2 est. Q3 est. Q4 est. Average est.
$15.00 $14.00 $13.00 $16.00 $14.50
$15.00 $14.00 $13.00 $16.00 $14.50
$15.00 $14.00 $13.00 $16.00 $14.50
$15.00 $14.00 $13.00 $16.00 $14.50
2011 Average est.
$15.50
$15.50
$15.50
$15.50
2012 Average est.
$19.00
$19.00
$19.00
$19.00
Notes: All historical averages computed using weekday data only. Source: FirstEnergy Capital Corp., Bloomberg; est. refers to forecasted value.
If our global crude oil market discussion sounds a bit on the optimistic side, then it is the heavy crude oil market for Canadian Producers that remains downright positive. Light-heavy crude oil price spreads have remained very tight over the first half of 2009 and we expect only a moderation in this tightness for the remainder of the year. The building blocks for this price spread tightening have been a long time in the making and remain generally consistent with the tighter price spread outlook that we have been expecting for several years. Those building bocks have been very closely aligned during 2009 as the WCS-WTI price spread has generally held under US $10 per barrel (Figure 18). We think that a good part of this tightness is actually more of a demand issue as opposed to a lack of supply in the market. Specifically, the rather mediocre looking crack spreads that refiners have been facing since Q4 2008 have persisted well into the middle of this year, especially for distillate margins. This has led to refiners in North America bidding for the cheapest - i.e. heavier - crude oil barrels that they can find. This bargain hunting, in attempt to pad refining margins, has led to the rather surprisingly tight light-heavy spreads that have been seen so far in 2009. Moreover, we expect that this situation will continue for the remainder of this year at a minimum, as refiners will be facing bloated stocks for numerous refined product Page 7 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update FirstEnergy Canadian Crude Oil Price Outlook Edmonton Light Old NEW $102.70 $102.70
Bow River Stream Old NEW $84.25 $84.25
W. Canada Select Old NEW $82.50 $82.50
Q1 Q2 Q3 est. Q4 est. Average est.
$50.23 $63.04 $68.60 $78.33 $65.05
$50.23 $66.18 $69.47 $74.81 $65.17
$44.20 $52.04 $58.60 $64.33 $54.79
$44.20 $62.13 $62.81 $62.81 $57.98
$42.28 $52.29 $59.26 $63.25 $54.27
$42.28 $60.17 $61.23 $62.98 $56.66
Q1 est. Q2 est. Q3 est. Q4 est. Average est.
$82.34 $87.29 $92.12 $83.23 $86.24
$77.55 $82.27 $87.39 $81.33 $82.13
$67.34 $73.29 $79.12 $67.23 $71.74
$62.55 $68.27 $74.39 $65.33 $67.63
$66.27 $72.62 $78.82 $67.05 $71.19
$62.50 $68.54 $74.86 $65.56 $67.86
2011 Average est.
$89.61
$89.37
$74.11
$73.87
$74.89
$74.70
2012 Average est.
$98.00
$98.00
$79.00
$79.00
$80.00
$80.00
Cdn $/BBL 2008 Average 2009
2010
Notes: All historical averages computed using weekday data only. Source: FirstEnergy Capital Corp., Bloomberg; est. refers to forecasted value.
categories and will continue to seek the cheapest barrels on the market. OPEC production cuts initiated late last year, though looking to be losing some traction of late, have also helped to tighten global light-heavy price spreads. With the OPEC nations taking their heavier and more sour barrels off the market first, this helped to alleviate some of the pressure on global and North American heavy oil markets. On the flipside, it is the gradual erosion of OPEC discipline and the “leakage” of these barrels that partly contributes to our view for some widening in the absolute dollar price spread in the latter stages of this year. Overall heavy oil production has improved in the last few months for Canada, but it is still lagging well behind where many in the marketplace thought it would be just 6 to 12 months ago. Underperformance has dogged some projects, while start-up problems and deferrals have plagued others, but are now starting to become a thing of the past as the enormous pressures have begun to ease on heavy oil and oil sands projects. This supply Figure 18: Canadian Crude Oil Differential WTI Versus Western Canada Select US$/BBL $50.00
2006
$45.00
2007
2008
$35.00
$50.00
2009
$45.00 $40.00 $35.00 $30.00
$25.00
$25.00
$20.00
$20.00
$15.00
$15.00
$10.00
$10.00
$5.00
$5.00
$0.00 Jan-2
$0.00 Feb-20
Apr-10
Source: FirstEnergy Capital Corp., Bloomberg.
May-29 Jul-17 Weekly Average
Sep-4
Oct-23
All seems to be running well for the Southern Access pipeline expansion (400 thousand B/ d), and the Keystone pipeline (435 thousand B/d) into the U.S. Midwest is still scheduled to enter service toward the end of this year. This will effectively create more shipping capability than the market can fill with heavy oil supply, so we anticipate that pipeline constraints will be absent for some time, possibly for next the several years.
All of these factors, combined with our long stated view that Canadian heavy oil is facing declining competition from other heavy oil sources in the Western Hemisphere, keeps us very optimistic that heavy oil prices can remain generally tight on a percentage basis versus the WTI price marker, though perhaps not quite as tight as has been in 2009 (Figure 19). Although our forecast has the absolute dollar price differential rising over time, this is consistent with a generally low percentage price spread versus historical averages (Figure 20). Figure 19: Ratio of the WTI-WCS Price Differential to the Price of WTI 70%
70%
2006 60%
2007
2008
2009 60%
2007 Avg: 32.0% 2008 Avg: 22.7% 2009 YTD: 17.2%
50%
50%
(to Jul 3, 2009)
40%
40%
30%
30%
20%
20%
10%
10%
Jan-2
(to Jul 3, 2009)
$30.00
underperformance has allowed the some aspects of the demand story (i.e. refiners) to get a grip on limited barrels, while at the same time allowing pipeline capacity expansions to catch up and overtake what was thought to be a lagging race against production increases.
0%
2007 Avg: $23.56 2008 Avg: $20.30 2009 YTD: $8.48
$40.00
July 13, 2009
Dec-11
0% Feb-13 Mar-27 May-8 Jun-19 Jul-31 Sep-11 Oct-23
Dec-4
Source: FirstEnergy Capital Corp., Bloomberg.
Depending on the speed at which other countries such as Mexico and Venezuela experience production declines, and the magnitude of future expansions in pipeline access from the U.S. Midwest to the U.S. Gulf Coast, our outlook for light-heavy price spreads on a absolute dollar and percentage basis may still be too conservative. In other words, even tighter price spreads than many thought possible even just a year ago, could be developing for the North American heavy crude oil market going forward, especially in an environment where poor demand trends continue to squeeze refinery margins, necessitating steady and strong bids for heavy oil by refiners. Page 8 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update Figure 20: WTI-WCS Price Spread and % Discount US $/BBL $30.00
WTI-WCS Spread % of WTI
45.0%
$23.57 $21.57 $21.00 $20.36
$25.00 $20.00 $15.00
Forecast
40.0% 35.0%
$19.00 30.0% $15.50 25.0% $14.50
$13.59 $10.58
$10.00
$8.19
20.0%
$8.82
$9.54
15.0%
$6.53
10.0%
$5.00 5.0% $0.00
0.0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: FirstEnergy Capital Corp., Bloomberg, Enerdata.
Conclusions. The wild crude oil price swings in the past
12 months are a testament to what is still one of the world’s most dynamic industries. From a forecasting perspective, we do not expect things to get any easier as there will be periods of time where seemingly inexplicable price swings to the upside and the downside will occur, and likely in a very rapid fashion. This is also a reflection of crude oil becoming a financial instrument beyond the fundamentals. The commodity inflation hedge is now more alive and well than it has been since the late 1970s and early 1980s, the last period of time when the global economy was passing through a period of sustained rising inflation coupled with strong and rising crude oil prices. We expect that financial flows will remain very potent in generating price volatility for the market and that financial capital will be looking for a home against which to protect itself from what will be a rising inflation threat at some point in the next 24 months. In a similar vein, is the story of U.S. dollar effects. In a world of rising inflation and one in which the United States is clearly racking up immense and unsustainable Figure 21: Near Month Nymex Crude Oil Price versus the USD-EUR Exchange Rate US $/BBL $150.00
USD/EUR 1.66
$140.00
1.62
$130.00
1.58
$120.00
1.54
$110.00
1.50
$100.00
1.46
$90.00
1.42
$80.00
1.38
$70.00
1.34
$60.00 $50.00 $40.00 $30.00 Jan-07
1.30
Nymex WTI USD versus EUR (rhs) Jul-07
Jan-08
Jul-08
Source: FirstEnergy Capital Corp., Bloomberg, Pacific Exchange Rate Service.
1.26 1.22 Jan-09
Jul-09
Jan-10
July 13, 2009
budget deficits, these deficits will have to monetize at some point, if not already being done so. The subsequent knockon effects merely add to the broader inverse commodity play against want will be a declining exchange value of the U.S. dollar (Figure 21). Beset by significant shifts in supply and demand factors, the market is now even more keenly aware of these impending financial plays, aside from the usual desire to send money to where it will fetch the best return at a moment’s notice. This alone will generate huge capital inflows and outflows from the commodity space depending on the relative performance of other asset classes, creating additional price volatility. Risk appetite seems to be returning in many investing categories and commodities are no exception. However, we do not see that risk appetite for the rest of this year and 2010 as being anywhere near the hyperactive levels of 2008, when cheap and easy credit drove a levered buying frenzy in crude oil and which rapidly saw prices become completely divorced from the fundamentals. With the average consumer and many industries repairing balance sheets, the flow of easy credit into the commodity and crude oil space should be more limited for some time. As much as we would like to ignore these financially related factors and remain exclusively focused on the fundamentals, these are a fact of life in the increasingly dynamic crude oil market. However, when combining these with the market’s current state of affairs, we think that balance of price risk remains neutral but is definitely tending to the bullish side over the next 6 to 12 months (Table 1).
Table 1: Price Directional Factors Bearish Contango Brent vs. Nymex Crude Inventories Product Inventories Floating Storage Shipping Rates OPEC Supply vs. Demand Crack Spreads U.S. Dollar Equity/Credit Markets Open Interest Summary Sentiment
Price Direction Neutral Bullish X
X X X X X X X X X X X
What has been satisfying has been to see prices generally move in the direction and to the levels that we have been forecasting since the beginning of 2009. Even with the small changes we have made for 2009 expected prices, we generally remain more optimistic than the Street (Figures Page 9 of 10
World Crude Oil Markets: Crude Oil Price Forecast Update 22 and 23) and more optimistic that the Nymex forward curve (Figure 24). Needless to say, we expect that the Street and the forward curve will continue to migrate to our view of the world.
July 13, 2009
Figure 23: Expectations for the Price of WTI in 2010 US $/BBL $95.00
(As of Jun. 25, 2009 survey; Nymex value as of Jul. 10, 2009) (Consensus estimate does not include Nymex value)
FirstEnergy
$90.00
All in, the crude oil market is undergoing a huge healing process from the wrenching financial and fundamental wounds that it suffered in 2008. All wounds take time to heal. This healing process will be measured by a gradual return to higher prices as the world once again comes to grips with what will be a daunting supply challenge.
Consensus
$85.00
Nymex
$80.00 $75.00
$70.87
$70.00
$75.00
$67.20
$65.00 $60.00 $55.00
Figure 22: Expectations for the Price of WTI in 2009
$50.00
(As of Jun 25, 2009 survey; Nymex value as of Jul. 10, 2009) (Consensus estimate does not include Nymex value) US $/BBL $85.00 $80.00
$45.00 $40.00 1
Consensus
$75.00
Nymex
$70.00 $65.00
$55.00
5
7
9
11 13 15 17 19 21 23 25 27 29 31 33 Number of Analysts
FirstEnergy Figure 24: Nymex Crude Oil Futures Strip versus FirstEnergy Crude Oil Price Forecast
$58.00 $56.28 $56.76
$60.00
3
Source: FirstEnergy Capital Corp., Reuters.
US $/BBL $150.00
$150.00
$50.00
$140.00
FCC July Forecast
$140.00
$45.00
$130.00
Nymex Strip as of Jul. 10, 2009
$130.00
$40.00
$120.00
$120.00
$35.00
$110.00
$110.00
$30.00
$100.00
$100.00
$90.00
$90.00
$80.00
$80.00
$70.00
$70.00
$60.00
$60.00
$50.00
$50.00
$40.00
$40.00
1
3
5
7
9
Source: FirstEnergy Capital Corp., Reuters.
11 13 15 17 19 21 23 Number of Analysts
25
27 29
31 33
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: FirstEnergy Capital Corp., Bloomberg.
Page 10 of 10
