Crude Oil Outlook and Forecast For 2013
Despite the relatively sideways trading range and declining volatility that the last few months of 2012 has brought the oil markets, underlying developments have remained fairly dynamic. The November election in the U.S. and change of power in China will have strong impacts on price direction, as will the developments on the production and transportation sides made earlier in the year.
Uncompromising leadership in the U.S. and drags from increased regulation and taxes will be countered by potential recovery in the Chinese and European economies as well as a possible euphoric bounce after a fiscal cliff and/or debt ceiling agreement early in the year. A challenge will be made to escape the long-term bullish mindset that has dominated oil markets in recent years and revert to an environment of higher production and potentially downward trending prices. As peak oil was a main factor offering support five years ago, increasing shale production and slowing demand growth are offering pressure now. Signs of oil shortages were a bullish driver a few years ago, but increasing domestic production and potential exports could put the Keystone XL pipeline from Canada into question. While the market may see a generally downward trend in 2013, it may also see short-term bouts of support if OPEC were to reduce production quotas, Israel struck Iran's nuclear capabilities, or if the economy grows strongly.
Our bias for 2013 suggests that the downtrend that began in May 2011 in both WTI and Brent is likely to continue and that a breach of the 2011 low in WTI at $75/bbl is possible. The market may exhibit wide trading ranges as it did in 2011 & 2012, with WTI expected between $75/bbl-$105/bbl, an average price of $90/bbl, and a year-end objective at $85/bbl. Brent may see its premium to WTI shrink toward $5-$10/bbl by year-end from the low-$20's as the Seaway pipeline expansion opens and BP's Whiting refinery completes its upgrades. Brent could range between $95/bbl-$125/bbl, with an average price of $110/bbl and a year-end objective at $105/bbl.
2012 in Review
The year 2012 brought a continuation of the downward trend in oil markets which began in May of 2011. The market peaked at that time after the first four months of 2011 brought the Arab Spring and reduced oil output from Libya. The shortfall was partially made up for by the third ever IEA storage release and the ramp-up of output from Saudi Arabia. The disruption would have been greater were it not for the slowdown in economic growth in Europe. An earthquake in Japan in March 2011 brought a solid increase for LNG shipments due to shutdowns of nuclear capacity, while oil demand only increased marginally.
A similar start was seen for 2012 where strength occurred early in the year before a peak in March/April. A continuation of the late-2011 rally helped, as did the second bailout of Greece on Feb 21st. U.S. economic data showed improvement early in the year, but received sobering news starting in early-May when payroll data began falling short of expectations. Both jobs and economic demand were brought forward to the winter months from the early-summer months, and made Q1 2012 economic data appear artificially better than it was. Expectations of a double-dip recession increased by summer as data slowed. The 2012 peak in prices was formed in March/April in WTI/Brent but that trend accelerated to the downside with the early-May payroll report. Worries about Greek debt resurfaced, as did concerns about Spain. It was a relaxation of conditions on emergency loans to Spain and Greece on June 29th that helped put in a bottom in oil prices. That was solidified later with a speech by ECB President Draghi on July 26th in which he promised to do whatever it takes to save the Eurozone. On Sep 6th, he launched the Outright Market Transaction plan which could buy bonds from distressed countries in order to lower their interest rates. The dollar has weakened since that time and offered support to oil prices. There were oil supply disruptions in Brazil and Yemen in 2012, but they didn't matter in face of increased shale production in the U.S. OPEC boosted production 1.14 mb/d from January through August, but cut back output by 0.99 mb/d between August and November.
November 6th brought the U.S. election and a glimpse into the effect that Washington will have on the energy markets. It may offer a negative impact as opposed to China which picked new leadership on November 8th, and Europe which worked out a framework for common banking regulation on December 13th. The U.S. should be bogged down with headwinds caused by continued slow-growth conditions, quantitative ease, uncertainty about taxes, the debt ceiling, and ongoing Washington partisanship. Economic growth is expected to improve slightly from 2012's 2.1% average. The fiscal cliff negotiations and the lack of progress in them in late-2012 showed that lawmakers are still unable to reach across the aisle. Corporate spending decisions are being delayed due to uncertainty about tax rates, and could be duplicated in late-February when the debt ceiling will need to be raised. The last battle in July-August 2011 resulted in S&P cutting the U.S.'s AAA credit rating and oil prices falling 25% in just a few weeks.
The composition of the Fed may become more dovish, as the hawkish loyal dissenter Jeffrey Lacker won't hold a vote. Fed Presidents Evans and Rosengren will vote this year and are both considered doves. Both argued for the 6.5% unemployment threshold adopted by the Fed at its December 12th meeting. KC's George will replace the hawkish President Hoenig, but she's been less critical of easy Fed policy than Hoenig has. President Bullard could be hawkish too, but he did not dissent at any time during his previous votes in 2010. A dovish Fed hasn't necessarily been good for oil prices like it has for markets like gold and equities (chart below). Oil may focus more on the Fed's adverse economic outlooks such as promises to keep rates low through 2015 than where easy money will be invested.
Europe is improving, with leaders there showing commitment to debt problems in Greece and Spain. Their resolve is unlikely to waiver, and the euro now appears likely to make it through this crisis without breaking up. China is a bright spot as well, and is showing improvement from a slowdown in FH '12. On May 24th, it said that banks would not meet their 2012 lending goals due to the slow economy.
Manufacturing PMI data reached a bottom in November 2011, but stagnated until a second bottom made in August 2012. Several injections of cash were made into the economy over the summer, and a $150B infrastructure project was announced on September 7th. The official measure of PMI has increased 1.4 points since its August low, while the HSBC measure has gained 3.3 points. Oil demand correlates to the HSBC measure as seen in 2009 when demand recovered as manufacturing activity bounced back (chart).
Production Gains Change Oil Supply/Demand Dynamic
Peak oil was a main factor cited in offering support to oil prices in 2007 and 2008 as WTI went from a low of $50/bbl in January '07 to a high of $147/bbl in July '08. Growth in Chinese demand had outstripped most of the excess supply and OPEC's spare capacity began to dwindle as producers ramped up output to meet demand. The financial crisis in 2008 and the losses in oil demand that it caused forced prices from $147/bbl to $32/bbl in the second half of 2008, but oil has never recovered more than the $115/bbl price level in the four years since. Part of the reason is that the economy is still struggling to regain pre-2008 strength, but it is also explained by growth in supply and OPEC spare capacity.
The growth rate of Chinese imports soared in the early-2000's and was still a relatively high 10.6% y/y in 2007 & 2008. The inability of supply to keep up with the new demand growth was a feature of the price surge in 2008, and essentially created an element of "growing pains" in the market at that time. Producers just couldn't keep up with the extra demand, and prices had to rise. That doesn't seem to be the case as much now, as the rate of Chinese import growth has slowed to 6.8%. Despite the slowdown in the growth rate since 2007 & 2008, the overall level of imports is much higher and yet global oil supplies are more plentiful. China's level of imports has increased to 5.26 mb/d in 2011 & 2012 compared to 3.43 mb/d in 2007 & 2008. Despite higher demand, suppliers are better able to cope with it and stocks are building globally. Oil stocks that are able to be measured such as OECD stocks fell to 53.2 days of demand cover in 2007. The level of cover increased sharply in 2008 and has averaged a steady 59.0 days in the last four years. Oil stocks in the U.S. are the highest above their five-year average since April '09 and are close to moving to the highest since at least 1990.
In addition to elevated inventories and high demand cover, the supply/demand balance and OPEC spare capacity also show the market loosening. The first chart below shows that prior to early-2008, the EIA's supply/demand balance ranged from -2.7 mb/d to +1.2 mb/d with an average 1.1 mb/d deficit. Between 2008 & 2011, the average was a 0.55 mb/d deficit largely because of Libya's civil war in 2011. In 2012, however, the balance averaged a surplus of 0.2 mb/d. The second chart below shows another comparison to the 2007-2008 period, where OPEC spare capacity has grown to 6.0 mb/d in late-2012 from a low of 2.2 mb/d seen in mid-2008 at the peak in prices. From 2007 to 2012, global demand has increased 4.3 mb/d while non-OPEC output has gained 3.2 mb/d and OPEC 2.9 mb/d for 6.1 mb/d combined. The EIA's forecast for 2013 demand growth is 0.96 mb/d while supply is expected to grow 0.85 mb/d. OPEC will play a deciding role in balancing the market again, but may have to cut production sometime in 2013. The bottom line is that supply growth has outpaced demand growth since 2007, which should add pressure to prices.
The increase in non-OPEC production of 3.2 mb/d since 2007 has seen 1.5 mb/d come from the U.S. Rig counts in North Dakota's Bakken shale formation have surged from 33 in May 2009 to over 200 in 2012 (chart 1). As a result, production from the region has increased from 100 kb/d at the start of 2009 to nearly 700 kb/d in 2012 (chart 2). Imports from Canada are still averaging around 2.4 mb/d. However, the increase in domestic output may call into question the need for the Keystone XL pipeline given environmentalists opposition to the rerouting of the pipeline over the Ogallala Aquifer in Nebraska. A decision on the pipeline is expected sometime in early-2013 and meanwhile, the rail trade from North Dakota continues to grow. Increasing discussion regarding oil exports may help to get oil out of the landlocked Midwest, but won't help the pipeline's cause.
Demand Growth Slowing
The EIA's prediction of 0.96 mb/d in global demand growth equates to a 1.08% increase and compares to 1.2% growth in 2011 and a 3.0% increase in 2010. The 2000-2007 pre-recession average was 1.6%. The first chart below shows the oil market's response to the overall level of crude oil demand, while the second chart illustrates the effect of the growth rate of demand vs. the y/y change in prices. A regression since 1993 implies that a 1.08% growth rate in 2013 would equate to around a 10.86% increase in oil prices. Given 2012's average through Dec 24th, it would suggest that a gain of $10.22/bbl is possible, which would put WTI at an average of $104.19. That's a bit high in our view, as we expect the global economy to be slower than the 1993-2011 average, and we also anticipate less commodity index investment than what was seen in the 2000's.
Natural Gas Outlook and Forecast For 2013
Following a tumultuous 2012 and a price decline to 10+ year lows at $1.90/mmbtu in mid-April, the market will start 2013 with only a slightly more optimistic view. Pressure may be applied early in the year from coal prices, which have kept pace with recent gains in gas prices and limited the attractiveness of coal-to-gas switching. Weather has also been a disappointment so far this winter, and could result in further reductions in demand. Prices could begin to rebound in Q2 or around mid-year based on falling natural gas rig counts and by stabilization in U.S. production growth. In the longer-term, the market will gain support from increasing retirements of coal plants in 2014 and from the eventual operation of LNG export facilities in 2015.
Our bias in prices for 2013 suggests that the long-term bottom near $1.90 will remain intact, however, the market may still struggle to maintain its upside momentum. A range of $2.75-$4.25 is possible, with a year-end rebound reaching a target at $4.00/mmbtu. Prices may average $3.50/mmbtu.
2013 Supply/Demand Outlook
The biggest issue pushing prices lower through Apr 2012 was the excess of inventories caused by increasing production and weak winter-related demand. Inventories reached levels that were 60% above the five-year average by late-March before falling and ending the year around 10% above the average. The EIA's monthly U.S. production figures showed an increase of 4.6% y/y in 2012 over 2011 levels while demand increased 4.7%.
Going into 2013, production is forecast to increase 0.5% while demand may fall 0.4%. As a result, the imbalance appears as though it will continue through 2013 which could weigh on prices. The EIA's full-year forecasts for 2013 have only gotten worse over the course of 2012. The forecast for 2013 demand growth began with its Jan '12 report expecting a decline of 0.8%. Despite growing discussions of transportation-related demand increases throughout the year, the Nov EIA report showed an expected demand decline of just 0.4% (chart 1). And despite production stoppages and declines in rig counts, supply forecasts went from -1.7% to +0.5%. The projected supply/demand balance is now a surplus in 2013 of 1.12 bcf/day compared to 0.85 bcf/day projected for 2012. The only upshot from the forecasts is that the rate of supply growth is slowing, as shown in the second chart.
Weather's Impact on Inventories
The possibility of warm winter weather may help inventories build at a faster rate than the five-year average again in early-2013. Winter temperatures usually continue falling through the third week of January. With that marking the mid-point of meteorological winter, both observed temperatures thus far and forecasted January temperatures will generally be above-normal up to that point. Beyond that point, the most recent CPC outlook published on Dec 20th showed forecast temperatures in the upper Midwest and Northeast near-normal, while temperatures across the South may be above-normal. Such observations could cause gas inventories to rebound again with respect to the five-year average (chart 2).
The longer-term upside will focus on power plant retirements and LNG exports. Despite courts vacating the Cross State Pollution Rule in Aug '12 that limits the amount of air pollution that can cross state lines, there are still retirements of coal-fired power plants scheduled. They accelerate in 2014 to around 6 GW and in 2015 to 12 GW, which could result in an extra 0.7 bcf/day and 1.4 bcf/day in incremental gas demand.
Exports of LNG have been held up by inaction on the part of the DOE, which licenses them to countries that are not part of free trade agreements. FERC approves terminal and pipeline construction. On Dec 5th, the DOE issued a report saying that the U.S. would become a natural gas exporter by 2020 and that exports would provide as much as $30B per year in trade revenue. It added that the cost of gas would rise but that its effect on consumers would be minimal. The report created a notion that exports would be approved fairly soon and that construction on new facilities could begin.
Cheniere Energy's Sabine Pass terminal is the only one approved so far. Cheniere received approval for its facility on Apr 17th, just two days before gas prices reached bottom. There are still political headwinds that need to be addressed, including Congressman Ed Markey who has suggested that the administration not rush to export gas abroad. Ron Wyden from Oregon is incoming chairman of the Senate's energy committee and is worried about the effect on consumers. However, the increased likelihood of exports could open the gas market up to comparisons with price action from April 2012 and create longer-term support.