By now we have heard every worthless Wall Street economist expound on the bull case for the economy courtesy of a ultrashort-term dip in oil and gas as a result of the moronic IEA decision to tap strategic reserves. And while short-term gyrations are largely irrelevant when as we presented yesterday, and as the FT confirmed, the bulk of volume and price formation comes from speculative daytraders, the longer-term dynamics for crude point in only one direction. Up. Here is UBS Andy Lees to explain why despite the brief jump in crude (which will likely never make it into the system courtesy of banks taking the purchased light sweet crude and storing it in tankers) supplies, we are facing a substantial supply-side crunch as soon as a few months from now.
From Andy Lees:
Reuters reports that lack of investment due to a heavy tax burden means Russian oil production will struggle to maintain present levels. A lack of new projects in the pipeline while existing fields mature will make maintaining production increasingly difficult. “Certainly Russia’s production growth is not catching up with the world’s growing demand. Russia’s mature fields base is so large that it needs a lot of new projects just to offset that decline” according to the IEA. “So any changes to the tax regime would have to be ones that encourage significant new fields start-ups. And/or investments needed into fields with declining production”. Nevertheless Russia is expected to issue RUB30bn (USD1.1bn) of 7 year bonds at between 7.75% and 7.8% as government finances are buoyed, at least in the short term, by the high oil prices.
In a second article Reuters warns that Saudi Arabian oil exports may trail far behind rising output this summer as its power stations burn more crude than ever before to keep the booming population cool, fed and watered. After defying OPEC its production is expected to reach 10m bpd in July but most of that will be soaked up by a summer surge in air conditioning and the ramp up of the huge refinery Rabigh after maintenance. “Available Saudi crude export capacity is getting squeezed from all sides” according to HSBC Saudi Arabia. Soc Gen estimates that the refinery will absorb 400,000bpd of extra production and domestic power consumption a further 300,000bpd leaving just 300,000bpd to offset the loss of Libyan crude exports. To some extent this helps explain the IEA’s action to release strategic reserves onto the market. Saudi sources say direct crude burning in power stations is likely to average 540,000bpd this year compared with 403,000 last year (although in July last year it was burning as much as 920,000 bpd).
Traders also highlight that the monthly discount of Saudi Heavy crude to the benchmark Oman/Dubai was actually lowered from USD2.65 to USD1.90. They had hoped for a discount to increase by more than USD1bbl. Asian refineries are unlikely to ask for additional term volumes at these prices. The refining margins are high and Saudi is justified in thinking it is not their job to boost Asian refinery margins, but it does mean that despite all their rhetoric of increasing production, they are not pricing the oil to achieve that aim. As a client tells me, “Do as they do, not as they say”.
Translation: those with a longer-term target on crude would be well advised to buy some CL at prevailing levels.