John Kemp http://blogs.reuters.com/john-kemp John Kemp's Profile Thu, 17 Dec 2015 21:03:16 +0000 en-US hourly 1 http://wordpress.org/?v=4.2.5 Strong oil imports lift U.S. crude stocks near record: Kemp http://www.reuters.com/article/us-usa-oilimports-kemp-idUSKBN0U02H120151217 http://blogs.reuters.com/john-kemp/2015/12/17/strong-oil-imports-lift-u-s-crude-stocks-near-record-kemp/#comments Thu, 17 Dec 2015 21:03:16 +0000 http://blogs.reuters.com/john-kemp/?p=1683 U.S. crude oil imports have accelerated over the last four weeks, pushing commercial crude inventories within a whisker of the record set in April.

Crude imports surged to 8.3 million barrels per day (bpd) last week, up from 7.0 million bpd four weeks earlier, according to the U.S. Energy Information Administration (tmsnrt.rs/1NV47Y4).

Imports are running at the fastest rate since September 2013, with almost all the extra crude arriving at ports along the U.S. Gulf Coast. (tmsnrt.rs/1NV4dyW)

Both the timing and the location are unusual because refineries and traders try to minimize stocks held along the Gulf Coast at year-end to avoid storage taxes imposed by Texas and Louisiana.

Faster imports have pushed crude stocks higher even as refiners have boosted the amount of crude they process to a seasonal record 16.6 million bpd.

Crude imports are notoriously volatile: while pipeline imports from Canada are somewhat regular and stable, tanker imports from other countries are much more variable.

Each very large crude carrier (VLCC) arrives with around 2 million barrels of crude, which is recorded in U.S. inventories once it has cleared customs.

The timing of ship arrivals and customs clearances can therefore have a big influence on reported weekly import volumes.

Heavy seaborne imports one week are often followed by a sharp drop the following one due to the timing of ship arrivals.

But the past four weeks have seen a fairly unusual and sustained increase in imports along the Gulf Coast, where imports have risen from the equivalent of around 9 VLCCs to 14 VLCCs per week.

Most of the additional crude has come from Saudi Arabia (roughly an extra two tankers per week), Mexico (one to two tankers per week), Venezuela (one tanker) and Iraq (one tanker). The reason for the upsurge in seaborne imports is not clear (tmsnrt.rs/1NV4emv).

The reason could be purely timing-related as tankers unload now after being delayed in transit or unloading back in November.

Or crude could be flowing to storage facilities in the United States because it is easier and cheaper to store there as terminals in the Caribbean, Europe and Asia fill up.

There are also strong commercial reasons to put oil into storage in the United States. The contango is running at nearly $1 per barrel per month on average for the first six months (more than enough to cover the cost of financing the inventory and leasing tank space).

Traders have a strong incentive to source as many surplus cargoes as possible from oil exporters in the Middle East and Latin America and bring them to the United States (tmsnrt.rs/1NV4jXg).

The sudden increase in importing could be a sign the market is running out of storage in other locations, in which case the rise in imports and inventories can be expected to continue through the end of the year and into the first quarter of 2016.

On the other hand it may be a short-term storage-related trading play, in which case import levels could revert to a lower level in the next few weeks.

(Editing by Dale Hudson)

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Oil makes only one promise and that’s volatility: Kemp http://www.reuters.com/article/oil-prices-kemp-idUSL8N1443E920151216 http://blogs.reuters.com/john-kemp/2015/12/17/oil-makes-only-one-promise-and-thats-volatility-kemp/#comments Thu, 17 Dec 2015 21:00:41 +0000 http://blogs.reuters.com/john-kemp/?p=1679 By John Kemp

LONDON, Dec 15 Just about the only thing we know about where oil prices are headed over the next few years is that most of the forecasts will be wrong.

The oil market has defied every attempt to fix or predict prices in terms of oil’s value to customers, the marginal cost of production, or the price of available substitutes.

“It was to me an economic aberration that oil remained much cheaper than Evian mineral water,” the deposed shah of Iran wrote in his memoir justifying his efforts to push for higher prices in the 1970s.

Mohammad Reza Shah Pahlavi thought oil should be intrinsically valuable because it was the source of more than 70,000 different products, including petrochemicals as well as fuels (“Answers to History”, 1980).

But more than a third of a century later, crude still sells for less than bottled water, currently on sale at the equivalent of more than $100 per barrel at supermarkets in the United States and Britain.

In the late 1970s, OPEC’s Long-Term Price Policy Committee adopted a different approach, recommending that the price of oil should be increased gradually until it was just below the cost of the nearest substitute.

According to ideas popular at the time, alternative sources of energy should cost the same. OPEC identified its main competition as synthetic diesel and gasoline fuels processed from coal.

Since the cost of producing synfuels was thought to be near $60 per barrel, almost $200 in today’s prices, that became OPEC’s implicit long-run target (“Genie out of the bottle” Akins, 1995).

OPEC managed to push average prices to a high of almost $37 per barrel in 1980, around $107 in real terms, but then the market slumped over the next six years, hitting a low of just $14 in 1986, about $30 in real terms.

As it turned out, the main competitors to OPEC’s were not expensive synfuels plants but rival oil producers in Alaska, the Gulf of Mexico, the North Sea, the Soviet Union and China, which were much cheaper.

At other times, economists and oil producers have assumed prices should be set by the marginal cost of production, which in the 1980s was assumed to be the North Sea.

With prices mired below $20 in the late 1980s, OPEC’s former secretary-general Ali Jaidah wondered how prices this low could be sustainable:

“I just cannot understand how this low oil price can sustain investment in high-cost oil areas. Someone somewhere must be losing his shirt.”

More recently, the marginal producers in the market were thought to be North America’s shale firms, and their cost of production was pegged by experts at $80-90 per barrel.

Before prices started to tumble in July 2014, there was increasing confidence among oil executives, analysts and OPEC that $100 had become the new price floor.

It was common to hear statements to the effect “$100 is the new $20″ because that represented the marginal cost of shale as well as complex megaprojects.

But as prices have plunged and oil producers were forced to become more efficient it turned out the marginal cost of oil from shale is as low as $50 or $60.

Most major oil companies and members of OPEC are now preparing for a world in which the long-run price of oil is around $60-80 (tmsnrt.rs/1O6JzxF).

FORECASTS ALWAYS WRONG

By now it should be clear that no one has been able to fix or predict the price of oil over the long term (greater than five years) or even the medium term (two to five years).

There is no evidence anyone can accurately and consistently predict the price of oil more than a few months ahead let alone for years or decades in the future.

Forecasts along the lines of “oil prices will be around $X per barrel by 2020″ or “oil prices will stabilise around $X because …” are almost inevitably wrong.

The first response should always be to question what assumptions they are making and why they could be proved wrong.

In the 1970s, OPEC failed to foresee the rise of rival production from the North Sea, Alaska, the Gulf of Mexico, the Soviet Union and China.

In the 1980s and 1990s, OPEC failed to predict the North Sea could continue to produce at real prices of less than $30 per barrel having been written off as a “high cost” area.

In the 2010s, forecasters failed to foresee the rise of production from shale and then its ability to remain competitive at much lower prices than previously assumed.

VOLATILITY IS NORMAL

The other lesson from history is that oil prices, like other commodity prices, are inherently volatile. Volatility is not some accidental attribute of commodity markets, it is their defining characteristic.

Prices have been unstable since the beginning of the modern oil industry when Edwin Drake drilled his first successful well in Pennsylvania in 1859. (tmsnrt.rs/1O6JytM)

Writing less than 20 years later, one of the first historians of oil observed: “Petroleum had no certain value, no determinate value. The fact that it sold for 50 and 25 cents per gallon proves nothing. It sold for that in 1859 but the first day’s production broke the market” and sent prices tumbling (“Early and later history of petroleum” Henry, 1873).

Oil prices fluctuated wildly in the 1860s from several dollars per barrel to just a few cents, and the extreme volatility has continued unabated ever since. (“Pennsylvania petroleum 1750-1872″ Giddens, 1947)

In the last 150 years, various combinations of private companies and governments have repeatedly tried to bring order to the market yet all have failed.

From Standard Oil in the late 19th century, through the “As-Is” agreement among the major oil companies signed at Achnacarry Castle in Scotland in 1928, to the foundation of OPEC in 1960, there is no evidence anyone has managed to dampen the extreme, cyclical behaviour of oil prices.

In fact, oil prices have been more unstable in the 55 years since OPEC was founded than they were in the previous 55 years.

It is tempting to blame the recent slump in oil prices on OPEC for failing to reach an agreement on limiting output.

But the truth is stability has been the exception rather than the norm. Neither OPEC nor private companies have ever managed to stabilise prices except for very short periods in very special circumstances.

It makes no sense to talk about “long term” or “equilibrium” prices since the price of oil depends on too many factors which are all dynamic.

Oil producers and consumers must adapt to prices as they find them.

Flexibility and the ability to survive through the price cycle are more important to oil producers and consumers than flaky forecasts about where prices are going over the next 3, 5 or 10 years.

The long-term price of oil is literally unforecastable. The only thing that can be said with absolute certainty is that oil prices will continue to defy the expectations of experts. (Editing by Jason Neely)

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Hedge funds add to record bearish positions in oil http://www.reuters.com/article/us-hedgefunds-oil-kemp-idUSKBN0TX24120151215 http://blogs.reuters.com/john-kemp/2015/12/17/hedge-funds-add-to-record-bearish-positions-in-oil/#comments Thu, 17 Dec 2015 20:57:03 +0000 http://blogs.reuters.com/john-kemp/?p=1676 Rather than taking profits, hedge funds continued to add to their record bearish positions after the Organization of the Petroleum Exporting Countries (OPEC) failed to reach agreement on a production target at the start of the month.

By Dec. 8, hedge funds and other money managers had accumulated short positions in the main WTI and Brent futures and options contracts equivalent to 364 million barrels.

The combined short position in Brent and WTI was up by almost 5 million barrels compared with the previous week and 161 million barrels since the middle of October (tmsnrt.rs/1YeMa8n).

The combined short position is easily the largest on record, dwarfing the previous records of 325 million barrels set in August and 299 million barrels in March.

Hedge funds booked some profits on Brent, reducing short positions by 8 million barrels last week, but added 13 million in WTI, according to data from the U.S. Commodity Futures Trading Commission and ICE Futures Europe.

Hedge fund short positions have been strongly correlated with movements in the price of Brent and WTI throughout 2015, so it comes as no surprise that the extra shorts helped push both markers to new lows (tmsnrt.rs/1YeMns9).

By the end of the week, both Brent and WTI were trading well below $40 per barrel, at their lowest levels since the depths of the financial crisis and recession in 2008/2009.

There has been no sign of mass short covering among speculators despite the fact that WTI and Brent prices have both fallen almost $12 in less than two months.

Both the poor supply-demand fundamentals and momentum trading strategies appear to favor the downside for the time being.

But the risks associated with such a large short position that will need to be covered at some point are clearly rising.

The cost of buying protection against a sudden price movement up or down through options is becoming progressively more expensive.

Brent crude options are now even more expensive than they were before the OPEC meeting on Dec. 4 as implied volatility continues to increase (tmsnrt.rs/1YeMYdp).

The implied volatility embedded within one-month at the money Brent options has risen to more than 50 percent, up from a previous high of 47 percent before OPEC’s decision was announced.

Implied volatility is now the in 93rd percentile for all trading days since 2006, according to estimates derived from Thomson Reuters Eikon (tmsnrt.rs/1YeOEDA).

In the short term, the short positions can be rolled forward profitably because the market remains in contango so the hedge funds are buying back cheap futures positions and selling more expensive ones.

Positive roll yield is adding to the returns from being short in a falling market and ensuring the positions are very profitable.

But at some point the short positions will have be scaled back significantly; the high level of implied volatility shows that option dealers are braced for turbulence when some of the hedge funds try to exit.

(John Kemp is a Reuters market analyst. The views expressed are his own)

(Editing by William Hardy)

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Oil makes only one promise and that’s volatility http://www.reuters.com/article/us-oil-prices-kemp-idUSKBN0TY2C720151215 http://blogs.reuters.com/john-kemp/2015/12/17/oil-makes-only-one-promise-and-thats-volatility/#comments Thu, 17 Dec 2015 20:51:48 +0000 http://blogs.reuters.com/john-kemp/?p=1673 Just about the only thing we know about where oil prices are headed over the next few years is that most of the forecasts will be wrong.

The oil market has defied every attempt to fix or predict prices in terms of oil’s value to customers, the marginal cost of production, or the price of available substitutes.

“It was to me an economic aberration that oil remained much cheaper than Evian mineral water,” the deposed shah of Iran wrote in his memoir justifying his efforts to push for higher prices in the 1970s.

Mohammad Reza Shah Pahlavi thought oil should be intrinsically valuable because it was the source of more than 70,000 different products, including petrochemicals as well as fuels (“Answers to History”, 1980).

But more than a third of a century later, crude still sells for less than bottled water, currently on sale at the equivalent of more than $100 per barrel at supermarkets in the United States and Britain.

In the late 1970s, OPEC’s Long-Term Price Policy Committee adopted a different approach, recommending that the price of oil should be increased gradually until it was just below the cost of the nearest substitute.

According to ideas popular at the time, alternative sources of energy should cost the same. OPEC identified its main competition as synthetic diesel and gasoline fuels processed from coal.

Since the cost of producing synfuels was thought to be near $60 per barrel, almost $200 in today’s prices, that became OPEC’s implicit long-run target (“Genie out of the bottle” Akins, 1995).

OPEC managed to push average prices to a high of almost $37 per barrel in 1980, around $107 in real terms, but then the market slumped over the next six years, hitting a low of just $14 in 1986, about $30 in real terms.

As it turned out, the main competitors to OPEC’s were not expensive synfuels plants but rival oil producers in Alaska, the Gulf of Mexico, the North Sea, the Soviet Union and China, which were much cheaper.

At other times, economists and oil producers have assumed prices should be set by the marginal cost of production, which in the 1980s was assumed to be the North Sea.

With prices mired below $20 in the late 1980s, OPEC’s former secretary-general Ali Jaidah wondered how prices this low could be sustainable:

“I just cannot understand how this low oil price can sustain investment in high-cost oil areas. Someone somewhere must be losing his shirt.”

More recently, the marginal producers in the market were thought to be North America’s shale firms, and their cost of production was pegged by experts at $80-90 per barrel.

Before prices started to tumble in July 2014, there was increasing confidence among oil executives, analysts and OPEC that $100 had become the new price floor.

It was common to hear statements to the effect “$100 is the new $20” because that represented the marginal cost of shale as well as complex mega projects.

But as prices have plunged and oil producers were forced to become more efficient it turned out the marginal cost of oil from shale is as low as $50 or $60.

Most major oil companies and members of OPEC are now preparing for a world in which the long-run price of oil is around $60-80 (tmsnrt.rs/1O6JzxF).

FORECASTS ALWAYS WRONG

By now it should be clear that no one has been able to fix or predict the price of oil over the long term (greater than five years) or even the medium term (two to five years).

There is no evidence anyone can accurately and consistently predict the price of oil more than a few months ahead let alone for years or decades in the future.

Forecasts along the lines of “oil prices will be around $X per barrel by 2020” or “oil prices will stabilize around $X because …” are almost inevitably wrong.

The first response should always be to question what assumptions they are making and why they could be proved wrong.

In the 1970s, OPEC failed to foresee the rise of rival production from the North Sea, Alaska, the Gulf of Mexico, the Soviet Union and China.

In the 1980s and 1990s, OPEC failed to predict the North Sea could continue to produce at real prices of less than $30 per barrel having been written off as a “high cost” area.

In the 2010s, forecasters failed to foresee the rise of production from shale and then its ability to remain competitive at much lower prices than previously assumed.

VOLATILITY IS NORMAL

The other lesson from history is that oil prices, like other commodity prices, are inherently volatile. Volatility is not some accidental attribute of commodity markets, it is their defining characteristic.

Prices have been unstable since the beginning of the modern oil industry when Edwin Drake drilled his first successful well in Pennsylvania in 1859. (tmsnrt.rs/1O6JytM)

Writing less than 20 years later, one of the first historians of oil observed: “Petroleum had no certain value, no determinate value. The fact that it sold for 50 and 25 cents per gallon proves nothing. It sold for that in 1859 but the first day’s production broke the market” and sent prices tumbling (“Early and later history of petroleum” Henry, 1873).

Oil prices fluctuated wildly in the 1860s from several dollars per barrel to just a few cents, and the extreme volatility has continued unabated ever since. (“Pennsylvania petroleum 1750-1872” Giddens, 1947)

In the last 150 years, various combinations of private companies and governments have repeatedly tried to bring order to the market yet all have failed.

From Standard Oil in the late 19th century, through the “As-Is” agreement among the major oil companies signed at Achnacarry Castle in Scotland in 1928, to the foundation of OPEC in 1960, there is no evidence anyone has managed to dampen the extreme, cyclical behavior of oil prices.

In fact, oil prices have been more unstable in the 55 years since OPEC was founded than they were in the previous 55 years.

It is tempting to blame the recent slump in oil prices on OPEC for failing to reach an agreement on limiting output.

But the truth is stability has been the exception rather than the norm. Neither OPEC nor private companies have ever managed to stabilize prices except for very short periods in very special circumstances.

It makes no sense to talk about “long term” or “equilibrium” prices since the price of oil depends on too many factors which are all dynamic.

Oil producers and consumers must adapt to prices as they find them.

Flexibility and the ability to survive through the price cycle are more important to oil producers and consumers than flaky forecasts about where prices are going over the next 3, 5 or 10 years.

The long-term price of oil is literally unforecastable. The only thing that can be said with absolute certainty is that oil prices will continue to defy the expectations of experts.

(John Kemp is a Reuters market analyst. The views expressed are his own)

(Editing by Jason Neely)

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Britain’s motorists should thank Ali Naimi for cheap fuel: Kemp http://www.reuters.com/article/us-britain-gasoline-kemp-idUSKBN0TU1KQ20151214 http://blogs.reuters.com/john-kemp/2015/12/17/britains-motorists-should-thank-ali-naimi-for-cheap-fuel-kemp/#comments Thu, 17 Dec 2015 20:48:45 +0000 http://blogs.reuters.com/john-kemp/?p=1670 Britain’s motorists have Saudi oil minister Ali al-Naimi to thank as the country’s supermarkets cut the price of petrol to less than one pound per liter for the first time in six years.

Morrisons, the country’s fourth-largest grocer, has cut the price of unleaded gasoline to 99.9 pence per liter, the lowest price excluding special promotions since 2009, and other supermarkets are expected follow, according to the BBC.

Brent prices have fallen to $39 per barrel for the first time since 2008/09 after the Organization of the Petroleum Exporting Countries (OPEC) failed to agree a production level at its meeting on Dec. 4.

Both OPEC and the International Energy Agency (IEA) have forecast the oil market will remain oversupplied in 2016, sending oil prices crashing to new lows.

Cheaper fuel as well as continued economic expansion and a faster rise in wages have combined to produce a surge in traffic on Britain’s roads.

Traffic volumes rose by 2.2 percent in the 12 months ending in September compared with the prior period, according to the UK Department for Transport.

Traffic has increased for 10 consecutive quarters, for the first time exceeding the previous peak, set back in 2007 before the recession (tmsnrt.rs/1NZxHNX).

Traffic growth mostly reflects the steady increase in economic activity and employment but lower fuel prices may also have contributed, the department says.

The increase in traffic is the fastest and most consistent for more than decade stretching back to the early 2000s, before fuel prices started to climb sharply.

Vehicles sales are also booming, according to the Society of Motor Manufacturers and Traders, a trade association.

For the first time since 2004, new car registrations topped 2 million in the first nine months of 2015. In September, registrations reached their highest ever level for the time of year.

Surging traffic and vehicle sales look a lot like the United States, where traffic volumes increased by 3.5 percent in the first nine months of the year, according to the Federal Highway Administration.

U.S. sales of cars and light trucks are on course this year to exceed the prior record set back in 2000, according to WardsAuto.

Cheaper fuel sales have also encouraged consumers to buy larger and more fuel-hungry sport utility vehicles (SUVs) and crossover utility vehicles (CUVs) rather than smaller cars.

Sales of light trucks, a category that includes SUVs and CUVs, are up 12 percent this year, while car sales have fallen by 2 percent, according to Wards.

As a result, U.S. gasoline consumption has risen almost 3 percent so far this year, the fastest increase since 2005, according to the U.S. Energy Information Administration.

Cheaper fuel may not last indefinitely. Saudi officials have indicated they believe oil prices of $60-80 per barrel will be needed in the longer-term to sustain investment in production.

“A prolonged period of low oil prices is … unsustainable, as it will induce large investment cuts and reduce the resilience of the oil industry, undermining the future security of supply and setting the sharp price rise” in a few years time, Naimi’s deputy warned a conference last month.

But in the meantime, cheaper fuel prices and rising consumption, coupled with a reduction in high-cost oil production, is an essential part of Saudi Arabia’s strategy for rebalancing the oil market.

Saudi Arabia is relying on low prices and strong consumption growth to mop up some of the excess crude oil production in the market and help absorb extra Iranian barrels once sanctions are lifted in 2016.

The opinions expressed here are those of the author, a columnist for Reuters.)

(Editing by David Evans)

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Oil producers offset fall in prices by raising output: Kemp http://www.reuters.com/article/us-oil-production-kemp-idUSKBN0TT1JC20151210 http://blogs.reuters.com/john-kemp/2015/12/17/oil-producers-offset-fall-in-prices-by-raising-output-kemp/#comments Thu, 17 Dec 2015 20:45:44 +0000 http://blogs.reuters.com/john-kemp/?p=1667 The first response of commodity producers to a drop in prices is normally to increase production – ensuring price falls become deeper and more prolonged.

Producers attempt to make up in volume what they have lost in prices. But what might be rational for one is disastrous collectively.

Cuba’s top trade negotiator warned a conference as long ago as 1946: “We know from experience that sometimes a reduction in prices not only does not bring a reduction in production, but as a matter of fact stimulates production, because farmers try to make up by a larger volume in production the decrease in income resulting from the fall in prices.”

He was speaking about sugar, but the same response has been true for other commodities, including petroleum.

In 2015, most oil producers have responded to the slump in prices by raising output, ensuring the market remains flooded and postponing the anticipated rebalancing of supply and demand.

Russia, Saudi Arabia and Iraq have all increased production in 2015. Iran hopes to follow in 2016 once sanctions are lifted.

Combined output from nine of the world’s largest oil and gas companies rose by 8 percent in the first nine months of 2015.

Output from U.S. waters in the Gulf of Mexico was almost 19 percent higher in September 2015 than the same month a year earlier, according to the U.S. Energy Information Administration.

Oil companies have said the Gulf of Mexico remains an attractive prospect even at low prices and they intend to continue increasing production there.

Even in the major shale-producing areas of the United States, production is not falling as fast as had been predicted.

Companies have sought to maintain production volumes even as they slash costs.

North Dakota’s oil output is down only 5 percent from the peak and has been surprisingly stable in recent months.

Bakken producers even accelerated output and sales in October ahead of an OPEC meeting they feared would result in even lower prices, the state’s chief regulator told reporters on Dec. 9.

In Texas, output from the Permian Basin, one of the oldest oil-producing areas in the country with particularly attractive geology, is still increasing.

INVESTMENT REDIRECTED

Some of the increase in worldwide production is the lagged effect of decisions taken to expand when prices were still high. New fields given the go-ahead between 2012 and 2014 are only now coming onstream.

But some of the growth is coming from a deliberate strategy to maximize production from existing fields even as spending on exploration programs and new field developments are cut back.

Britain’s North Sea oil and gas producers have managed to raise output this year by reducing the number of field outages. The new mantra for North Sea operators is to do more with less.

Russia and Iraq have ramped up output from existing assets in 2015 even as they have cut spending on new fields scheduled for development in 2016 and beyond.

In effect, oil and gas producers are sweating existing assets harder to maximize production in 2015 and 2016 even as they cut back on investment needed to maintain and increase production in 2017 and beyond.

Capex is being redirected towards projects which increase short-term output and away from projects with a longer-term focus.

Around the world “nearly 5 million barrels per day of projects have already been deferred or cancel led,” Prince Abdulaziz bin Salman, Saudi Arabia’s vice minister of petroleum and mineral resources, has warned.

“Beyond 2016, the fall in non-OPEC supply is likely to accelerate, as the cancellation and postponement of projects will start feeding through into future supplies,” he said at a conference in Doha in November.

In theory, this creates an even more exaggerated production and price profile, with prices falling further in 2015 and 2016, then rebounding faster and higher in 2017 and 2018.

But there are reasons to be very cautious about both the predicted decline in production and rebound in prices as a result of spending cuts.

RESETTING THE COST BASE

In the second half of the 1980s and throughout the 1990s there were repeated predictions that low prices would soon lead to a sharp drop in non-OPEC output and a rebound in prices, which failed to materialize.

OPEC’s former secretary-general, Ali Jaidah, told the Oxford Energy Seminar in 1988:

“We hear senior managers of oil companies haranguing OPEC, preaching to the organization that the state of the oil world, however depressed, will undoubtedly improve in the next few years.

“They seem to say – please remain strong and confident, we are going through a difficult period just now, but the wheels of fortune are bound to turn in your favor soon.

“I just cannot understand how this low price can sustain investment in high-cost oil areas. Somebody, somewhere must be losing his shirt.”

In practice, the international oil companies learned to survive and even grow at prices which had previously be considered unsustainable.

“Oil companies are accepting that they can’t count on higher prices to stimulate the currently low global drilling pace,” Petroleum Intelligence Week reported in April 1988.

Instead, the international oil companies learned how to find and produce more while spending less money through innovations like three-dimensional seismic surveys and deviated drilling.

Production from areas like the North Sea, which had been dismissed as high-cost, continued to increase as operators learned to do more with less.

The entire cost base of the industry was reset downwards through an intense focus on standardizing operations and squeezing costs as well as cutting wages and staffing.

At the same time OPEC producers Iran and Iraq constantly tried to increase output to raise revenues amid stagnating prices.

OPEC spent much of the late 1980s and 1990s struggling to balance the market in the face of continued growth in non-OPEC production and pressure for output increases from revenue-hungry members within its own ranks.

There was no sustained recovery in real prices until 1999/2000, almost 15 years after prices crashed in 1985/1986 (tmsnrt.rs/1Z0NkGH).

LESSONS FROM HISTORY

There are important differences between the price collapse in the 1980s and the current slump, principally the large amount of excess production capacity inherited from the early 1980s which is not present this time around.

Saudi Arabia’s vice minister of petroleum warned his audience: “One fundamental flaw in the current narrative is the tendency to compare the current price fall with that of the mid 1980s. But this comparison is simply misguided. Market conditions now are fundamentally different from what they were then.

“In 1985, global oil consumption stood at just over 59 million barrels per day and the available spare capacity was at a historical level of over 10 million b/d … In 2015, oil consumption is estimated to reach 94 million barrels per day, while usable spare capacity, mainly held in Saudi Arabia, is estimated at 2 million barrels per day.”

But there are also important similarities, including the ambitions of Russia, Iran and Iraq to continue increasing production even at low prices; efforts of the major international oil companies to sustain production and reset their cost base; and the unexpected resilience of non-OPEC production so far in the face of a large price shock.

In the 1980s, countries and companies were repeatedly surprised by the market’s failure to recover, which should be a warning to treat the predicted fall in output and recovery in prices in 2017 and 2018 with great caution.

(John Kemp is a Reuters market analyst. The views expressed are his own)

(Editing by David Evans)

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Yamani legacy haunts the oil market: Kemp http://www.reuters.com/article/us-saudi-opec-kemp-idUSKBN0TS1HO20151209 http://blogs.reuters.com/john-kemp/2015/12/17/yamani-legacy-haunts-the-oil-market-kemp/#comments Thu, 17 Dec 2015 20:42:39 +0000 http://blogs.reuters.com/john-kemp/?p=1664 “All political lives, unless they are cut off in midstream at a happy juncture, end in failure, because that is the nature of politics and of human affairs,” wrote British politician Enoch Powell.

Saudi Arabia’s veteran Oil Minister Ali al-Naimi may wonder if he is destined to become the scapegoat for the current collapse in oil prices which is inflicting so much damage on the kingdom’s finances and economy.

Ahmed Zaki Yamani, Naimi’s predecessor-but-one, was dismissed by King Fahd in 1986 following a prolonged slump in prices. Naimi could be forgiven for wondering if history will repeat itself.

Saudi Arabia has had just four oil ministers in the last 55 years: Abdullah Tariki (1960-1962), Yamani (1962-1986), Hisham Nazer (1986-1995) and Naimi (1995 – ).

The petroleum minister has always been the most powerful member of the government from outside the royal family.

But like all ministers, the oil minister serves at the pleasure of the king and the court, and if policy is deemed to have failed the minister is ultimately responsible.

TIMING IS EVERYTHING

Naimi was reportedly asked to nominate possible successors in 2010. But the expected cabinet reshuffle was postponed as the kingdom’s rulers sought to project an image of stability and continuity amid the revolutions convulsing the Arab world in 2011.

If Naimi had been allowed to retire as planned in 2011 he would have left office a hero for orchestrating production cuts among the members of the Organization of the Petroleum Exporting Countries (OPEC) in 2008/09 and engineering a recovery in prices following the global financial crisis.

For three and half years between 2011 and mid-2014 oil prices averaged over $100 and cash poured into the kingdom, enabling it to build up financial reserves of more than $730 billion.

Then it all went wrong.

Brent oil prices slumped from around $115 per barrel in June 2014 to $77 by November in response to slowing demand growth and accelerating supply, especially from U.S. shale.

Guided by Naimi, OPEC decided in November 2014 to maintain its production, defend its market share, and let prices fall to curb the growth in production from high-cost rivals.

Prices have slumped further. One year later, prices have fallen by another $37 to $40 per barrel.

OPEC members are hemorrhaging cash. Even Saudi Arabia’s formidable reserves are draining away rapidly.

Commentators with close links to the Saudi oil ministry insist the kingdom’s policymakers always understood it would take 2-3 years to curb shale growth, encourage more demand, and rebalance the oil market.

But almost 18 months into the price slump, progress has toward rebalancing has been far slower than anyone, including the Saudis, thought likely in 2014.

SLOW STRATEGY RESULTS

U.S. shale production has stopped accelerating but remains stubbornly high. Russia has increased its output. Most other oil producers have also increased production in part to offset lower prices.

Oil demand has increased by 1.8 million barrels per day in 2015. But the market remains oversupplied. Stocks are rising by more than 1 million barrels per day.

Iran, whose oil exports have been crippled since 2012 by sanctions related to its nuclear program, is poised to increase its production and exports if sanctions are lifted in 2016, adding to the oversupply.

Saudi officials insist they will not cut production unless other non-OPEC countries agree to reduce their own output and Iran and Iraq accept limits on future production growth.

The result is that the latest OPEC meeting ended on Dec. 4 without any agreement at all on production, leaving members free to pump as much as possible in the months ahead.

Brent prices have continued to slide and are now at the lowest level since the depths of the slump in February and March 2009 that followed the global financial crisis.

Historians will argue for years how much the crisis reflects forces beyond Saudi Arabia’s control and if it has been worsened by miscalculations in Riyadh.

Saudi Arabia was clearly correct to recognize a price above $100 had become unsustainable by mid-2014 because it was encouraging too much supply and not enough demand. Much lower prices were required to rebalance the market.

But whether it was right to unleash a volume war for market share and flood the market with excess crude oil is more controversial.

It is not clear what alternative course Naimi could have taken in 2014, but if he hoped to curb production from high-cost rivals in the U.S. shale fields, the North Sea, Russia, the Gulf of Mexico and other areas, the results have been meager so far.

The strategy has led to a complete collapse of cooperation within OPEC itself, which is no longer even making a pretence of acting like a cartel.

Saudi Arabia launched a volume war on other oil producers in 2015; Iran is poised to respond in kind in 2016.

Volume warfare has shifted the battle from between OPEC and non-OPEC to inside the cartel itself.

Saudi Arabia is now at loggerheads with almost everyone in the oil market – from Russia, U.S. shale producers, Iran, Iraq, Venezuela, Ecuador and Nigeria to the oil majors. Just about the only allies the Saudis have left are Kuwait and the United Arab Emirates.

The slump may have begun with factors outside Saudi control, but the kingdom’s policy has arguably made it worse and left Riyadh isolated, with few friends and no good options. The question is whether a more nuanced and emollient policy could have rendered the slump shorter and less deep.

REPRISE OF 1986?

Volume warfare looks and sounds a lot like the situation in the mid-1980s when Saudi Arabia tired of acting as the swing producer and ramped up its production to win back market share lost to rivals within OPEC as well as producers in the North Sea, the Soviet Union and the Gulf of Mexico.

In 1986, unrestricted volume warfare sent oil prices plunging to an average of $14 per barrel, around $31 today after adjusting for inflation. At one point, prices dropped below $10, around $22 today after adjusting for inflation.

Current news reports about the disarray within OPEC bear an eerie similarity to press reports from 1986 cited by economist Morris Adelman in his retrospective study on OPEC in the 1980s (“The Cartel in Retreat” 1993).

“Saudi Arabia believes that the price war eventually will eliminate much oil from non-OPEC producers, such as Britain and the United States, because their oil is too expensive to produce,” the Wall Street Journal reported on June 30, 1986.

“The Persian Gulf producers said prices had fallen to ‘unacceptable levels and only cooperation between all producers inside and outside OPEC’ could improve matters,” according to the New York Times in March 1986.

“Even the Saudis are becoming concerned about the rapidity and depth of the current price plunge,” Petroleum Intelligence Week wrote, also in March 1986.

Ultimately, volume warfare failed to produce the hoped-for reduction in non-OPEC supplies, at least not until many years later.

OPEC called a ceasefire in the second half of 1986 and the Saudi oil minister, Yamani, was dismissed by the end of October.

Yamani was removed for a variety of reasons, not least because he had become estranged from then-king Fahd and other powerful princes, and was seen as an overmighty subject, according to his biographer (“Yamani: the Inside Story” 1988).

But there is no question that he was also a scapegoat for a failed oil policy and his removal signaled a change in direction imposed from within the royal court.

There are important differences between 1986 and 2015 so the parallel should not be taken too far.

Saudi Arabia had been cutting rather than raising production in the early 1980s. The kingdom’s foreign reserves are in much better shape currently to withstand a prolonged financial siege.

Yamani shouldered the blame for the failed experiment with netback pricing. And shale production may be more responsive to low prices than the North Sea was in the 1980s.

But Saudi Arabia is once again embroiled in a price crisis, the biggest since 1986. The current minister must hope this time it ends differently.

(The opinions expressed here are those of the author, a columnist for Reuters.)

(Editing by William Hardy)

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Oil storage business is booming: Kemp http://www.reuters.com/article/oil-storage-kemp-idUSL8N13S4ZQ20151204 http://blogs.reuters.com/john-kemp/2015/12/17/oil-storage-business-is-booming-kemp/#comments Thu, 17 Dec 2015 20:36:26 +0000 http://blogs.reuters.com/john-kemp/?p=1658 By John Kemp

Dec 3 Oil producers may be struggling as a result of low prices but the oil storage business has never been in better shape.

U.S. refiners, traders and logistics companies added an extra 11 million barrels of working storage capacity for crude oil between March and September, according to the U.S. Energy Information Administration.

Since September 2011, total capacity for storing crude in the United States has expanded by almost 87 million barrels, 19 percent, the EIA reported on Monday (“Working and Net Available Shell Storage Capacity” Nov. 30).

Most of the extra capacity has been added at tank farms and other offsite locations (+84 million barrels) rather than refineries (+2.5 million barrels) where space is often constrained.

The biggest additions have come in states on the U.S. Gulf Coast (+50 million barrels) with most of the rest in the Midwest (+32 million barrels) especially around the NYMEX delivery point at Cushing (+18 million barrels).

Some commercial crude is stored in underground salt caverns leached from salt domes or bedded salt but most is held in aboveground storage tanks constructed to special standards set by the American Petroleum Institute (API 650 tanks).

By contrast, the U.S. government’s Strategic Petroleum Reserve, which contains almost 700 million barrels of crude, is entirely stored in salt caverns in Texas and Louisiana.

Commercial storage capacity is also expanding around the rest of the world including major trading hubs in Singapore, South Africa and the Caribbean.

Commercial storage is big business although the companies involved all prefer to keep a low profile.

Most facilities are owned by unlisted private firms or subsidiaries of oil companies, although one international operator, Vopak, with storage facilities around the world, including some in the United States, is quoted on the Amsterdam stock exchange.

Storage remains profitable because there are high entry barriers to both owning and storing physical crude.

Crude is bought and sold in large volumes and requires expensive specialist tanks connected to marine terminals, refineries and the pipeline network.

The entire business is capital intensive and networked among a small professional community which is relatively closed to outsiders.

Furthermore, oil is toxic so the business of owning and storing oil is strictly regulated by local, state and federal governments.

MORE TANK FARMS

Demand for storage has been growing rapidly in recent years. In response a large number of new tank farms and tank farm expansions have been commissioned.

Total working crude storage capacity has grown from 465 million barrels in September 2011 to 551 million barrels in September 2015, according to the EIA, and is set to expand further in 2016.

Some extra storage is needed for operational reasons to maintain an uninterrupted flow of oil to refineries, settle out water and blend different crude streams to optimise the mix before it is fed into refinery distillation towers.

As U.S. oil production has risen from 5 million barrels per day in 2008 to more than 9 million barrels per day in 2015, operational storage requirements have also risen.

But some extra storage is more speculative in character and used to make money when the oil market is trading in contango.

When prices for future delivery are above spot prices, refiners and traders buy physical oil and put it into storage, selling an equivalent number of contracts for future delivery at the higher forward price.

When the futures contracts mature, the physical oil can be delivered against them, or the contracts can be rolled forward by selling another set of contracts even further in the future.

Profits from the strategy, which carries little risk, are equal to the difference between the spot price and the future price, minus interest and storage fees.

Since 2011, the U.S. crude market has been in contango on three days out of every four, with an average price gap of 23 cents per barrel per month between the first and third futures contracts.

In 2015, the market has been in contango every day, with an average price difference of 65 cents per barrel per month between the first and third futures contracts.

With interest rates close to zero, most of the contango remains to be shared out between the owner of the crude oil and owner of the storage space.

The strategy is attractive when the oil market is oversupplied and inventories of crude and refined products are rising, which has been the case throughout 2015.

Storing oil has become enormously profitable, with the result traders have bought as much physical crude as possible and sent it to tank farms.

In turn, traders and third-party logistics providers have scrambled to construct as much new space as possible to cash in on the storage boom. (Editing by David Evans)

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Expensive oil options point to fear of sudden price move: Kemp http://www.reuters.com/article/us-opec-meeting-options-kemp-idUSKBN0TL20K20151203 http://blogs.reuters.com/john-kemp/2015/12/17/expensive-oil-options-point-to-fear-of-sudden-price-move-kemp/#comments Thu, 17 Dec 2015 20:33:30 +0000 http://blogs.reuters.com/john-kemp/?p=1655 Oil options are becoming increasingly expensive as the market waits nervously for the outcome of the OPEC meeting in Vienna and eyes the large concentration of bearish bets by hedge funds.

Most oil analysts and investors expect OPEC will leave its production target unchanged at 30 million barrels per day or even increase it slightly to accommodate the return of Indonesia to membership.

But hedge funds have already amassed a near-record short position of almost 300 million barrels in Brent and WTI futures and options betting on a further drop in crude prices.

If the outcome of the meeting is not thought to be in doubt there is considerable uncertainty about how the market will react afterwards.

If ministers leave production unchanged it could give hedge funds a signal prices will fall further, sending the market into a tailspin below $40 per barrel.

But if prices do not fall as expected, there is a strong chance the market will rally, perhaps sharply, as hedge funds book profits and trim their positions.

And in the unlikely event oil ministers cut production, the large number of short positions could result in a very brutal short-covering rally.

The large concentration of short positions held by hedge funds has introduced a high degree of uncertainty into the short-term outlook for oil prices.

In 2015, large hedge fund short positions in Brent and WTI have presaged sudden price moves and an upsurge in volatility.

The only other time hedge funds have held a short position this large, in mid- and late August, it preceded a brutal short covering rally, which saw prices surge $11 per barrel, or 25 percent, in just three trading days.

Option prices are directly related to traders’ estimates of the probability of sharp price moves in the future, technically known as implied volatility.

Implied volatility for Brent options has been steadily increasing since the middle of October as the market reacts to the big build up of hedge fund short positions and the imminent OPEC meeting.

Implied vol for at-the-money Brent options has climbed from 34.5 percent in mid-October to 44 percent at the start of December and is at the highest level since the price spike in August (tmsnrt.rs/1NHlo8P).

The average or median level of implied volatility since 2006 has been just under 31 percent.

Implied volatility is currently in the 86th percentile for all trading days since 2006 – in other words implied volatility has only been higher than it is at present 14 percent of the time (tmsnrt.rs/1NHnoxR).

The fact implied vol is almost 1.5 times higher than normal indicates traders see a relatively high risk of large price moves in the near future.

(John Kemp is a Reuters market analyst. The views expressed are his own)

(Editing by David Evans)

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Shorting OPEC, hedge funds leave crude prices at risk from recoil: Kemp http://www.reuters.com/article/us-opec-meeting-kemp-idUSKBN0TK5CY20151201 http://blogs.reuters.com/john-kemp/2015/12/17/shorting-opec-hedge-funds-leave-crude-prices-at-risk-from-recoil-kemp/#comments Thu, 17 Dec 2015 20:30:14 +0000 http://blogs.reuters.com/john-kemp/?p=1652 As ministers from the Organization of the Petroleum Exporting Countries head to Vienna, hedge funds have almost never been more bearish about the outlook for oil prices.

Hedge funds and other money managers held short positions in the main WTI and Brent crude futures and options contracts amounting to 294 million barrels on Nov. 24, according to regulators.

The combined short position has risen by 126 million barrels since the middle of October and is within a whisker of the record level of 297 million barrels set in mid-August.

Commentators and investors are almost unanimous in expecting OPEC to leave its production target unchanged (or even increase it slightly to accommodate the return of Indonesia).

In turn, investors expect the oil market to remain oversupplied, with a further increase in inventories and more downward pressure on prices.

OPEC ministers, led by Saudi Arabia’s Ali Naimi, have done nothing to contradict that view, leaving hedge funds free to continue selling in the expectation prices will move even lower.

But the enormous degree of investor short interest in the market has itself become a source of potential instability.

OPEC could decide to confound investors by agreeing to cut output in a bid to drive prices higher, though there is no reason to expect a December surprise at the moment.

The bigger risk comes from the enormous concentration of short positions and the possibility of a short-covering rally if the funds all try to take profits and scale them back at the same time.

The only other time hedge funds have been this short of Brent and WTI futures and options was in mid and late August.

Shortly afterwards, prices soared by more than $11, more than 25 percent, over just three trading days between Aug 27 and Aug 31 (tmsnrt.rs/1l5bLEt).

The unexpected surge in volatility was the largest since the oil market flash crash in May 2011 and before that March 1998 (tmsnrt.rs/1l5bOjM).

The March 1998 volatility spike was triggered by an agreement between OPEC and certain non-OPEC countries to cut production.

But the May 2011 flash crash had no apparent external cause and was driven entirely by the internal dynamics of market re-positioning.

It is a reminder that when everyone in the market thinks and is positioned the same way the situation can become fragile, with or without an external trigger.

How the hedge funds will exit from this large short position remains unclear. The stakes for both ministers and hedge funds have rarely been higher.

(Editing by William Hardy)

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