Energy Monitor July – Energy market surpluses

by: Hans van Cleef

Oil: small price ranges now, lower prices in 2014

While gas prices were under pressure due to oversupply and coal prices due to a lack of demand, oil prices are still stuck within a small range of roughly USD 100-106. Oil prices were driven by several events in June. Despite these events, the impact seems to be rather limited at this moment. By mid-June, the Syria conflict entered a new phase, after the US authorised sending weapons to Syrian rebels.

Brent versus WTI oil and Brent/WTI spread (1st generic future contract) Source: Thomson Reuters, ABN AMRO Group Economics
Brent versus WTI oil and Brent/WTI spread
(1st generic future contract)
Source: Thomson Reuters, ABN AMRO Group Economics


This news boosted fears about a possible spread of the unrest to other parts of the region, including the major oil producers. As a result, oil prices found support and WTI even touched a nine-month, intraday high. Just a few days later, prices dropped significantly after the Federal Reserve indicated that it will slow monetary stimulus. Adding to this are worries regarding about a possible change in Chinese monetary policy as well. The Chinese central bank during the recent stress episode in liquidity markets, at least initially, showed some reluctance in supporting the banks. But this was short-lived as the central bank a few days later appeared to change its mind and indicated that it was willing to support any bank that had temporary funding shortages.  With interest rates and the US dollar rising, and news about rising physical crude stocks, (Brent) oil prices dropped to just below USD 100. The Brent/WTI spread dropped to the lowest level since January 2011 (USD 6.02/barrel). Traditional Q2 stock building started very late this year, due to the below-average temperatures during the previous months. As a result, demand remained high, while normally heating demand eases significantly before cooling demand sets in. Nevertheless, oil production in Saudi Arabia increased to 9.7 million barrels per day (mbpd) in May, compared with 9.3 mbpd in April. The largest OPEC producer anticipated the rise in seasonal demand during the summer months. We do not think a bigger dip in oil prices is likely, as it is too late for stock building, unless this summer will continue with below-average temperatures. We do not expect oil prices to rally, either. The rise of seasonal demand may trigger some support for oil prices, but the economic drive for a structural rise in demand should not be expected soon. forecast ENAll major oil organisations, such as the OPEC, the Energy Information Administration (EIA) and the International Energy Agency (IEA), cut their 2013 demand forecasts again. On top of that, all organisations expect demand to pick up only moderately in 2014, which is in line with our own forecast. With the Fed, and possibly the Chinese central bank, tapering their stimulus measures – and keeping the anticipated rise in US-yields, a stronger US dollar, as well as an oil oversupply in mind – we slightly adjusted our forecast for Brent oil prices from a yearly average of USD 100 to USD 95/barrel in 2014. The expected average Brent oil price for 2013 remains unchanged at USD 105/barrel.

Tight oil oversupply continues

The EIA doubled its estimates for ‘technically recoverable’ oil and gas resources available globally from its estimates released in April 2011. The EIA indicated that the estimates are highly uncertain and must be extensively tested before they can be confirmed. The adjustment is the result of the changed role of shale- and tight gas; they are now considered as sources of crude oil. Furthermore, geologic research and well-drilling results were not available in 2011.

Crude supply versus demand  (in million barrels per day) Source: IEA, ABN AMRO Group Economics
Crude supply versus demand
(in million barrels per day)
Source: IEA, ABN AMRO Group Economics

The total technically recoverable resources of shale gas, including the US, were adjusted from 6,622 trillion cubic feet (tcf) in 2011 to 7,299 tcf in 2013. The total technically recoverable resources of shale-/tight oil were adjusted from 32 billion barrels to 345 billion barrels. Note that these numbers concern resources (estimates of oil and gas in the ground), and not reserves (the amount of oil and gas that will actually be produced). Whether the higher resources, especially oil, will lead to a further decline of oil prices strongly depends on the willingness of OPEC members to cut production to avoid a continuation of the oversupply. This oversupply is already in place since early 2012. Except for Saudi Arabia, a production cut seems very unlikely, though. In fact, Iraq has the ambition to triple its oil output from slightly over 3 mbpd to 9 mbpd in 2020 in its ‘medium’ scenario. So, oversupply is here to stay, at least in the next few years, outpacing the rise in demand and thus keeping oil prices under pressure.

Gas price differentials Europe/US to halve

In our Q2 Quarterly Commodity Outlook, as well as in the previous Energy Monitor, we forecasted that the gas price differential between Europe and the US will shrink significantly, potentially by more than 50% (figure 3). This will improve Europe’s competitiveness and could prove to be an accelerator for economic growth. The reasons behind this forecast are: lower prices in Europe and higher prices in the US. European gas prices will remain under pressure due to long-term contract renegotiations between Russia (Gazprom) and its European customers. The shale gas revolution forces Gazprom to accept a new role.

US Natural Gas versus Gas NL TTF (in USD/mmBtu) Source: Thomson Reuters
US Natural Gas versus Gas NL TTF (in USD/mmBtu)
Source: Thomson Reuters

After all, oversupply results in lower spot prices and customers do not take long-term oil linked contracts for granted any longer. Currently, NL TTF gas is trading at EUR 26.13/KWh. This is equal to USD 10/mmBtu. The US Henry Hub is currently trading at USD 3.73/mmBtu. The price differential is USD 6.26. In other words, European gas is almost twice as expensive as US gas. We assume a price decline of ‘only’ 10% in European gas by 2015 due to the renegotiations for a more market conform price, but this could be more. We also expect US gas prices to appreciate to USD 5/mmBtu, due to the rise in demand (please note that this is still extremely low in a historical perspective). The 10% price drop of European gas would bring prices to approximately EUR 23.5/KWh or USD 7.60/mmBtu. Keeping in mind our forecast of EUR/USD 1.10 in 2015 (due to increased US yields), this would lower the price differential from USD 6.26 to ‘only’ USD 2.60 per mmBtu (a decline of more than 50%).

Carbon emission plan, phase two

In the first week of July, the European Parliament will vote on a depleted rescue plan for the carbon market. The European MPs voted against the original plan in April. As a result, the surplus of carbon permits pushed carbon emission right prices to a record low of EUR 2.46. Prices have doubled since then, but stayed at historically low levels. The new plan includes a delay of the sale of some carbon permits, which will be back loaded to the market after one year. This would be a one-time intervention of 600 million permits, compared with 900 million permits with a three-year delay in the original draft. The second plan is already approved by a parliamentary panel, which recommends the European Parliament to support the plan. If approved, the chairman of the panel can start negotiations with representatives of national governments on the final wording of the legislation. It will likely take another several months before a final version can be presented. In the meantime, prices may continue to recover from their record low in April. Whether a price rally in the coming months will be strong enough to actually change the energy production policy – a switch from coal to gas, or even renewables – should be strongly doubted.