Slowly but surely the myths over supposed supply shortages in the crude oil market are being exposed. As leading US investment magazine Barron’s wrote this week:
“In May, U.S. production hit its highest monthly average level since 1988 and is projected to keep rising. Domestic supplies have piled up in storage, especially on the Gulf Coast, and market watchers think supplies could get perilously high this fall when refineries traditionally shut down units for seasonal maintenance….
“A pipeline linking Cushing to Gulf Coast refineries has relieved a glut of oil at the hub, shrinking stockpiles there to the lowest level in six years, but analysts say supplies could start building again this fall. New pipelines bringing oil from Canada and the Northern U.S. to Cushing are expected to open in late summer or early fall.”
Supplies “perilously high”. “A glut of oil”. This is the reality after 3 years of record high annual oil prices.
It is also the background to last week’s decision by the US Administration to approve condensate exports. In turn, this is a likely game-changer for global oil markets and long-suffering petchem producers. They probably mark the first step in a return to a more normal relationship between oil and gas prices:
- Oil has 6x the energy content of natural gas, and its logistics are more flexible
- So it has normally sold for around 9 times natural gas levels, as the chart shows
- Currently it sells at a massive premium to this of around 25 times gas prices
- This is only due to the influence of pension funds and hedge funds, who bid up prices in response to the Fed’s money-printing, as they raced to find a ‘store of value’
But there has never been any reason for this premium in terms of supply/demand balances. Quite the opposite, in fact. Not only have there been no supply disruptions in the past 5 years to justify the premium. But supply has grown to such an extent in the US that it is close to running out of storage.
Thus we may well be getting close to the end-game of this particular story.
2 events suggest that the world may be about to return to a more normal relationship between oil and gas. The first is that oil trading has slowed almost to a stop:
- Oil traders have made desperate efforts to push up oil prices in response to the terrible events in Iraq
- They have been in danger of losing their bonuses, as volatility has almost disappeared
- Early in June, a whole week passed with just a 30c/bbl range in daily closing prices
- But now their push to the upside appears to have failed, as Iraq’s exports are clearly not reduced by the fighting
- As a result, we can expect their next push to be downwards, to pressure prices as summer driving season ends
The second event is the US decision to allow exports of condensate (a light form of naphtha) in order to keep supplies under control:
- The US will become the world’s largest oil producer by 2016, and is already the largest natural gas producer
- ExxonMobil suggest it could be energy self-sufficient by the end of the decade
- US refineries are running strongly, exporting gasoline and other products to the world
- Now the export ban on exporting crude is being loosened, with condensate exports now legal
- A major expansion is now underway in the splitter capacity to produce condensate
The key issue is that US demand is not recovering, as the blog has noted with shale gas developments. So the US administration had to allow condensate exports to take place, as there will soon be nowhere to store all the new oil production. As Reuters noted at the weekend:
“The U.S. oil boom has created a glut of light oil and condensate that Gulf Coast refineries, largely built to run heavy crudes, have been unable to fully absorb.”
The world “glut” is important. US propane is already heading in increasing quantities to China and elsewhere to boost propylene production. Now large quantities of US condensate will be also heading into export markets. This is very good news for those European and Asian crackers that have been under pressure from low-cost US ethane. They will soon have US condensate suppliers lining up to supply them with cheaper product.
In turn, this will likely prove the first step towards returning oil prices to their normal relationship to natural gas. Unless geo-political events intervene, today’s weakening demand growth combined with growing energy surpluses in the US and elsewhere can lead to only one possible outcome.