Crude prices in 2013: 3 resistance factors, 2 support
In yesterday's article, Crude Oil in 2013: Brent boxed into price range of USD 90-125, I discussed how Brent Crude oil has been trading within a relative stable trading range during the last couple of years. We expect the price to remain between USD 90 and USD 125 during 2013 and 2014 as well.
Here are some of the factors providing support and resistance.
Resistance: Higher prices trigger higher Saudi production
During the early parts of 2012 when the price of Brent Crude was elevated we often heard verbal intervention from Saudi Arabia’s Minister of Petroleum Al-Naimi in order to bring the price lower. As the Kingdom is one the world’s largest producer of oil and the only one with any available spare capacity, the world take notice when he speaks. Following the embargo on Iranian oil they increased their production close to 10 million barrels per day in order to make good on his intention to help bring the price of oil back towards 100 USD/barrel, a level which is acceptable to both producer and consumer. With the global economy still in a fragile state of recovery high oil prices act as a deterrent for growth and thereby demand.
Resistance: Release of Strategic Petroleum Reserves (SPR)
Rising prices due to geopolitical tensions also carries the risk of OECD nations stepping in to calm markets by releasing oil or products from its Strategic Reserves. Members of the International Energy Agency are obligated to hold an emergency reserve that would cover 90 days of imports and with the US the largest consumer, they currently hold nearly 700 million barrels, according to the US Department of Energy. Although the release in June 2011 - due to the loss of Libyan production - had a limited longer term impact, the threat of a release is sometimes enough to deter speculative investors from getting too involved, thereby preventing the price from moving even higher.
Resistance: Rapid increase in US oil production
Outside OPEC the main growth in production in 2013 will come from US shale. This growth has already resulted in a dramatic reduction in net crude oil imports over the last five years. The US Energy Information Administration (EIA) in their Annual Energy Outlook 2013 said that “The advent and continuing improvement of advanced crude oil production technologies continued to lift projected domestic supply” and they see production reaching 7.5 million barrel per day by 2019. This paradigm shift in global oil markets over the coming decade could eventually, according to the International Energy Agency, see US production surpass Saudi Arabia. Such an increase should help increase the buffer between demand and available supply, thereby reducing the risk of price spikes during periods of supply disruptions.
Support: Shale oil production needs high prices
Just like we seen in the past where high prices have been the best cure for high prices the same also happens when the opposite occurs. The low prices in US natural gas during the early months of 2012 triggered a major shift by power generators from coal to gas and that eventually helped bring the price back to more comfortable levels from a production perspective. The price at one stage went so low that the cost of this new production technology exceeded the revenues, and had it gone on for much longer production would have been scaled back. The same goes for oil shale production, which at this early stage is still punitively expensive to produce. It is only the above the 100 USD per barrel price level we have witnessed during the last few years that has made such new innovations economically viable. Until technological advances in production methods bring the cost down, it is estimated that a break-even price above 70 dollars on WTI crude (equivalent of USD 90 on Brent Crude) is required to stay profitable.
Support: Oil producers need high prices to balance budgets
Following the Arab Spring uprising in 2011 and continuation of tension in the Middle East, many OPEC governments have sharply increased their government budgets in order to spend their way out of potential socioeconomic problems. With oil revenues the main source of income for many of these nations, the break-even oil price needed to balance their budgets has shifted much higher during this time and it is likely to move even higher in 2013. Saudi Arabia is estimated to have a breakeven around 80 dollars while others, such as Nigeria and Russia, a non-OPEC member, are estimated to be much closer to 100 dollars. On this basis any price weakness much below 90 dollars is not going to be acceptable and could be defended by means of reducing production.
A true paradigm shift
While global oil prices continue to be exposed to sudden sharp moves, primarily to the upside, caused by supply disruptions, the recent changes especially in new production methods should leave the market in better and less volatile place than in previous years. While the worry about peak oil may not have gone away, it has at least been postponed for a number of years. This will buy the world additional time to continue to improve production methods through new technology. This will increase the demand for natural gas – and the world has plenty of natural gas.
Meanwhile, the automobile industry will continue to improve the effectiveness of engines, something that is already making an impact on US gasoline consumption.
It’s truly a paradigm shift and one we feel will be the biggest positive input to growth and markets over the next ten years. The fact that one of the byproducts is reduced carbon footprint does not make this a less appealing case. We see the price of Brent Crude remaining within the 90 to 125 dollar range in 2013 with an average price around 111 dollars.