That Time of the Month Again

Jim Brown
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Once a month energy investors are subjected to irrationality, irritability, mood swings and bipolar behavior.

I am referring of course to the monthly demand projections from OPEC and the IEA. What did you think I was referring to?

The various monthly reports confuse investors with the various attempts by reporters to put out a headline that will attract attention. "Crude Demand Drops," "OPEC says demand to fall," "IEA projects record oil demand in 2012." If you are scanning the headlines you would have no idea who was right or wrong. In reality they are all correct but it all depends on the perspective of those reporting thus the confusion in oil prices and investor sentiment.

OPEC released its Monthly Oil Market Report (MOMR) with their forecast for the world economic growth to remain unchanged at +3.6% in 2011 but they revised predictions down to +3.7% for 2012. They believe the deceleration of growth seems to have stabilized although many risks remain, particularly in the Euro-zone.

The U.S. is expected to grow +1.6% for 2011 and +1.8% in 2012. The Euro-zone is expected to grow by +1.6% for 2011 but only +0.8% in 2012. Japan is expected to grow +2.4% in 2012 after contracting -0.8% in 2011 due to the earthquake. China's estimate is 9% for 2011 and 8.5% for 2012. India was revised lower to 7.6% for both 2011 and 2012.

Global oil demand "growth" was revised down by -180,000 bpd to 900,000 bpd for 2011. A drag on estimates is the attempt to slow the economy and curb inflation in China. They have the fastest growth rate in oil consumption so any slowing of the economy will cut their demand growth by some percentage. OPEC believes oil demand will rise +1.2 mbpd in 2012. That is -100,000 bpd below their last estimate.

Oil Demand Growth Chart

It should be noted that the world is currently consuming oil at record levels of about 88.54 million barrels of oil per day. OPEC predicts that will grow to 90.37 mbpd in Q4-2012 and the EIA is projecting 90.73 mbpd. With just a little acceleration in Japan's earthquake recovery, U.S. economic growth and/or China's economy that number could be over 91.0 mbpd very easily. Can we really grow from tight supplies today at 88.54 mbpd consumption to 91.0 mbpd in 12 months?

2012 Demand Expectations

Non-OPEC oil supply is expected to increase by 400,000 bpd for 2011. That is -160,000 bpd less than their prior estimates because of lower than expected supply from Canada, the UK, Brazil and Azerbaijan.

In 2012 non-OPEC supply is expected to rise by 800,000 bpd because of increased production in Brazil, Canada and Columbia. Natural gas liquids and nonconventional oils are expected to increase by 400,000 bpd in 2012.

OPEC production in September was reported to be 29.9 mbpd based on information from secondary sources. Information from OPEC members themselves is unreliable and they admit that. OPEC believes the demand for its crude will average 29.9 mbpd in 2012. That is -100,000 bpd lower than prior estimates.

Just to make sure we understand what is going to happen I will make it simple. OPEC expects their production to be flat in 2012 and actually -100,000 bpd lower than prior estimates. In the chart below OPEC expects non-OPEC supply to increase by 830,000 bpd to 53.46 mbpd. Do the math and you get 53.46 +29.9 = 83.36 mbpd with demand expected to be near 91.0 mbpd. Obviously that would be a disaster if it were not for the natural gas liquids (NGLs) and a sprinkling of biofuels. Even with those components the stretch between demand and production is growing.

In 2012 net global production is expected to increase by +730,000 bpd while demand is expected to increase by 1,190,000 bpd. How much longer can this mismatch continue before disaster strikes?

2012 Non-Open Crude Production

OPEC noted that increasing bearishness on the global economic front had pressured crude prices but for all but a couple grades they finished higher than August. It was the volatility during the month that can't be seen in this table.

OPEC Reference Price Table

Every energy investor should realize that only a small portion of the oil produced and sold by U.S. companies is sold at WTI prices. The vast majority is sold at prices indexed to Brent, which is $25 higher than WTI. Note that only a couple grades in the above table are under $100. Oil company profits should be very strong.

OPEC blamed the volatility and the "weakness" in crude futures on the strength of the U.S. dollar. While that is correct I had a laugh that triple digit oil prices for OPEC crude over the last two months was considered "weak." How quickly they became accustomed and addicted to that $110-$115 oil.

The spread between Brent and WTI set a record of $26.87 on September 6th. This is why the pipeline companies are racing to construct pipelines from Cushing to the Gulf Coast so the price of WTI will again move in tandem with Brent and other water borne crudes.

At the end of September net long positions in crude futures was at a 52-week low and that corresponded with the decline in WTI prices to less than $80 in the last few days of the month.

Net Long Futures Positions Chart

Full MOMR Report Here

IEA Oil Market Report

The IEA report was a clone of the OPEC report. I can't list it in detail here because it is an annual subscription of 2,000 euros a year. With OPEC and the EIA performing the same monthly function for free I see no reason to subscribe.

To summarize the IEA expects 2012 demand to grow by 1.25 mbpd. That is -160,000 bpd less than last month's prediction. They expect 2012 demand to average 90.48 mbpd with Q3/Q4 well above that level. They cut their growth forecast for 2011 by -50,000 bpd to 990,000 bpd. The IEA said OPEC production was 30.15 mbpd in September and slightly over the 29.9 mbpd OPEC reported. Oil inventories in the OECD countries declined by 3.4 million barrels and below the five year average for the first time since June 2008.

EIA Report

The EIA report released on Wednesday claimed demand in September had declined slightly and production in the U.S. had risen slightly. However, "despite this easing, the EIA continues to expect global markets to rely on inventories to meet some consumption growth in 2011 and 2012." And, "Oil consumption growth from countries outside OECD is projected to outpace the growth in supply from OECD producers, implying a need for OPEC producers to increase their output to balance the market in 2011 and 2012."

"Oil prices continue to face upward price pressure due to supply uncertainty and downward price pressure because of lowering expectations of economic growth. Upside uncertainty to the crude oil price outlook remains as a result of ongoing unrest in oil-producing regions. Heightened turmoil in Syria, which produced an average 400 thousand bbl/d in 2010, and the potential for more sanctions on the country's energy sector is one source of risk to non-OPEC supply. At the same time, downside demand risks predominate, as fears persist about the rate of global economic recovery, contagion effects of the debt crisis in the European Union, and other fiscal issues facing national governments. On the supply side, there may be downward price pressure if Libya is able to ramp up oil production and exports sooner than anticipated."

"EIA expects that world crude oil and liquid fuels consumption will continue growing from its record-high level of 87.1 million barrels per day (bbl/d) in 2010 and reach 88.4 million bbl/d on 2011 and 89.8 million bbl/d in 2012."

The EIA does expect stronger growth in global production in 2012 for a variety of reasons however, there will still be a decline in excess capacity over the short term. That is expected to rebound slightly when Libyan production resumes. They expect half of the 1.6 mbpd to resume by the end of 2012.

EIA Short-Term Energy Outlook Here

It is amazing to me the IEA, EIA and OPEC can publish these monthly reports and calmly continue reporting as though there is no problem. Oil will just magically appear when they project the demand will arrive. Once the demand and supply lines on the charts cross into negative status I suspect the tone of the reports will be significantly different. For the time being they don't want to stimulate the slumbering beast because the blame game will erupt into a firefight once the beast is out in the open. Why didn't you warn us? That will be the complaint by all the nations that pay millions to the IEA for their management of the demand-supply expectations.

In the energy sector we have seen a very nice rally in stocks thanks to a +$11 rebound in crude prices to $86 for WTI and $111 for Brent. I believe crude prices are extended and are due for a rest even though I do expect them to move higher in Q4.

The equity market is pricing in better than expected results in Europe as a result of the bank recapitalization plan. However, it remains undefined, unapproved and unimplemented. There is a tremendous amount of hope being priced into the outcome without a reasonable expectation for success. Since the European debt crisis began have you seen anything out of the Eurogroup that was complete, timely and effective? The answer is no. All we have seen is debate, delay, defend and in the case of Greece, defy.

I have no confidence the current programs in motion will conclude successfully and a failure will reduce growth in Europe and likely weigh on our stock markets.

Offsetting the worry over Europe could be better than expected economics in the U.S. and better than expected earnings. Currently the S&P is expected to post earnings growth of 13%. That is down from 17% on July 1st. Estimates have been cut and there is plenty of opportunity to beat the street. If you remember back in late July when companies were reporting earnings the news headlines were blaring U.S. debt default and the possibility of a ratings downgrade. I am pretty sure most companies guided conservatively lower because of the many unknown factors. Since July the economy did not fall off a cliff and we have actually seen some positive growth. If earnings begin to come in strong we could be off to the races in the U.S. markets. Hopefully we can gain some significant ground before Europe deteriorates again.

Jim Brown

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