Oil Market Report September, 2011

Markets continued all over the place in September with few – if any – participants demonstrating an understanding of the dynamics in play. Oil markets were no different: up one day, down massively the next day, shooting back up the next day, etc, etc. Clearly the hand of speculators is at work here, with volatility and a vacuum in economic policy presenting the market gamblers with big financial opportunities. Long-term “bets” are still off though, as it is clear that no-one has yet grasped the complexity of the long-term picture. Can China single-handedly rescue the world economy? Maybe. Can the USA recover from the economic doldrums? Unlikely. Will the EU debt crisis go-away? No. And perhaps more popular in the likes of the Fulford Arms (a Portland Boardroom of sorts), is will fuel prices come down? Probably not.

That is not to say that oil prices will continue to go up (other than the Chancellor’s proposed 4ppl duty rise in January). In fact, oil prices may even make a moderate retreat. But the thought that the UK consumer could any time soon, be buying fuel at sub £1 litre (the last time was July 2009) remains unlikely.

Putting aside the current turbulent economic picture, nothing much has actually changed in oil terms for over 10 years – when the current long-term rise in oil prices began. Demand from emerging economies has steadily increased, whilst significant constraints in refined product supply (particularly diesel) have magnified. Unsurprisingly, this creates a backdrop of rising prices and only a prolonged worldwide recession will halt that.

Now the regulars at the Fulford Arms will tell you that the problems with high oil prices are the result of OPEC. This neat and simple synopsis was once embarrassingly shared by Gordon Brown, who more or less argued that OPEC has a deliberate policy of starving the West of oil, thus increasing the latter’s dependency on OPEC and perpetuating high prices. Easy to understand as it may be (*plus see below), such simplifications are rarely accurate and the continued shortage of Libyan crude highlights this.

Before the Arab Spring, the vast majority of Libyan crude ended up in European refineries. The logic goes that when Libyan crude was interrupted, OPEC should have stepped in with spare capacity. In fact, Saudi Arabia did indeed release extra capacity from their reserve quota. But Saudi crude is far more dense, sulphurous and higher in metal content than the sweet crude produced in Libya. So the geriatric refineries of Europe are unable to effectively process Saudi crude, because their creaking old units are geared to processing “sweet” crude, traditionally from the North Sea. The logistical outcome then, is that much of the Saudi crude released is being shipped to modern Asian refineries to be processed into European spec and then shipped back to Europe.

This logistical distortion might be a boon for the shipping industry, but it presents an already stretched supply-chain with extra predatory price pressures from arbitrage traders (people who speculate on geographical differences in price), the prospect of local Asian markets snapping up the product before it reaches Europe and rapidly rising freight charges, as sea miles are racked up. There are of course, other sweet crudes out there, in addition to Libyan product (eg, Nigeria), but incremental demand here only shifts the bottle-neck and creates further price spikes as these crudes are not normally exported to Europe in such high quantities.

So with our refineries so ill-equipped to deal with the reality of the modern, multi-sourced oil market, is it any wonder that the European consumer is prey to rising fuel prices? Left-leaning economists might see such high price premiums as justifiable – after all, the West can still better afford high prices for fuel, than say, sub-Saharan Africa. But it once again highlights how the West is now being punished for the lazy decisions of the past, where cheap energy and abundant high quality crude oil were seen as everlasting. In the boom days of the 60’s, 70’s and 80’s, where were the refiners and oil strategists pointing to a future whereby European refineries would need to upgrade in order to keep pace? If they existed they were few in number. Far more likely, they were enjoying champagne cocktails with the bankers and economists who concluded that growth could come from endless borrowing, that retirement at 50 was sustainable and that house-prices would always rise.

* and the recent appointment of an Iranian Revolutionary Guards Commander as OPEC President, does little to slow the momentum of conspiracy theories.