Oil Market Report January, 2013

The beginning of a new year usually comes with a plethora of predictions or, if you follow the Mayan Calendar, there is always the end of the world to consider (again). Although sensible people in the oil world know better than to make predictions about oil prices, the question is still always asked, so perhaps some possible pointers would not go amiss.

Firstly looking back at the whole of 2012, we can say that although prices remained high, they moved little overall (Jan 12 Brent = $110.62 / Dec 12 Brent = $109.39). Yes there were major fluctuations (Mar 12 Brent = $125.26 / Jun 12 Brent = $94.89), but compared to 2011 (Jan 11 Brent = $96.59 / Dec 11 Brent = $107.87), 2012 ended up going nowhere on the price front. Questions were still asked though, as to why prices did not drop. Whereas in 2011, we experienced the Arab Spring and severe product shortages from Libya, 2012 had no similar events. In fact, all the indicators should have brought prices down; Europe and America entered their 4th year of recession / economic stagnation, there was a slow-down in Chinese growth and Libyan production came back on stream.

Whilst the above points are all true, it still must be noted that total world oil demand did increase in 2012 and this continued to put prices under pressure. After all, Chinese growth slowed in 2012 rather than stopped and the economies of South-East Asia and Latin America continued to march forward impressively. On the technical / supply side, there was also the subject of available oil reserves and this is a point worth exploring.

When the Libyan crisis hit, back in 2011, OPEC reluctantly released stocks to meet the supply shortfall. In reality, this was not an OPEC action, but a Saudi action, with the latter being the only OPEC member with sufficient spare capacity to actually meet production shortfalls. Releasing Saudi’s spare capacity to address the Libyan crisis drained the world’s only significant crude reserve to empty. What this meant was that prices remained high throughout 2012, because world oil supply was on a knife-edge, with no spare reserves available. Even casual Market observers will be aware that the fear of shortages is one of the main drivers behind price rises – think endless petrol station chaos following the Government’s instruction to fill up our Jerry Cans. Factor that up many times and you have the situation in 2012, with the big strategic buyers (notably the Chinese National Reserve) pushing prices up, as they purchased excessive quantities of oil to protect against the worldwide lack of reserves.

The good news is that now we have entered 2013, ample capacity seems to be returning. As Libyan production came back on stream in 2012, so excess Saudi production was taken off the market and went back into building up the reserve to pre-2011 levels. This means prices should ease, but if and when this does happen, expect an immediate return to the historical OPEC divisions around production and price.

In simple terms, “hawkish” members of OPEC such as Venezuela will immediately want to start tightening supply in an effort to push prices back up – this of course to enable the continuation of their extensive and expensive social infrastructure programmes. On the other side, we will have the price “doves” (Kuwait, Saudi), who are far more sanguine about prices falling and will only really start making noises, when prices start to drop below the $85 per barrel mark. Such a relaxed attitude from Saudi Arabia is largely borne out of their huge production capacity, which allows them to rely on large volume production rather than high prices, to generate required revenues. Such a position makes them rather unpopular within OPEC, as in reality, the other members know that only the Saudis can really affect prices. Plus, when Saudi Arabia responds to Western requests to increase production, other OPEC members suffer a “double-whammy”; not only do prices fall, but Saudi’s dominant position within the group is further accentuated.

Irrespective of OPEC’s internal wrangling, the increase in the world’s oil reserves will clearly take the heat out of the market. But Portland still sees little chance of prices dropping significantly, as there is no getting away from the fact that demand for oil in 2013 will again increase (by about 4%). So if anything, expect a repeat of 2012; prices will remain high and liable to sudden increases due to socio-political tensions, but overall, we would like to think that they will remain stable.

1. For our opinions on the recent OFT study into Wholesale and Retail fuel prices, see our September 2012 Oil Market Report.