Natural gas storage facilities in the U.S. appear headed for overfill, but the global outlook for crude oil supply is less clear. Despite sluggish gross domestic product growth globally, oil demand is expanding, and supply remains a high-risk challenge, according to Vikas Dwivedi, global energy strategist for Macquarie Commodities Research. He presented the commodities-trading firm’s outlook for crude oil at a recent gathering of Denver’s Energy Finance Discussion Group.

"Global supply risk around the world has never been higher," he said.

OPEC spare capacity is low, transportation demand is solid in many growth markets and power generation related to oil demand is burgeoning. "A little more than one-third of oil demand globally is not for transportation," he said. "Political and military risk is potentially broad, and finding and development (F&D) costs remain near all-time highs."

Global crude production has continually disappointed. Dwivedi says the Brent-WTI spread will widen further.

"What I get asked the most is, what about demand destruction? Given global oil prices, this is big on clients’ minds. I don’t think prices are high enough to eat into demand."

Some market observers fear the demand destruction of ’08 and ’09 will resurface in OECD markets. Europe and North America are still grinding down their energy demand, especially for oil, although trough levels may be in sight. "We think we are close to transportation base-load demand levels," Dwivedi said.

The European economy is probably not out of the woods, he said. If Europe falls on its face this year, China will go with it in a direct, one-to-one way, as China’s fastest-growing export market.

For a number of reasons, Dwivedi does not believe demand destruction is inevitable. First, global subsidies for energy consumption buffer consumers in many countries. "Prices would have to go materially north of $130 per barrel for demand destruction to occur," he said.

Second, some of the fastest-growing demand markets are also big exporters, such as the Middle East and Latin America; intrinsically, they are long oil as an economy.

"One thing people forget is how big Saudi Arabia’s market is," said Dwivedi. "The country is three times the size of Texas, they buy big cars, have big subsidies, and are long oil as a nation—it’s a great recipe for consumption.

"Saudi Arabia consumes about as much oil as Germany and is growing fast. Same for many Latin American markets, including Venezuela and Brazil. They are all setting records," he said.

Are fears concerning global limitations on supply warranted? "There has been very little growth in real crude oil production in the past 10 years, except a few percentage points from OPEC. You can point to issues in Iran, Libya and Nigeria, and there are challenges, but at some point, scoreboard counts. Supply hasn’t grown.

"The challenges in growing real crude oil production have been masked by rapid increases in natural gas liquids (NGLs) and condensate production, but you can only put so much condensate into a refinery, so it’s not an infinite substitute for crude oil."

Historically, the amount of supply at risk from OPEC has averaged 700,000 barrels per day, with spare capacity at 4 million on average—or roughly 18% at risk. "Today, the amount at risk is 4- to 5 million barrels, and spare capacity is about 2 million, so we’re at a 200% risk ratio.

"Not all hot spots will flare up, but there are so many, it’s hard to imagine at least a few won’t. To escape without product cuts, that would be a piece of luck."

Macquarie’s reinvestment model shows global F&D at nearly $30 per barrel and rising. "The cost structure is high, and won’t subside soon," he said.

"We think the fair value of crude is well north of $100, especially if demand keeps growing and there aren’t technological breakthroughs on a global scale."

As for natural gas, "The Houston hedge fund community is gas-focused in dollars traded so there are a lot of smart, experienced traders. Finding a legitimate bull is difficult," he said.

Macquarie recently pulled its gas price deck numbers down to $2.40 for 2012 and to $3.70 for 2013.

Despite the lack of bulls, Dwivedi noted that "somebody’s been buying a lot of futures. The gas trader category went bullish several weeks ago and it’s starting to get large, with long net positioning among traders. I think there are some macro funds buying with the view that gas is very cheap and they are willing to hold."

Comments