Oil markets tightening quickly

The slippery balancing act known as supply and demand has taken its toll on the oil and gas industry numerous times, most recently in 2008 as a result of a larger worldwide economic crisis. Arguably, the oil industry rebounded much more quickly than other industries, with per-barrel prices resting comfortably in the US $80+ range for much of 2010. And reports from agencies such as the International Energy Agency (IEA) and Energy Information Administration (EIA) that track supply and demand trends indicate that the industry is headed for an even more comfortable state as it enters 2011.

Global energy use is expected to grow by 36%, with non-OECD countries – led by China, where demand surges by 75% – accounting for almost all of the increase. (Graph courtesy of the International Energy Agency)

In a research report titled “Improving fundamentals point to higher oil price trading range,” Simmons & Co. International studied data from these two agencies covering much of the past year. While Simmons analysts tend to be more bullish in general than the IEA or EIA, the former surprised them in November by reporting one of its largest monthly demand revisions, expecting 3Q 2010 demand to grow by almost 1 MMbbl/d of oil. “With the upward revision, global demand growth has accelerated every quarter in 2010,” the report states, “resulting in a quarterly record high global demand of 88.5 MMbbl/d of oil in 3Q 2010.” The EIA also upped its September US demand statistics by more than 200,000 b/d of oil, further increasing the record-high 3Q 2010 global demand estimates.

Additionally, IEA revisions indicated that the oil market was undersupplied in the second half of 2010, partly due to a rapid decline in floating storage inventories.

Overall, the Simmons report indicates that 3Q 2010 marked “a significant milestone” as it was the quarter in which global demand fully recovered from the effects of the economic meltdown. Global demand of 88.5 MMbbl/d of oil topped the previous quarterly high of 88 MMbbl/d of oil in 4Q 2007. Not surprisingly, this is mostly due to non-OECD countries, where 3Q 2010 demand was 10% higher than 4Q 2007 demand.

2011 outlook
What do last year’s trends mean for this year? Simmons is modeling “more normalized demand growth” as it

Worldwide E&P spending is on the rise, particularly outside of North America. (Graph courtesy of Barclay’s Capital)

recognizes that many variables exist. For instance, while developing countries are seeing gross domestic product (GDP) numbers that are outstripping expectations, inflation and rising interest rates could dampen growth going forward. Continued pressure to the US dollar will make exports more competitive, and other factors such as slowing Japanese production, austerity measures in Europe, and displacement of crude oil used for heating and power generation also will help stymie demand growth.

Therefore, Simmons modeled flat demand in the OECD and a 3.3% increase in non-OECD countries, including China at 5% growth.

Meanwhile, supply growth is expected to be more modest in 2011 than in 2010. The report cited factors such as a mild hurricane season in the US and onshore supply growth from the Bakken and natural gas liquids (NGLs) as factors spurring supply increases in 2010. But the glacial permitting process now taking place post-morato- rium in the Gulf of Mexico should ensure declining production offshore, which possibly could offset onshore supply gains.

Other countries will see modest supply growth, including Russia, Brazil, and Colombia, and biofuels are expected to add another 200,000 b/d of oil to the supply mix.

What about OPEC? The report notes that global demand growth has outpaced both OPEC and non-OPEC supply by about 400,000 b/d of oil. To help fill the gap, Simmons expects that OPEC will need to ramp up its production by about 1 to 30.1 MMbbl/d of oil. “OPEC has been producing between 29.15 and 29.25 MMbbl/d of oil since July with no meaningful commentary on increasing production,” the report states.

Overall, the report concludes that the supply and demand framework will tighten more quickly than had been anticipated previously. “While our demand assumptions for 2011 are well-grounded, it must also be said that upside optionality outweighs downside risks based on leading-edge trends and assuming global GDP growth of about 4% or better in 2011,” it states. “Further, our non-OPEC production assumptions do not necessarily have the same degree of upside potential as our demand assumptions.

“The bottom line is that it is more likely that the global physical markets for oil tighten more quickly than more slowly in 2011.”

2010 to 2015
The most recent IEA forecast indicates a “modest” upward supply revision and a 300,000 MMbbl/d of oil demand increase. However, the mid-term estimates (2010 to 2015) are positive, with a demand in global growth of 5.9 MMbbl/d of oil, offset only marginally by increased supply. OPEC spare capacity is expected to decline from 5.1 to 3.6 MMbbl/d of oil over this period.

Simmons analysts found this report particularly encouraging because demand forecasts were revised higher for the sixth consecutive month. Looking into 2011, the IEA revised its demand forecast by 300,000 b/d of oil over its previous forecast. The latest estimates put global demand at 88.8 MMbbl/d of oil for 2011.

To 2035
In a November 2010 presentation to the press, the IEA forecast a 36% rise in global energy use by 2035, with non-OECD countries accounting for almost all of the increase. China alone is expected to see demand surges of 75% over this time frame. Demand for all types of energy will increase in non-OECD countries, while demand for coal and oil will decline in the OECD. Meanwhile, conventional oil production is expected to be flat, even including fields yet to be discovered or developed, and incremental supply surges will come from unconventional oil and NGLs.

The presentation notes that natural gas is set to play “a key role” in meeting the world’s energy needs. The agency forecasts unconventional gas plays will account for 35% of the increase in global supply to 2035, and increasingly this will come from non-US fields. Worse news for gas producers, though – the IEA expects the “gas glut” to peak soon but dissipate very slowly. This will keep pressure on gas exporters to move away from oil price indexation, particularly in Europe. And as many have predicted, sustained low natural gas prices are likely to beat out renewable and coal in power generation.

From an oil standpoint, demand is expected to increase before 2020 but taper off by 2035, with declining OECD demand overpowering growth in non-OECD demand.

Industry plans
As if in anticipation of this tightening market, the global energy market is planning record spending in 2011, according to a survey by investment bank Barclay’s Capital. The survey reports international E&P spending is expected to rise 12% in 2011. “We believe the industry is in the early stages of a long international upcycle,” the report states.

More than 400 oil and gas companies were surveyed. The largest spending increases will be felt in Latin America, the Middle East/North Africa, and Southeast Asia. It also is anticipated that supermajors will outspend national oil companies for the first time in several years. “We view this as a positive indicator,” the report states.