By John Richardson
OIL markets have reached an important tipping point as the bulls and the bears try to exert decisive influence.
There is resistance from the bulls which helps to explains why, after last week’s collapse in oil prices, crude bounced back last Friday and on Monday of this week.
But the physical realities of the market has the potential to tip the balance decisively towards the bears. Prices may, as a result, continue to decline towards my forecast of $35/bbl or lower by Q4 of this year.
See the above chart where I forecast Brent prices until the end of this year, and also naphtha prices, which is of course is a major petrochemicals feedstock. Under this scenario, Brent crude averages $40/bbl and naphtha $357/tonne CFR Japan from June until December 2017. This would compare with an actual Brent price at at an average of of $53/bbl in Janaury-May, and naphtha at $487/tonne CFR Japa
Here is what is behind this thinking.
Supply May Get A lot Longer
I believe that we will continue to see a rise in US shale-oil production. There are some suggestions that a large percentage of US shale oil production is approaching break-even variable costs as a result of last week’s collapse in crude.
I don’t buy this view. Innovation in hydraulic fracturing will not stop because the fracking revolution is so important to the US economy.
Ever-cheaper US oil and natural gas production has the potential to further boost the domestic economy through raising the competitiveness of local manufacturing and service industries.
Energy exports will also continue to rise. Already in the case of oil, The Wall Street Journal estimates that US exports will average around 1m/bbls a month in 2017 following last year’s lifting of the ban on exporting crude.
All the signs are that the White House recognises the importance of energy to the US economy. This recognition could have two broad implications for US energy policy:
- The US government will do everything it can to boost US oil, liquefied natural gas and liquefied petroleum gas exports through a new approach to geopolitics.
- Add to this better tax breaks and more relaxed environmental legislation, and the only way seems to be up for US oil and gas production.
I will look at these themes in detail in a later post. The relevance here is that if and when consensus opinion fully takes on board the above two points, crude prices might well enter their next big downcycle.
The other issue on supply is what OPEC, and the non-OPEC producers outside the US, do next. I think they could well recognise that they have the lost their ability to control prices, and that as a result recent production cutbacks have been counterproductive. Led by lowest-cost producer Saudi Arabia, they might try to win back market share by returning to a policy of maximising production.
China Demand Slowdown Likely To Continue
Demand for crude is still of course mainly about the extent of the Chinese economic slowdown, given that China is the biggest source of global incremental demand growth for crude.
My ICIS colleagues in Guangzhou, who cover refining markets, report weaker demand growth for diesel and gasoline on a slower economy. They are, as a result, maintaining their view that China’s oil imports will only grow by around 5% this year compared with 13.6% in 2016.
Evidence continues to also build across the Chinese broader economy of what I believe will be a moderate slowdown in Chinese growth during the rest of 2017 and into 2018.
For example, Standard Chartered’s China Small and Medium Enterprise Confidence Index for June slumped to a 16-month low of 54.7, signalling smaller companies are finding it harder to obtain credit as regulators move to damp financial risks.
“Although the central bank will likely provide sufficient liquidity to avoid a liquidity crunch, banks may still prefer lending to bigger rather than smaller companies amid tighter liquidity conditions,” the bank’s economists told Bloomberg.
This is of particular relevance to the chemicals and polymers industries as the majority of end-users of chemicals and polymers in China are small- and medium-sized enterprises.
Bloomberg also reports that the China Satellite Manufacturing Index fell to 49.6, which was the first time it had been in negative territory of below 50 since last August. The index, which is provided by the San Francisco-based company SpaceKnow, uses commercial satellite imagery to monitor activity across 6,000 industrial sites in China.
This further supports my argument that China is continuing to display an appetite for the pain of economic reform that is surprising many people.
This appetite will not be diminished during the rest of this year and into 2018. If anything, reforms will be accelerated as Beijing tries to deal with its debt crisis now before it gets any worse.
Why do I think this? Because of many reports from my contacts in China to this effect, and a flurry of newspaper articles about new reform initiatives.
On Friday, I will look at what lower oil prices and the Chinese slowdown might mean for the Asian high-density polyethylene (PE) market. This will follow last week’s focus on Asian linear-low density PE.