Shell Chemicals General Manager, Kate Johnson, asked a great question at our Conference last week, to which not a single hand went up in reply, as everyone had forecast an oil price around $100/bbl :
“How many of your companies used $60/bbl as their oil price forecast in the 2015 Budget?”
“Group think” is clearly alive and well in the chemical industry. And according to some delegates, it means that executives routinely refuse to mention the potential for low oil prices within their company. This would “only cause trouble”, said one, “as it would undermine the investment case for our US projects”.
Budgets and strategies are, of course, supposed to be about reality. And one topic on which everyone agreed at the Conference was that we were seeing chaos in both feedstock and end-product markets:
- Chaos in the feedstock markets caused by the ongoing collapse of oil prices, combined with the collapse of natural gas and coal prices, due to over-supply
- Chaos in end-product markets caused by China’s decision to move away from its previous stimulus policies, and by the drop in demand linked to the ageing of the global population
Is it sensible, therefore for companies and investors to continue to ignore the impact of these factors on their likely future sales and profits? Or, to put it another way, how much money have they lost this year by having failed to prepare for the impact of over-supplied energy markets and the demand downturn?
This, of course, is why we have launched our 5 Critical Questions Study with ICIS, to look at the potential impact of different Scenarios:
- Clearly it would be foolish to ignore the fact that Brent prices have been around $50/bbl for most of this year
- It would also be foolish to ignore that they were at $100/bbl before this
- But isn’t it equally foolish to ignore that, as the chart shows, they have averaged much lower prices over history?
They have averaged $34/bbl in $2015 since 1861 when BP data begins. And they average just $24/bbl if one leaves out the price peaks due to the OPEC crisis and recent central bank liquidity programmes.
Developments in the US oil sector also confirm the danger of indulging in wishful thinking over prices. As Reuters reported, CEOs learnt a painful lesson earlier this year, when they failed to hedge their production at higher prices:
“Oil producers’ rapid response to the latest move upward comes in contrast to the second quarter, when a moderate price recovery was met with only modest hedging interest as many executives bet – wrongly – that the worst was already behind them….for some, hedging is now less an insurance policy than a lifeline as those who have scrimped on protection watched with despair oil prices shuffling between $43 and $48 for six weeks.
Other key indicators are also indicating the potential for further price weakness:
- US oil companies routinely sell off inventory in December to avoid year-end taxes
- Inventories for US natural gas (which competes with oil) have risen to all-time highs of 4tn cu ft
- There are queues of oil tankers waiting to discharge at many major ports
- Iran has said it will continue to increase production even if prices drop to $20/bbl
- The International Energy Agency says global inventories are at a record 3bn barrels (a month’s world supply)
- Iraq is already selling its heavy crude at $30/bbl for December as it ramps up exports
Plus of course, there is ample evidence from other commodity markets that China’s slowdown is causing prices to return to historical levels, or lower. The Baltic Dry Index, which reflects demand for copper, iron ore, fertiliser and other commodities is now trading at all-time low.
Of course, oil markets are always full of surprises. But is it really sensible for companies to refuse to even consider perfectly reasonable oil price Scenarios?
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 58%
Naphtha Europe, down 52%. “Naphtha refining margins rose to a near five-year high this week on the back of high-volume exports to Asia, and helped by a fresh wave of West African gasoline demand.”
Benzene Europe, down 56%. “US benzene markets as well as crude oil and energy movements have steered prices.”
PTA China, down 41%. “An increase in export volumes is expected next year as China looks for sales outlets for locally-produced product”
HDPE US export, down 33%. “Prices for domestic exports moved up on thinning supply”
¥:$, down 20%
S&P 500 stock market index, up 7%