Monday, March 07, 2011

Energy Report - March 7, 2011

Energy Report
Important Highlights
Oil prices hit 2 year high on Libya unrest and worries about supply disruption. Countries could opt for Strategic Petroleum Reserves if supply concerns rise. IEA strategic oil stocks total 1,000 days. US Q1 oil demand outlook cut by 1 percent EIA. Chinas consumption of oil and oil products to near 460 million tonnes this year. Crude oil production in India on the rise

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Crude oil price movements Brent and WTI
The surge in crude oil continues unabated with prices touching a fresh 2 year high with each passing day. Crude oil prices have spiraled by over 20 percent since the start of the year, surpassing the psychological $100/bbl levels, driven by fears of supply concerns in the aftermath of the political turmoil in oil producing Libya and fears of its spread to other oil producing Middle Eastern countries. WTI prices have on a year-to-date basis, increased by more than 16 percent to over $106 /bbl (7 March10) while Brent crude oil rose by nearly 23 percent to over $118/bbl, levels last seen in September 2008. Although, the ongoing unrest in oil exporting Libya has resulted in
Source: Reuters

Chart 1: Crude oil price movement

$116.85

$104.34

daily output in the region falling by half from 1.6 mn barrels to around 7,00,000-8,00,000 barrel, the shortfall in supply is being assuaged by Saudi Arabia. The key oil producer who contributes 11.6 percent of global oil has assured oil importers that it would fill in the shortfall in crude oil supplies and if required draw from its spare capacity of nearly 3.5 million barrels per day. Saudi Arabia has reportedly increased output to 9 mn barrels per day from its average 8.4 mn barrels per day. This goes to show that the current rally is largely fear driven and that supply has not been hampered to justify the price rally. The current situation of high oil prices is viewed by many as a temporary phase and prices would stabilize as the situation in the political turmoil affected regions normalize. Supply disruption and strategic oil reserves Even though concerns abound about the continued rise in oil prices owing to supply disruptions and its impact on some of the worlds largest energy users, there is a belief that these nations may be able to compensate for the supply shortages by using oil held in their emergency oil reserves if prices cross threshold levels. Member nations of the International Energy Agency reportedly have emergency strategic oil reserves totaling 1000 days, equivalent to almost three years of Libyan crude output. The government of the US, the worlds largest oil consumer, has indicated that it could tap its SPR in a bid to safeguard economic growth amid a scenario of rising oil prices. The US SPR holds around 727 million barrels of oil, which is equivalent to around 38 days of consumption. The International Energy Agency (IEA) also said that it could release oil supplies in an event of severe oil supply disruption. Total oil stocks in the IEA member countries stand at 4.2 billion barrels as of 2009. This stockpile will be able to satisfy global oil demand for a period of 50 days. IEA director Nobuo Tanaka said that the agency could release 2.0 million barrels per day for a period of as much as two years. Hence, the upside in oil prices will be limited further as backup of oil supply by way of IEA stockpiles or US SPR could ease concerns.
Chart 2: Spread between Brent and WTI crude

oil

Rising spread between Brent and WTI

Although WTI prices too have increased, the quantum of rise in recent times is far less than that of Brent crude, despite of it being of superior quality. The recent geo-political tensions in North Africa have had a greater impact on the Brent variety. During the last three weeks, the spread between Brent and crude oil has widened sharply- from around 0.9 in January to as high as 19.3 on 15
th

February, 2011. In 2009 and

widening since the start of 2011. The year-o-date average alone stands
Source: Reuters

Energy Report - March 7, 2011

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stood at 0.7 and 0.8 respectively. This spread witnessed a significant

2010 (Chart 2), average spread between Brent crude and WTI prices


at 10.3 as against the period between 2004 and 2006 when WTI was trading at a premium to Brent. During September 2008, WTI prices were trading much higher than Brent. WTI traded at a premium of 14.9 on 22
nd

September.

The reason for the decline in premium for WTI as compared to Brent is that the latter got support from tightness in the North Sea. Recently, the premier now commanded by Brent, indicates a structural shift occurring in the oil industry. The key delivery point of WTI oil contract in Cushing, Oklahoma has been witnessing high inflows which has taken its volumes in storage to record high (average of 352.72 in 2010), dragging down the premium associated with WTI. In recent times, Brent crude oil has been receiving support from worries about supply disruptions from the Middle East which would affect European countries, which is dependent on oil from the region. Crisis in Egypt had also provided an edge to Brent crude over WTI, as oil prices in the region are closely associated to the Brent contract on the Inter Continental Exchange and on concerns over disruption in operations at the Suez Canal, a vital waterway for Europe for oil and trade with Asia that could affect oil deliveries. Cargo operations at Egypts Alexandria and Damietta ports had come to a practical standstill due to the spreading unrest.

Main oil markets affected due to Libya

It holds the largest oil reserves in Africa and is the first OPEC country to be affected with political turmoil. Libya produces around 1.6 million barrels per day, which is around 2 percent of world demand. The country holds the 17
th

Chart 3: Percentage crude oil imported from Libya 2010

rank among the world oil producers. Concerns in Libya affect the global oil market more than that of Egypt or Tunisia as Libya is an oil exporter, unlike Egypt , where only oil passes through the Suez Canal. Tunisia on the other hand is only a small exporter and concerns there did not have a major impact on the oil market. Although crude oil prices are rising on the back of escalating worries in Libya, we feel that the effect is more sentimental than fundamental especially when we consider only Libya in the picture. Only if the concerns spread to other oil producing OPEC countries, will the real problem arise. This is because even if Libya stops producing oil completely, there is still plenty unutilized production capacity in the other oil exporting countries.
Chart 4: Libyas oil exports by destination 2009
Source: Reuters

The European region is expected to suffer the most if supply disruptions from Libya rise (Chart 4). This is because Europe imports around 80 percent of Libyas oil, whereas the US imports only about 5 percent (Chart 3). But again, if the impact is only in the short-term then the current strategic reserves in the Europe and the US are sufficient enough to meet short-term break in supply. In the US the scenario is far more comfortable as the country has emergency stockpiles to meet demand for oil for 38 days of consumption. Additionally, the commercial inventories in the US remain high and act as a cushion to the worsening situation in Libya. Surplus capacity in the US is around 4.65 million barrels per day, which is triple of Libyas production.

Source: Reuters

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Domestic Oil Market
Chart 5: Indian crude oil basket vs. Intl Prices

The Indian crude oil basket has risen sharply this year. Geo-political tension in Egypt boosted prices of Brent crude which accounts for more than 40 percent in the Indian crude oil basket. Chart 5 shows clearly that Indian crude oil basket moved in line with rise in international prices.

Source: Reuters

Table 1: Indian crude oil production vs. oil imports

Indias crude oil production has been witnessing a steady increase since the last fiscal. Domestic crude production has risen 11.9 per cent (provisional) during April-January 2010-11, against a negative (-) 0.1 per cent growth reported during the same period of 2009-10. January alone recorded an 11.8 percent growth in output. Consequently oil imports have been on a decline. The month of December witnessed a sharp decline in oil imports (Table 1). Domestic Oil production has been rising on the back of rise in production from Cairn India Ltds block in the western state of Rajasthan.
Source: Reuters

India produced 3.36 million metric tons of crude oil in December (795,092 barrels a day), 15.8 percent higher than a year earlier. Output for the month of December exceeded the governments target of 3.34 million tons, or 789,819 barrels a day. This has been the highest year-on-year growth in crude oil production.

Oil Demand
In its recent forecast, the EIA indicated that global oil demand in the first-quarter of this year is expected to rise by 3 percent or 2.6 million barrels a day to 88.06 million barrels a day. However, demand outlook for the US was cut by 1 percent i.e. 190,000 barrels a day on the back of sliding revision in demand in major industrialized countries. Demand in China, the worlds second-largest oil consumer has been revised up by 130,000 barrels a day for the quarter to 9.61 million barrels a day. Considering the current supply concerns, the EIA estimates came in as a relief as it projects OPEC to raise its oil output by 400,000 barrels a day this year and by 1.2 million barrels a day in 2012. Commercial stocks held by the OECD nations are sufficient to cover demand for a period of 60 days.

Soaring oil prices the biggest economic risk

We feel that a major risk to the global economy currently is the rise in crude oil prices which could hit economic growth. The advanced economies are back on track of economic growth but rising tensions in the Middle East oil producing countries could turn out to be a major economic risk. Retail prices of crude oil will rise and set a problem of inflation even in the emerging and developing economies, which are currently grappling with risks associated with rise in prices. When oil prices rose above $140/bbl in 2008, the amount of money the world spent on oil was around 5 percent of GDP. If concerns persist then oil prices could stabilize above $100/bbl levels and this could drag the global economy in another round of recession.

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Outlook
From the short-term perspective we expect crude oil prices to rise as geo-political issues have led to concerns over supply, although these are overrated as supply cutback from Libya could be easily offset by Saudi Arabia. On the back of this, we expect sharp gains in oil prices to be capped as markets become aware of the comfortable supply-side scenario. Even if geopolitical worries spread to other oil producing countries, the supply-side shocks could be brought under check if the IEA stockpiles are released or if the US government sells from its reserves. Nevertheless, sentiments seem to have more of an impact on the oil market and investors continue to support the rally in oil on expectations of supply disruptions.

Technical levels and Strategy

Crude Oil MCX March Nymex Support 1 4600 102 Support 2 4350 98 Resistance 1 4900 110 Resistance 2 5200 114

Strategy:Buy MCX March Crude oil at 4580 to 4600, SL 4350, Target 4950.

For Research Queries, please contact: Reena Walia Nair Sr. Research Analyst (022)-3935 7600 Ext: 6134 reena.walia@angelbroking.com
Disclaimer: The information and opinions contained in the document have been compiled from sources believed to be reliable. The company does not warrant its accuracy, completeness and correctness. The document is not, and should not be construed as an offer to sell or solicitation to buy any commodities. This document may not be reproduced, distributed or published, in whole or in part, by any recipient hereof for any purpose without prior permission from Angel Commodities Broking (P) Ltd. Your feedback is appreciated on commodities@angelbroking.com.

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Energy Report - March 7, 2011

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