WTI closed November just shy of $89 a barrel on hopes of an
improving economy. I think there is an argument for an improving economy in
2013, but it is just too early to tell how things are going to come together
with the economy, and all the ramifications of basically an anti-business and
social agenda political leadership of the last four years.
I am not making a political statement that there aren`t some benefits to be gained by such governmental policies, more to state the fact that with a lot of the legislative and fiscal policies of the last four years we have yet to fully understand some of the costs and unintended consequences of these policies like higher taxes, increased healthcare costs, and increased business regulation costs.
So this is an area that remains to be seen how all this
plays out in the economy. Just last year many analysts were expecting 2013 to
be an increased chance of a recession, we shall see.
But even with the best case scenario for a stronger 2013
economy in the US, this isn`t going to effectively change the actual demand
picture for Petroleum products in a mature market like the US to any
significant degree.
In addition, with the
latest employment numbers coming out of Europe and the slowdown finally hitting
Germany it appears Europe is not going to have a robust 2013. Asia, namely
China appears to be coming off the bottom, but the days of 12% economic growth
are over for the emerging market, in short, they have finally “emerged”!
China has infrastructure and inflation constraints that
hamper growth levels higher than 7% going forward, and real growth may be much
less than reported. This economic reality is priced into the Chinese stock
market, which has had an abysmal year.
In regard to Japan, they are about to have another
leadership change, the 7th one in as many years, and this economy is
in a state of perpetual deflationary decline which has lasted for the last
twenty years. So despite the new leadership change, Japan has major demographic
and anti-competitive businesses constraints that auger more of the same for
2013.
So the US market, which is a mature market may actually have
the best economy of the major economies and users of Petroleum products in
2013, and that`s not saying much from the demand side of the equation.
 |
| Source: EIA |
Now we get to the supply side of the equation, and here is
the problem for Oil bulls, and partly the reason so many funds got killed in
2012 trying to aggressively invest in Oil through Futures, ETF`s and the like.
No established trends could take hold because the supply levels globally and
domestically are well above the five-year average, and at the height of that
range. So we have had a drop in WTI from $109 to $78 totaling $31 a barrel, and
$100 to $84 totaling $16 a barrel which is not good if you’re a fund manager
investing long-term.
The most noteworthy trend in the Oil markets for 2012 is the
increased role of US and Canadian production, and it is only going to get
stronger for 2013 and into the future. The trend is definitely not a fluke; we
have had a nice run of over a decade of high prices which has spurred a lot of
economic investment into new technologies and an increase in smaller,
independent operators searching for opportunities to make money by producing
oil in North America.
 |
| Source: EIA |
Well, we are finally starting to see the results of the
increased capital investments, and just like Shale Natural Gas, these projects
once they get going stay online, even as prices drop substantially. Expect the
same for Oil, as frankly, there just aren`t a lot of areas where you can make
the kind of margins that are attainable in the Oil market. It is a good
business to be in versus many other industries vying for capital resources.
 |
| Source: EIA |
The only reason Oil isn`t much lower
currently is that there has been a lot of increased Oil storage for newly built
capacity in China and the US. For example, Cushing Oklahoma which is the
location that the WTI Futures contract is based upon, had a storage capacity of
approximately 47 million barrels in March 2011, with increased Capacity
upgrades it stands just above 60 million barrels as of March of 2012.
 |
| Source: EIA |
But here is the kicker, on September 30,
2011 Cushing had just under 30 million barrels in storage, as of last week
Cushing has 46 million barrels stored at this location, this is an increase of
16 million barrels in one year, if we have a repeat in 2013, which all signs
point to as the trend is getting stronger not weaker, than Cushing will be
running out of working storage capacity of just over 60 million barrels. I am
sure Cushing is building more workable storage capacity as we speak, but at
some level what is the point, 2013 is when WTI starts really pricing in some of
this supply glut that comes from increased US and Canadian production.
The supply glut just
isn`t in WTI it is felt in total US inventory levels which to quote directly
from the EIA Report: “At 374.1 million barrels, U.S. crude oil inventories are
well above the upper limit of the average range for this time of year.” The US
Inventory level will probably bust through the 400 million level in 2013 for
the first time in history.
 |
| Source: EIA |
Prices have also been
supported by international cases of many supply disruptions during the past two
years, but slowly but surely, this oil is coming back online, and expect more
output internationally.
Libyan oil is now up to
full speed, Iraq output had been greater than expected, and is the real
wildcard because they are just now starting to hit their stride, and have the
potential for much more on the upside if all those new projects start
producing, not only for 2013, but for the next decade plus, it all depends upon
political stability in the country.
But here is the thing
you have to remember about international Oil, everybody needs money, regardless
if your extremist, Islamic fundamentalist, Democratic it still all applies to
the need for money, and whomever is in charge, is going to need to monetize
their resources, and these countries have very little competitive options other
than oil for generating revenue, one way or another this Oil finds its way to
the market.
As it happens, many of
the international countries robust in Oil resources need to generate Oil
revenues because a large portion of their respective populations is subsidized
through Oil exports, this trend will continue as it has for the last 30 years
with no major supply disruptions.
In fact, I expect OPEC
will need to start entertaining supply cutbacks in 2013 to address swelling
inventory levels globally, but again here is the irony, they may talk up the
market with production cuts, but the fact remains, the incentive is even
greater for cheating on quotas the lower the price goes, because the
governments still have budgets based upon the same level of revenue, and the
only way to get the same revenue with lower prices is to pump more oil.
Moreover, since a lot
more capacity is capable of coming online in 2013 globally, and all these
governments from Iraq to Sudan need money, expect greater achievement towards
capacity which is bearish for Brent Oil prices as well, i.e., expect Brent to
test the $85 level sometime in 2013.
The last decade has been
exemplified by higher energy prices, and with this came increased CAP EX
investment, new technologies were refined, and North America has seen a rebirth
in energy activity. It all started with natural gas, and now we are starting to
experience this sea change in the Oil market.
Prices in 2012 started
addressing this dynamic change, but the real effects of this trend will start
taking shape in 2013 as storage constraints start kicking in, demanding a
re-pricing of the commodity.
After all, no matter how
much the Fed devalues the dollar, unlike Gold or Silver, you can only store so
much Crude Oil, and with 700 million in the Strategic Reserves, another 400
million in US Reserves, how much do we really need to store in an increasingly
energy independent North American Region?
Economics will dictate
that you can only build so much storage to avert the price drop from continual
over supply, and right now the world produces more Oil than it consumes each
day, and it has for the past 16 months, this trend will only get worse in 2013.
So expect prices to finally start to address this over supply issue in the Oil
Markets in 2013.
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