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Hedging takes shape in midst of ambivalence
Published in The Saudi Gazette on 01 - 07 - 2012


Syed Rashid Husain

As I write these lines, oil has recovered slightly from the lowest close in nine months on somewhat positive news from crisis hit Europe, dwindling exports from Iran and the continuing strike in Norway, yet the mid-term crude outlook remains hazy - to say the least.
Crude increased as much as 3.2 percent Friday, trimming the biggest quarterly decline since the final three months of 2008. Markets are keeping a close eye on Iranian crude exports which according to the Iranian Deputy Oil Minister Ahmad Ghalebani is to "gradually" fall amid maintenance on fields and reservoirs starting next week. Shipments may decline by 20 percent to 30 percent, said Ghalebani, who is also head of National Iranian Oil Co. Some are taking the statement with a pinch of salt. Iran's output was 3.23 million bpd in May, the lowest level since June 1992, according to data compiled by Bloomberg.
In the meantime, Norway's strike that is currently halting around 200,000 - 250,000 bpd of oil a day is also impacting the global crude equation. Markets have taken cue from these developments.
However, pundits are weary of the mid- to long-term prospects. Global oil supplies are growing so fast that they could outstrip demand and lead to a collapse in world prices, some are now asserting. And they have reasons to be pessimistic.
"Most analyses today are still marked by this obsession with oil running out," Leonardo Maugeri, formerly of Eni SpA, and now at Harvard, underlined at a discussion at the Center for Strategic and International Studies in Washington.
Interestingly, in a study, analyzing capacity at more than 1,000 oil fields around the world, he found that depletion of oil supplies was occurring "much more slowly and gently than expected," estimating that world oil production capacity could go up by 17.6 million bpd between now and 2020, from 93 million barrels per day currently to 110 million bpd by 2020.
"Contrary to what most people believe, oil supply capacity is growing worldwide at such an unprecedented level that it might outpace consumption," he wrote in his analysis, published as a policy brief by Harvard's Belfer Center for Science and International Affairs. "This could lead to a glut of overproduction and a steep dip in prices."
As fundamentals weaken, markets are softening. Unless oil demand grows at a sustained yearly rate of 1.6 percent - compared with a bit less than 1 percent now - overproduction and price collapse are possible, Maugeri added. "However, world demand is sluggish due to the lagging economy and focus on energy efficiency," he wrote. "If these trends continue, we could see a significant dip - or even a temporary collapse - of oil prices."
JPMorgan Chase & Co. and Bocom International Holdings too have brought down their forecasts for oil prices this year, citing global economic weakness. Brent will average $107 this year, compared with an earlier prediction of $115, they said in a recent report.
Brent will average $95 a barrel in the third quarter, down from previously projected $120, JPMorgan said in a report dated June 25. Fourth-quarter prices will be at $100, down from $125. WTI will be at $88 a barrel in the three months ending September, compared with an earlier forecast of $113, according to the bank.
The increase in demand for oil from emerging countries is not enough to counteract the fall in demand from established economies, Alejandro Barbajosa of Argus Media said recently in an interview to CNBC. Elaborating, he said "I find it very difficult to see a move higher in the short term." He explained that oil for prompt delivery had recently discounted to a level relative to the supplies to be delivered at a later date, a market structure known as a "contango".
"This is a result of the Saudi increase in production," Barbajosa added, saying "it took a very long time for Saudi Arabia to actually set the market into that type of structure and it's unlikely that any reversal of decision in output would have any immediate effect in restoring the market back to the previous situation of backwardation, where there's a premium for those prompt supplies." He however, clarified that it was very difficult to tell what level it may reach. "The surplus is coming and filling up inventories across both developed and developing nations," Barbajosa said.
Leo Drollas of the London based Centre for Global Energy Studies, too believes that "prices have further to fall" and could go as low as $70, pointing to oil inventories around the world as a sign of an "oil glut." Deutsche Bank and Morgan Stanley analysts also expect prices to fall to $80-$85 when Opec started curbing output more heavily.
And interestingly, good, old friend, Fatih Birol, the virtual head pundit of the global energy fraternity too believes it: "If the global economy continues to deteriorate, I will not be surprised if we see more downward pressure on oil prices."
Consequently, airlines, trucking companies and other big energy consumers are betting on further oil price falls, with many reluctant to lock in at current levels amid fears prices could plunge if the global economy weakens further.
Consumers are largely on the sidelines of the oil market in spite of a 30 percent drop in price, commodities bankers point out. And consumers' wait-and-see approach does not bode well for future oil prices as it removes a key source of forward buying. It also mimics the behavior of big consumers in late 2008 at the start of the global financial crisis, when they moved to the sidelines as prices plunged from an all-time high of nearly $150 to a low of $45.Though major companies keep their hedging plans close to their chests, but anecdotal evidence confirms bankers' views. Laura Wright, chief financial officer at Southwest Airlines, the largest low-cost carrier in the US, told investors earlier this year that the airline's hedge protection for the second quarter was "minimal".
Crude markets have entered an interesting phase.


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