A significant development has occurred since we released last month’s Heating Season Fuels Outlook for 2014—a crack has appeared in OPEC’s price support wall. Historically, a lack of long-term discipline in OPEC was the order of the day for many years. Regardless of a commitment to hold prices at a certain level, invariably a member (often Venezuela) would decide to cheat and the overall commitment among other members would gradually collapse. That seemed to have changed in the 2000s, with a focus on keeping production controlled to push the highest prices that could be supported short of destroying the economies of OPEC’s oil customers.
At the start of October, Saudi Arabia indicated that it is apparently more interested in maintaining market share than price, leading to a bump in volatility and downward prices. While this is seen as a significant development much of the original discussion in last month’s article still holds true, and in fact this reinforce some of the underlying assumptions about the impact on petroleum markets and politics resulting from the U.S. shale boom.
Alan Levine, CEO and chairman of Powershouse®, which provides hedging and price risk management services, took part in the price report last month, and made the following comments in his firm’s Weekly Energy Market Situation newsletter, sent Oct. 20:
The sharp selloff in oil prices rested at week end with a slight lift off the lows. October has experienced dramatic reductions in the value of petroleum, based in large part on unexpected events. The markets have known about the build in U.S. inventories of oil and gas; this has been priced into the value of oil and gas.
What the markets did not expect were sharp reductions in the economic well-being of Europe cutting into product demand. The markets did not expect Saudi Arabia to change its production policy to support market share at the expense of price.
The week ending October 17th ended with broad ranges for products and WTI crude oil. Distillate fuel oil fell to $2.42 during the week, a fourteen cent range. RBOB prices had a similar range. Gasoline’s high price was $2.27; its low was $2.135. During the month of October, ULSD lost 29.6 cents in value. WTI gave up $15.12 during the month to date.
Brian Milne, the editor of Schneider Electric’s MarketWire, a real-time market and news service focused on US oil prod- uct markets, also took part in last month’s article. He agreed to a quick conversation on the developments.
“Those pressures were building and they’ve been out there for a long time, but it’s almost been taken for granted that Saudi Arabia would just make these production cuts to help balance the market [and keep prices higher],” Milne said. “It appeared that Saudi Arabia would make the cuts and make room for the new supply coming online, including Iraq, and it seemed to be what everybody was thinking. However, it’s changed with the Saudi’s cutting the market prices and signal- ing that they are looking to maintain market share in Europe and Asia—that’s a big development. That upends what the Bulls were thinking, and that turned everything on its head. When the Saudi’s made that decision we saw the hedge funds that were still in the market unloading positions in a big way, and it’s triggered responses with Iran cutting prices and Kuwait indicating they’re cutting prices to defend market share. That’s a big deal. You hear the Saudi say they can live with an $80 per barrel price for a number of years.”
While market share is likely a core driver, there are more issues at work with the decision. The United States has really developed into an energy producing giant through shale production technology, and that includes oil as well as natural gas. However, extract- ing oil from shale, while more efficient than ever, still has a premium in production costs compared to conventional oil production. Higher oil prices have easily fueled U.S. oil and gas production expansion, and lowering those prices is seen as applying a brake to the expansion and perhaps even initiating a retraction.
“You have some good analysts noting that it isn’t just about maintaining market share among OPEC members, but it’s also about helping to slow U.S. shale oil production,” said Milne. “The Saudi’s do not come out and say that, but that is the think- ing because some of the higher cost shale oil producers need an $80 price. So you start putting pressure on those producers and they start pulling back from that supply growth, because supply growth has outpaced estimates over and over again.”
There is previous history to suggest this can be an effective policy. As prices were ramping up before the crash in 2008— with suggestions from entities like Goldman Sachs that $200 per barrel oil was on the way and here to stay—there was a significant expansion in oil production underway. The 2008 price crash was devastating for many producing companies initially, though prices recovered significantly in the following years. However, Milne noted that the U.S. shale production might not be as sensitive to price pressures as might be assumed.
“There has been a string of stories out there talking about consolidation among the U.S. oil producers because some of those operators are stretched thin,” Milne said. “But, I just saw not too long ago the International Energy Agency’s Executive Director Maria Van der Hoeven noting that the [producer’s] breakeven price was below $80, and about 82% had a breakeven price of $60 or lower. So those numbers could mean that some of these U.S. producers can hold on longer. What it all means though is we have lower prices, and will have them for a while.”
Just what does he expect from a price standpoint?
“I was expecting the average [for retail gasoline] to come in somewhere between $3.10 and $3.20 per gallon around the middle of November, and now I’m thinking we are going to punch below $3 with the bottom around $2.90 or $2.85,” said Milne. “For heating oil, futures could go down and test the low $2.20 range. In January, when retail prices are likely to be the strongest, you’re likely looking at around $3.50. If Europe has a mild winter that could limit the amount of distillates exported, and the government is forecasting the likelihood for above normal temperatures in the Northeast. This would limit price gains.”
A milder winter in the United States was noted in the Energy Information Administration’s Winter Fuels Outlook released on Oct. 7. As the report stated:
Forecast temperatures based on the latest forecasts from the National Oceanic and Atmospheric Administration (NOAA) are much warmer than last winter east of the Rocky Mountains, with the Midwest 16% warmer, the South 12% warmer, the Northeast 11% warmer.
This prediction is at odds with the forecast from ImpactWeather’s StormWatch Manager/Meteorologist Fred Schmude, presented in the FON fuels price outlook last month. As he stated (and as was unfortunately partially cut off through a production error): “So we should see a similar winter to last year, but what I’m concerned about is that we may be getting into a pattern similar to what we saw in the late 1970s,” Schmude said. “So we could be seeing, at times, some historic cold.”
This prediction is also at odds with the meteorological resources Milne uses at Schneider Electric.