Af­ter Vienna, term struc­ture of oil shows a hump­back

BOFA MER­RILL LYNCH RE­PORT

Kuwait Times - - BUSINESS -

Crude oil prices have re­sponded to the re­cent OPEC and non-OPEC deal in Vienna by bouncing firmly into the $50+/bbl range. No­tably, the term struc­ture of the Brent crude oil mar­ket has pushed from a very steep struc­tural con­tango into a hump­back shape, show­ing a dis­count in near-dated con­tracts but back­war­da­tion past the Septem­ber 2017 con­tract. Why? The agree­ment to cut out­put may push the oil mar­ket into deficit as soon as Jan­uary. Yet, stocks re­main ex­ceed­ingly high and it should take months to nor­mal­ize them. Mean­while, pro­duc­ers keep sell­ing pa­per oil for­ward into 2018, an­chor­ing longer dated con­tracts. Pro­ducer, con­sumer, pas­sive in­vestor, stor­age, and spec po­si­tion­ing flows all feed into this awk­ward oil curve. We re­fer to it as “the hunch­back of Vienna”.

Is this oil curve shape new? No, the crude oil mar­ket de­vel­oped a sim­i­lar shape that lasted for 28 months in 2005-07. Could it per­sist? Yes, we be­lieve it could per­sist for the next four months and pos­si­bly longer for four rea­sons. First, we ex­pect large-scale high yield and in­vest­ment grade oil pro­ducer for­ward sell­ing to con­tinue in Cal­en­dar 2018. Sec­ond, high in­ven­tory lev­els will likely keep de­press­ing front-month oil con­tracts un­til the crude over­hang is partly cleared in 2H17. Third, a pos­si­ble surge in pas­sive in­vestor flows next year could dampen a shift to back­war­da­tion in front-to-third month oil spreads. And fourth, on the con­sumer side, air­lines may not come back in size into the mar­ket un­less spot oil prices spike above $75/bbl, an un­likely event.

Given the re­lent­less sell­ing pres­sure of shale pro­duc­ers, US nat gas pro­vides a good tem­plate for oil struc­ture. Since US shale gas out­put started 9 years ago, the front-to-thir­teenth month curve has moved from con­tango into back­war­da­tion three times. Each con­tango pe­riod lasted for at least 2 years. For Brent to move into back­war­da­tion, we es­ti­mate to­tal OECD crude oil in­ven­to­ries would have to drop to 1.1bn bar­rels. With stocks cur­rently at 1.18 bil­lion bbl, this ro­ta­tion will likely take at least 6 months of crude in­ven­tory de­clines of 440 thou­sand b/d. Said dif­fer­ently, the “hunch­back of Vienna” may not de­part un­til the July Brent con­tract be­comes prompt on April Fools’ day. Should OPEC and Rus­sia fail to de­liver deep cuts in 1H17, it could very well take a lot longer.

Macro out­look

Global GDP in USD terms at mar­ket ex­change rates is stag­nant. China’s GDP is chang­ing, with ser­vices over­tak­ing in­dus­trial ac­tiv­ity as a driver of growth. US Repub­li­can win means stronger USD, higher rates, more trade bar­ri­ers, and re­duced US oil sup­ply re­stric­tions.

Fed tight­en­ing cy­cles and a strong USD do not bode well for oil, as ris­ing US rates and flat­ter yield curves hurt EM de­mand. Global oil out­put was un­changed YoY in 3Q, as OPEC growth off­set again non-OPEC field de­cline rates of 5.0 per­cent. We project non-OPEC sup­ply to con­tract by 910 k b/d this year and 30 k b/d in 2017, com­pared with an av­er­age 20-year ex­pan­sion of 710 k b/d. We see shale oil out­put bot­tom­ing out in 1Q17. Ef­fi­ciency gains are flat­ten­ing out ev­ery­where ex­cept in the Per­mian, which is set to lead the out­put re­cov­ery as prices rise.

With global in­ven­tory trends di­verg­ing, our work shows Light Louisiana Sweet (LLS) is turn­ing into the global oil bell­wether 2017 global oil de­mand growth will av­er­age 1.2mn b/d in 2017 while sup­ply is roughly un­changed, re­sult­ing in a 2017 Brent price of $61.

OPEC agreed to cut crude oil out­put by 1.2mn b/d with key non-OPEC pro­duc­ers in­di­cat­ing a 558k b/d curb, a first since 2001. Coun­try quo­tas and an in­de­pen­dent pro­duc­tion mon­i­tor­ing com­mit­tee are also part of the deal, so we ex­pect firmer com­pli­ance.

OECD de­mand will grow by 80k b/d this year as Amer­i­cans drive over 3tn miles, but we project flat OECD de­mand in 2017. Yet we see EM oil de­mand ex­pand­ing by 1.2mn b/d in 2017 but ac­knowl­edge down­side risks on the back of higher US rates. OPEC’s ac­tion won’t pro­pel prices much above our $70 mid-year tar­get. Longer-term, we es­ti­mate global oil de­mand will in­crease by 1.2mn b/d per an­num over five years at $55-$75, and by 1.7mn b/d at $30/bbl. Peak global oil de­mand lies be­yond 2050 if oil stays be­low $100, as trans­port de­mand off­sets ef­fi­ciency and sub­sti­tu­tion. Faster EV adop­tion or ef­fi­ciency gains, e.g., due to higher oil prices, could al­ter this path and bring peak de­mand by 2030.

2017 En­ergy Out­look

Refin­ing mar­gins have re­bounded from their Septem­ber lows across all re­gions on planned and un­planned re­fin­ery out­ages. Yet we now see mar­gins fall­ing as refin­ing costs struc­tures rise and global crude stocks re­bal­ance faster than prod­uct stocks. Also, we project CDU ca­pac­ity ad­di­tions glob­ally of 960 and 860 thou­sand b/d in 2017 and 2018, and re­main bear­ish dis­til­late. While the de­mand bounce in 2010 was cycli­cal and diesel-geared, to­day’s petroleum de­mand is con­sumer-and thus gaso­line-geared.

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