Demand for oil has surpassed supply for the first time in years. Analyst Torbjørn Kjus shares his thoughts with us.
Demand for oil has surpassed supply for the first time in years and this has seen prices start to recover after a dramatic fall between 2014 and 2016.
Meanwhile, shipping industry fuel burning regulations set to take effect in 2020 could change demand trends in the bunker oil market. Things happen quickly in the oil market, but as DNB Markets Oil Analyst Mr Torbjørn Kjus notes, people become complacent when things stay in a tight range for an extended period of time. Eventually, when the market moves, it takes a while for it to get noticed. This is a lesson many have learned in 2017.
“The narrative regarding the oil market has changed. To start 2017, the narrative from commentators was Organisation of the Petroleum Exporting Countries (OPEC) is cutting production and inventories are not growing. That was because US shale kept filling the inventory gap. The conclusion was nothing would work to reduce global oil inventory,” Mr Kjus pointed out during the Norwegian Business Association luncheon talk held in Singapore.
He continued, “Now the narrative is OPEC discipline is high, inventories are down and because they are down, political risk has more impact on the price. It is a very different situation then we had four months ago when the price was at USD 45 a barrel. The price is now up to USD 64 per barrel. People forget just how fast the market can change and it is pleasant to see the situation rebound.”
One of the biggest shifts in the oil market has seen demand surpass supply, something last recorded back in 2013. The change has been due in large part to OPEC and its allies outside the group, including Russia, agreeing to cut production to 1.8 million barrels per day in 2016. This move has been the catalyst for recovering oil prices, but in Mr Kjus’ view, neither banks nor the media have reported on the falling inventory.
“There was an assumption from the Wall Street banks that the OPEC deal would collapse, but now we are seeing Wall Street revise their estimates, as OPEC discipline remains strong,” he stated.
Despite the scepticism, OPEC was able to stay true to the agreement with the majority of countries having fully complied or reached at least 80 percent on average of the cutback target. Some countries, such as Saudi Arabia, Angola, Qatar, Brunei and Mexico, slashed production beyond what they had initially promised.
In November, OPEC, along with its allies, agreed to extend the production cuts until the end of 2018. Nigeria and Libya, who were exempt from the production agreement when it was first signed, joined with it as part of the extension.
“Fundamentally, the cuts have worked well,” Patrick Pouyanne, chief executive officer of Total SA, told Bloomberg. “I’m not surprised they decided to extend. ”
OPEC’s ability to follow through with production cuts wasn’t the only surprise the oil market saw in 2017. Where the increase in oil demand is originating from has been a revelation to some in the industry. Despite expert predictions, oil demand from the Organisation for Economic Co-operation and Development ( OECD) has come back to growth in the past few years.
“That wasn’t supposed to happen. OECD demand was believed to have peaked ten years ago. It peaked in
Europe in 2006 and fell every year up until 2014,” Mr Kjus reported. “It started turning around in 2015. There was also a large growth in 2016 and again in 2017. The growth in 2015 and 2016 suggest it may be due to price elasticity since there was no economic growth in the OECD during this period.”
The jump in demand was shown in the prices. Mr Kjus notes that if prices are at USD 100 per barrel, demand from Europe shrinks by 250,000 barrels per day. However, when prices are at USD 50 a barrel, European demand jumps by 250,000 barrels a day.
“This is a very meaningful number and surprisingly elastic. The situation went from minus to plus on the demand side,” Mr Kjus said.
Shipping industry looks to 2020
The shipping, oil and refining industries already have their sights set on 1 January 2020. This is when shipping vessels will no longer be allowed to burn 3.5 percent sulphur mass by mass (m/m) fuel. New regulations ratified by the International Maritime Organisation stipulate that shipping vessels are only allowed to burn 0.5 percent sulphur m/m fuel.
The policy was approved in 2008 and confirmed by the IMO’s Marine Environment Protection Committee in 2016. The 3.5 percent sulphur fuelburning limit took effect in 2012.
“This is a huge change. It’s the largest specification change in the oil industry and it is going to have the biggest effect,” Mr Kjus stated. “There are three options available to those needing to become compliant. They can either switch fuels to a compliant type, invest in scrubbers and de-sulphurise on the ship or utilise LNG fuel engines.”
DNB Markets believes scrubbers won’t have a meaningful impact by the 2020 deadline. Investment in this method have been rather limited thus far due to timing uncertainty and the challenging economic environment for most shipping sectors. At the moment, less than 0.5 percent of the total shipping fleet uses scrubbers.
Dual fuel engines capable of burning either LNG or liquid fuels are also unlikely to be widely implemented before the 2020 deadline. They are cost prohibitive and while this is something the shipping industry could adopt in the future, it doesn’t make sense for most firms at the present time.
“LNG makes up around 2.5 percent of marine fuel consumption and both technology and infrastructure are evolving slowly meaning this method will only have a limited impact in 2020,” Mr Kjus noted. This leaves switching fuel type as the most likely option for many firms.
The groups most likely to be impacted by the new IMO bunker standards change are container lines, tankers and dry bulk since they currently use the most high sulphur fuel oil. According to Maersk, the ten largest container lines will be 100 per cent compliant with the new sulphur burning regulations once they kick in on 1 January 2020.
Some cheating is to be expected in the short term as firms still use high sulphur fuels, but even if this is the case, compliance rates will still be relatively high. For example, an IMO GHG study in 2014 found that if there is 50 percent cheating taking place within tankers and bulkers, the overall compliance rate would be 67 percent.
Demand of 0.5 percent sulphur blend fuels is expected to increase by 2.5 million barrels per day in 2020 and refineries will be under pressure to produce the on spec material. One key issue facing refineries is how will they meet demand for low sulphur fuel oil. DNB Markets predicts that even when using all their tools, such as cokers and crackers, to produce low sulphur fuel oil, they won’t be able to meet demand from the shipping industry in the coming years.
According to Kjus, this means refineries will also need to feed crude oil into distillate towers. When using these, for every three barrels of crude put it, only one barrel of marine gas oil is produced.
“The only way refineries are able to produce enough marine gas oil is to increase throughput. If they don’t increase throughput of crude oil, they won’t be able to meet the increase in demand,” Mr Kjus said. “We see that there is enough spare capacity in the refining system to meet the increase in demand for low sulphur marine gas oil as long as utilization rates improve.”
And while increasing throughput into distillate towers may allow the refining industry to meet the spike in demand, it will also create more high sulphur resid fuel that must also be moved. Mr Kjus noted there will be an oversupplied high sulphur resid fuel market once refineries move to produce the low sulphur fuel the marine industry will require in 2020. Refineries must look at ways to reduce the expected glut.
“The other uses for high sulphur fuel are power generation and industrial production. Refineries will need to find a way to move this fuel onshore which will most likely be of use in Africa, the Middle East and Asia,” Mr Kjus noted. “The high sulphur resid fuel will need to be really cheap. Demand for it won’t be great, so it will have to push its way onto the market.
Above: The ten largest container lines will be 100 per cent compliant with the new sulphur fuel burning regulations when they take effect in 2020.