Schork Oil Outlook: Don’t Bet on Asia Boosting Prices
Last Wednesday, some brave soul at the EIA fought through Washington’s snowstorm to release February’s Short Term Energy Outlook (STEO).
The EIA’s analysis is a valuable blend of hard data and fundamental analysis, with the only significant downside being its less than frequent release schedule.
Coming out just once a month, sharp movements in the markets can leave the STEO’s forecasts outdated within a week. Yet prices have an eerie habit of returning to the STEO’s numbers by the end of the month: The contract for February delivery settled a dollar away from the STEO forecast, despite huge inter-week variations. Traders and analysts are clearly paying more attention to the STEO.
The EIA expects oil prices to “strengthen again this spring with NYMEX WTI rising to an average of about $81 [in Q3 and Q4 2010] and $84 per barrel in 2011.” This is in line with January’s STEO; in fact, the forecast settles have been unchanged from month to month. The EIA justifies these high prices by citing China’s 12 percent year-on-year increase in fuel consumption levels and the ongoing Asian-led economic recovery.
This makes sense and is backed up by yesterday’s news that Japan’s GDP grew by 4.6 percent for the three months ending Dec 31, well above analyst expectations of 3.5 percent growth.
Be that as it may, keep in mind consumers in China don’t pay gasoline at market rates, they pay whatever the government decides. 2008 saw American drivers paying $4.00 at the pump while their Chinese counterparts paid $2.50.
It is thus in China’s best interests to see lower crude oil prices. If crude oil prices rise, but Chinese retail prices don’t, China’s state-owned oil companies begin to suffer. If retail prices are increased, Chinese demand for gasoline and motor vehicles (and all the taxes they generate) will probably drop drastically. Either way, the government loses.
Similarly, Japan has effectively zero oil reserves. High crude oil prices will lead to increased import expenditure (effectively selling the yen to buy dollars to buy crude), which will lead to a devaluation of the yen and reduced purchasing power, sending the Japanese economy back in to a tailspin.
After all, as today’s chart of the day shows, Japan’s meteoric growth sputtered out when the yen began falling, and has spent the last two decades in stagnation. Will a weaker yen really bring more good news for Japan?
Analysts at are thus less hesitant to place all our chips on China and Asia. On the other hand, the EIA seems to believe the market’s recent correction below $70 was a temporary blip, not a fundamental correction. That means oil prices will rise because they are under the influence of the Wall Street bulls and Asia’s magic demand, not the refiners losing billions when oil prices are above $70.
Back in the U.S., the EIA forecasts that prices at the pump will increase from $2.35 per gallon in 2009 to $2.84 in 2010 and $2.97 in 2011. In addition, prices may cross $3.00 (on average) this summer. Meanwhile, diesel fuel prices are forecast at $2.95 and $3.16 per gallon in 2010 and 2011 respectively.
We consider these numbers slightly below expectations: according to gasoline station receipts, consumers have been returning to the pump en masse and spending more than expected.
What’s more, room exists for further growth: as of Q4 2009, consumers were spending 3.46 percent of total expenditure on gasoline and other energy goods, but during 2007-08 were spending an average of 3.91 percent. That creates a cushion of ~$35.6 Bn which consumers have available to spend on gasoline.
We expect that retailers will more likely than not respond to this cushion by pushing up prices regardless of fluctuations in crude oil prices. Given how badly downstream profits have been hit, it’s the only way to bring the majors’ retail operations back in to the money.
For natural gas, the Henry Hub spot price for 2010 is forecast to average $5.37 per MMBtu, a $1.42 MMBtu increase over 2009’s $3.95 average. The EIA expects total natural gas consumption to increase 0.4 percent in 2010 and another 0.4% in 2011, while January’s frigid temperatures led to an 8.4 percent jump in the “monthly estimate for electric-power-sector- natural gas consumption” from the previous forecast, leading to record high for demand in January.
This led to a mostly upward revision in the forecast settles for 2010. March’s settle was revised from 5.32 in January to 5.35 while the summer saw even bigger revision, September is up from 4.90 to 5.21.
We assume the STEO’s model incorporates increasing shale production in the future and the concept that high prices will lead to higher production — marketable natural gas production is expected to decline 2.6 percent in 2010 and rise 1.3 percent in 2011; and December 2010 has been revised lower from 6.12 to 6.10 in anticipation of increasing supply. All told, there is nothing shocking in the EIA’s forecast for natty.
It is the position of that the EIA has a bullish bent for wholesale prices and a bearish bent for retail prices, i.e., the opposite of what the fundamentals suggest.
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Stephen Schork is the Editor of, and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.