Oil trader: "There is no growth"

SUBHEAD: World's largest oil trader has a stunning warning for OPEC pricing strategies. 

By Tyler Durden on 10 May 2017 for Zero Hedge -
(http://www.zerohedge.com/news/2017-05-10/there%E2%80%99s-no-growth-worlds-largest-oil-trader-has-stunning-warning-opec)


Image above: Oil price cartoon "Diminishing Returns" by David Simonds for the Observer. From (http://www.execreview.com/2017/04/as-wind-wave-and-shale-power-converge-could-this-be-the-end-for-opec/).

When it comes to the oil market, the narrative over the past year, ever since OPEC's first aborted meeting last April, has been just one: limit crude supply in hopes of rebelancing the oil market, reducing excess inventories, in the process sending the price of oil higher.

However, echoing what we have warned for many months, overnight the world’s biggest independent oil trader said OPEC's efforts could be in vain because the oil producing cartel is seeking to control the wrong thing:

"It's not a matter of supply, but global demand which is simply not there."

According to Vitol Group, the world's biggest independent oil trader demand isn’t expanding as much as expected, and U.S. shale output is growing faster than forecast, Bloomberg reports.

As a logical outcome, that’s increasing the burden on the world’s biggest producers, who need to stick to their pledges to cut supply just to keep prices from falling, said Kho Hui Meng, the head of the company’s Asian arm.

Meanwhile, shale continues to capture OPEC, and mostly Saudi, market share as do countries such as Iran and Libya which are not bound by the Vienna agreement production quotas.

But the biggest variable is demand, of which there is simply not enough: “What we need is real demand growth, faster demand growth,” Kho, the president of Vitol Asia Pte., said in an interview in Kuala Lumpur. “Growth is there, but not fast enough.”

The problem in a nutshell: originally, oil consumption, or demand, was forecast to expand this year by about 1.3 million barrels a day, growth has been limited to about 800,000 barrels a day so far in 2017, Vitol's Kho said, adding that meanwhile U.S. output had grown 400,000-500,000 barrels a day more than expected.

“If demand goes back to where it should, where it’s forecast, then it’ll help, but my gut feel tells me it is still a bit long,” he said. Vitol's dour demand outlook has been shared by the International Energy Agency itself, which trimmed its forecasts for global oil demand growth this year by about 100,000 barrels a day to 1.3 million a day as a result of weaker consumption in OECD member countries and an abrupt slowdown in economic activity in India and Russia, according to a report released last month.

As a result, the Paris-based IEA cut its estimate for India’s 2017 oil-demand growth by 11% . It's not just India: there’s also concern that consumption may slow in China, the world’s second-biggest oil user. As we reported in March, China's independent refiners or "teapots", which account for a third of the nation’s capacity, have received lower crude import quotas compared with a year earlier, prompting speculation their purchases could slow.

“The oil market is looking for growth but there’s no growth,” Vitol’s Kho said, adding that the refiners may only get approval for the same volume of imports as last year. And while U.S. gasoline consumption is expected to hit its seasonal summer peak soon, demand growth “is not there yet,” he said.

Yet, in what may be the third law of oil price (dis)information, for every bearish oil trader, there is an equally bullish oil producerm, in this case Saudi Arabia. And indeed, the world’s biggest crude exporter is quite optimistic on oil's prospects.

According to Bloomberg, Saudi Arabia expects 2017 global consumption to grow at a rate close to that of 2016, Energy Minister Khalid Al-Falih said on Monday.

“We look for China’s oil demand growth to match last year’s, on the back of a robust transport sector, while India’s anticipated annual economic growth of more than seven percent will continue to drive healthy growth,” he said in Kuala Lumpur.

While some fear a slowdown in Chinese oil demand, Sanford C. Bernstein & Co. doesn’t see any cause for concern. Growth in the nation’s car fleet will support gasoline demand, with increasing truck sales and air travel also helping fuel consumption, it said in a report dated May 9.

Saudi Arabia and Russia, the world’s largest crude producers, signaled this week they could extend production cuts into 2018, doubling down on an effort to eliminate a surplus.

It was the first time they said they would consider prolonging their output reductions for longer than the six-month extension that’s widely expected to be agreed at an OPEC meeting on May 25.

And then there is shale.

“We’ve always talked about the call on OPEC, how much OPEC oil is needed to satisfy world demand,” said Nawaf Al-Sabah, chief executive officer of Kufpec, a unit of state-run Kuwait Petroleum Corporation:

“Now, in this new paradigm, it’s really becoming the call on shale. And the market is setting itself at the marginal cost of a shale barrel.”

As Bloomberg points out, U.S. output has jumped for 11 weeks through the end of April to 9.29 million barrels a day, the most since August 2015, Energy Information Administration data show.

Furthermore, according to an EIA forecast released on Monday, US crude output for 2017 is expected to rise again, from 9.22MMbpd to 9.31MMBpd, and jump in 2018 from 9.9MMbpd to an all time high 9.96MMpbd.

That may prove optimistic.

According to a separate Bloomberg report, U.S. shale explorers are boosting drilling budgets 10 times faster than the rest of the world to harvest fields that register fat profits even with the recent drop in oil prices.

Flush with cash from a short-lived OPEC-led crude rally, North American drillers plan to lift their 2017 outlays by 32 percent to $84 billion, compared with just 3 percent for international projects, according to analysts at Barclays Plc.

Much of the increase in spending is flowing into the Permian Basin, a sprawling, mile-thick accumulation of crude beneath Texas and New Mexico, where producers have been reaping double-digit returns even with oil commanding less than half what it did in 2014.

Needless to say, that’s very bad news for OPEC and non-OPEC in the ongoing, and failing, global campaign to crimp supplies and elevate prices. Wood Mackenzie Ltd. estimates that new spending will add 800,000 barrels of North American crude this year, equivalent to 44 percent of the reductions announced by the Saudi- and Russia-led group.

Drilling budgets around the world collapsed in 2016 as the worst crude market collapse in a generation erased cash flows, forcing explorers to cancel expansion projects, cut jobs and sell oil and natural gas fields to raise cash.

The pain also swept across the Organization of Petroleum Exporting Countries, which in November relented by agreeing with several non-OPEC nations to curb output by 1.8 million barrels a day. So far, independent American explorers such as EOG Resources Inc. and Pioneer Natural Resources Co. are holding fast to their ambitious growth plans.

Some recently finished wells in the Permian region yielded 70 percent returns at first-quarter prices, EOG Chief Executive Officer Bill Thomas told investors and analysts during a conference call on Tuesday.

But the worst news for OPEC is that a new flood of oil may be imminent: "U.S. oil production is already swelling, even though output from the new wells being drilled won’t materialize above ground for months." In other words, "in a few months" expects a whole new wave of shale oil to hit markets.

It is unclear how long the shale strategy can continue: drillers can afford to be sanguine despite oil’s recent tumble because they’ve cushioned themselves with hedges, Martin said. Hedges are financial instruments that lock in prices for future output and shield producers from volatile market movements.

“There is some price malaise creeping in,” Martin said. “But the aristocracy of the U.S. independents have insulated themselves” through hedging.

At the end of the day, however, the biggest culprit for OPEC's failed strategy may be none other than the Fed and its peer central banks, who have made access to cheap money virtually problematic, money which shale companies that were near bankruptcy a year ago, are now using to pump record amounts in hopes of stealing Saudi market share.

“The specter of American supply is real,” Roy Martin, a Wood Mackenzie research analyst in Houston, said in a telephone interview. “The level of capital budget increases really surprised us.”

If Riyadh really want the price of oil to go up, perhaps it should send a letter to Janet Yellen to make it more difficult for shale companies to get the funding they need to produce any amount of oil with virtually no capital limitations.

Finally, we go back to Vitol’s Kho, who tried to end on an optimistic note.

He failed:

“I am still watching the U.S. summer gasoline demand,” he said. “OPEC has said it will try and extend its output cuts beyond June. So if that happens, and the discipline is good, and if the U.S. lack of growth in demand changes into summer, then we may see oil go back to the low $50s, but the prevailing mood today is not.”

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The oil drenched Black Swan

SUBHEAD: Events unforeseen and uncontrollable will trigger waves of other unforeseen and uncontrollable consequences.

By Charles Hughs Smith on 1 December 2014 for Of Two Minds -
(http://charleshughsmith.blogspot.co.uk/2014/11/the-oil-drenched-black-swan-part-1.html)


Image above: Black Swan at Lake Rotoiti, New Zealand. Photo by Robyn Carter. From (http://blog.bird-rescue.org/index.php/2011/06/photographers-in-focus-robyn-carter/).

PART ONE
Given the presumed 17% expansion of the global economy since 2009, the tiny increases in production could not possibly flood the world in oil unless demand has cratered.

The term Black Swan shows up in all sorts of discussions, but what does it actually mean? Though the term has roots stretching back to the 16th century, today it refers to author Nassim Taleb's meaning as defined in his books, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets and The Black Swan: The Impact of the Highly Improbable:

"First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme 'impact'. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable."

Simply put, black swans are undirected and unpredicted. The Wikipedia entry lists three criteria based on Taleb's work:

1. The event is a surprise (to the observer).
2. The event has a major effect.
3. After the first recorded instance of the event, it is rationalized by hindsight, as if it could have been expected; that is, the relevant data were available but unaccounted for in risk mitigation programs.

It is my contention that the recent free-fall in the price of oil qualifies as a financial Black Swan. Let's go through the criteria:

1. How many analysts/pundits predicted the 37% decline in the price of oil, from $105/barrel in July to $66/barrel at the end of November? Perhaps somebody predicted a 37% drop in oil in the span of five months, but if so, I haven't run across their prediction.

For context, here is a chart of crude oil from 2010 to the present. Note that price has crashed through the support that held through the many crises of the past four years. The conclusion that this reflects a global decline in demand that characterizes recessions is undeniable.

I think we can fairly conclude that this free-fall in the price of oil qualifies as an outlier outside the realm of regular expectations, unpredicted and unpredictable.

Why was it unpredictable? In the past, oil spikes tipped the global economy into recession. This is visible in this chart of oil since 2002; the 100+% spike in oil from $70+/barrel to $140+/barrel in a matter of months helped push the global economy into recession.

The mechanism is common-sense: every additional dollar that must be spent on energy is taken away from spending on other goods and services. As consumption tanks, over-extended borrowers and lenders implode, "risk-on" borrowing and speculation dry up and the economy slides into recession.

But the current global recession did not result from an oil spike. Indeed, oil prices have been trading in a narrow band for several years, as we can see in this chart from the Energy Information Agency (EIA) of the U.S. government.

Given the official denial that the global economy is recessionary, it is not surprising that the free-fall in oil surprised the official class of analysts and pundits. Since declaring the global economy is in recession is sacrilege, it was impossible for conventional analysts/pundits to foresee a 37% drop in oil in a few months.

As for the drop in oil having a major impact: we have barely begun to feel the full consequences. But even the initial impact--the domino-like collapse of the commodity complex--qualifies.

I will address the financial impacts tomorrow, but rest assured these may well dwarf the collapse of the commodity complex.

As for concocting explanations and rationalizations after the fact, consider the shaky factual foundations of the current raft of rationalizations. The primary explanation for the free-fall in oil is rising production has created a temporary oversupply of oil: the world is awash in crude oil because producers have jacked up production so much.

Even the most cursory review of the data finds little support for this rationalization. According to the EIA, the average global crude oil production (including OPEC and all non-OPEC) per year is as follows:

2008: 74.0 million barrels per day (MBD)
2009: 72.7 MBD
2010: 74.4 MBD
2011: 74.5 MBD
2012: 75.9 MBD
2013: 76.0 MBD
2014: 76.9 MBD

The EIA estimates the global economy expanded by an average of 2.7% every year in this time frame. Thus we can estimate in a back-of-the-envelope fashion that oil consumption and production might rise in parallel with the global economy.

In the six years from 2009 to 2014, oil production rose 3.9%, from 74 MBD to 76.9 MBD. Meanwhile, cumulative global growth at 2.7% annually added 17.3% to the global economy in the same six-year period. What is remarkable is not the extremely modest expansion of oil production but how this modest growth apparently enabled a much larger expansion of the global economy. ( Other sources set the growth of global GDP in excess of 20% over this time frame.)

Global petroleum and other liquids reflects a similar modest expansion: from 89.1 MBD in 2012 to 91.4 MBD in 2014.

Given the presumed 17% to 20+% expansion of the global economy since 2009, the small increases in production could not possibly flood the world in oil unless demand has cratered. The "we're pumping so much oil" rationalizations for the 37% free-fall in oil don't hold up.

That leaves a sharp drop in demand and the rats fleeing the sinking ship exit from "risk-on" trades as the only explanations left. We will discuss these later in the week.

Those who doubt the eventual impact of this free-fall drop in oil prices might want to review The Smith Uncertainty Principle (yes, it's my work):

"Every sustained action has more than one consequence. Some consequences will appear positive for a time before revealing their destructive nature. Some will be foreseeable, some will not. Some will be controllable, some will not. Those that are unforeseen and uncontrollable will trigger waves of other unforeseen and uncontrollable consequences."

I call your attention to the last line, which I see as being most relevant to the full impact of oil's free-fall.

PART TWO
(http://charleshughsmith.blogspot.co.uk/2014/12/the-oil-drenched-black-swan-part-2.html)

All the analysts chortling over the "equivalent of a tax break" for consumers are about to be buried by an avalanche of defaults and crushing losses as the chickens of financializing oil come home to roost.

The pundits crowing about the stimulus effect of lower oil prices on consumers are missing the real story, which is the financialization of oil. Financialization is another word that is often bandied about without the benefit of a definition.

Here is my definition:

Financialization is the mass commodification of debt and debt-based financial instruments collaterized by previously low-risk assets, a pyramiding of risk and speculative gains that is only possible in a massive expansion of low-cost credit and leverage.

That is a mouthful, so let's break it into bite-sized chunks.

Home mortgages are a good example of how financialization increases financial profits by jacking up risk and distributing it to suckers who don't recognize the potential for collapse and staggering losses.

In the good old days, home mortgages were safe and dull: banks and savings and loans issued the mortgages and kept the loans on their books, earning a stable return for the 30 years of the mortgage's term.

Then the financialization machine appeared on the horizon and revolutionized the home mortgage business to increase profits. The first step was to generate entire new families of mortgages with higher profit margins than conventional mortgages. These included no-down payment mortgages (liar loans), no-interest-for-the-first-few-years mortgages, adjustable-rate mortgages, home equity lines of credit, and so on.

This broadening of options and risks greatly expanded the pool of people who qualified for a mortgage. In the old days, only those with sterling credit qualified for a home mortgage. In the financialized realm, almost anyone with a pulse could qualify for one exotic mortgage or another.

The interest rate, risk and profit margins were all much higher for the originators. What's not to like? Well, the risk of default is a problem. Defaults trigger losses.

Financialization's solution: package the risk in safe-looking securities and offload the risk onto suckers and marks. Securitizing mortgages enabled loan originators to skim the origination fees and profits up front and then offload the risk of default and loss onto buyers of the mortgage securities.

Securitization was tailor-made for hiding risk deep inside apparently low-risk pools of mortgages and rigging the tranches to maximize profits for the packagers at the expense of the unwary buyers, who bought high-risk securities under the false premise that they were "safe home mortgages."

The con worked because home mortgages were traditionally safe. Financialization did several things to the home mortgage market:

1. Collateralized previous low-risk assets into high-risk, high-profit financial instruments
2. Commoditized this expansion of debt and leverage by securitizing the exotic mortgages
3. Built an inverted pyramid of leveraged speculative debt on the low-risk home mortgage
4. Used the Federal Reserve's vast expansion of liquidity and credit to originate trillions of dollars in new debt and leveraged financial instruments.

Consider a house purchased with a liar-loan, no-down payment mortgage. Since the buyer didn't even put any cash down or verify stable income, there is literally no collateral at all to back up the mortgage. The slightest decline in the value of the home will immediately generate a loss of capital.

Now pile on derivatives, CDOs, etc. on the inverted pyramid of risk piled on the non-existent collateral, and you have the perfect recipe for financial collapse.

Like home mortgages, oil has been viewed as a "safe" asset. The financialization of the oil sector has followed a slightly different script but the results are the same:

A weak foundation of collateral is supporting a mountain of leveraged, high-risk debt and derivatives. Oil in the ground has been treated as collateral for trillions of dollars in junk bonds, loans and derivatives of all this new debt.

The 35% decline in the price of oil has reduced the underlying collateral supporting all this debt by 35%. Loans that were deemed low-risk when oil was $100/barrel are no longer low-risk with oil below $70/barrel (dead-cat bounces notwithstanding).

Financialization is always based on the presumption that risk can be cancelled out by hedging bets made with counterparties. This sounds appealing, but as I have noted many times, risk cannot be disappeared, it can only be masked or transferred to others.

Relying on counterparties to pay out cannot make risk vanish; it only masks the risk of default by transferring the risk to counterparties, who then transfer it to still other counterparties, and so on.

This illusory vanishing act hasn't made risk disappear: rather, it has set up a line of dominoes waiting for one domino to topple. This one domino will proceed to take down the entire line of financial dominoes.

The 35% drop in the price of oil is the first domino. All the supposedly safe, low-risk loans and bets placed on oil, made with the supreme confidence that oil would continue to trade in a band around $100/barrel, are now revealed as high-risk.

In the heyday of mortgage financialization, exotic mortgages were tranched into securities that were designed to fail, to the benefit of the originators, not the buyers.These financial instruments were sold with the implicit understanding that they were only low-risk if the housing bubble continued to expand.

Once home prices fell and the collateral was impaired, it only made financial sense for borrowers to default and counterparties to refuse to pay until their bets were made whole by another counterparty.

The failure of one counterparty will topple the entire line of counterparty dominoes. The first domino in the oil sector has fallen, and the long line of financialized dominoes is starting to topple.

Everyone who bought a supposedly low-risk bond, loan or derivative based on oil in the ground is about to discover the low risk was illusory. All those who hedged the risk with a counterparty bet are about to discover that a counterparty failure ten dominoes down the line has destroyed their hedge, and the loss is theirs to absorb.

All the analysts chortling over the "equivalent of a tax break" for consumers are about to be buried by an avalanche of defaults and crushing losses as the chickens of financializing oil come home to roost.

.