Our latest Transport fuel market report

1. Fuel Market Research
- Taking the “Recovery Position” -
Edited and published by United Energy Advisors Ltd 9 June 2009
As we approach the half way mark of 2009, we have taken a snapshot of the market to summarise the market
action seen in the first half and what we can expect from the transport fuels market during the remainder of
the year.
As the macro movements are based on crude, the broad movements of ICE Brent in the first half of the year
cannot be overlooked. Brent has risen in 14 out of 23 weeks so far, rallying over 78% in H109. The benchmark
has recovered over a quarter of the decline since its peak in July last year. On a weekly basis, the futures prices
look poised to tackle the $70 resistance as well as the 52 week moving average.
Despite the shaky start to the year, the crude oil market has clearly taken the new year as the cue to start the
recovery process. Q1 provided very little direction and most markets traded in a range bound fashion as the
OPEC production cuts started
to take effect. Also the
realisation that all assets had
been oversold (equities
bottomed out in early March,
and most commodities also
started their bull runs
around this time) has
contributed to the rally in
prices. The supply situation
was good, evidenced by the
steep contango and low
refining margins, making the
market upstream led, albeit
not though a lack of supplies.
The steep contango also
prompted oil companies to
store crude oil in offshore
storage to be sold at a higher
price later, as storage started becoming a viable alternative for anyone riding down the curve. The barrage of
weak economic data wrecked havoc in the FX markets too which quite frequently triggered large swings in oil
prices where the weaker dollar attracted bargain hunters. Amongst the various reasons offered by many
analysts, the principal factor and the continuing theme is the sudden blockage in the new investment to
explore and produce new oil. In order to replace maturing wells and to prepare for the eventual demand rise,
investment needed to continue and many fear the production crunch may materialise. Whatever happens, the
marginal cost of production has been jumping up and for a tight market in products the marginal barrel is
produced around the $90 /bbl mark. However the average cost of production has also been on the rise
(although recent reductions in rig rates and rig counts may have eased on the cost pressure temporarily). All
the above contributed to the very steep contango we have seen in last a few quarters.
Meanwhile, European products have not shown signs
of similar rebound. Most cracks remain close to, or at
historic lows as demand remains much weaker. In
particular, the general conditions affecting the
transportation industry, especially the airline industry,
which consumes about 12% of the fuel consumed
globally, seem to weigh heavily on middle distillate
prices. Refiners on both sides of the Atlantic have spent
the last few years gearing up for increased
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2. gasoil/diesel production to cope with anticipated increase in demand, particularly in Europe. While the
Europeans opted for more diesel operated cars, American cars remain almost entirely gasoline operated.
However with the new directives from the White House we expect this to change – however whether this will
spark a shift towards diesel or whether newer
technologies will be integrated into the US cars of the
future remains to be seen. In the past although US
refiners were running crude slates that yielded a
gasoline rich product slate in refineries where
gasoline production was the main objective, and
consequentially there was a constant flow of
overstock diesel from the US to tanks in ARA, and
surplus European gasoline blendstock was exported
to the US. Combined with reduced jet fuel
consumption and reduced diesel consumption, the
European middle distillate market has been over‐
supplied this year. This is evident from ARA diesel stock levels which have been growing steadily and even
though there is a notch down in Jet A1 the absolute stock levels remain high. In the US the state of the economy
can be seen reflected in the gasoline cracks as well. Reduced mileage driven had a notable impact on the crack
‐ prior to run reductions. The trend in refinery runs has
been down since late 2006 (seasonally adjusted for the
summer driving season). In the US, by September 2008,
the extremely pessimistic outlook prompted the
refineries to drastically cutback the gasoline
production pushing the inventory level to the lowest
levels since the record began in 1990. Despite the low
inventory levels, the gasoline crack against WTI took a
nosedive to negative figures and remained that way
until beginning of this year. The recovery from this
extreme condition added some spark in cracks market,
including European cracks. The fuel oil market, however, has found itself in a unique situation and has
remains firm compared to other products. Many modern refineries use fuel oil as major feedstock and many
are actually short of it. Some use a blend of crude and fuel oil as feedstock. As OPEC began cutting crude oil
production volume in 2008, the cutbacks started in the less profitable sour grade crudes which also added to
the increase in demand for fuel oil as the replacement feedstock.
One of the more reliable indicators for changes in global economic health are the freight indices which have
started to indicate some recovery in the anticipated movement of goods. This also offers an explanation to the
strong fuel oil crack. This index, as you can see, is
quite volatile as it indicates an almost 5 fold
recovery since January 09, following a huge
collapse to about 1/18th of the highs seen last
summer. The series of pirate attacks off Somalia
coast has forced some traffic to avoid the Suez
Canal and has prompted vessels to go around the
Cape of Good Hope, adding to the temporary
shortage of available tonnage and increased
consumption of fuel. Furthermore, as mentioned
earlier, some oil companies have taken advantage
of the steep contango by storing crude oil in any
storage they have access to, including large oil
tankers anchored off shore.
Looking ahead, global energy demand will remain well below last year for the remainder of the year as many
industries concluded 2009 a lost year long time ago. According to Mr Giovanni Bisighani, CEO of IATA at recent
annual general meeting in Kuala Lumpur, the air transport industry is in survival mode. They have estimated
the average traffic this year is about 20% down on the same time last year. As seen above, sea freight rate is on
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3. the mend but is still way below the average of past several years. To save costs, many goods will now be
transported by sea, where possible.
Crude oil inventories are expected to remain high as product cracks, especially in Europe will not entice
refiners to operate at rates we have seen last year. The recent pick‐up in front month deliveries in crude oil
futures have promoted some of the above mentioned oil companies with tanks full of crude oil to start off‐
loading. At the same time, OPEC members’ compliance with the production quota is softening, both adding
pressure on the oil prices to drop.
In recent years, the day‐to‐day crude oil price has been influenced by the fluctuation of the dollar to an ever
greater degree. Not only are we concerned with the energy consumption by US, which consumes about a
quarter of the global oil, the strength of the dollar has now become a crucial part in understanding the oil price
movements. Crude oil futures are increasingly used as protection against falling dollar in addition to
traditional commodities such as gold. This movement is countered by non‐dollar denominated traders who
would see weak dollar as an opportunity to buy crude oil at discount.
We have also seen a de‐coupling of the correlation between the US petroleum inventory report and the prices.
Implied demand published by the Department of Energy each week has often provided an important clue to
the energy demand of the world’s largest economy. Crude oil futures, however, has deviated away from this
relationship in last several weeks. This is partially due to the fact that it is hard to determine the whereabouts
of so called “floating storage” which could come in or out of the inventory volume during the week, and has
produced some unpredicted figures in last several months.
While there is no doubt that the world is still very much mired in a global recession, we think that it is fair to
say that we have already hit or will hit the bottom soon. Investors have concluded that not all banks will go
out of business and the massive infusions of liquidity have restored confidence in the banking system. Large
stimulus packages have been passed by the G7 governments and despite the fact that the banks are very much
not out the woods yet (operating profits are fine, but balance sheets still matter). The worrying amount of
sovereign debt some of the major economies will be laden with, together with increased savings rates will cast
doubt on medium to longer term real GDP growth potential and this may dampen or prolong the recovery.
H209 has been very much a story of recovering ground from panic selling, but whether the monetary and fiscal
actions and their ramifications will be sufficient to boost confidence back to the pre‐crisis levels is still up in
the air. In terms of the massive increase in Sovereign balance sheets the question of currency valuations
becomes timely. As the world has seen the sterling dive following the downturn in one of the key sectors of the
UK economy, commodity ETFs have seen reasonable inflows in the past months as investors have started
worrying about governments’ collective actions as soon as the economic outlook has strengthened. Since
increasing taxes may stall recovery governments may choose to set real rates to sub zero to encourage
spending and simultaneously inflate their way out of the new debt position. Printing presses may start running
in overly indebted economies.
While it will be difficult to determine the exact timing of this “bottoming out”, we have noticed that the traders’
attentions are increasingly focused on the positive news. This is manifested by more up‐beat sentiments
including the recent US Consumer Confidence index.
All this implies middle distillate prices remain weak but will be subject to short term spikes as refineries
continue to run at lower rates until we see all or most of G7 nations come out of recession which should then
lead the dependent nations out of recession. As we are now in middle of US driving season and entered the US
Hurricane Season, US petroleum product prices will add seasonal support and should see mid distillate prices
head for $600/MT mark. As for fuel oil, for those refineries that can crack it, it will remain a viable source of
cheaper feedstock compared to crude oil. When the sour grades of crude oil from OPEC nations start to flow
again, the relative strength of fuel oil price compared to other European products may begin to wane. This is
unlikely though, until confidence is restored in global economy with increased energy demand.
For crude oil, the story is more complex and gloomier. The biggest worry we have right now, which has been
with us since last year, is that the recent freeze on new investments into oil exploration and production means
we are now behind the curve in replacing maturing wells. Actual supply shortage has always been and will
continue to be the biggest fear factor in oil market. The sudden disappearance of investment as we have seen
in last year or so is expected to have a detrimental effect to the crude oil prices in next a few years. We also
recall the huge drive in US, promoted by George Bush to wean itself from Middle Eastern crude oil which
diverted major investments into “new fuels” and “green fuels”. The world was already screaming for more
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4. skilled technicians to maintain and replace the aging wells. Therefore, crude oil prices will be susceptible to
geopolitical instabilities cantering around oil producing nations. Short term outlook for crude oil looks slightly
bullish as WTI closed above $70 on 9 June 09 for the first time this year. This rally, as it is not a demand driven
one, may not prove to be a sustained one, as higher prices will act as an incentive for stored oil to be released
and encourage further OPEC cheating.
To conclude, as the title of this report declares, we feel that this is ideal time to be preparing for economic
recovery and likely oil price rally. The timing of the precise moment of “bottoming out” might vary from
industry to industry and location to location, but we feel that this is just around the corner. We have all seen
what 6 months can do to oil prices and we hope businesses have learned to be proactive rather than reactive.
It is time to be prepared, to quantify risks, make plans and learn from past and avoid panic trading.
At United Energy Advisors, there is an arsenal full of ideas and expertise to aide your business become as
prepared as possible to cope with these uncertain times and more importantly, exploit the eventual return of
global optimism and associated energy price movements. We are here to listen and help you implement
responsible risk management solutions. Before accepting a strategy proposed by your trading counterpart, let
us give you an expert and impartial advice on it. Every business is different and so our solutions.
For further information, please visit www.ueadvisors.com or contact us at info@ueadvisors.com.
Data
Data on this report was provided by Bloomberg ©
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