International oil price regime

International oil price regime

3rd Annual Marine Money Geneva Forum, Hotel President Wilson, 25 June 2015

Dr. Rouben Indjikian

Professor and Lecturer in Commodities

Webster University Geneva

Outline • Oil in international trade in commodities

• Evolution of crude oil price regimes

• International and domestic prices

• Oil price declines and current outlook

• Supply management: the unique case of OPEC

• Natural gas and coal prices regimes

• Energy supply & demand: short versus long term

Dr. Rouben Indjikian 25 June 2015 2

The most important 10 commodities in international trade (Exports in 1938, 1977, 2011, in millions of USD)


1938 USD 1977 USD 2011 USD

Cotton 600 Crude petroleum 145,161 Crude petroleum & bituminous oil

1,635,481

Coal 530 Oil products 42,760 Heavy petroleum & bituminous oil

937,123

Crude petr. 448 Coffee 12,918 Natural gas 270,192

Wheat 442 Coal 10,907 Gold non monetary 222,100

Wool 435 Pearls & stones 9,972 Pearls & pr. stones 161,318

Petroleum 394 Gas 9,293 Copper 149,197

Tobacco 359 Meat 9,291 Iron ore 144,346

Sugar 340 Wheat 7,987 Aluminum 126,237

Copper 325 Wood 7,810 Fruit nut 86,471

Butter 304 Sugar & honey 7,612 Meat 75,292

Sources: League of Nations, UNCTAD, Fiona Gordon-Ashworth

Commodities: volatility and correlations

25 June 2015 4

Commodity price indices, 2008-2015

Source: UNCTAD, UNCTADstat


-

50

100

150

200

250

300

350

400

450

500

1Q

20

08

2Q

20

08

3Q

20

08

4Q

20

08

1Q

20

09

2Q

20

09

3Q

20

09

4Q

20

09

1Q

20

10

2Q

20

10

3Q

20

10

4Q

20

10

1Q

20

11

2Q

20

11

3Q

20

11

4Q

20

11

1Q

20

12

2Q

20

12

3Q

20

12

4Q

20

12

1Q

20

13

2Q

20

13

3Q

20

13

4Q

20

13

1Q

20

14

2Q

20

14

3Q

20

14

4Q

20

14

1Q

20

15

2Q

20

15

UNCTAD non-oil commodity price index All food

Agricultural Raw Materials Minerals, ores and metals

Crude petroleum

Evolution of crude oil price regimes • In 50-60s low and stable posted prices (for fiscal purposes) of crude oil were under 7

Sisters oligopolistic 1928 Achnacarry Agreement regime. Crude oil as well as dollar ceased to be key price anchors in the 70s. Since then world of floating prices/rates.

• OPEC price regimes (official, selling, buy-back and netback prices) existed from mid 70s to mid 80s.

• Since the 80s the crude oil and oil product prices started to be formed by spot and futures markets. Main commodity exchanges of New York and London and also elsewhere determine prices of many commodities. OTC markets gravitate around.

• Crude oil prices are quoted through mainly two benchmarks: Brent and WTI (West Texas Intermediate). Their differentials are fluctuating. There is also Dubai. Other crudes are priced due to the use of various differentials and coefficients around the benchmarks.

• In the short term supply of and demand for crude oil are inelastic to price signals: hence the volatility due to supply/demand mismatch. For example when prices collapsed in 2008, supply streams were still coming and adding up to the situation of a glut. Elasticity increases in medium-long term. The 1980s and 1990s were a period of low prices and underinvestment in the oil industry. Due to the boom of 2000s (so-called supercycle) the oil industry faced the challenges of limited production capacities, shortage of workforce, and cost inflation, increasing the cost of capital expenditure.

• While oil prices are formed in futures markets, gas prices say in Europe, while being linked to oil price, are still negotiated in the framework of longer term contracts.


International and domestic prices • International prices on crude oil are reflecting market fundamentals, including the

state and prospects of demand, supply and stocks. Inelastic demand and supply and low level of stocks increase volatility of prices. Information is asymmetric due to lack of timely statistics on production, consumption and stocks. No exact numbers behind so called fundamentals. Hence, the guesswork of forecasters.

• Financialization of futures markets and increasing number of actors and volumes of finance betting on futures probably contributed to upward price swings and fluctuations thus deviating prices from equilibrium in the short run. Decrease in banks involvement in commodities futures coincided with recent lower volatility.

• Dodd Franck, EMIR, MIFID etc increase oversight of exchanges/OTC markets. Basel3-4 make lending more costly. So trading companies face constraints and higher costs of compliance. It could be translated into higher prices and volatility.

• Domestic prices are key for shaping the demand for oil and its products. High excise taxes on oil products in Europe diminish demand for oil.

• Export taxes on crude oil push exporting countries to seek higher prices or sales.

• Subsidies or low domestic prices on oil products increase demand for them.

• Domestic energy policies, in particular taxes & subsidies, and resulting domestic prices, are influencing demand & supply, and hence international prices


Crude Oil Prices: booms & busts, and plateaus

25 June 2015 7

(January 1960 – April 2015)

Source: UNCTAD, UNCTADstat Monthly, Equally weighted average of Brent, Dubai and WTI


0

20

40

60

80

100

120

140 01-1

960

06-1

961

11-1

962

04-1

964

09-1

965

02-1

967

07-1

968

12-1

969

05-1

971

10-1

972

03-1

974

08-1

975

01-1

977

06-1

978

11-1

979

04-1

981

09-1

982

02-1

984

07-1

985

12-1

986

05-1

988

10-1

989

03-1

991

08-1

992

01-1

994

06-1

995

11-1

996

04-1

998

09-1

999

02-2

001

07-2

002

12-2

003

05-2

005

10-2

006

03-2

008

08-2

009

01-2

011

06-2

012

11-2

013

04-2

015

Crude oil price fluctuations and outlook

• 1986: Saudi Arabia decided to stop being a swing producer and OPEC stops targeting prices. Prices fell by 66% in 82 days.

• 1990-1991 First Gulf War: 48% fall in 71 days • 2008 Financial Crisis: 77% drop in 113 days • 2014: OPEC and especially SA in November decided to defend market share ie

abandoned swing producer role second time. Oil prices fell from US$115/bbl on 19 June 2014 to a five-year low of US$45/bbl on 13 January 2015. A drop of 61 % . Since then YTD prices have recovered by around 15%.

• The first and last sharp price drops were the result of abandoning of supply management policies, ie swing producer role by OPEC. That role was and may still make OPEC a major factor in crude oil price formation. Currently the name of the game is attrition of marginal high-cost producers. US shale is not yet in that category.

• Raising supply first from the US, and also from OPEC and other sources, combined with modest growth in Chinese demand, the increase in stocks, and the strengthening of US dollar, were the main determinants of current crude oil price dynamics . Middle Eastern, Ukrainian conflicts and other geopolitics didn’t alter the picture.

• Futures prices for crude oil are still in contango and IMF assumes prices growing from around $60/barrel in 2015 to around $65 in 2016 and around $70 in 2017. Are we in a plateau period?

25 June 2015 Dr. Rouben Indjikian 8

Supply management: the unique case of OPEC

• 1st and 2nd oil crises in 1970s, brought in OPEC as a major player in price formation.

• Other commodity exporters were inspired by the success of OPEC, but couldn’t repeat it.

• While IEA members were holding the main strategic and commercial buffer stocks, it was the OPEC production quotas and unused spare capacities, that were supporting the price levels. When OPEC abandoned quotas in 1986 and 2014, the prices fell dramatically. In the first case they stayed low till early2000s. Whether and how long they will gravitate around $60 depends both on demand but also on the state of traditional oilfields.

• Currently OPEC is a price taker, but still has a leverage on supply and hence prices. The paradox is that now instead of Saudi Arabia, the swing producer are the stubborn US shale oil/gas companies, which made the US in 2014 the leading world crude oil producer.


Natural gas prices: North America, Europe and East Asia

25 June 2015 10

(January 2005 – January 2015)

Source: World Bank US: Henry Hub Louisian Europe: average importborder price Japan: LNG import price CIF


0

2

4

6

8

10

12

14

16

18

20

20

05

M0

1

20

05

M0

4

20

05

M0

7

20

05

M1

0

20

06

M0

1

20

06

M0

4

20

06

M0

7

20

06

M1

0

20

07

M0

1

20

07

M0

4

20

07

M0

7

20

07

M1

0

20

08

M0

1

20

08

M0

4

20

08

M0

7

20

08

M1

0

20

09

M0

1

20

09

M0

4

20

09

M0

7

20

09

M1

0

20

10

M0

1

20

10

M0

4

20

10

M0

7

20

10

M1

0

20

11

M0

1

20

11

M0

4

20

11

M0

7

20

11

M1

0

20

12

M0

1

20

12

M0

4

20

12

M0

7

20

12

M1

0

20

13

M0

1

20

13

M0

4

20

13

M0

7

20

13

M1

0

20

14

M0

1

20

14

M0

4

20

14

M0

7

20

14

M1

0

20

15

M0

1

Natural gas prices

Natural Gas US Natural gas EUR Natural gas Japan

Natural gas: a fragmented market

• Development of the US shale gas and Henry hub futures market delinked the US gas prices from European and Asian ones.

• The latter while being linked to oil, are traded in the framework of longer term contracts.

• The increase in share of LNG at the expense of pipeline systems may bring more price convergence in future.

• Demand for natural gas as a clean source of electricity generation, fuel, etc will increase. However, increase in supply and competition between various energy sources, may check for a while the increase in prices


International coal prices

25 June 2015 12

(January 1960 – April 2015)

Source: World Bank Commodity Price Data (the Pink Sheet) 90 days forward prices, fob, main export ports


0

20

40

60

80

100

120

140

160

180

200

20

05

M0

1

20

05

M0

7

20

06

M0

1

20

06

M0

7

20

07

M0

1

20

07

M0

7

20

08

M0

1

20

08

M0

7

20

09

M0

1

20

09

M0

7

20

10

M0

1

20

10

M0

7

20

11

M0

1

20

11

M0

7

20

12

M0

1

20

12

M0

7

20

13

M0

1

20

13

M0

7

20

14

M0

1

20

14

M0

7

20

15

M0

1

Coal prices ($/mt)

Coal price Australia Coal price Colombia Coal price South Africa

Coal: more domestic than international

• Steam or thermal coal represents the bulk of coal production, and meets around one third of world energy demand. This share may even grow.

• More than four-fifth of coal production is used domestically. The share of internationally traded coal is increasing.

• Prices are quoted as 90 days forwards in fob terms loaded at the main commodity in international ports like Newcastle, Australia.

• Although some commodity exchanges are quoting coal futures contracts, their numbers and volumes are still very limited.

• As the graph on exported thermal coal prices shows the coal export prices are strongly correlated, ie markets are not fractured as is the case for natural gas.


Oil, gas and coal price regimes • While there are standardized futures contracts for crude oil, gas and coal, it is the

prices of all crude oil that are linked to the contracts of bechmarks. It is also the case for the US natural gas. However the bulk of gas and coal are traded differently and their prices are not determined by next month futures contracts.

• The differences in price regimes could be explained by the economic history, level of development and geographic location of the main producers and consumers of these key energy commodities

• The oil price regime evolved in a quite dramatic way and some of its periods could be explained by the main forces shaping the supply chain of oil: the oil majors known as “7 sisters”, followed by OPEC. The role of OPEC as a factor of price formation is still important for participants of futures market.

• In case of natural gas, it mainly followed the path of oil in the US, while in Europe the market power of Gazprom as the main supplier of gas for Europe, was behind the oil linked longer term price formula, which according to producer was giving more price certainty, conducive to maintain investment in infrastructure. High prices for LNG mainly exported by Qatar and destined to Japan are also reflecting limited options for the importer.

• Coal unlike oil and gas is mainly consumed domestically and main exporters represent a very diverse group of countries. Unlike, oil and gas, geo-economics plays much less role here.


Energy supply and demand: short-term versus long-term structural changes

• According to IEA Oil Market Report the world demand will reach 95mbd by the end of 2015. Supply is expected to surpass that level.

• OPEC surplus capacity and OECD inventories also suggest that we are still in period of high stocks. So we are in the buyer’s market.

• Probably low volatility and current price band will stay in coming 2-3 years, until the lower investment and higher demand will become critically important, which in combination with exogenous or other short term shocks may precipitate the next oil price spike.

• China still biggest importer. India is becoming a considerable importer.

• Europe and the US still continue to be major importers

• Due to shale oil, the US is now the leading world oil producer.

• World natural gas production will increase. Probably it is true also for coal.

• More investment and efforts in renewables due to climate change.

• The impact of cleantech on future demand for oil.

• Will we ever reach peak oil?

• Will more efficient production and use of energy continue keep demand lower than supply and hence keep downward pressure on real prices?

• Will hydrocarbon man turn into environmental man by the turn of the century (from G7 target to a new consensus in Paris at the UN Climate Change Conference)?


Thank you


For questions and background materials pls. contact:


[email protected]

mailto:[email protected]

mailto:[email protected]

Documents

International oil price regime