Platts consultant Jonathan Kingsman is the founder of Kingsman SA, which is now a unit of Platts, and is an occasional guest blogger on O&G industry blog site The Barrel. In his most recent post, Kingsman highlights that “In a trader’s ideal world oil prices would fluctuate in a range, giving traders just enough volatility for risk-free plays on shipment dates and tonnages.”
He goes on to note that lower oil prices and a battered crude oil market, however, do offer some advantages to traders.
Low oil prices offer some benefits for oil traders
One factor on the plus side for traders is that lower oil prices have reduced financing costs and capital requirements for trading. The halving of the oil price since last summer means that trading companies can hold twice as much stock for the same investment, something that comes in rather handy with the current contango [upward bias] in the oil market.
Kingsman suggests that what oil traders really want in 2015 is a “buffalo market”. He says: “…oil traders may be wishing for a “buffalo” market where prices are at home in a range: a stable (but weak) flat price accompanied by a strong contango.”
Oil prices likely to stay low for some time
We begin 2015 with an estimated oil surplus of more than one million barrels a day. This surplus could come down if the situation in Libya or Nigeria gets worse, but neither OPEC nor Russia are going to cut production any time soon as they are more worried about market share than price.
The big drop in oil prices will eventually lead to a reduction in capital expenditure for many U.S. shale producers. That said, a recent report from Citibank noted “a capex cut of up to 60% would still see growth (in production) in 2015 due to inertia, but could keep production volumes constant in 2016 (but with growth from 2017 onward)”.
It’s unlikely that demand for oil will ramp up quickly even if the U.S. economy continues to pick up steam. That means the surplus will have to be stored. Kingsman notes that “the Chinese may already be taking a view on the flat price and could be importing more now to increase strategic reserves.”
He also points out that the “heavy lifting” in terms of oil prices will have to be related to market structure. This has led some analysts argue that the contango situation will have to strengthen to at least the point where floating storage in Very Large Crude Carriers becomes economic.
Related to this, freight rates for VLCCs are up recently, largely relating to extra demand for vessels as importers build up stocks, but also as traders project an increase in demand for storage. Of course, the increase in freight rates will mean that the oil price contango will have to widen further to make floating storage work.
However, for the contango to strengthen, either spot oil prices have to fall further or forward oil prices must increase.
Kingsman concludes by explaining why oil prices will stay low for some time longer. “With the current slow growth in global oil demand it could take a while for demand to catch up with supply – and even when it does, stocks will have to be used up first. This makes it hard for traders to be too bullish about forward prices. It is therefore little surprise that spot prices have slid further over the past couple of weeks.”