There are very high levels of oil storage at present are the main reason for oil prices to go below US$50. Why are the storage tanks so full reports The Economist?
1. OPEC’s agreement with non-members such a Russia to cut production from 1st January attracted a lot of demand to take advantage of future price increases. This did produce higher prices which win turn encourages more supply as American shall producers started to pump more oil. American oil rigs have increased in number from 386 in 2016 to 617 in 2017 producing 400,000 barrels of oil a day more than the low levels in September 2016. Much of the oil has gone into storage terminals.
2. Before OPEC cut production it increased output and exports. A lot of this oil went into storage in the USA as refineries there were down for maintenance reasons.
3. Futures prices of oil are closely related to the level of inventories. It was hoped that the OPEC cut in production would push the futures market into ‘backwardation’ – short-term prices are greater than long-term (futures) prices which means that purchasers will use the oil rather than storing it. However with the release of US storage levels the immediate price of oil fell in comparison to longer-term rates – referred to as “contango” which makes it worthwhile to buy oil and store it. It is estimate that the price of storing a barrel oil is 41 cents per month compared to contango of 65 cents for the same period. Therefore you make 24 cents on each barrel. See video below from EKTInteractive.
So the more oil stored the lower the short-term prices go – the challenge is to break the loop. Maybe oil output cuts beyond June may force some to release their inventory.
Source: The Economist 16th March 2017
Commodities have been the engine of growth for many sub-Saharan countries. Oil rich nations such as Nigeria, South Africa and Angola have accounted for over 50% of the region’s GDP whilst other resource-intensive countries such as Zambia, Ghana and Tanzania to a lesser extent.
I have mentioned the ‘resource curse’ in many postings since starting this blog. It affects economies like in sub-Sahara Africa which have a lot of natural resources – energy and minerals. The curse comes in two forms:
- With high revenues from the sale of a resource, governments try and seek to control the assets and use the money to maintain a political monopoly.
- This is where you find that from the sale of your important natural resource there is greater demand for your currency which in turn pushes up its value. This makes other exports less competitive so that when the natural resource runs out the economy has no other good/service to fall back on.
However it is the fall in commodity prices that is now hitting these countries that have, in the past, been plagued by the resource curse. As a lot of commodities tend to be inelastic in demand so a drop in price means a fall in total revenue since the the proportionate drop in price is greater than the proportionate increase in quantity demanded.
The regional growth rate for 2016 is approximately 1.4% but it is not looking good for commodity driven economies:
- Nigeria – oil – 2016 GDP = -2%
- Angola – oil – 2016 GDP = 0%
- South Africa – gold – 2016 GDP = 0%
In 2016 resource rich countries will only grow by 0.3% and commodity exporting countries have seen their exports to China fall by around 50% in 2015. Furthermore, public debt is mounting and exchange rates are falling adding to the cost of imports. With less export revenue the level of domestic consumption has also decreased.
It is a different story for the non-resource countries of sub-Sahara. It is estimated by the IMF that they will grow at 5.6%. By contrast they have been helped by falling oil prices which has reduced their import bill and public infrastructure spending which has increased consumption.
As is pointed out by The Economist numbers should be read wearily as GDP figures are only ever a best guess, and the large informal economy in most African states makes the calculation even harder. Africa may have enormous natural reserves of resources, but so far most Africans haven’t felt the benefit. In Nigeria, for instance, what’s seen as a failure to spread the country’s oil wealth to the country’s poorest people has led to violent unrest. However, this economic paradox known as the resource curse has been paramount in Africa’s inability to benefit from resources. There is a gravitation towards the petroleum industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports. What is needed is diversification.
The Organisation of Petroleum Exporting Countries (OPEC), is a cartel of 12 countries made up of Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.
Recently OPEC countries have proved skeptics wrong by deciding to cut oil production. Previously OPEC seemed quite content maintaining oil supply levels even with low oil prices – maybe with the intention of driving prices down and putting companies with high costs of extraction out of business. But the collapse in oil prices since June 2014 – see chart – has battered the economies of oil-producing nations as some investment projects are no longer financially feasible and this could result in a new supply shortage within a few years.
However a deal signed in Algiers in September has seen OPEC countries will reduce production for the first time since 2008 by approximately 1.2 million barrels per day (bpd) which means its production is around 32.5 million bpd – see table below:
Agreed crude oil production adjustments and levels*
* Reference base to crude oil production adjustment is October 2016 levels, except Angola for which September 2016 is used, and the numbers are from Secondary Sources, which do not represent a quota for each Member Country.
From the table the big cuts in production are from Saudi Arabia, Iraq, UAE and Kuwait. Iran is allowed to raise output by 90,000 barrels as they have sought special treatment as it recovers from sanctions. It is unclear whether the Opec cuts were wholly contingent on the planned 600,000bpd cuts by non-Opec members, including a 300,000bpd cut by Russia. Mr al-Sada of OPEC said the agreement would “definitely help rebalancing the market”, enabling the industry to “come back and reinvest” in new production capacity to ensure future security of supply.
In simple economics this reduction in supply of a very inelastic product should, in theory, increase the price of oil and on the news of the cuts oil prices surged as much as 10pc to hit $52-a-barrel – see graph opposite.
With oil prices being at historically low levels, oil exporting countries have been struggling to generate the revenue that was once apparent not so long ago. In Venezuela, for instance, oil accounts for 95 percent of Venezuela’s export earnings and plummeting world prices have severely hit the government’s revenue stream. The Middle Eastern countries with their abundant supply of oil and the ease at which it extracts it, are starting to look at alternative revenue streams as the rent from oil is no longer sufficient to sustain public goods and services. As noted in The Economist the Arab world can be divided into three broad categories:
- Resource-rich, labour-poor – Gulf sheikhdoms with lots of oil and gas but few people;
- Resource-rich, labour-abundant – Algeria and Iraq, that have natural resources and larger populations;
- Resource-poor, labour-abundant – Egypt, that have little or no oil and gas but lots of mouths to feed (see chart).
To a degree the whole Arab world is an oil-driven economy: all three groups tend to rise and fall with the price of oil. However although some countries have significant reserves of wealth this does not offer an alternative to weaning them off their dependence on the oil industry. Saudi Arabia’s Vision 2030 intends to be free of oil dependence by 2020 and among the proposals is a plan to launch a new defence company, combining Saudi industries under a single company and be floated on the Saudi Stock Exchange.
The country plans to list less than 5 per cent of Aramco (Saudi Arabian Oil Co), which is worth more than US$2 trillion. The sale of Armco would be big enough to buy Apple Inc., Google parent Alphabet Inc., Microsoft Corp. and Berkshire Hathaway Inc. – the world’s four largest publicly traded companies. The plan is for the government to be a lot more prudent in its spending and making sure that the budget deficit doesn’t exceed 15% of GDP which is a very high figure. Furthermore using the private sector to provide education and health care as well as selling valuable land to developers, will reduce the burden of the State. But this will bring about significant social change that the population of Saudi Arabia may not be prepared for. As The Economist said:
A generation of men that expected to be paid for do-nothing government jobs will have to learn to work. The talents of women, who already make up the majority of new university graduates, will have to be harnessed better. But for now even the limited reforms to give women more opportunities have gone into reverse. To achieve its goals, Saudi Arabia will have to promote transparency and international norms, which will mean overcoming resistance from the powerful religious establishment and the sprawling royal family.
Source: The Economist – May 14th 2016
For most economies that have natural endowments like oil (Saudi Arabia) or minerals, there is the risk of the economy experiencing the ‘resource curse’. This is when a natural resource begins to run out, or if there is a downturn in price, manufacturing industries that used to be competitive find it extremely difficult to return to an environment of profitability. According to Paul Collier, Nigeria has a resource curse of its own, the civil war trapin which 73% of the low income population have been affected by it, as well as a natural resource trap- where the so-called advantages of a commodity in monetary value did not eventuate – on average affecting only 30% of the low income population. It seems that in Nigeria there is a strong relationship between resource wealth and poor economic performance, poor governance and the prospect of civil conflicts. The comparative advantage of oil wealth in fact turns out to be a curse. governments and insurgent groups that determines the risk of conflict, not the ethnic or religious diversity. Others see oil as a “resource curse” due to the fact that it reduces the desire for democracy.
Click here for more on the Resource Curse from this blog
Below is an informative clip from Al Jazeera which looks at the worst performing economy in the world – Venezuela. With oil accounting for 95 percent of Venezuela’s export earnings, plummeting world prices have severely hit the government’s revenue stream. GDP is forecast to contract 5.6% and inflation to hit 700% in 2016. The Economist has likened it to Zimbabwe and produced a graph showing the similar acceleration in inflation.
With 80% of all food items being imported and most of its agricultural land abandoned there are now major food shortages in the country – decrease in supply – cost-push inflation. As a consequence of this consumers are trying to stockpile goods as the prices increase – this shifts the demand curve to the right – demand-pull inflation.
Authorities are trying to clamp down on shoppers stockpiling goods by taking fingerprints before buying their ration of price-controlled goods. However the law of supply and demand is never far away as speculators use the black market to sell goods at a higher price as people becoming desperate for the essentials. Furthermore, producers can get around price controls by adding ingredients to staple food which therefore makes it unregulated – Venezuelan firms have added garlic to rice, called it “garlic rice”
A HT to Kanchan Bandyopadhyay for this piece from the Associated Press. Petrol prices in North Korea since February have risen by approximately 14% as it contends with the tougher international sanctions over its nuclear programme which is potentially putting a brake on the emerging market economy. However it is difficult to say what is exactly happening as officials in North Korea don’t discuss issues like this openly
What about supply and demand?
It might be a simple matter of the market. With more vehicles on the road there is more derived demand for petrol putting the price up. It is also possible that more fuel is being used for military purposes or for government construction or development projects. Most of the supply of petrol comes from China and the impact of sanctions is limiting the supplyThe fear that prices will rise further has consumers stock piling petrol coupons. In North Korea customers usually buy coupons for the equivalent amount of fuel that they wish to purchase. To purchase 15 kilograms (petrol is sold by the kilogram in North Korea) it about $12 in Pyongyang which equates to a 20% increase in price. As with most planned economies the supply of petrol is controlled by the state and it decides on who gets what – military and public transportation such as street c
ars and buses are still kings of the road.
Black market currency
Strangely enough North Koreans usually pay for their fuel in US dollars or euros. One kilogram of gas is currently about 80 North Korean won but no one actually pays that.
80 won = 80 U.S. cents under the official exchange rate, but only about eight-tenths of a cent under the unofficial exchange rate most North Koreans use when buying and selling things among themselves – the “real economy,” in other words.
The number of passenger cars has grown rapidly and rather than the typical black limousines or blue Mercedes sedans driven by communist party officials, they are middle of the range cars imported from China.
The growth in traffic in the capital is a visible indicator of economic activity the North generally prefers to keep under wraps. Many vehicles these days are clearly being used in an entrepreneurial style, moving people and goods around for a fee.
Higher gas prices could put a damper on such activities, or at least cut into their profits. The rise of automobiles is focused on the capital, which remains a very special place. Most North Koreans don’t have cars, or even access to cars. In the countryside, major highways are still not very well traveled and often not even paved. And gas, when it’s available, is usually more expensive.
Below is a video clip from the FT outling the reasons for the debt build up in the energy industry which is making investors nervous. Fracking has been partly responsible for the increase in oil output in the US by 400m barrels a day between 2010-2015. It was encouraged by high oil prices and also meant the sector took on a lot more debt – assuming that oil prices would stay above $100 a barrel. However as oil prices collapsed to around $30 a barrel oil extraction companies are finding it increasingly difficult to service their debt. Worth a look and with some very informative graphs.