Unusual economic uncertainties cloud oil and gas market outlook

Jan. 7, 2013
More than usual uncertainty about the economic drivers of energy markets complicates forecasts about oil demand in a year of continuing relocation of the growth centers for supply and demand.

Bob Tippee
Editor

Laura Bell
Statistics Editor

More than usual uncertainty about the economic drivers of energy markets complicates forecasts about oil demand in a year of continuing relocation of the growth centers for supply and demand. Global demand for energy in general and oil in particular remains strongly linked with economic performance, about which large questions loom, their answers dependent on actions by policy-makers in the US and Europe.

At this writing in the last week of December, doubt remained that leaders of the Republican-led House of Representatives would reach agreement with Democratic President Barack Obama on a set of fiscal measures able to avert large tax increases and spending cuts scheduled for yearend. The combination was widely believed to be disruptive enough to knock the US economy into recession. In Europe, meanwhile, questions hovered over the implementation and effectiveness of steps taken in recent months to resolve financial crises threatening viability of the euro. And the economies of China and India, recently the main sources of growth in global oil demand, have weakened.

Because economic forecasts for 2013 must be cautious, forecasts for oil demand are limited to fractional gains worldwide and in the US.

IMF's forecasts

In its most recent World Economic Outlook (WEO), issued in October, the International Monetary Fund made resolution of the US and European policy impasses conditions of modest forecasts for 2013. It projected global growth of 3.3% in 2012 and 3.6% in 2013—lower than rates forecast in a July update of its preceding WEO, issued in April.

One of two crucial assumptions underlying the IMF's outlook for continued but moderate growth is adoption in Europe of "policies that gradually ease financial conditions further in periphery economies." The group welcomed steps by the European Central Bank to lower borrowing rates in distressed Euro-zone countries and called for implementation of the European Stability Mechanism (ESM), created by a treaty signed in February 2012 and ratified in October as a way to raise capital for lending to distressed banks in countries belonging to the European Union. Also necessary, the IMF said, was further progress toward economic and monetary union, including establishment of "a banking union with a unified financial stability framework and implementing measures toward fiscal integration, on the principle that more area-wide insurance must come with more area-wide control."

The Council of European Finance Ministers moved toward banking union on Dec. 13 by agreeing to give the European Central Bank supervisory authority over large banks in countries that use the euro. Among other things, the agreement complements the ESM by centralizing the assessment of banks at risk in determining the needs for recapitalization by the new fund. But even supporters of the agreement acknowledge that supervisory authority was just a first step toward banking union. A Dec. 17 speech by Michel Barnier, the European Commission member responsible for internal market and services, cited difficult steps remaining to be taken toward European banking union. They include centralized rules on issues such as capitalization requirements and deposit guarantees and a single resolution authority to ensure rescue funds are available when bank crises occur, especially when they cross international borders.

This progress thus might not fully satisfy the European assumption in IMF's baseline economic forecast. And the late-year absence of progress toward an agreement that would rescue the US from its "fiscal cliff" left the second assumption in jeopardy. In its October outlook, the IMF estimated a one-in-six chance that global growth would fall below 2% in 2013—a rate it called consistent with recession in advanced economies and low growth in emerging markets and developing economies. "Ultimately, however, the WEO forecast rests on critical policy action in the euro area and the United States," it said.

The US and Asia

US economic growth at risk because of the fiscal cliff was far from robust. At its Dec. 12 meeting, the Federal Open Market Committee (FOMC), part of the Federal Reserve System, reported that, since an earlier gathering in October, economic activity and employment had "continued to expand at a moderate pace in recent months, apart from weather-related disruptions."

Individual projections by the committee's 12 members for 2013 growth in US gross domestic product were as low as 2.3% to as high as 3%, up from estimates for 2012 of 1.7-1.8%. The members forecast the unemployment rate next year at 7.4-7.7%, slightly better than the 7.8-7.9% estimated for 2012. The committee expected the inflation rate to remain at or below its target of 2%/year.

The FOMC said it would continue its "highly accommodative" monetary policy, keeping interest rates historically low at least as long as the unemployment rate remains above 6.5% and inflation projections remain close to its target rate.

Across Asia, meanwhile, economic growth remained moderate in the first half of 2012 as export-oriented economies responded to slowdowns in imports by struggling countries in the developed world. A slowdown in Chinese growth also reflected a tightening of monetary and credit policies undertaken in 2010-11. Although the government had begun easing those policies, IMF said in its October WEO that the effects weren't yet evident in economic data.

India's growth slowed more than expected in the first half, IMF said in its October outlook report, "an outcome of stalled investment caused by governance issues and red tape and a deterioration in business sentiment against the backdrop of a rising current-account deficit and the recent rupee deterioration."

IMF's projections

IMF projected combined GDP growth of advanced economies of 1.5% in 2013, compared with an estimated 1.3% in 2012. It expected the "newly industrialized Asian economies" of South Korea, Taiwan, Hong Kong, and Singapore to fare better, with combined GDP increasing 3.6% in 2013 vs. 2.1% in 2012.

Among advanced economies, IMF's growth projections for 2013 were mixed: 2.1% in the US (vs. 2.2% in 2012), 0.2% in the euro area (vs. contraction of 0.4%), 1.2% in Japan (vs. 2.2%), 1.1% in the UK (vs. contraction of 0.4%), and 2% in Canada (vs. 1.9%).

IMF projected real GDP growth to grow in China to 8.2% in 2013 from an estimated 7.8% in 2012 and in India to 6% from 4.9%. For Indonesia, Thailand, Malaysia, the Philippines, and Vietnam as a group, IMF estimated growth of 5.8% in 2013 vs. 5.4% in 2012.

International markets

While economic assumptions are especially uncertain this year, geographic changes in the oil market are much less so. In a trend now well-established, most if not all oil demand growth occurs outside the industrialized world.

For the third year in a row, oil demand among the industrialized countries represented by the Organization for Economic Cooperation and Development (OECD) will decline in 2013, according to the December Oil Market Report of the International Energy Agency. The IEA forecast for OECD oil demand of 45.7 million b/d this year compares with 46 million b/d estimated for 2012, 46.5 million b/d in 2011, and 46.9 million b/d in 2010. Outside the OECD, oil demand will increase nearly 3% to 44.8 million b/d this year, IEA said, continuing a long series of annual demand gains.

The December IEA report noted that five of the world's top-10 oil-consuming countries don't belong to the OECD. In September, the US continued to hold top ranking with 18.2 million b/d. China ranked second with 9.8 million b/d, followed by Japan, 4.4 million b/d; India, Russia, and China, about 3.4 million b/d; and Brazil, 3 million b/d. Others top-10 oil consumers in September were Canada, 2.5 million b/d, Germany, 2.3 million b/d, and South Korea, just below 2.3 million b/d.

Oil & Gas Journal adopts the IEA projection for the international part of its forecast, supplying its own assumptions for stock changes and production of crude oil by members of the Organization of Petroleum Exporting Countries. With an assumed stock build averaging 500,000 b/d this year, OPEC crude production would need to be 30.3 million b/d to balance the market. That's down from an estimated average of 31.4 million b/d in 2012.

Within OPEC, the main production changes recently have been an increase by Iraq and a decrease by Iran. Iraqi production reached 3.2 million b/d in November, according to the IEA, but disputes between the Kurdistan Regional Government and central Iraqi government in Baghdad keep the outlook clouded. Iranian production, at 2.7 million b/d in November, is limited by toughening international sanctions imposed to discourage the regime from developing nuclear weapons.

Outside OPEC, former Soviet Union production will stay at 13.6-13.7 million b/d this year as record-high Russian production balances declines in Azerbaijan, while gains continue in North America. IEA projects supply from "OECD Americas" at 16.5 million b/d in 2013, up 800,000 b/d from 2012. US production is rising from the surge of horizontal drilling and massive hydraulic fracturing in low-permeability formations. And Canadian output will benefit as fields off the eastern provinces fully return from extended maintenance to enhance steady gains from Alberta's oil sands.

Oil production in Brazil, another important source of new supply, will rebound to more than 2 million b/d in 2013 after falling in 2012 for the first time since 2004 because of maintenance work in offshore fields.

US outlook

For its US forecasts, OGJ relies heavily on the December Short-Term Energy Outlook of the US Energy Information Administration, adopting EIA's assumption for US GDP growth in 2013 of 1.8%. With continued efficiency gains, total energy use increases slightly less that—by 1.2%.

The EIA expects the Brent crude oil spot price in 2013 to average $104/bbl and the West Texas Intermediate spot price to average $88/bbl.

Although motor gasoline remains the dominant product in the US oil market, demand for it has stagnated. With fuel-use efficiency of the vehicle fleet increasing, the long-term outlook is for little or no growth.

Distillate, a category that includes both heating oil and highway diesel, is the segment of the US oil market most likely to expand over time. But distillate consumption fell in 2012, due partly to warmer-than-normal weather early in the year and partly to transport demand suppressed by the slow-growing economy. An expected rebound in distillate demand this year assumes normal winter weather and an uptick in consumption related to transportation. Demand for diesel is more sensitive than that for gasoline to economic activity, so failure of the US economy to grow as expected would spoil the distillate forecast.

Demand for natural gas will change little in 2013 after increasing nearly 5% in 2012, when gas use for power generation jumped by 21.3%, overwhelming declines in residential and commercial consumption. An assumption of normal weather underlies an expected pullback this year in the power-generation market for gas, which nevertheless remains large by historic standards and is expected to grow.

Although EIA expects the average spot price of natural gas at Henry Hub this year to rise to $3.68/MMbtu from $2.78/MMbtu in 2012, that level would still be below the $4/MMbtu of 2011 and stay far lower than the energy-equivalent value of oil. The disparity will keep drilling and supply projections focused on oil and natural gas liquids.

US oil output

While total US production of natural gas is expected to increase only marginally in 2013, output of crude oil and lease condensate will jump 10% to an average 7.05 million b/d. With average production of NGL expected to be 2.36 million b/d and of renewable fuels to be 970,000 b/d, both virtually unchanged from last year, total US liquids production will reach 10.38 million b/d.

Oil production gains are greatest in the Bakken play of the Williston basin and the Eagle Ford trend and Permian basin of Texas. EIA estimated November production levels at 1.25 million b/d in the Permian basin, 930,000 b/d in the Western Gulf basin (Eagle Ford), and 860,000 b/d in the Williston basin.

For 2013, EIA projects production from Alaska at 520,000 b/d (vs. 530,000 b/d in 2012) and from the federal Gulf of Mexico at 1.4 million b/d (vs. 1.27 million b/d in 2012).

With oil demand flat and production rising, imports will fall—of crude oil by 8.1% and of products by 1.2%. In fact, the US now exports more products than it imports. OGJ projects average net product exports in 2013 at 940,000 b/d.

Beyond 2013, rising domestic production and supply from Canada will lower US reliance on long-haul crude oil in a trend that will make Asian markets increasingly important to crude exporters in the Middle East and Africa.