Home' Trinidad and Tobago Guardian : December 4th 2014 Contents Recent movements in the
price of crude oil have cap-
tured local attention. Much
of the discussion has been
around the fall in price and
the impact on our national
budget and, by extension, our proposed
The issue is, however, fundamentally not
about how much we are able to spend this
year but rather whether the current oil price
dynamic is sustainable and how this impacts
our economy in the years to come.
Appreciate that we have ramped up spend-
ing exponentially since 2004 and have relied
on rising oil and gas prices to accomplish
this objective. Also recognise that we are well
on our way to a decade of deficit spending
and there is the promise of a balanced budget
within the next three years.
A realistic issue to explore is how will the
landscape in T&T look with a general election
in 2015 and oil prices of US$60 per barrel in
2016. The answer you are most likely to get
from the politicians is that we are a gas econ-
omy as opposed to an oil economy and so
a falling oil price is not as bad as it may
appear on the surface. For sure, the current
dynamic does provide some measure of sta-
bility from a T&T perspective.
Over the past year, the weekly average
crude oil spot price is down around 20 per
cent but natural gas spot prices are also up
15 per cent over the same period.
Yet it is also important to appreciate the
global dynamics at play as that improves our
ability to anticipate what lies ahead.
The first thing to recognise is all the talk
about renewable energy has not had an off-
setting impact, at least not yet.
According to the International Energy
Agency (IEA) in the 1980s coal, oil and gas
comprised 82 per cent of global energy. In
2014 the percentage remains exactly the same
at 82 per cent.
Demand has increased which means there
is more renewable energy output but it has
not displaced fossil fuels in any way. What
has changed is the mix of coal, oil and gas
over the decades with natural gas becoming
WTI vs Brent
The story really starts with an understanding
of the discrepancy between Brent Crude prices
and West Texas Intermediate (WTI). Normally,
you would expect the "better" product to sell
at the higher price. You may have heard that
WTI is a lighter and sweeter crude than Brent.
Light refers to the American Petroleum Institute
(API) gravity. Sweet refers to the level of sulphur
The API references the density of oil to the
density of water. An API of over 10 means
that the oil is lighter and will therefore float
on water. WTI has an API of around 39 and
is of a higher quality than Brent. However
Brent sells at a higher price. T&T crude sits
in between WTI and Brent in terms of qual-
ity.As at the close of play Friday last Brent was
at US$70.15 per barrel and WTI was at
US$66.15. The latter represented a greater
than 10 per cent decline on the day. Historically,
WTI would trade higher than Brent with a
very narrow spread between the two bench-
From 2005 onwards with the combination
of the advent of shale oil in the US, trans-
portation bottlenecks, the US inability to export
oil resulting in supply glut and, to some extent,
a lack of refining capacity in the US for that
particular benchmark, WTI started to trade
lower than Brent.
The peak divergence came in 2012 when
WTI averaged US$17.47 less than Brent with
a maximum spread of US$23.44 on February
8 of that year. The current spread is fairly nar-
row and both prices are falling in tandem. The
implication is that there is a more fundamental
global reason for the price decline compared
to any isolated regional situation.
According to the IEA "supply/demand fore-
casts indicate that barring any new supply
disruptions, downward price pressures could
build further in the first half of 2015." They
point to "deep structural changes at work in
the oil market."
These changes in the short term are reflected
in robust crude oil production growth in the
US, the return of Libyan production, weakening
expectations for the global economy and sea-
sonally low refinery demand. Note that Libya
has the highest level of proven reserves in
Over the long term it s all about US shale
oil. Current US oil production stands at just
over nine million barrels per day, the highest
level since 1983. Next year production is
expected to reach 9.4 million barrels levels
not seen since 1972.
Current estimates puts supply in excess of
demand by two million barrels of oil per day.
That s about the productive capacity of six
members of the oil cartel OPEC. The more
oil that the US is able to push out interna-
tionally the bigger the game change in the
global oil markets.
The general feeling is that OPEC and Saudi
Arabia, in particular, is seeking to maintain
production levels in order to drive the price
of oil down and slow the rate of output from
US production. The challenge with that strategy
is that it will take a couple years for lower
production levels to come into effect and lots
can happen in the interim.
The expectation is that lower prices will
shake out weaker producers in the US shale
oil industry. Yet only around 4.0 per cent of
existing US production needs a price above
US$80 to be profitable according to the IEA.
The IEA suggests that many existing fields in
the US can operate at a price of US$42 per
barrel. The result is that they expect production
to continue to increase into next year.
On the other side Russia is suggesting that
they can withstand prices in the high US$50s
to US$60 per barrel level while most of the
Middle East producers can go as low as US$30
The challenge is with places like Venezuela
and Nigeria where poor infrastructure and
lack of investment means that current prices
are already starting to cause problems.
It may seem counter intuitive but low prices
can cause prices to go even lower in the short
term. This is because oil revenues for any
country are a function of price and quantity.
If the price falls then one way to make up for
the revenue shortfall is through increased pro-
duction which has the impact of increasing
the supply/demand imbalance pushing prices
There is, of course, a difference between
the cost of production and the revenues a
country needs to support its various social
programmes. This is where the challenge will
come and a number of global producers in
particular Venezuela need prices at US$100
per barrel in order to survive politically.
Overall roughly 2.6 million barrels of daily
crude oil production out of a total production
of 93.2 million barrels (2.8 per cent) comes
from projects with a breakeven price in excess
of US$80 per barrel.
Demand for next year is forecast to be 93
million barrels per day. With supply outstrip-
ping demand and increased supply from stable
sources such as the US the risk premium tra-
ditionally present from potential supply dis-
ruptions and geopolitical risk evaporates. The
bottom line is there is a long road ahead before
While all of the above makes the next couple
years very interesting indeed there is a further
dimension to the story. Oil is priced in US
dollars and during the period when the US
dollar was falling against other world currencies
oil prices were on the rise. Today that situation
is reversed as the dollar is strengthening. The
move against the resource currencies such as
Canada and Australia is obvious. However,
Central Banks in Europe and Japan are actually
seeking to lower their currency against the
dollar in an effort to stimulate their respective
It is possible that the dollar will get too
strong for the liking of those in the US and
this may cause the US Federal Reserve to inter-
vene. That aside the overall situation is such
that global interest rates are likely to remain
lower for longer. The role of the Central Banks
represent one of the factors but the other is
that lower oil prices translate into falling gaso-
line prices and lower cost to consumers for
products where oil prices are a key input.
The impact of these movements is lower
inflationary pressures, especially amongst the
developed world. Given that the Central Bank
actions in Europe and Japan was in part to
deal with a deflationary threat another virtuous
cycle presents itself.
Stay tuned. Things are changing rapidly.
Ian Narine is a broker/dealer and invest-
ment adviser registered with the SEC.
BUSINESS GUARDIAN www.guardian.co.tt DECEMBER 2014 • WEEK ONE
Changing crude oil dynamic
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