US EIA chief shares short-term outlook for oil market: Fuel for Thought

The 100th episode of the weekly S&P Global Platts Capitol Crude podcast, which aims to demystify the complex world of US oil policy, featured Adam Sieminski, head of the US Energy Information Administration.

Here are excerpts from the interview, edited for space. Listen to the podcast in full.

Q: Where do you and EIA see prices headed?

A: The forecast in the STEO (Short-Term Energy Outlook) is probably pretty good. And what it says is we’re expecting the markets to begin to rebalance as we get towards the end of this year and as we get into the middle of 2017 we should see prices beginning to come back up again.

There must be some sense of that out there in the real world because the rig count has been inching up a little bit and that’s typically a sign that people in the business think that it might make some sense, their cost structure is more under control and prices are sufficient to keep them going.

One of the things that we do is we use a very sophisticated algorithm based on the Black Scholes work that was done back in the 1970s and to try to understand what near-term volatility is.

It’s remarkable, it says to get a 95% confidence level on oil prices you would have to have a range that’s as low as $20 or $25/b and as high as $90 or $100/b. So we know that there’s a huge, almost yawning gap in what oil prices could be. That doesn’t mean that you have to be at either end of those things, but it says that it’s a possibility.

Q: What do you think is going to drive oil prices above $60/b and, conversely, what could drop them below $30/b?

A: The typical thing that causes prices to go up is a geopolitical crisis somewhere. We’re seeing some of that going on right now in places like Iraq and Nigeria, Libya, there’s been a lot of social and political turmoil in
Venezuela and Venezuela’s still exporting more than 2 million b/d of oil to the global market.

The downside risk generally tends to come with economic slowdowns. Do we learn that something is really going wrong in the economy in China which is responsible for a lot of the growth in oil consumption? Or how’s Europe doing? Or, for that matter, how’s the United States doing?

The downside surprise is in economic activity and the upside surprise can often come from geopolitical crises.

Q: Now that we have all this growth in US supply, does the impact of any single event matter as much?

A: Yes, it still does. The United States is still part of a global oil market and a problem anywhere in the world ultimately gets reflected in the market which makes then a difference in the United States.

We’ve become less dependent on imports from different parts of the world, but we’re still part of this global market. But it still matters whether Venezuela has political stability or not, to the United States.

Q: With all the changes we’ve seen, is this market still defined by booms and busts?

A: It’s really hard to get away from boom and bust cycles in oil and the reason for that is what economists refer to as a low elasticity of supply and demand.

Let me translate that: it takes big changes in prices to cause people to use less or for producers to go out and find more.

What this Black Scholes algorithm that we use essentially says is that there’s still a lot of potential volatility out there. The thing with this algorithm that we use, it’s based on options prices in the WTI futures and options market. So it’s the market itself that’s saying that things are potentially volatile with a big range. Who’s in the option market? It’s producers and refiners and hedge funds and airlines and trucking companies, so it’s not like it’s all speculators.

There’s plenty of people that are actually involved in the business that are in these markets. In essence, what the people that are in that market are saying, with the dollars that they put in to these contracts, is that it’s still kind of the Wild West.

Q: What are the signs that we’re at the bottom and a rebound is coming?

A: One of those things is the rig count … which seems to be flattening and we’re beginning to see signs that rigs are coming back to work again. Production has come down, but we’re beginning to see that level out.

So the second half of 2017 in our Short Term Energy Outlook is not a lot different from the first half of 2017. So we’re seeing that bottoming occurring about a year from now and then it begins to gradually move back up again. Now that’s kind of our reference case, keep in mind, you don’t always get the reference case.

Q: What do you see as OPEC’s role in the world oil market and its influence on fundamentals going forward?

A: OPEC’s success as a market manager has been mixed and recently the Saudis, who have almost all of the spare capacity, seem to be more interested in just letting the market set the price, rather than trying to have a consensus develop in Vienna at OPEC meetings. How long that can last really depends on internal politics within OPEC. Since EIA is a statistical agency and not part of the international policy community, we stay away from that
kind of thing.

Q: Surplus production capacity within OPEC is shrinking but does EIA view this as less significant than it was in the past?

A: What EIA looks at is how the markets rebalance and what would happen if there was an emergency. Rebalancing, in our reference case, takes place on just a straight supply and demand basis. We’re not building in any kind of assessment of OPEC or anybody else unilaterally cutting production or adding production to do
something in an extraordinary way.

You know, you’re back to, I think, in today’s very fast acting world, its market forces that drive these things, and not groups like OPEC.

Q: World production in recent years has really outpaced consumption, but EIA sees supply and demand reaching parity next year. Could we be looking at demand outpacing supply?

A: Well, you had talked earlier about turning points, so we’ve already seen one: the rate of build in inventories is slowing down. So we had inventories accumulation rising very rapidly back at the end of last year and earlier this year. And that’s really starting to slow down. So that’s a sign, but inventories don’t seem to be accumulating.

It hasn’t gone negative yet, we’re not drawing on those inventories. That’s what we’re forecasting to begin to happen as you get further out into 2017. So when that happens then that’ll be a second indicator that the markets
are rebalancing. That could happen sooner if economic growth surprises to the upside or if there is further difficulty in producing oil in places like Nigeria, Libya, Venezuela or anywhere else.


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