The Global Crude oil Scenario: We Begin with the BrentWTI Spread

We follow up with --Shale Boom Cuts Gulf Oil Premium ; Light Louisiana Sweet moves to discount , planned pipelines Cushing to Gulf coast changes pricing rules Keystone XL and Northern Gateway : Speculative position in Crude exchanges : U.S. petroleum deliveries fall Emerging Market Growth and Geopolitical Obstacles : Focus on Saudi & Divergent Contrarian Views : Commodity rally could be losing steam post QE3

The Brent-WTI spread was at US$15.7/barrel during August 12 and we expected the spread to persist and increase at times and this to last into 2015, driven by resilient emerging market consumption growth, despite a Chinese slowdown, persistent oversupply at Cushing and an inability to move new supply to the regions of the world where it is needed. During Sept 12 ; 2nd half the spread widened towards 20$ per barrel

BrentWTI Spread by Contract Has Changed With Time (US$/barrel)

Planned pipeline additions into Cushing reflect the need to absorb record levels of tight oil production from U.S. shales, most notably the Bakken formation that underlies Montana and North Dakota (and Saskatchewan, Canada), as well as Canadian oil sands from Alberta. Last year, U.S. and Canadian crude oil production combined rose by 440,000 bpd to 11.36 million bpd (including NGLs), according to the BP Statistical Review, and the EIA expects North American production growth of 880,000 bpd and 540,000 bpd in 2012 and 2013, respectivelymaking the region the largest contributor to non-OPEC output growth. In the longer term, U.S. crude oil production alone could rise from 5.5 million bpd in 2010 to 7.8 million bpd in 2035 (based on the EIAs best case scenario), depending on U.S. energy policy, global consumption trends, efficiency trends, alternative technologies and oil prices etc. U.S. tight oil production could range from 0.7 million bpd to 2.8 million bpd. Future changes to infrastructure plans would change the spread.

Shale Boom Cuts Gulf Oil Premium to 24-Year Low: Energy Markets The U.S. shale boom has driven the cost of Gulf Coast light, sweet oil to its lowest level versus Brent crude in almost a quarter century as the nations dependence on foreign supplies wanes. Light Louisiana Sweet, the benchmark grade for the Gulf Coast known as LLS, has traded on the spot market at an average of 15 cents a barrel more than Brent this year, the smallest premium since at least 1988, data compiled by Bloomberg show. The spreads highest annual average was $4.02 in 2008. About 300,000 barrels a day of Bakken oil is being shipped from North Dakota by rail.. The drop has cut costs for refiners in Texas and Louisiana accounting for 45 percent of U.S. capacity and replaced competing shipments from Africa. Gulf imports of light, sweet crude have fallen 56 percent since 2010, according to U.S. Energy Department data. A shale-oil influx from the Eagle Ford formation in Texas and Bakken in North Dakota and new ways to bring crude to the Gulf, such as this years reversal of the Seaway pipeline, may accelerate the shift. The market dynamics are changing, When the Gulf Coast was a crude importer, they had to attract crude from elsewhere in the world, which meant LLS had to be at a premium to Brent. But now were moving into a totally different situation. Light Louisiana Sweet, a grade prized because its low- sulfur content and density make it easier to process into fuels such as gasoline, was $1.26 cheaper than Brent yesterday. It averaged 23 cents less than the benchmark in the third quarter. The spread was at a 63-cent discount today in New York. Brent oil for October settlement rose 40 cents, or 0.4 percent, to $113.49 a barrel yesterday on the London-based ICE Futures Europe exchange. The contract advanced 76 cents, or 0.7 percent, to end the session at $114.25 a barrel today. U.S. oil output surged to the highest level in 13 years in July, according to weekly Energy Department data. The U.S. met 83 percent of its energy demand from domestic sources in the first five months of this year and is heading for the highest annual level since 1991, department figures compiled by Bloomberg show. Unconventional oils and gas are changing everything about competitiveness in the United States, sweet crude that in the U.S. Gulf Coast is not going to be importing light, sweet crude, and that happens next year Houston, New Orleans and other ports along the Gulf Coast accepted about 554,000 barrels a day of light, sweet oil from outside the U.S. in June, down from 964,000 barrels a day in June 2011 and about 1.25 million in June 2010, according to the Energy Departments Energy Information Administration. The West African nations of Nigeria, Angola, Gabon and Equatorial Guinea accounted for 58 percent of the light, sweet crude imported into Gulf Coast ports in June 2012. North African nations accounted for a further 30 percent. Like oil in the Midcontinent, the relationship between LLS and Brent has been upended by surging shale production. West Texas Intermediate oil at Cushing, Oklahoma, the U.S. benchmark grade traded on the New York Mercantile Exchange, shifted to a discount to Brent almost two years ago after trading at a premium for decades.

Cushing inventories surged to 47.8 million barrels in June, the highest level since Energy Department records for the hub began in 2004. The WTI-Brent spread reached a record $27.88 in October. It was at $18.03 a barrel today. Over the last year and a half, with the WTI-Brent spread blowing out, the primary beneficiaries have been the Midcontinent players, As LLS disconnects next year, the benefits to Gulf Coast refiners will be brought to the forefront. Enbridge Inc. (ENB) and Enterprise Products Partners LP (EPD) reversed the flow of crude on the Seaway pipeline on May 19. The link, carrying as much as 150,000 barrels a day from Cushing to Gulf Coast refineries, is scheduled to pump as much as 400,000 barrels a day early next year. The capacity to transport light, sweet oil to the Gulf Coast from Cushing and inland shale formations will expand to more than 2 million barrels a day by the end of this year and 4.5 million by the end of 2014 from less than 500,000 barrels a day at the end of 2011, Inflection Point .Companies such as Phillips 66 (PSX) are also rethinking long-term business plans because of cheaper domestic supply that the refiner had changed its mind about selling its Alliance plant in Louisiana in part because of forecasts that LLS will shift to a $2- or $3-a-barrel discount to Brent. The shift in the U.S. market could have lasting repercussions on global markets as well. A drop in U.S. imports of light, sweet oil could weaken Brent, Raymond James is forecasting $80 Brent next year, based predominantly on production growth in non-OPEC countries like the U.S., People think that U.S. supply growth is sort of disconnected or irrelevant because it cant export, but it can back out imports and we believe that will have a significant impact on the global oil marketsFederal law restricts exports of crude oil without permission from the president. The U.S. exported just 0.7 percent of domestic oil production in June.

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Emerging Market Growth and Geopolitical Obstacles Should Ensure that the Spread Remains While the majority of non-OPEC supply growth is flowing into North America, non-OECD countries and regionspredominantly China, the Middle East and Latin Americaare the drivers of demand growth. Global crude oil consumption grew by 800,000 bpd in 2011 and the EIA expects growth of 700,000 bpd in both 2012 and 2013, with China offsetting European declines in consumption growth. Despite Chinas investment-driven growth slowdown, we expect oil consumption to remain robust, as the consumption driven portion of GDP (tied to transportation) holds up. Stimulus and subsidies should also keep oil consumption robust in oil exporting countries, while recurrent geopolitical strains will put further strain on Brent and keep local light crudes more correlated with Brent.

The regional imbalance between production and demand growth accentuates the lack of adequate infrastructure out of Cushing, maintaining pressure on the Brent-WTI spread, as greater resources are required in emerging markets. Greater U.S. consumption could mop up some of the excess capacity in Cushing, but this is dependent on being able to transfer the oil from Cushing to refineriesthe planned infrastructure buildout at present isnt sufficient (this could change). Furthermore, U.S. growth would need to improve significantly from our forecast growth level of 2.1% for the year and the weak levels of gasoline demand we have seen. This is not our baseline scenario; in fact, recent data suggests the U.S. will be close to stall speed in H2 2012-2013 and we envisage U.S. growth remaining below 2% through 2016.

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Focus: Saudi supply increase and its impact on Crude prices

Crude oil prices have been under persistent downward pressure this week, with both Brent and WTI having surrendered around $8/bbl since Fridays close. Some of this can be ascribed to the profittaking, after last weeks Bernanke boost, that weve seen across the commodity markets. However, the declines in oil markets have been particularly acute, with other events having contributed to further downside. Of particular interest was the news that Saudi Arabia was consulting with refiners, having stepped up its supply of crude oil and would increase it further should demand conditions warrant it. The scope for doing so is there, with Saudi Arabian spare capacity at 2.6mbd (26% of current production of 9.9mbd). Developed nations continue to face high product prices which have led to talks of a release of Strategic Petroleum Reserves (SPR), most notably in the US. We feel that the Saudis would prefer to keep control of the situation, by rather increasing their supply (and consequently cooling down crude oil prices) than see high crude oil prices force an SPR release.

The last time Riyadh engaged in similar consultations with refiners and increased supply was in March this year. As Figure 1 illustrates, this marked the beginning of a threemonth downward trend in crude oil prices. From their high in March to Junes low, Brent and WTI fell 29% and 28% respectively. Now the question is could we again see such a drop on the back of increased Saudi supply? The answer is conceivably Yes. The Contrarian Views..

OPEC has Probably Deceived Us About the Size of its Oil Reserves
Has OPEC misled us about the size of its oil reserves? The short answer is probably. The long answer is that currently, there is no way to know for sure.The next question we should ask is: Does it matter? The answer is most definitely yes. OPEC, short for the Organization of Petroleum Exporting Countries, currently claims that its 12 members hold 81.3% of the world's oil reserves. And, with few exceptions the world believes them. Trouble is these reserves "are not verified by independent auditors," according to a study (PDF) done by the U.S. Government Accountability Office, the nonpartisan investigative

The Contrarian Views..

The Implications of Saudi Arabia becoming a Net Oil Importer

Ambrose Evans-Pritchard, wrote last week in The Telegraph, Saudi oil well dries up. He presented the following chart of projected Saudi oil consumption, vertical bars, and production, dark blue line.By these estimates, in 2022, Saudi Arabia will no longer be supplying oil into global demand but will be competing in global demand for foreign oil. Long before we reach the trade-off point, however, certain exigencies will emerge. First consider the area on the chart between the two curves. This area is highly correlated to their balance of trade and their foreign exchange reserve acquisition. The website Suite 101 states that [t]he

And what about changes of production schedules in the north sea.

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Speculative position in Crude (CFTC): As in March, net speculative length (see Figure 2 from CFTC data published on the net ), although slightly lower, is extremely high at almost double the 5year average. As a percentage of open interest, net speculative length indicates a market that is extremely overstretched and vulnerable to swift and significant downside movesongoing from Mid Sept onwards. And as this week has shown, while there is a lot of length in the noncommercial market, confidence in those long positions is lacking. However, we do feel that other factors also contributed to the downward trend earlier this year, which might not play out this time around and therefore could limit the extent of any decline.

According to latest CFTC data, after a brief interruption in the previous week, net speculative length for NYMEX WTI resumed its climb this past week with 15.1m bbls added (the week ended 11 September, so it does not include the post QE3 reaction). Underlying the overall improvement was a confident 13.3m bbls addition to speculative longs. A mild 1.8m bbls were surrendered from short positions. Net speculative length stands at 305.6m bbls, almost twice the 5 yearaverage. This puts net speculative length as a percentage of open interest at 11.8%, well above the 5year average of 6.4%. This is indicative of a market that is considerably overstretched and vulnerable to correction. First, there was an easing of Middle East concerns over that period. Once again though, the Middle East is in the spotlight, with no end in sight of the Iranian tensions and the conflict in Syriathis could serve as counterbalance to any downward price pressure. Second, there was a growing awareness of the weakness in the US economy in Q2:12, without any policy support. Now, while it is acknowledged that the US recovery is tepid and fragile, we at least have the support from the Feds openended commitment to easingthis should keep oil prices well supported, not from a real demand perspective, but at least from non commercial interest. In conclusion, while we believe that increased Saudi supply could lend a downward bias to oil prices over the next quarter but this downside should not be as extreme as seen earlier this year.

EIA Crude oil inventory

EIA inventory showed an unexpected increase in stocks: recent pipeline configuration changes in and out of Tulsa have brought about certain situations that have altered the ground scenario dramaticallyA report and chart by SOCGEN throws up this picture well. U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) increased by 8.5 million barrels from the previous week. At 367.6 million barrels, U.S. crude oil inventories are above the upper limit of the average range for this time of year.

To see our various commodity and related world financial market articles visit www.slideshare.net And www.scribd.com and type Shamik Bhose in the search column to access our latest review and outlook articles along with most recent reading interest ;

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Oil Markets Losing Lustre...........hat tip to oilprice A U.S. energy trade group said the petroleum market in the country was hit by slumping demand. Total petroleum deliveries for August were at their lowest level for the month in 15 years and domestic oil production followed similar trends. Unemployment figures and data from the manufacturing sector were listed as contributing factors. Overseas, meanwhile, the IMF said there were short-term prospects for recovery, though trouble was brewing over the horizon.

The American Petroleum Institute reported that U.S. petroleum deliveries were down to 18.6 million barrels per day. While this represents a 2.8 increase from the previous month, it reflects a 4.3 decline from the same period last year and marks a 15-year low for the month. Petroleum deliveries are an indication of market demand and the API's chief economist, John Felmy, said levels for August are indicative of a lack-lustre economy."Given the nations weak employment situation, its no surprise petroleum demand was off," he said in a statement. "Contraction in the manufacturing sector probably also reflects the slipping numbers." The U.S. rate of unemployment has stayed above 8 percent for 43 consecutive months, the longest period since World War II. Gasoline demand for August was down 0.4 percent compared to the same time last year. Hurricane Isaac, which struck the southern U.S. coast as a Category 1 storm late August, shuttered gulf coast production, causing a spillover effect in retail markets. Some regions of the United States saw prices hover above $4 per gallon for several weeks after the storm. API, however, said demand for gasoline was down nearly a full percentage for the year. Imports of crude oil, however, declined but so did the number of rigs operating in the United States, API said. No mention was made by the API of White House considerations for a drawdown from the Strategic Petroleum Reserve. The industry group, which represents more than 500 oil and natural gas companies, said crude oil stocks were up 2.7 percent compared to August 2011, but down nearly 2 percent from their July levels. Overseas, OPEC, in its latest monthly report, said it expected the Euro-zone to return to growth after suffering further contractions this year. Christine Lagarde, managing director of the International Monetary Fund, said expiring tax cuts and spending cuts in the United States presented a "serious" risk to the health of the global economy. For the Eurozone, the situation was notably worse. "We continue to project a gradual recovery, but global growth will likely be a bit weaker than we had anticipated even in July, and our forecast has trended downward over the last 12 months," she said in a statement. Talking about crude pipeline, oil prices and fundamental political economy influences on commodity prices

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Bulls Running for Canadian Crude.. oil sands The top administrator at the Bank of Canada last week said high oil prices were good for the national economy. Crude oil prices were mixed in early trading this week as North Sea oil production declined because of maintenance. Operators in the Gulf of Mexico, meanwhile, moved slowly back to work following Hurricane Isaac. About 14 percent of the oil output from the Gulf of Mexico remains shut in as operators continue their slow march back to work following Hurricane Isaac, a Category 1 storm that struck Louisiana in late August. Crude oil prices have increased at a relatively steady pace since June. Brent prices have climbed more than 25 percent since then, prompting concerns from the Saudi oil minister, Ali al-Naimi. He said Monday the price of oil was "simply not supported by market fundamentals." Bank of Canada Gov. Mark Carney, however, said higher energy prices were good for the national economy and no action would be taken to get in the way of increases in the value of the Canadian dollar. The Canadian dollar has added nearly 3 percent to its value since Aug. 1 when compared with the U.S. dollar. "Most fundamentally, higher commodity prices are unambiguously good for Canada," he said. He dismissed claims that higher oil prices, coupled with high currency values, could lead to declines in the country's manufacturing sector. This logic, he said, would lead to the shut down of oil sands production, thus forcing the country to "abandon our resource wealth."Canada ranks third in the world in terms of oil reserves. Its 175.2 billion barrels represent 11 percent of the world's total reserves, just behind Venezuela and Saudi Arabia respectively. U.S. politicking and environmental concerns over the Keystone XL pipeline, planned for Canadian crude, in part prompted the Canadian government of Prime Minister Stephen Harper to look to Asian markets for a diversified consumer base. Two planned pipelines alone Keystone XL and Northern Gateway represent about $14 billion in Canadian infrastructure........... hat tip to oilprice

Focus: QE3 top commodities pick The decision by the Fed to buy USD40bn MBS per month until labor market conditions are to the Feds liking, could amount to considerable QE. The Fed also pushed back its rate hike guidance until mid-2015. If the Fed were to buy MBS up to that point, at a rate of USD40bn per month, it would add up to USD1.3tr. We believe this statement and the press conference saw the Fed is keen to show that theres more it can and will do if necessary. We think that this will continue to push the dollar lower with euro/dollar headed into a 1.30-1.35 range and help riskier assets, like commodities. What does this imply for commodities? We have little doubt that most commodities will rally in fact they have rallied already.

The question is: which commodities are likely to rally more than others? We pick gold, silver, Brent and aluminum. We look at the relationship between the Feds balance sheet and commodity prices over two periods (1) since 25 Nov 2008 and now (the period since the Fed first announced they would buy agency-backed mortgages) and (2) 4 Nov 2010 until June 2011 (six months following the announcement of QE2. These two periods allow us to gauge the longer term effect (which may be distorted by commodity specific factors). The shorter period following QE2 is likely to be less influenced by commodity specific factors.

Therefore, looking purely at QE, we put more weight on the commodity price movements following the announcement of QE2. We also look at the period following QE2 rather than QE1, as liquidity was a major issue in the months following QE1 something which was not as prevalent after QE2 and now. In interpreting the data, we look at the beta between the Feds balance sheet and the commodity but also how much variation of the commodity price movement is explained by the Feds balance sheet. This provides us with some indication of how commodity prices may react but also how certain we can be about the possible price reaction. Given that QE is initially purely a monetary phenomenon with a possible real economic effect only later, we note that price reaction may differ from what one would expect, looking purely at commodity specific fundamentals.. however the Commodity rally could be losing steam post QE3

The table shows that gold, silver, Brent and aluminum are likely to move higher with the most certainty or highest confidence. These four commodities would be our top long picks on the back of QE. Brent and silver rallied strongly following QE2 (Brent rallied even before the start of the Arab Spring). While gold benefits substantially (although less than silver and Brent),the price variation explained by the Feds balance sheet is high and, as a result, we can be more sure about the outcome. The same argument goes for aluminum (this would be via aluminums link with energy as an input in production).

The rally in commodity prices seems to be losing steam after the announcement of a third round of quantitative easing (QE3) by the US Federal Reserve in the middle of this month. Prices were already up before the announcements and once the news was out, followup buying from real sectors didnt happen due to growth concerns. While smaller metals are still up, prices of copper, aluminum, crude oil and gold have stalled or fallen after the announcement. Analysts say the growth issue is again at the fore, not leaving any strength for the sort of rally seen following earlier liquidity pumping by central banks in the past. In 2009 and 2010, when the first two rounds of QE were announced, commodities rallied sharply before the announcements. Market players were hoping liquidity easing will find its place in financial markets, as players will buy commodities before real demand picks up. Compared to QE2, this time commodities have not fallen sharply. In the current quarter, prior to the announcement of QE3, metals, precious metals and crude oil went up 10-26 per cent on hope of QE3. Prior to QE2, too, commodities markets were significantly up but after this, profit booking in commodities was sharper and most were down by three to five per cent, with smaller metals falling 10 per cent in the first fortnight after the announcement. However, at this point, growth is the big problem for commodities, not liquidity. When QE2 was announced in November 2010, the global economy was halfway through a quarter in which GDP growth averaged four per cent, followed by one of 3.7 per cent. Crucially for commodities, China was expanding at an annualised rate of 9.5 per cent. Even if QE3 proves successful, growth over the remainder of this year will likely be much lower. Global leading indicators have deteriorated markedly in the past month and are pointing to the risk of a big slowdown in the manufacturing sector, while economists are cutting their forecasts for Chinese and European growth. In fact, the August trade data from China, a major commodity consuming country, showed moderation, with crude oil imports falling to the lowest in two years and copper import growth contraction. Lead imports rose 50 per cent and so did its price on the London Metal Exchange. Lead was up four per cent after QE3 and by 17 per cent prior to QE3. Hat tip to Bloomberg

Shamik Bhose (Executive Director) Commodity & Currency & Interest rate futures Markets Archan Singha (Senior Dealer & Senior Analyst) Commodity / Brij Bhushan Tiwari To see our various commodity and related world financial market articles visit www.slideshare.net And www.scribd.com and type Shamik Bhose in the search column to access our latest review and outlook articles alongwith most recent reading interest ;