We forecast that oil prices will continue to slide lower on average in 2014, just like they have done in 2013. We are quite happy with our reading of the 2013-market as in retrospect it seems we timed our turning point from bullish to bearish quite well in the summer of 2012. Our regular readers will know that we had been bullish to the oil market for more than 4 years when we made that U-turn. On 22 August 2012 the Brent price was 116 $/b and we forecasted 107 $/b for 2013, a forecast we maintained in our 2013 oil market outlook, published 29 November 2012. We are now on track to see an average oil price in 2013 at 108.7 $/b, which implies a reduced oil price of about 3 $/b (2.7% down) for 2013. An oil price drop of 3 $/b does not seem much but becomes more significant when noting that during the last 15 years this will only be the third time we have seen an oil price decrease. For 2014 we believe the price decrease will be about twice as large as for 2013 and we maintain our forecast of 102 $/b, which would imply a 6-7 $/b (6%) lower oil price than in 2013.
We were correct for the direction of the market in 2013 and we have a fairly high conviction that we will be correct in our assessment of the 2014 market as well. If anything we think there is more downside risk than upside risk to our 102 $/b forecast. The key downside risk is connected to a quicker return of Libya/Iran to the market than we currently expect, the risk of what can happen to the markets (particularly the emerging markets) when the FED QE-tapering starts and the risk of much weaker economic growth in China than what we currently expect. Upside risk is mainly related to further geopolitical risks, particularly Iraq which has seen growing violence since the summer, and the possibility that OECD oil demand could surprise to the upside. If OECD demand grows quicker than we assume we believe that will be connected to upside surprises in the US, rather than in Europe and Japan. We believe several OECD countries will perform better in 2014 than 2013 with respect to oil demand changes, but for many of them this has to do with growth rates becoming less negative rather than turning positive.
Our key argument to expect further weakness in oil prices for 2014 is that we expect Non-OPEC supply growth to materially outpace global oil demand growth, creating a need for significantly less oil from OPEC. IEA in fact expect record high non-OPEC growth in 2014 of 1.8 million b/d and note that IEA was too pessimistic for non-OPEC growth in 2013 when they expected 1.0 million b/d of growth. It is worth emphasising that the last 5-6 months we have started to see meaningful production growth in other non-OPEC countries than just USA/Canada as well. To put it in oil terminology; the “Call on OPEC” will drop meaningfully next year and when that happens the average oil price tends to drop as well. Geopolitical risk will however likely continue to be supportive for oil prices also in 2014, but there are large wild-cards relating to the Iranian nuclear deal that was reached in November. If a broad based deal with Iran can be reached during the next six months of negotiations, the price picture could turn out much more bearish than our forecast of 102 $/b for 2014.

Long Held Relationships Breaking Apart
We are now in a period where it has become more difficult than ever before to predict future oil prices. The reason is that we have seen destructions of old data relationships that have been with us for decades and we also see exponential developments in important parts of the energy markets. It is always hard to predict exponential developments. Let us start by mentioning an example of what is going on with respect to the Chinese effort to move Heavy Duty trucking over from diesel to natural gas (LNG). In its recently released World Energy Outlook the IEA writes that in 2012 there were 800 LNG filling stations in China and that the sales of LNG Heavy Duty Trucks increased by 60% in 2012. The interesting issue is that there are no longer 800 LNG filling stations in China. According to ChinaOil, the number of LNG filling station increased by almost 30% (from 1325-1700) just during the third quarter of 2013… One of the key reasons for why this exponential growth in LNG for trucking is happening is related to local pollution in the cities (particles emissions more than CO2). This movement over towards LNG for Heavy Duty Trucking is probably one of the reasons why diesel demand has not performed in China the last two years. We also see the start of possible meaningful momentum in US Heavy Duty trucks moving over to natural gas, but this is related to the blow out in the price spread between natural gas and oil in the US. US sales of natural gas fired trucks in the HDV-segment is set to increase from 1% in 2013 to 5% in 2014 and the inflection point looks to be the new LNG-engine from Westport-Cummins. We could in other words be in for an exponential development in both China and the US with respect to natural gas usage in Heavy Duty trucking.
We have seen several other developments the last years and also just the last 3-4 months that makes it hard to predict the future. The old relationship between economic growth and oil demand growth in the OECD that for decades suggested that if GDP in the OECD grows 1% then oil demand should grow 0.5% has broken apart and since 2005 there has been very little “bang for the buck” with respect to oil demand growth in the OECD on the back of economic growth. The relationship has in fact turned negative, and unfortunately for those that need oil demand growth we believe some of these changes are structural and not only cyclical. It has mainly to do with efficiency improvements but substitution also plays its meaningful part, particularly for oil used in stationary purposes. We do however believe that substitution related to the US Heavy Duty Trucking is just around the corner.
Total US Vehicle Miles Travelled (VMT) has disconnected from both population growth and disposable income per capita since 2005. Why is this happening? How much is caused by structural factors like demographic changes (baby-boomers becoming pensioners), technology break throughs (different use of the internet by young people after the smart phones entered the world), etc, etc? We think some of the changes are structural and not all cyclical, otherwise we would have expected the development in disposable income per capita to still correlate with the total VMT. Important is also the huge shift in driving standards in the USA which has just started to be hiked after decades of standstill. The Corporate Average Fuel Efficiency (CAFÉ) standard will be hiked from 30 Miles Per Gallon (MPG) in 2013 to about 50 MPG by 2025 (about a 67% improvement in efficiency). According to the University of Michigan - Transport Research Institute the improvements in efficiency are already very visible. The window-sticker MPG for new light-duty-vehicles sold in the US has improved from about 20 MPG in 2008 to almost 25 MPG in 2013 (the window sticker MPG this is not the same as the CAFÉ-standard).
We also see other relationships breaking apart during 2013, like USD vs oil prices, the Equity market vs oil prices and the price spreads between international oil prices and waterborne crude oil in the US GOM has recently blown out of all historical proportions. What kind of consequences will all this have? Well one consequence is that European refiners are being slowly “strangled” by US GOM refiners which now have immensely cheaper feedstock than its European peers due to the law that forbids US exports of crude. Instead they now refine their cheap crude and send the products to Europe.

Continued Increase In Outages Necessary For Higher Oil Prices
The last one and a half year the Brent price has been undershooting, overshooting, undershooting, overshooting compared with our average price forecast. This is also how it is going to continue. Our forecast is a forecast of the average price and not a price target, like for example equity analysts will operate with for the share price in a company they cover. Oil producers generally receive an average price for their production and consumers pay an average price for their consumption and hence it makes more sense to us to forecast average prices than price targets for oil. Only 3 weeks is left of 2013 and we can hence with a 99.9% certainty state that the average oil price this year will be down. The Brent price will have to average above 160 $/b the last three weeks of the year in order to avoid a drop in the average price. If we drag 112 $/b forward the Brent price will average 108.7 $/b for 2013 which is about 3 $/b down on 2012.
As already stated we are maintaining the average price forecast for 2014 at 102 $/b and we would claim that the only reason why international oil prices have not already fallen below 100 $/b is to be found in the very large increase in unplanned outages that has happened the last two years. The escalation in outages started with the “Arab Spring” in the winter of 2011. The first material outage came from Libya. Then as Libya came back into the market much quicker than anybody had expected during 2012, Iran fell out of the market with more than 1 million b/d of reduced production and exports due to the European oil embargo and the US/European financial sanctions. Now Libya has again fallen out with more than 1 million b/d reduced output since August, due to strikes and political unrest. Current estimates are that Libya is now producing only 200-300 kbd compared with about 1.35 million b/d during the first half of 2013.
Some have said during the last year that since the Brent price is still above 100 $/b despite the large increase in US shale oil output, these barrels are not as important as we and others have claimed. We would instead turn this around. You could rather ask yourself the question on how high oil prices would have been without the 2.5 million b/d growth in US shale oil we have seen the last 2-3 years. The answer is that there would have been no spare capacity left in the global upstream production space and international oil prices could have been much higher than were they are right now. The shale oil revolution in the US has also already had large geopolitical consequences as the US would never have dared to push Iran as hard as they have through the very large tightening of sanctions had we not seen the massive increase in US shale oil output.
In fact the delta in shut out barrels out of the market has more than offset the increased shale oil output from the US the last two years. The key question to ask would be; will this continue also in 2014 and 2015? We have problems believing that will happen as we are already at a historically high level of shut out barrels as we enter 2014. Shut out barrels right now are almost at par with what we saw during the Venezuelan strike in December 2002 and the war in Iraq that started in March 2003. Should we really expect the shut out barrels to increase from here to levels only seen since the break up of the Soviet Union in the 1990’s? We struggle to have that as a base case. Yes, we could lose some more barrels from Iraq, Venezuela and Nigeria, but we find it easier to believe some barrels will return to the market on the net.

Global Oil Supply vs Demand in 2014

The supply-demand balance for 2014 is looking very weak in our opinion. We think global oil demand will increase by 1.1 million b/d while we have non-OPEC supply growth (including biofuels) up 1.7 million b/d. We think the oil demand growth will be about similar to what we have seen in 2013, but the split between OECD and non-OECD will be different. We think OECD oil demand will grow for the first time in 4 years in 2014. For many countries in the OECD, however, we are not talking about net oil demand growth, but rather that the delta in oil demand becomes less negative instead of turning positive.
We think we will continue to see some oil demand growth in the US in 2014, based on more positive macro economic data, but there remains a large risk in how the expected FED tapering will affect the macro economic sentiment during the year. We expect OECD Europe to post a minor net oil demand growth but it can hardly be described as strong by any means. For the third largest oil consumer in the world (Japan), we believe the oil demand growth will continue to be negative, despite “Abenomics” and improving macro economic numbers. Why is that? Well, the country has not started any nuclear facilities yet and if that happens, it should be negative for both direct burn of crude and residual fuel oil used for generating power. As far as we understand there are 12 applications to restart nuclear facilities in Japan and the central government wants to get these reactors back into operation. Local governments have the last world, however, but we expect that during 2014 the Japanese central government will be able to restart at least a handful of nuclear facilities.
In total we expect OECD oil demand growth of 0.1 million b/d for 2014. Now how about the emerging markets? Will these countries continue to grow as strongly as before? We think not. Non-OECD oil demand growth was 1.3 million b/d in 2011, 1.4 million b/d in 2012 and is on track to come in at 1.1 million b/d for 2013. All these numbers are based on IEA data, except we have replaced the IEA numbers for US and China with data reported directly from these two key countries. For 2014 we believe oil demand growth in the non-OECD will continue to weaken to 1.0 million b/d on the back of lower total GDP-growth coupled with what looks to be more service oriented growth rather than the same growth in investments that we have seen for the last ten years. This means the content of the growth in emerging markets will on average be less energy intensive than during the last ten years. This change is already starting to become visible in the oil data: Saudi Arabian oil demand grew 133 kbd in 2012, but is year-to-date up 90 kbd. Similar numbers for China is 355 kbd vs 308 kbd (and the toughest year-on-year comps are in Q4), India is 148 kbd vs 31 kbd, Latin America is 230 kbd vs 214 kbd (and note that the last three months vs the same months the prior year is up only 176 for Latin America). The likely FED tapering could also be a further drag on some of these emerging economies as one would expect their currency to start weaken against the USD as the longer term US interest rates becomes pressured higher when FED scales back its massive buying of US bonds. If we were to evaluate the risks in our demand forecasts we could see some upside risk connected to OECD but there is similar downside risk connected to our non-OECD numbers.
What does the most influential other analysts expect of supply-demand growth for oil in 2014? It is common to compare one’s own numbers with the ones posted from IEA, OPEC and EIA. The average of these agencies estimates of changes to “Call on OPEC” for 2014 is a decrease of 0.6 million b/d for 2014. IEA is the most pessimistic, while OPEC is the least pessimistic. EIA is just in the middle. Looking at what has happened to the average oil price since the change of the millennium it has been common to see a drop in the oil price whenever the “Call on OPEC” falls significantly. That happened in the beginning of the 2000’s, it happened in 2009 and it happened in 2013. It is going to happen also in 2014 in our opinion.

Global Oil Demand Growth

OECD oil demand growth peaked in 2005-06 and is since down about 10%. We think there could be some pockets of oil demand strength in parts of the OECD in periods where economic growth outpaces the improved efficiency and substitution but we believe these will only be pockets that may last at max 6-12 months. We are still convinced that during the next 5 years, the efficiency improvements in the US car fleet, coupled with substitution in particularly heavy duty trucking will outweigh any positive effect of economic growth in the coming 5-year period. We suspect we will see a period of stronger oil demand growth in the US, maybe at the start of 2014 but the growth in oil demand will not be particularly strong at below 100 kbd for 2014 on average.
For OECD Europe we expect a small growth of about 50 kbd in 2014 after coming in negative at 130 kbd in 2013. Unfortunately (for those selling oil that is) we still see no meaningful evidence of stronger oil demand growth in the key European countries, except in UK. Oil demand is in the latest IEA figures contracting in Germany, France, Spain and Italy. But based on some better sentiment in the macro economic indicators in Europe the last couple of months we choose to have a slightly positive bias to oil demand for 2014 in Europe.
When it comes to oil demand growth in the non-OECD, the delta in the growth rate is in fact looking less positive. After having seen non-OECD oil demand growth performing at 5-8% growth rates for large parts of the period from 2000-2010, the growth rate is now hovering more in the 3-4% range. The last couple of months the demand has in fact grown at only about a 2% rate compared with last year. We have already mentioned the weaker growth rates for oil demand in India, Latin America and Saudi Arabia that we have seen recently. We expect this kind of demand growth to continue also into 2014. A 1.0 million b/d demand growth rate for non-OECD equals about 2.2% oil demand growth for that region.
China will again be the key for non-OECD oil demand growth and we continue to expect weaker growth rates in oil demand for China also for 2014. We have been used to seeing a yearly growth of 0.5 million b/d for China but we have argued many times the last two years that we believe this growth rate will drop to the 300-400 kbd range in the coming years. This year the Chinese oil demand growth is set to come in somewhere between 250-300 kbd, while next year we factor in demand growth of about 350 kbd. The key reason why we are no longer seeing 0.5 million b/d yearly growth in China is that diesel is no longer contributing to positive oil demand growth. As total Chinese GDP growth has dropped to 7% instead of the 10% plus and as the growth becomes less energy intensive, this affects diesel demand negatively. Diesel is also meeting competition from natural gas in the transportation sector and wind, solar and nuclear in the stationary sector. We believe car sales and hence gasoline consumption will continue to perform strongly in China also in both 2014 and 2015, but this will not be enough to offset the fact that diesel is not performing anymore.
We would also like to highlight the fact that in some of the most populous countries in emerging Asia, the oil price has climbed to heights were several countries can no longer afford to subsidise petroleum products to their citizens to the same extent as before. The best example is Indonesia, which use 14.5% of their domestic budget on petroleum subsidies. On the 22cond of June the country removed parts of their subsidies on diesel and gasoline and the prices on these products jumped 20% to 40% for the end users. Then it will become possible to do some sensitivity analysis based on prices in such a country. India and Malaysia have also started scaling back petroleum subsidies in 2013. This will not hinder further demand growth for petroleum but the growth rate will most likely not be as strong as we have been used to. You can try to tell Indonesia, India and Malaysia that oil is cheap. They will not agree with you.
Source: DNB Markets