Costs vs Price; Oil & Gas Headwinds Remain

Adam Longson, Stefan Revielle, Elizabeth Volynsky, Lee Jackson -

The scale and speed of price falls in metals and bulks markets this year is now prompting investors to seek some perspective

How do spot prices sit relative to each commodity’s cost curve now? What production capacity is at risk? And how does all of this compare with the history of these trades?

Despite selloff more headwinds remain for oil in 2H15. While the Iran news is behind us, we continue to see several negative overhangs for oil.

  1. Crude demand is near a seasonal peak and will decline into the fall.
  2. We continue to see risk to distillate and refining margins in 2H15. Gasoline has supported refining margins recently, but diesel will need to support margins and runs in the fall/winter. Yet, margins are already slipping.
  3. The USD continues to rise with a Fed rate hike expected by Dec 15, while much of the world is easing.
  4. Supply is returning from Canada and new projects continue to comeonline.
  5. Macro concerns and deteriorating risk appetite are limiting buying from macro funds, while producer and sovereign hedging could be greater factors in 2H15.

To drive prices higher, we likely need a reversal in the DXY index or a large geopolitical event or supply outage.

WTI has even greater concerns. With the US export ban in place, the US is setup to face more challenges going forward. The USGC maintenance schedule looks relatively benign this fall, so a repeat of fall 2013 seems less likely.
The greater concern is 1H16. The US will exit 2015 with similar or greater production than the start of the year. As a result, the US sets up for another large stock build in 1H16, but from a higher starting point. The only way to avoid this build is through wider diffs. Much of the producer hedging activity will also occur in WTI, yet there is no natural buyer. More near term, Canadian outages helped lift US imports, esp from the Atlantic, yet Canadian production is returning. If both coincide with refinery maintenance, we could see outsized pressure on diffs.
More likely, US stocks will build in Oct/Nov, but storage should be sufficient. Plus, storage doesn’t set price.

Adam Longson, Stefan Revielle, Elizabeth Volynsky, Lee Jackson – Morgan Stanley Research