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I posted this on BDLive this morning......

Oil prices are notoriously speculative at the best of times. The cost of producing the marginal barrel (the one that creates either excess demand or supply) is generally where the price should settle in an efficient market. If we assume the oil from shale condensate is the marginal barrel then around US$65 is probably reasonable. This also happens to be the price you reach when you extrapolate a long term trend line from around 2005. Anything above or below this price is typically down to speculators.

Commodity prices trade in lumpy jumps and we should quite quickly see the price going back to around 60 to 70. Hopefully the Rand will strengthen in this time which will still leave us with a fairly low BFP price to which the government adds their taxes and levies, giving us the pump price. Remember that with low oil prices, the SA oil import refiners such as Shell, BP, Engen, Total are probably making more money on their refining side than on their marketing side. This is because refining margins are probably growing as crude oil prices (their purchases) are dropping faster than refined product prices (their sales). Sasol benefits when oil prices are high as they sell at the BFP price for refined products but their cost inputs are mostly cheaper gas and coal and less crude oil.

Either way we are in for an interesting year. Expect equities and commodities to remain weak this year as interest rates in the US rise and the USD remains strong. Hopefully the Rand will be able to hold its own as our SA economy (finally) starts to improve.

I wouldn't be too big. Yes, Sasol should recover somewhat as oil prices recover. However, Sasol only started looking at crude hedges when oil prices were around US$58. So, assuming they are hedged now, they will miss any upside above that hedge level. You always know that commodity prices are about to turn when miners, oil producers etc. finally decide to hedge in a panic. Also, Sasol has spent expensive Rands (now worth a lot less) on developing the Louisiana Project and can't turn back now. Gas prices are starting to take a knock in the US as well now and Louisiana could be under water for Sasol which would mean horrible write downs for them. But equity traders will of course use the Brent oil price as a proxy for Sasol and so expect Sasol to rally when oil rallies and vice versa. Until the write downs of course.....

I get a daily report from my OTC oil broker in London every day. From time to time I might post it here....

Oil bears firmly in control
Equity indices suffered a volatile start to the week as yet another big slump in oil prices weighed on investor appetite for risk and dragged energy shares lower. Risk assets did appear to be rebounding in early trading on hopes that the Federal Reserve would extend its time frame for the eventual normalisation of interest rates following last week’s mixed US jobs report. However, fears of a global economic slowdown compounded by further oil price weakness along with concerns that the latest US corporate earnings will fall short of expectations ensured that caution dominated market sentiment. Risk aversion looks set to continue this morning as oil resumes its downward path whilst investors shrug-off stronger-than-expected Chinese trade data.

Global oil supply shows no signs of let-up, so far
This week will see the release of the latest set of monthly reports on supply/demand. We will find out whether there is any recognition that global demand has been stimulated by falling oil prices over the last month and whether OPEC believes that it has started to reclaim market share at the expense of non-OPEC suppliers. The EIA will release its report this afternoon, OPEC on Thursday and the IEA on Friday. Below we take a look at the latest available supply data, recent changes in Official Selling Prices from Middle Eastern oil producers and how slumping oil prices have altered price forecasts for this year.

Energy Intelligence published their December global output figures at the end of last week and it did nothing to encourage oil bulls. They put global oil supply at 96.717 mbpd last month, up 982,000 bpd on November. Non-OPEC supply grew by less than 300,000 bpd (+0.51%) with the US producing 87,000 bpd more in December than the month before. OPEC output jumped 612,000 bpd (+2.04%). OPEC crude oil market share increased from 31.30% in November to 31.61% in December whilst the cartel's share including NGL/condensates and other oil rose from 38.23% to 38.55% during the same period.

Looking at the latest OSPs for February from Iraq, Kuwait and Saudi Arabia, the message is that there is relatively good demand emerging from Asia whilst Europe and the US are over supplied. The above-mentioned Persian Gulf producers all increased their differentials to the Far East for next month whilst cutting them for the rest of the world. Asian buyers will have to pay around 50-60 cents/bbl more for their crude purchases in February than this month whilst the cut to Europe and the US varies between $2.10/bbl (Arab Extra Light and Light Mediterranean Ras Tanura) and 10 cents/bbl (Arab Extra Light US Gulf). We have learnt overnight that Iran also raised its OSP to Asian customers. They will sell their light crude 60 cents/bbl and their heavy crude 65 cents/bbl more expensive than in January.

With global supply staying high in December and Persian Gulf OPEC producers clearly determined to stick to their strategy, oil price forecasters have had no option but to revise down their latest estimates for this year. The latest revision came from Goldman Sachs who published their updated report yesterday. The investment bank cut its 2015 WTI forecast from $73.75/bbl to $47.15/bbl and Brent from $83.75/bbl to $50.40/bbl. The price pressure is expected to be most pronounced in the first quarter with the three-month forecast for Brent standing at $42 against a price curve for this period of currently around $49/bbl. SocGen and Citi have also cut their 2015 price forecast this year.

Money managers are resilient
Whilst there are no fundamental signs emerging that oil prices are close to their bottom, money managers are taking a different view. Financial investors in both WTI and Brent increased their net length last week by 3,000 and 15,000 contracts respectively, despite a price drop of more than $6/bbl during the latest reporting period.

In fact, Brent net length has increased in 11 out of the last 14 weeks even though prices have fallen from $94 /bbl to $51/bbl. Although net speculative length has been rising, its composition has undergone significant changes. When speculators were least exposed in Brent at the end of September last year, they were net long 36,704 lots composed of gross length of 194,099 contracts and a gross short position of 157,395 contracts. Last week net length stood at 140,169 contracts consisting of 254,232 lots of long positions and 114,063 lots of short positions.

This was the first week that saw not only a significant reduction in short positions but also a more than 26,000 lots increase in long positions. In other words, net length grew not only because of short-covering but also due to fresh long positions entering the market. Whilst this seems bullish further price weakness could easily force these longs abandon their positions in the near future. Yesterday’s price fall did nothing to make them feel better as WTI lost $2.29/bbl, Brent $2.68/bbl, Heating Oil 489 points and RBOB 487 points. In a sign of demand revival China’s crude oil imports hit a record high of 7.15 mbpd in December. This, however, seems to have failed to change the prevailing sentiment as Brent has lost another $2/bbl this morning. At the moment the bottom is not in sight

I expect to see massive see-sawing between $45 and $65 oil for some time to come. The reason is that at $45 the frackers don't make money and cut rigs and new drilling completely which reduces supply quite quickly. At $65 the frackers are just making enough money to remain above the variable cost of production, and thus pay off some of their debt and capital etc. which means that all the excess supply is in the system. Which is when the Saudis will again try to drive them out of business by increasing their production and hanging onto market share. It's going to be an interesting game of cat and mouse between the US frackers and the Saudi Sheiks. If only the ZAR would strengthen so we can get some real benefits from the oil price drop.

Once costs are sunk, some can produce at $0,99 per barrel.
 .......
Once oil companies sink cash into drilling wells, lining them with steel pipes and concrete, blasting the surrounding rocks into rubble with hydraulic fracturing, and linking them to pipeline systems, they have no incentive to scale back production, said Andrew Cosgrove, an analyst at Bloomberg Intelligence in Princeton, New Jersey.

That's mostly true but realise that Exxon and others are talking their book, trying desperately to remove the Saudi argument in the immediate term. In terms of conventional oil, these wells last for around 20 years so the marginal cost of production can be as low as $0.99 i.e. they have paid off all capital and are massively profitable. But with fracking, these wells generally only last for 3 to 4 years which is why frackers continually need to drill new wells, with associated capital costs etc. The proof of the pudding is already out there.... 1) Rig utilisation in the US is dropping massively, even though production is currently staying constant. Also, gas prices, which fracking is 80% about, is already starting to respond to potentially lower production. The production cuts will come in a year or so and the oil price will react to that forward view in a few months or so.

Brent rallied last week and now looks overbought on short term momentum. Looking for another downside move this week to test the $40 level.