In my article to the Business Section of the Daily Mirror of 29 January 2013, I summarized five scenarios of energy surprises in 2013 mainly spotlighting on oil and gas.
As a follow up, I will discuss the possibility of oil prices declining in 2013 and how Sri Lanka can take advantage in such a situation as it will be vital for the economy to keep pace with its present rate of growth.

It is reported that the annual oil bill which varies depending on world prices now stands at around US $ 5 billion while the GNP is around US $ 60 billion. (Details of oil imports at http://tiny.cc/LakOil)

It is therefore of paramount importance to take advantage of declining oil prices in the world market and very closely monitor any changes for futures trading or hedging.
Recent findings of scientists from the British Antarctic Survey examining ice cores showing climate records for tens of  thousands of years  are  that the ice sheets  retreat due to global warming often suddenly stabilizes “for decades to centuries” despite the warming,  justifying  increased use of non renewable energy. This anomaly is also applicable to oil where the supply and demand fundamentals indicate that prices should decline but still stay high.

As far back as October 2012 Goldman Sachs (GS) analyst David Greely stated that the firm’s previous oil price forecasts made for 2011 and repeated several times “the right price of oil “in 2012 and 2013 is US$ 125 per barrel for the US marker blend WTI (West Texas Intermediate) and US $ 139 for the European and Asian marker blend Brent (major trading classification of sweet light crude oil) were too high. The mistake made by Greely was to use the oil market trader’s codes.  Subsequently Greely stated “oil markets are now cyclically tight but structurally stable”. He further stated that GS now sees long dated Brent Crude oil stabilizing at around US$ 90/bbl in 2013, a price level with a shocking US$ 40 per barrel or less!

However as of 22 January 2013, Brent prices are around US $ 112 per barrel. A significant number of market analysts say that US$ 120 and above and another group will forecast US $ 50 a barrel or less and with such a range of price forecasts someone should hit the jackpot!!





Cyclically tight –Structurally stable
The above revised forecast could save face for GS, when oil prices decline, depending how fast and how much and who brings the overpriced oil down. It is expected that prices can easily decline 10 to 15 per cent range below current levels. But the major players namely oil producers and exporters would take a tough stand on who gains from global market trading.

World trade in crude oil is valued at US$ 10 trillion a year and is only 50 per cent.   Trades related to oil namely bets on the spread of premium between Brent and WTI, refined product price bets (hedging), on speculation related to refining value gains from different types of processing tanker, pipeline and rail transport trades and others make up another US $ 10 trillion. Accordingly, the total turnover on speculation in oil trading will therefore run into over US$ 20 trillion a year- about US$100 billion every single trading day of the year. This is “normal paper value” at most the ratio of real and “physical” trades on oil and refined products to speculation or futures trade (hedging) on prices is 1:80!

Financing of this speculation is not structurally stable and can dry up overnight and surge the next GS and a selected major international banks , broker traders, oil producer corporations, refiners, pipeline companies , oil transporters and offset trade operators and what they know about oil  is simple.= things are better for them when prices are high. This fact is the “dirty secret” of global oil trading and is totally opposite of how the majority of market actors and players in the speculation in oil trading operated up to about 2005.Previously they played a low profile and acted to push down oil and oil product prices. However for the past 8 years these major players now consistently act to maintain or increase oil and oil product prices causing severe strain on the world economy.

Oil traders and analysts were not fooled by October 2012 forecast by GS and if GS says that it exaggerated, the “right price of oil “and the prices should now fall it is good time to buy calls on futures because prices will probably rise according to oil  market trading  psychology.

Further Greely’s of GS pricing regime going back to crude oil market in the 1990’s when Brent prices were anchored at US$ 20 /barrel which would mean $16.75 /barrel in terms of 2013 dollars. The reality of such stability in prices coming back according to GS is total fiction or a crude attempt to fool rival brokers and traders into getting them on the wrong footing related to future prices (hedging).Greely is also of the view that present OPEC and Russian spare capacity that gave rise to long dated low prices in the 1990’s can happen again. He also argues that “substantial growth in crude oil supplies from US shale, Canadian oil sands and global deep water oil provinces will contribute to decline in oil prices.





World oil demand
It is observed that growth in world oil demand is relatively flat or declining not only in US .Europe,   Japan but also in emerging economies and Greely states that US WTI grade crude is low priced relative to Brent “and nobody seems to have noticed”. However outside observers including OPEC and NOPEC oil producing countries (Russian Federation ,US, Canada China, Brazil Norway and Britain producing 48 billion barrels  a day comprising 60 per cent of production)have noted that at present Brent grade crude costs about US$2 5 for each barrel than WTI grade crude .It has been noted that the world economy is able to absorb this differential and high oil prices., but OPEC and NOPEC producing countries oil ministers  often state that they only get a part of this windfall and slashing their own export prices for crude or refined products makes no sense to them.

 The reason why the WTI prices now trade at a massive discount is NYMEX Futures  pricing “hub” for physical delivery   cannot be transported onward to US Gulf Coast for refining and are not able to ship outside the US earning the US4 25 a barrel mark up in Brent-priced markets.

Greely from GS also refers to the lack of US pipeline capacity and advocates seaway pipeline expansion from the current capacity of 150 000 barrels a day to its new capacity of 400,000 b/d in 2013. However conversely in the meantime the addition of substantial new rail loading and unloading capacity in 2012 to move Brakken crude (from oil shale in South Dakota) to the Gulf Coast and also to Pacific Coast for export to Asian markets where Brent pricing rules.

In theory anyone who can get WTI priced oil out from US to any place in Europe and Asia has a long term winning business plan. For OPEC and NOPEC producers price decline for both WTI and Brent is no threat if it is “moderate but the “fraternity” of oil traders, brokers, bankers and fixers like GS are taking too much. For as long as they do,  prices have to stay where they are – shown by recent warnings from Saudi Arabia and the Russian Federation , the world two biggest oil exporters who will have no problem in cutting production and watching prices rise.





Privatizing Petroleum Corporation
In conclusion, I would like to comment on the recent statement by the Deputy Minister of Finance that the Petroleum Corporation which imports and distributes refined oil and gas and also operates a refinery having a capacity for refining of 2 million metric tons of light crude oil from 1969 should be privatized due to heavy losses incurred over the past years.

It is the prerogative of the Government to decide on the privatization of the Petroleum Corporation .However in the analyses given above it is prudent to bring in the private sector for Sri Lanka to effectively resolve the complexities involved in world oil markets.

To this end, an experienced and dedicated team of analysts who can be drawn from various disciplines in the financial sectors locally and internationally   will be able to master futures trading in world global oil markets and avoid pitfalls from the vicious circle of producers, brokers, traders and fixers etc.  I would like to stress that this could only be achieved only with the dedication and innovative action of the private sector in close collaboration with the related agencies of the government.
I hope to continue this dialogue showing how the new Port of Hambantota and the Port of Trincomalee can play in the development of the local and regional petroleum sectors with foreign collaboration in my next article.

Reference:  Information and data have been extensively drawn from an article titled “Will Oil Prices Decline in 2013” by Andrew Mckillop   from Oil Voice Magazine February 2013.

(The writer is a retired Economic Affairs Officer United Nations ESCAP and can be reached at [email protected] )