BMI View : We examine our price forecasts for the Urals and OPEC baskets amidst structural changes in the Russian and OPEC markets. The Iranian negotiations have been a crucial element behind Brent's recent trading, but (if a successful conclusion is reached) they will also disturb OPEC's trading patterns and threaten to push the benchmark below US$100/bbl. Russia's pivot towards the Asian markets combined with Rosneft's consolidation of Russia's supply culminated in the US$85bn supply agreement with China and the diversion of crude oil East. This is a long term strategic shift for Russia, which underpins our view that the spread between Urals and Brent will narrow reflecting tighter supplies of Russian crudes to European markets.
We maintain our 2013 and 2014 Brent and WTI price forecasts, seeing a number of factors - from Iranian negotiations to the new Keystone Gulf Pipeline opening in early January- that strongly reinforce our long held view of lower Brent and higher WTI as we go into Q1 2014 ( see "Oil Price Outlook - Narrowing Spread In 2014 On Ameliorating Cushing Flow", 30 October).
In this month's Oil Price Outlook we turn our attention to our forecasts for the Urals and OPEC baskets. Over an extraordinary 2-month trading period (July-August 2013) we saw Ural's break its usual pattern of trading at a discount to Brent into trading on par, and at times, at a premium. We believe structural changes in the Russian oil trade have caused this break with the traditional pricing pattern. Our forecasts anticipate an even thinner spread between Brent and Urals for 2014 as the Brent price retracts at a faster pace than Urals.
The negotiations with Iran have been a crucial factor moving Brent in recent weeks trading. Negotiations are also going to be pivotal for the OPEC basket, which is a bellwether on how close the OPEC producers are trading from the all-important US$100 mark. Comments and statements from the latest OPEC meeting reflected the nervousness amongst OPEC producers about the potential impact of simultaneous Iranian and Iraqi production ramp-ups with implications on global oil prices. We maintain our OPEC forecast for 2014 at US$101.8/bbl noting a strong downside risk, and we highlight our expectation that the oil basket's average annual price will drop to below US$100/bbl in 2016.
BMI And Bloomberg Consensus Forecasts* For WTI And Brent, US$/bbl
| || 2013f || 2014f || 2015f || 2016f || 2017f |
| Brent Forecast - Bloomberg Consensus || 108.4 || 105 || 102 || 102 || 93.5 |
| Brent BMI Forecast || 107.6 || 102.8 || 102 || 101 || 99 |
| || || || || || |
| WTI Forecast - Bloomberg Consensus || 99.2 || 99.5 || 95 || 95 || 90 |
| WTI BMI Forecast || 98.4 || 101.5 || 101 || 96 || 94 |
| * BMI is a contributor to Bloomberg Consensus. f=forecast. Source: Bloomberg, BMI |
Urals: No Widening Of Discount To Brent Expected
2013 has seen the price of Russian Urals outperform expectations as the medium sour crude traded near parity with the lighter and sweeter Brent through most of the year. The discount of Urals to Brent in the year-to-date (YTD) is at US$0.80/bbl - the lowest level recorded since 1999.
Urals, Brent and Price Spread Forecast, US$/bbl
| || 2005 || 2006 || 2007 || 2008 || 2009 || 2010 || 2011 || 2012 || 2013f || 2014f || 2015f || 2016f |
| Brent || 55.2 || 66.3 || 72.6 || 98.3 || 62.4 || 80.3 || 111.0 || 111.7 || 107.6 || 102.8 || 102.0 || 101.0 |
| Urals || 50.9 || 61.2 || 69.7 || 95.1 || 61.4 || 78.3 || 109.3 || 110.6 || 106.2 || 102.0 || 101.0 || 100.0 |
| Spread || 4.3 || 5.0 || 2.9 || 3.2 || 1.0 || 2.0 || 1.7 || 1.1 || 1.4 || 0.8 || 1.0 || 1.0 |
| f=forecast. Source: Bloomberg, BMI |
| Urals-Brent Discount At A Low |
|Average Price Of Brent & Russian Urals (LHS) & Discount Of Urals To Brent (RHS), US$/bbl|
The narrowing of Urals' discount to Brent has taken place in view of the following changes in fundamentals of the Russian market:
Growing Domestic Refining Demand For Crude Oil
Contrary to the price trend exhibited by Russian Urals in 2013, total Russian crude oil output has in fact continued to grow over the year. In the first 11 months of 2013, oil production averaged at about 10.5mn barrels per day (b/d) - a 1.3% year-on-year (y-o-y) increase from 2012. However, demand for crude oil by domestic refineries grew by 3.4% over the same period between 2012 and 2013.
| Domestic Refiners Increase Crude Demand |
|Russia - Share Of Domestic Crude Use In Total Crude Production (mn b/d)|
Growing domestic demand for crude has in fact seen Russia's crude oil exports fall by 2% y-o-y in the first 11 months of 2013. Hence, given the domestic downstream sector's reliance on domestic crude for production, a faster rate of demand to supply growth has supported Urals, while the global crude benchmark Brent was hit particularly in Q213 by bearish sentiments regarding global growth on the back of disappointing PMI figures for China and Europe in the second quarter of the year.
Consolidation Of Rosneft's Control
However, this alone should not have sustained Urals' high price relative to Brent. This is particularly as Brent recovered H213 as a result of the following: better-than-expected economic growth figures from China and the Eurozone, and unplanned output disruptions especially in Libya and Nigeria combined with heightened political risks in the Middle East.
One of the key supports for Urals through Brent's price recovery is the consolidation of state-owned Rosneft's control of Russian crude oil production. The acquisition of Russia's third largest crude oil producer TNK-BP earlier in 2013 has significantly boosted its dominance in the Russian market. For example, Q313 saw total oil output attributable to the firm grow by 70.8% year-on-year (y-o-y), from 2.45mn barrels per day (b/d) in Q312 to 4.19mn b/d in Q313 ( see 'Rosneft's Ambitions Offer Opportunities', October 31). This has in turn seen Rosneft' share of total Russian crude oil production rise from about 25% in 2012 to nearly 40% in 2013.
| Giant Increases Footprint In Market |
|Rosneft's Share In Total Russian Oil Production (mn b/d)|
This has given Rosneft's considerable control over the availability of Russian crude oil supplies. According to statistics by Russia's Ministry of Energy, the country has seen an increase in crude oil that has not been used for domestic refining purpose nor exported in 2013. It is likely that this has been put in storage instead (see chart above).
That the increase in unused oil in the Russian system coincides with Rosneft's greater control over the country's crude oil supplies is notable. It is not for a lack of both internal and external demand that this storage has taken place. Reuters reported in July 2013 that European refiners have made a rare move to turn to crude supplies from the UAE in response to the shortfall of Urals available on the market. Within Russia, independent refiners without long-term supply deals with major upstream producers have also experienced difficulty securing crude oil feedstock from the market.
On the one hand, it could be a means of controlling prices in the short-term. On the other hand, Rosneft's growing long-term supply obligations backed by oil-for-loan deals has also increased pressure for it to prioritise deliveries to these clients over supplies to the open market. In 2013, it entered into agreements that could oblige it to supply 1.56mn b/d in 2014 to these partners alone - about 33% of Russia's total crude oil exports in 2013 and 37% of the firm's total liquids output in Q313.
This figure could be further raised if it concludes a seaborne crude supply deal with shareholder BP by end-2013/early 2014 as widely expected. Moreover, Rosneft is also contractually obliged to supply China with an additional 300,000b/d of crude by 2018 under a second oil-for-loans deal finalised in June 2013. These deals remove a considerable amount of supplies available to the Russian spot market.
Rosneft's Long Term Supply Contracts Inked In 2013
| Company || Country || Quantity ('000 b/d) || Total Value (US$bn) || Duration (years) || Effective Date || Notes |
| PKN Orlen || Czech Republic || 120.49 || 15 || 3 || 2013 || |
| Eni || na || 20.08 || na || na || 2013 || |
| Glencore || na || 188.37 || 10 || 3 || 2013 || |
| Vitol || na || 84.35 || 3 || 2013 || |
| Sinopec || China || 200.82 || 85 || 10 || 2014 || MOU signed |
| Trafigura || na || 40.61 || 1.5 || 5 || 2013 || |
| CNPC (ESPO) || China || 301.23 || 270 || 5 || In place || Conservative estimate |
| CNPC (ESPO) || China || 602.47 || 25 || 2018 || |
| CNPC (via Kazakhstan) || China || 140.58 || 5 || 2014 || In addition to existing supplies |
| CNPC (For Tianjin) || China || 182.75 || na || 2018 || Assuming FID is made by 2014 |
| PKN Orlen (Unipetrol) || Czech Republic || 166.28 || 6.2 || 3 || 2013 || |
| Saras || Italy || 300.00 || na || na || 2013 || |
| || || || || || || |
| Contracted Volumes For 2014 (Based On Average) || || 1,562.81 || || || || |
| Source: BMI Research |
2014: Downstream And External Demand To Keep Urals-Brent Discount Tight
Thus, domestic and external demand for Urals has contributed to the significant narrowing of the Russian Urals' discount to Brent especially in 2013. In the year ahead, we see few indications that this discount would widen.
Rosneft's contractual obligations: The prioritisation of supplies for contracted customers would continue to put pressure on remaining crude oil output available for the Urals market;
Downstream expansion: Although we expect a consolidation of the Russian downstream market as independent refiners are squeezed out by the high cost of crude, major integrated players such as Rosneft and Gazprom Neft will continue to increase their output. This is a result of an ongoing modernisation programme that these firms have embarked on, that would either increase capacity or plant efficiency. Less downtime could be expected as integrated refiners continue to boost output not only to capture gains from lower export taxation on refined products, but also economies of scale to feed domestic and export demand.
| Domestic Refined Demand To Stay High |
|Russia - Crude Oil Refining Capacity (LHS) & Refined Products Output (RHS), '000b/d|
As such, we maintain our forecast for the discount of Urals to Brent at US$0.80/bbl in 2014.
...But If Iran Comes Back Online
However, neither do we expect Urals to trade at a sustained premium to Brent in 2014, even if there could be short instances as witnessed in 2013. This is largely due to our expectations of that an easing of tensions between Iran and the West could see the return of some supplies of Iranian crude back into the global market. We have already factored this into our forecast for Brent, contributing to our expectations for the global crude benchmark to fall to an average of US$102.80/bbl for 2014.
Urals could be particularly hit, as the medium sour crude grade had been one of the key substitutes for Iranian crude that was taken off the market in 2012. However, we believe the impact of this could be limited considering:
Production start-up: Time will be needed to restart production wells in Iran that had been shut-in as a result of sanctions. This would prevent a rush of Iranian crude into the global market that would significantly push out Urals;
Long-term supply deals: Russia had emerged as one of the biggest winners of the loss of Iranian crude particularly in the Chinese market. The existence of a long-term supply deal, which contracted quantity is only set to expand up to 2018, will lock-in Chinese demand. Other large supply deals inked by Rosneft will also cap the amount of Russian crude oil in the spot market.
Nonetheless, we see significant downside risks if Iranian crude is able to return to the market at a faster speed than we currently anticipate. This could arise particularly if Iran has sufficient crude oil stored that can be immediately offered to the market.
OPEC: Over-Supply Risk Likely To See Downward Prices
We are maintaining our forecast for the OPEC basket price, as the global oil market will remain well supplied in the months ahead. Our 2013 average price forecast for OPEC basket remains unchanged, at US$105/bbl as does our 2014 price, at US$101.5/bbl.
BMI's OPEC, Brent and WTI Price Forecast, Average price (US$/bbl)
| || 2012 || 2013 || 2014 || 2015 || 2016 |
| OPEC basket, US$/bbl || 109.5 || 105.5 || 101.8 || 100 || 99 |
| Brent US$/bbl || 111.7 || 107.6 || 102.8 || 102 || 101 |
| WTI US$/bbl || 93.3 || 98.4 || 101.5 || 101 || 96 |
| Source: BMI |
At the OPEC ministers meeting in December 2013, OPEC members reached the agreement to keep their current crude output ceiling of 30mn barrels per day (b/d) for the time being, until at least their next meeting in June 2014. This decision had been widely expected, with Saudi Arabia and many of the other OPEC members announcing in advance of the talks that they are comfortable with current oil market fundamentals, including a price above the US$100/bbl mark. Saudi production has been particularly high, reaching production records in July, August and September 2013, which in part offset the impact of unplanned outages in other OPEC producers such as Libya. The slowly improving global economic situation is also providing sufficient demand to justify a maintaining of OPEC output at this point.
| Record Saudi Arabian Production Offsets Unplanned Outages |
|Saudi Arabia Oil Production (000b/d)|
The projected increase in non-OPEC supplies, led by a ramp-up in US production, means that the global oil market will remain well supplied in the next six months. When added to OPEC production which is set to remain at 30mn b/d until at minimum June 2014, world oil supply will increase faster than demand creating downward pressure on prices.
| US Leads In Non-OPEC Supply Growth |
|United States Oil Production and Net Exports (000b/d)|
However, an important question that remains will be OPEC's and Saudi Arabia's reaction to a potential resurgence of output from Libya, Iraq, and most importantly, Iran. Libya has experienced severe cut backs in production in recent months, due to ongoing domestic strife and the blockading of oil export terminals. In November 2013, Libyan production fell to just 250,000b/d, well below levels of 1.4mn b/d in earlier months of the year.
| Underperforming Libya |
|Libya Oil Production (000b/d)|
Similarly, Iraqi production has underperformed in recent years, with an average oil production of 3.1mn b/d for the months of January-November 2013. However, with the level of investment and development in the country, we see Iraqi production likely increasing to above 4.3mn by 2016. Lastly, Iran has also stated that it would want to produce 4mn b/d as of next year, up from November 2013 production levels of 2.6mn b/d should the interim agreement reached in Geneva result in a comprehensive agreement on the nuclear issue and a lifting of sanctions. While such a large increase is unlikely for 2014, we do believe that Iran could quickly return to levels of above the 3mn b/d threshold shortly after a hypothetical lifting in sanctions.
| Large Iraqi Potential |
|Iraq Oil Production (000b/d)|
A potential resurgence of these volumes would result in excess supplies which would push prices much lower in the short-term if production cuts are not made. OPEC's reaction and Saudi Arabia's reaction would be crucial here for oil prices. Recent comments by OPEC members suggest that they would likely accommodate an increase in Iranian oil and that an adjustment of output quotas is likely if sanctions are lifted.
Nevertheless, we believe that cuts in Saudi Arabian production would most likely not suffice to offset a return of Libyan, Iraqi and Iranian volumes, resulting in excess supplies from OPEC members. Members could increasingly face competition from one another to gain a share in the increasingly limited demand market, as US production continues to increase and as European demand wanes. This will result in a drop in OPEC prices in the coming years.
However, we do note both short and possibly long term upside risks to our forecast:
Short-term risks: The continued threat of disruptions in OPEC countries such as Nigeria, which has seen large divestments by major companies due to crude theft, pipeline vandalism and an uncertain regulatory environment is an important upside risk to our price forecast. Venezuelan political unrest is also a concern, and could lead to a further decrease in production. Other issues could occur, such as the planned incremental supply from Iraq which could not emerge due to civil unrest, and an unlikely return of Libyan production in the near term.
Medium to longer-term risks:
With the majority of OPEC producers reliant on high oil revenues to fund national budgets and support domestic spending programmes, a substantial fall in prices is not an economically viable option. This means that OPEC could have to reduce its quota at some point in the future, possibly in mid or late 2014. These developments could create upside risks to our price forecast.