Energy and Financial Markets Overview: Crude Oil Price Formation Richard Newell, Administrator May 5, 2011 www.eia.gov EIA’s Energy and Financial Markets Initiative • Collection of critical energy information to improve market transparency – improved petroleum storage capacity data – other improvements to data quality and coverage • Analysis of energy and financial market dynamics to improve understanding of what drives energy prices – internal analysis and sponsorship of external research • Outreach with other Federal agencies, experts, and the public – expert workshops – public sessions at EIA’s energy conferences – solicitation of public comment on EIA’s data collections 2 Richard Newell, May 5, 2011 Synthesis of current perspectives on oil price formation 3 Richard Newell, May 5, 2011 Who’s who in global oil markets • Producers – international oil companies (private) – national oil companies (government-controlled) • Consumers – individuals (autos and space-heating) – transportation fleets (trucking, shipping, air) – industrials (chemicals and plastics manufacturers) and power generation • Traders, hedgers, speculators, and investors – merchants: firms facilitating physical trade – financial market participants • index investment by pensions, endowments, and others • commodity trading advisors, hedge funds, and individuals • swap dealers: typically banks and merchants serving customers • Policymakers – demand-side (subsidies); supply-side (OPEC quotas); market regulation (position limits) 4 Richard Newell, May 5, 2011 Many factors influence the formation of oil prices and other energy prices Supply Physical balancing Demand Affected by current • Inventories Affected by current conditions and future conditions and future expectations for: Markets & market behavior expectations for: • energy prices • Energy prices • energy prices • OPEC supply capacity ‐ spot • economic growth • usable spare capacity ‐ futures • industrial production • non-OPEC capacity ‐ options • goods transport • geopolitics ‐ spreads • personal transport • weather ‐ swaps • weather • E&P costs • Other financial markets • innovation in energy- • E&P investments using equipment ‐ other commodity prices • E&P innovations ‐ commodity investment ‐ currency exchange rates ‐ stocks and other assets ‐ interest rates 5 Richard Newell, May 5, 2011 EIA is actively examining the role of both supply-demand fundamentals and other factors in oil price formation • EIA has asked several academic partners to conduct thorough reviews of economic literature regarding supply-demand fundamentals and the role of financial market speculation and investment in the oil-price formation process – the work is ongoing, but still at an early stage • Some researchers are finding evidence that factors including unexpectedly strong economic growth in China and stagnant supply were at least associated with, and may have contributed to, the sharp oil price run-up and subsequent decline during the 2007-2008 period • The researchers are also finding some evidence suggesting that the price run-up and decline may have been exacerbated by the formation and collapse of an oil price bubble, perhaps triggered by fundamental factors in both the oil market and the broader global economy • As discussed later in the presentation, both internal EIA and academic research is also addressing the major increase in oil derivatives trading, significant change in the composition of derivatives traders (such as the growth of swap dealers, hedge funds, and commodity index funds), and increased correlation of oil and other markets over the past several years 6 Richard Newell, May 5, 2011 Crude oil prices react to a variety of economic and geopolitical events price per barrel (real 2009 dollars, quarterly average) 140 Global financial collapse Imported refiner acquisition cost WTI crude oil 120 Iran-Iraq War 100 Low spare capacity 80 Saudis abandon 9-11 attacks swing producer role 60 U.S. spare capacity Asian financial crisis exhausted 40 OPEC cuts quotas Iranian revolution 4.2 mmbpd 20 Iraq invades Kuwait OPEC cuts quotas Arab Oil Embargo 1.7 mmbpd 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 Sources: EIA, Thomson Reuters 7 Richard Newell, May 5, 2011 World oil prices move together due to arbitrage price per barrel (real 2009 dollars, monthly average) 160 WTI crude oil 140 Brent crude oil MARS crude oil 120 Tapis crude oil Dubai crude oil 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: Bloomberg, Thomson Reuters 8 Richard Newell, May 5, 2011 Crude oil prices are the primary driver of petroleum product prices price per gallon (real 2009 dollars, monthly average) price per barrel (real 2009 dollars) 4.00 Forecast 160 Unplanned refinery 3.50 down-time 140 Post-hurricane 3.00 refinery repairs 120 2.50 100 2.00 Hurricane Katrina shuts down refineries & pipelines 80 1.50 60 1.00 40 gasoline wholesale (left axis) 0.50 diesel wholesale (left axis) 20 WTI crude oil (right axis) 0.00 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: EIA, Thomson Reuters 9 Richard Newell, May 5, 2011 Oil demand 10 Richard Newell, May 5, 2011 Oil demand and consumption: What matters? • Oil consumption is determined by demand drivers and price • Demand is closely related to the state of the global economy – oil is an input into industrial production and the transport of goods – household income and employment drive personal transport demand • Demand in recent years has come increasingly from non- OECD countries, led by China – growth expectations for Asia ex-Japan approached 10% by 2010 • Price increases tamp-down fundamental demand drivers – the net effect on consumption depends on the relative strength of price impacts and economic growth 11 Richard Newell, May 5, 2011 In non-OECD countries, economic growth has a strong impact on oil consumption percent change (year-on-year) 12 Forecast 10 8 6 4 2 0 -2 non-OECD oil consumption non-OECD GDP -4 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: EIA, IHS Global Insight 12 Richard Newell, May 5, 2011 Economic growth in Asian economies surprised to the upside in 2007 and 2009 and to the downside in 2008 percent GDP growth in Asia-ex Japan (annual expectations) 10 9 8 7 6 2007 5 2008 4 Starting in January of each year, each line shows the expected forecast of GDP growth for 2009 3 the specified calendar year, which tends to move toward the actual realized growth outcome 2010 2 as the year progresses. Expectations continue to evolve into the next calendar year as revised 1 GDP data become available (e.g., 2007 GDP expectations are revised even during 2008). 0 2007 2008 2009 2010 2011 Source: IHS Global Insight 13 Richard Newell, May 5, 2011 In OECD countries, price increases have coincided with lower consumption percent change (year-on-year) price per barrel (real 2009 dollars) 6 135 Forecast 4 90 2 45 0 0 -2 -45 OECD consumption (left axis) -4 WTI crude oil (right axis) -90 -6 -135 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: EIA, Thomson Reuters 14 Richard Newell, May 5, 2011 Rising oil prices held down global oil consumption growth from 2005-2008, despite high economic growth percent change (year-on-year) price per barrel (real 2009 dollars) 6 135 Forecast 5 4 90 3 2 45 1 0 0 -1 -2 World oil consumption (left axis) -45 World GDP (left axis) -3 WTI crude oil (right axis) -4 -90 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: EIA, Thomson Reuters 15 Richard Newell, May 5, 2011 Oil supply 16 Richard Newell, May 5, 2011 Oil supply and production: What matters? • OPEC – actively sets production quotas for members (compliance varies) – can influence prices with announced price targets and quotas – maintenance of spare capacity by Saudi Arabia gives it the option to pursue price objectives – in times of low spare capacity, OPEC’s ability to respond to supply shocks or rising demand is reduced – this reduced ability coincided with 2004-2008 oil price increases • Non-OPEC – production is typically at or close to full capacity – unlike OPEC producers, almost no near-term price-driven variation in production levels – even with rising prices, there was almost no net annual production increase during 2005-2008 17 Richard Newell, May 5, 2011 OPEC production often acts to balance the oil market; OPEC quota cuts tend to lead to price increases million barrels per day change (year-on-year) percent change (year-on-year) 5 100 4 80 3 60 2 40 1 20 0 0 -1 -20 -2 -40 -3 OPEC quotas (left axis) -60 WTI crude oil (right axis) -4 -80 -5 -100 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: EIA , Thomson Reuters 18 Richard Newell, May 5, 2011 Non-OPEC production saw strong growth in 2009-2010. EIA expects these increases to slow in 2011-2012 million barrels per day change (year-on-year) price per barrel (real 2009 dollars) 2.0 140 Forecast 1.5 105 1.0 70 0.5 35 0.0 0 non-OPEC production (left -0.5 axis) -35 WTI crude oil (right axis) -1.0 -70 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: EIA, Thomson Reuters 19 Richard Newell, May 5, 2011 Non-OPEC supply expectations were adjusted upward in 2009-2010 after production decreases during downturn million barrels per day (annual average expectations) 52.0 2007 2008 2009 2010 2011 51.5 51.0 50.5 50.0 Starting in January of each year, each line shows the 49.5 expected forecast of non-OPEC supply growth for the specified calendar year, which tends to move toward the actual realized growth outcome as the year