Welcome to the first in our blog post series from David Fyfe, Chief Economist at Argus Media. In this episode, Dr. Rouben Indjikian, lecturer in energy and commodities at Webster University Geneva speaks to David about the state and future of global energy.
This podcast was produced by and republished in agreement with Webster University Geneva.
Rouben Indjikian [00:00:01] Hello everybody. Today's 20 June 2019. And we are running for time an event called 'State and Future of Energy' in Webster University, Geneva. I'm Dr. Rouben Indjikian, Professor of Energy and Commodities here at WUG. And, it is my honour and pleasure to host David Fyfe, Chief Economist of Argus Media, with who will run this event in 30 minutes time. But before doing that I would like to register and podcast some views of David on key questions which I'm going to ask him. So, my first question, David, would be, the following: Argus Media is a leading oil and energy price reporting agency. What are the main sources of price data and how are you collecting them; how your price reporting system evolved with the development of ICT technologies, which I believe permits making information nearly instantaneously available for market participants, thus helping them to determine the contract prices. Are they also simultaneously collecting that data from other price reporting agencies, or using data of one of them will suffice for them to engage in trade? That is my first question.
David Fyfe [00:01:42] Rouben, thank you very much for hosting me here and thank you for the question. I am going to step back initially and say, why do people make use of the price reporting agencies and why do commodity traders buyers and sellers require price benchmarks; and the job of the PRAs, as we call ourselves, is to shine a light onto physical trades and relatively opaque markets. We can all get the price of Brent Crude or of Nymex WTI from the Wall Street Journal or the Financial Times, every day, that is a very transparent market.
[00:02:24] But the actual physical dealings, in whether it's physical Brent, physical WTI, a myriad of other crude grades, and indeed refined products grades, that requires the PRAs to essentially take a survey of real deals done, or bids and offers in the physical market, and that is what we are doing; we're gathering together data, every day, every hour of every day, of physical deals and bids and offers made in the market.
[00:02:57] Now, of course that used to be done with perceived market experts who would sit and scratch their chin and say, 'well my view is that prices today roughly did this or that,' on the basis of half a dozen phone calls to market players.
[00:03:15] The methodology has evolved a lot since then, as you suggest, and it's now essentially done electronically and therefore participants in the physical market - whether they are conducting a deal or making a bid or an offer - will submit that data electronically to the PRAs who will collate that data, will examine it, look for any outliers or any unusual trades that look suspicious for any reason. There's an ability to exclude anything that looks out of the ordinary, or unrepresentative of the trades during the day, and then they will publish each and every day an assessment for that particular crude oil or that refined product; and then that price assessment will be used by market players as the benchmark off which they will trade, make their deals, make their transactions.
Rouben Indjikian [00:04:17] Very interesting, so in a way, just to comment your answer to the first question, the market participants are interested, themselves, to submit information electronically to price reporting agencies, so that they will learn also the whole picture from others who are also submitting; so it is becoming quite a sophisticated collaboration between PRA and market participants.
David Fyfe [00:04:46] Yes, yes it is, although I would say that participation is not necessarily 100 percent. There are some companies who prefer not to have their bids and offers scrutinised in a public window, such as the Platts window, or the Argus open market system, and they continue to undertake deals outside of that reporting process. But there are many people who are keen that their transactions are recorded and are seen by third parties out there in the market.
Rouben Indjikian [00:05:23] I see. The next question is about your role as a chief economist of Argus Media. I believe you are looking at the bigger picture of world economy growth and its implications on energy production and consumption, especially in the short term. How do you see the current state of the world economy in that respect, and also a related question, how do you think the escalation of import tariffs in US-China standoff can impact trade inflation and growth in those key economies and the world at large, and as a result, impact on energy consumption?
David Fyfe [00:06:02] That's a very big question to try and answer in about one or two minutes. But I think we are at a stage now - and really yesterday's statement from the US Federal Reserve I think was an example of that - where there are real concerns about this slowdown in macroeconomic activity taking place worldwide. We've had 10-11 years unbroken years of US economic expansion and historically it has been the case that the cycle for continuous expansion and economic activity tends to have a lifetime of let's say 10 or 12 years, and therefore it's not surprising that we're seeing the beginnings of a slowdown in world economic growth. The IMF has reduced its expectations of economic growth for this year down to 3.3 percent globally. Many people think that if we achieve 3 percent growth this year, on an annual basis, we will be lucky. So, there are definite signs, and all the trade data that we see out there, month on month trade, the pace of growth in trade is slowing very dramatically. So, the signals are there that we confront a slowdown and that's important for commodities, because the demand for commodities more than anything else is driven by the pace of economic activity. So, if we have slower economic growth, we're going to have slower growth in both the consumption and the trade of commodities. And I think that is clearly quite likely to happen in 2019 and 2020.
[00:07:42] Now when we look at the trade war between the US and China, we ran a, if you like, a back of the envelope calculation - a very macro top down calculation - and we said okay, well, what if the trade war expands - maybe the US imposes tariffs on Mexico and other places - what are some of the scenarios for economic growth? And we said if instead of getting 3.3 percent GDP growth this year we got 3, and instead of getting 3.6 percent global growth in 2020, we only got 3 percent, what would that do to global oil demand? And our calculations suggested that, were that scenario to play out, total oil demand in 2020 could be as much as half a million barrels per day lower than in the IMF's base case. So, it's a a non-negligible impact, potentially, on global oil demand in overall terms. Now, we're not saying that we think that will be the impact of the trade war on economic growth; we're just saying what if that happens, what would be the impact on oil? And it's quite substantial.
Rouben Indjikian [00:08:56] So, the related question to that expectation is also that we have, as a result of ongoing shale revolution, the USA became the world leader in crude oil production and also expanding gas production. So, that must have downward pressure on spot prices and future curves. So, what is the situation with current oil prices and how Opec and Opec+ can resist through supply management, the downward pressure on prices, and due to record oil production; and now as you said, the expectation of slower world economy growth; in other words, are we in contango or backwardation?
David Fyfe [00:09:49] Well the Brent market is in backwardation; WTI actually is in contango, so the two are in fundamentally different structure for the nearby months. What I would say is the market is being pulled in two different directions. There are a set of bullish market forces that would tend to suggest higher prompt prices, and there are a couple of more bearish elements that would tend to suggest lower prices. The bearish factors, as you've identified, are the economic slowdown and the rapid pace of US supply growth. US crude supply is expected to grow by over 1.5 million barrels per day this year, as it has over the last couple of years. And, if oil demand is only growing by something similar on a global basis, it tells you there's not much room for Opec to expand its supply. However, offsetting that clearly are a couple of other elements that are more supportive of crude. One of those is geopolitical tensions, and we've seen what's happening in the Middle Eastern Gulf over recent weeks; attacks on product tankers and more recently - just yesterday - the shooting down by the Iranian Revolutionary Guard of a US drone. So, there are clearly concerns about the stability of oil supplies out of the Gulf. My own view would be that the Iranians are unlikely to try to close the Straits of Hormuz unless the regime itself was under some existential threat, which I don't think is the case at the moment. Nonetheless, the market is very worried about that, and that is supporting prices in the face of economic slowdown and rapidly growing shale.
[00:11:44] The final factor that I think will be supportive of crude in the second half of 2019, is the impending change in marine fuel sulphur specifications, because what that is going to do is it's going to require global refiners to buy more crude, to run more crude, to build inventories of low sulphur components to put into the marine fuel pool. And, therefore, you know, that's why I think we have prices that are sort of oscillating around a 60 dollar per barrel level at a moment because the market can't really decide whether the bearish factors hold sway or the more bullish factors hold sway.
[00:12:29] And we're going to have to see how that plays out. But the bottom line is, there's not a lot of room for Opec producers to raise supply over the next, I would say, 18 months to two years.
Rouben Indjikian [00:12:43] In that respect what would you think would be the situation with stocks strategic and commercial stocks. Are they going to build up because of some relative supply. Excess supply given the situation with demand or it will just stay where they are.
David Fyfe [00:13:09] It depends. It depends if we go to that lower oil demand trajectory. I think if Opec, and let's assume that Opec would like to continue drawing global inventories a little bit further to get a bit of breathing space. If we're on the base case demand projection for this year of 1.5 million barrels per day of growth or more, than inventory will probably keep drawing, which is what I think Opec producers and potentially Russia would like to see. If, however, we get a real hit on oil demand from trade war and a sharper than expected slowdown in economic growth, then clearly Opec producers might have to cut even more; they're currently producing about 30 million barrels per day. And, if we had the impact of trade war and slower economic growth potentially, they might have to cut by a further 0.5 or 1 million barrels per day in 2020 in order to keep inventories drawing further.
Rouben Indjikian [00:14:14] Very interesting; and let me ask also that my last question is about the impact of long term outlooks on current situation, because we have industries frequently blamed to reflect the interests of producers and being biased towards major oil or fossil fuels in world energy balance for coming years and even decades. At the same time, environmental regulations are expected to be much stricter. So, we have a situation where we see conflicting expectations from one side. People think that, due to the increase of population and increase in demand for energy; in absolute terms, oil and coal will still be produced in the more or less current amount. The other group of people says no, the renewables will enter into the play much more dramatically, and there will be no more possibilities for price spikes for oil, for example, or coal, because the inter energy competition and more flexible the reaction of markets of energy markets by switching from one source of energy to another source due to the situation. So, what do you think, how these long term views, I would say conflicting views, are these somehow reflected in prices today or these are not?
David Fyfe [00:16:01] I think we're talking here about the energy transition and, I sometimes smile when I hear it called 'the energy transition', because in the 35 years that I've been in the energy business, I've never known it being anything other than transition. That is the nature of of the business that we are in.
[00:16:22] What I would say is, I am someone who sees the glass half glass half full for the hydrocarbon sector, because I think it will be impossible to meet the material demands of a growing global population to the basics of light and shelter, and heat and nourishment, without a role for hydrocarbon energies going forward. I think, from an environmental standpoint, we have to try and lower our carbon footprint. But the idea that we can suddenly make this switch away from hydrocarbons, for 85 percent of our energy needs to zero, anytime in the next 30-40 years is frankly, fanciful. Hydrocarbons will have a role, alongside a growing share for renewables. Remember, most perceptions, at present, with current technology expect that renewables at best can attain 15 or 20 percent of the energy mix by between 2030 and 2040.
[00:17:29] So, what is the rest of the world going to use? It's going to rely on improved energy efficiency; it's going to continue to require on more sophisticated, more efficient use of oil and gas. Coal is still going to be in the mix, albeit in a diminishing market share. I think we're going to have to, at some stage, put a price on carbon, because that will be a way to try and reflect society's concerns about pollution, going forward, and to bring forward technologies such as carbon capture and storage, which are vital for us to be able to continue to meet society's rising energy needs; not so much in Switzerland and the UK, and the US, but in the emerging world, where people have a right to improved living standards, a right to higher survival rates, which energy and access to energy brings. So let's be more holistic about this. Let's talk about security of supply. Let's talk about the availability of resource. Let's talk about the affordability in emerging countries, and also the environmental sustainability. So renewables, electric vehicles, have a role to play, but so, too, do hydrocarbons, and perhaps we need to start thinking about spending money on mitigating the impact of global warming; accepting that we're going to have to use hydrocarbons to a certain extent going forward.
Rouben Indjikian [00:19:08] I do share with you these views. Thank you very much for this dense and illuminating analysis during this short period of time. We are now coming to the end of this interview and will move on to run our event during a longer period of time - two hours - where we will find out more the views of our participants and we'll try to answer to these questions. So, thank you very much for this excellent interview.
[00:19:45] I reminded that it was the podcast at Webster University Geneva devoted to energy issues and linked to our annual event on the 'State and Future of Energy.'.
[00:20:01] Thank you very much.