Erosion of Qatar’s dominance in LNG could drive demand responsiveness

Erosion of Qatar’s dominance in LNG could drive demand responsivenessErosion of Qatar’s dominance in LNG could drive demand responsiveness

The recent Saudi Arabia-led confrontation with Qatar could drive an increase in the use of flexible liquefied natural gas contracts and thus allow demand to be more responsive to price. Erosion of Qatar’s dominance in LNG could drive demand responsiveness.

As we noted in “US natural gas – international demand unlikely to absorb domestic glut”, the liquefied natural gas (LNG) market is in the midst of change. Qatar is the world’s largest producer of LNG with most LNG transacting in long-term contracts at fixed price. However, the emergence of Australia and the US as large players in the market will lead to growth in flexible contracts. Based on EIA projections, the US is likely rise from being a negligible player (less than 1% of global supply) to the world’s third largest (after Qatar and Australia), with the US LNG market growing six-fold by 2020.

(Click to enlarge)

This development could resemble the evolution we saw in the oil market in the 1970s and 1980s

This development could resemble the evolution we saw in the oil market in the 1970s and 1980s. Until the late 1970s, almost 90% of the world’s crude oil was sold under long-term contracts at prices set by the major oil companies. OPEC produced 67% of the free world’s crude oil, allowing it to dominate the price and quantity of oil sold. In the late 1970s and early 1980s, market-based spot and futures trading gained in importance as production from the non-OPEC countries surpassed OPEC oil production and as non-OPEC producers went to the spot markets to build market share. By the end of 1982, almost half of all internationally-traded oil was traded on exchanges using flexible futures contracts.

Prices driven by local fundamentals

Unlike crude oil, the global natural gas market is fragmented with prices driven by local fundamentals. LNG, which is gas turned into liquid and then shipped before re-gasification at destination, represents a small proportion of the local natural gas market. For example, the price of natural gas in the US is less than half the price of natural gas in Europe or Asia. While the US natural gas futures (Henry Hub) is the most liquid market and is used as main benchmark, prices move in response to domestic fundamentals leaving it a poor hedge for natural gas prices in other countries. In addition, the size of the LNG market is currently too small for LNG to truly impact on natural gas futures prices.

Considering this, the recent Saudi-led confrontation with Qatar can pose a risk to global supplies of LNG. Although shipments from the country have not been affected as yet, we cannot rule out an impact if the impasse intensifies. We believe that it could be a catalyst to quicken the migration away from long-term fixed contracts with Qatar to flexible contracts in countries like US and Australia. With importing countries eager to maintain energy security, they may demand Qatar also alter contracts to be more flexible (especially for new contracts).

Nitesh Shah, Research Analyst at ETF Securities

Nitesh is a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).

OPECs choices, double down or do nothing

OPECs choices, double down or do nothing

OPEC’s current strategy is not working. Oil prices have given back nearly all their gains since the cartel agreed to cut production in November 2016. We believe the credible options for their next move, to be discussed at their May 25th meeting, will be to either to cut deeper or let the deal collapse. The latter option seems the most likely outcome. OPECs choices, double down or do nothing.

As we argued in our recent outlooks, the efforts of OPEC members with assigned quotas, are being undermined by:

1.    the growth in supply from the OPEC members who don’t have quotas 2.    non-OPEC members participant to the deal that are not adhering to it 3.    the rapid growth in supply from other countries, most notably the US

Today’s release of OPEC’s Monthly Oil Market Report acknowledges the extent to which supply from the US, Canada and Brazil is set to rise.

We therefore believe that repeating the same strategy for another six months will do little to shore up oil prices. OPEC nations have given up market share and have barely reaped any price gains. Given that consensus expectations are for a simple deal extension (i.e. that is what is currently priced-in), following the status quo is unlikely to be met with a positive price response. We believe that if OPEC is serious about getting the market to balance it will have to cut deeper in order to ‘shock’ the market and drive prices higher. Sacrificing volume requires higher prices.

However, gaining a consensus agreement on a bolder move will be difficult. The smaller and more financially constrained members will be reluctant to give up more volume. Saudi Arabia is vocally supportive of a deal extension. But if Iran insists on being able to increase production further while Saudi Arabia has to bear the brunt of further production cuts, the deal’s flaws will become even more accentuated. We believe that doing nothing and letting the deal collapse will be default option in the event that the cartel is unable to gain support for a deeper cut.

While OPEC surprised on the upside at its November 2016 meeting by coming to an agreement, we believe the May 25th 2017 meeting will surprise on the downside with a lack of agreement. In such event, oil prices could decline close to US$40/bbl (from US$48/bb currently), which we believe is the structural floor for oil prices, set by the breakeven price of US shale oil production.

Nitesh Shah, Research Analyst at ETF Securities

Nitesh is a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).

Oil: US supply response to weigh on prices

Oil: US supply response to weigh on prices

While the market has greeted OPEC’s 90% compliance rate with its new quota with a lot of enthusiasm, we believe that rising US production will continue to weigh on oil prices and limit WTI oil to US$55/bbl in the first half of the year, US supply response to weigh on prices.

As oil prices have stabilised in the US$50-55/bbl region since December 2016, oil production in the US has surged. Rig counts in the US have risen 85% since the low was reached in May 2016. Gains in rig efficiency mean that the US can produce a lot more oil with less rigs in operation than in back in 2014.

(click to enlarge)

Production in the US is now only 7% below the peak reached in June 2015, after production surged since October 2016.

(click to enlarge)

US crude oil inventory is only 1% below its all-time high. The last time inventory was this high (September 2016), WTI was trading at US$45/bbl.

(click to enlarge)

With so much faith placed on the OPEC/non-OPEC deal to cut output, we fear that the market is set up for disappointment. Speculative positioning on NYMEX WTI futures contracts is more than 2.5 standards deviations above its historical average. Compliance with quotas often starts strong and deteriorates as time goes on. While Russia has cut oil production and therefore has complied with its deal with OPEC, it aims to increase exports, offloading existing stocks. With seasonal low demand in Saudi Arabia, we believe that exports from the country could also remain strong despite productions cuts that more than meet the quota requirement. In 2016 Saudi Arabia exported record levels of oil (7.65 million barrels per day).

(Click to enlarge)

Nitesh Shah, Research Analyst at ETF Securities

Nitesh is a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).

Loonie set for near term tumble

Loonie set for near term tumble

Trade Idea – Foreign Exchange – Loonie set for near term tumble

Highlights

  • The tentative agreement reached by OPEC last Wednesday has sent oil prices to the top of their recent range and lent support to oil linked currencies.
  • In practice the production limit will be hard to implement and oil prices will likely retrace gains in coming months.
  • The CAD looks to continue its downtrend as extended positioning corrects lower and monetary conditions are eased.
  • OPEC surprises markets
Global crude benchmarks and oil linked currencies jumped last Wednesday on news that members of OPEC had tentatively agreed to implement a production target for the first time in seven years. Both commodity and currency markets responded positively to the surprise deal that was viewed broadly as an unlikely prospect due to long standing differences between key group members, Saudi Arabia and Iran. While the deal certainly marks a shift in stance of the oil exporting group, we do not believe it is enough to sustain support for the CAD which is at risk from a confluence of bearish factors, specifically underwhelming economic performance, stretched speculative positioning and technical resistance. We therefore see current levels as an attractive point to gain long exposure to the USD/CAD and EUR/CAD currency pairs which are set to benefit from near term oil weakness.

Symbolic but not practical

We believe the uplift in the oil market provided by the latest OPEC agreement will not last for long as the practicalities of the arrangement and wider concerns over slowing global oil demand growth keep oil prices contained. The deal itself, while an important move symbolically, did not provide a definite promise to remove a significant amount of output from the global oil market (removing anywhere from 200-700k barrels per day (bpd)) and requires the implementation of country level quotas. This is a large and politically sensitive task and is unlikely to be completed before the next OPEC meeting in November. In addition, the deal failed to provide clarity over conditions for countries under duress such as Venezuela, Nigeria and Libya where production is currently far below capacity, but has the potential to increase in the interim. Thus, support from oil prices is therefore likely to be absent for the CAD in the coming months. (Click to enlarge)

CAD underperforms NOK

While both the NOK and CAD are heavily linked to the oil price, prospects for the two currencies have recently diverged. Latest growth and inflation data from Norway has surpassed the expectations of its central bank, causing the Norges bank’s Executive Board to deliver a more hawkish policy message and raise its projected rate path. In contrast, lacklustre inflation, retail sales and manufacturing data has prompted a more dovish tone from the Bank of Canada (BoC), which makes it increasingly likely to ease monetary policy at its upcoming meetings. This has been reflected in the relative outperformance of the NOK in the past month, which has rallied by 2.8% relative to CAD on a trade weighted basis (see Figure 1).

Positioning stretched

The USD/CAD and EUR/CAD are on strong longer term upward trends (CAD weakening) which look well placed to continue. Net speculative positioning underpinning the CAD is hovering at record highs and looks increasingly subject to a correction. A fall in oil prices or further easing by the BoC could see CAD longs (which are at the strongest level in two years) fall sharply and shorts gather momentum, exacerbating any rise in USD/CAD and EUR/CAD. Investors wishing to express the investment views outlined above may consider using the following ETF Securities ETPs: Currency ETPs EUR Base ETFS Long CAD Short EUR (ECAD) ETFS Short CAD Long EUR (CADE) GBP Base ETFS Long CAD Short GBP (GBCA) ETFS Short CAD Long GBP (CAGB) USD Base ETFS Long CAD Short USD (LCAD) ETFS Short CAD Long USD (SCAD) 3x ETFS 3x Long CAD Short EUR (ECA3) ETFS 3x Short CAD Long EUR (CAE3) 5x ETFS 5x Long CAD Short EUR (ECA5) ETFS 5x Short CAD Long EUR (CAE5) Currency Baskets ETFS Bullish USD vs Commodity Currency Basket Securities (SCOM) ETFS Bearish USD vs Commodity Currency Basket Securities (LCOM)

Important Information

This communication has been provided by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”). The products discussed in this document are issued by ETFS Foreign Exchange Limited (“FXL”). FXL is regulated by the Jersey Financial Services Commission. This communication is only targeted at professional investors. In Switzerland, this communication is only targeted at Regulated Qualified Investors. The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value. This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States. This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective, officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents. ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit. Short and/or leveraged exchange-traded products are only intended for investors who understand the risks involved in investing in a product with short and/or leveraged exposure and who intend to invest on a short term basis. Potential losses from short and leveraged exchange-traded products may be magnified in comparison to products that provide an unleveraged exposure. Please refer to the section entitled “Risk Factors” in the relevant prospectus for further details of these and other risks. Securities issued by FXL are direct, limited recourse obligations of FXL alone and are not obligations of or guaranteed by any of Morgan Stanley & Co International plc, Morgan Stanley & Co. Incorporated, any of their affiliates or anyone else or any of their affiliates. Each of Morgan Stanley & Co International plc and Morgan Stanley & Co. Incorporated disclaims all and any liability whether arising in tort, contract or otherwise (save as referred to above) which it might have in respect of this document or its contents otherwise arising in connection herewith. The Morgan Stanley Indices are the exclusive property of Morgan Stanley & Co. Incorporated (”Morgan Stanley”). Morgan Stanley and the Morgan Stanley index names are service mark(s) of Morgan Stanley or its affiliates and have been licensed for use for certain purposes by ETF Securities Limited in respect of the securities issued by FXL. The securities issued by FXL are not sponsored, endorsed, or promoted by Morgan Stanley, and Morgan Stanley bears no liability with respect to any such financial securities. The prospectus of FXL contains a more detailed description of the limited relationship Morgan Stanley has with FXL and any related financial securities. No purchaser, seller or holder of securities issued by FXL, or any other person or entity, should use or refer to any Morgan Stanley trade name, trademark or service mark to sponsor, endorse, market or promote this product without first contacting Morgan Stanley to determine whether Morgan Stanley’s permission is required. Under no circumstances may any person or entity claim any affiliation with Morgan Stanley without the prior written permission of Morgan Stanley.

Doha – Desert storm in a teacup

Doha – Desert storm in a teacup

Doha – Desert storm in a teacup Expectations at the Doha OPEC Summit were for a simple rubber stamping of the agreement to freeze OPEC production but this didn’t happen. The scaling up or Iran’s production is unlikely to have much impact on global supply in the short-term with global supply falling into deficit in Q3-Q4 2016.

The acrimony between Iran and Saudi was evident as Iran did not even attend the meeting. Iran has refused to freeze production and Russia has sympathised. Saudi has picked up market share lost by Iran when sanctions were imposed and Iran sees that it is only right that they have the opportunity to regain this share. We believe the Saudi Arabia has taken such a hard-line to protect its own interests, the current oil price is painful for them given that their fiscal costs of production are around $100/bbl, pushing their budget balance to -19% of GDP for 2016 according to the IMF.

Currently Iran has managed to scale-up production from 2.88mbpd in December 2015 to 3.29mbp in March (404k change), slightly below the consensus expectations of 500k. In the short-term we believe production in Iran is unlikely to move substantially higher as production is close to maximum potential with current infrastructure. A couple of projects assisted by China could push Iranian production up by 200kbpd in 2017.

The Saudi/Iran proxy war in Syria and Yemen isn’t helping stability within the region and there is a general skepticism amongst international banks and oil exploration and production companies over Iran’s nuclear deal. It is therefore likely that additional production infrastructure will not come online in the shorter term.

June 2nd is the next OPEC meeting but it’s unlikely a production freeze will be agreed at that point either. The oil price initially dived 7% reflecting a knee-jerk reaction by investors but has since settled at -2.5% at time of print. We expect little impact on market balances and we expect a global supply deficit by either Q3 or Q4 2016.

James Butterfill, Head of Research & Investment Strategy at ETF Securities

James Butterfill joined ETF Securities as Head of Research & Investment Strategy in 2015. James is responsible for leading the strategic direction of the global research team, ensuring that clients receive up-to-date, expert insight into global macroeconomic and asset class specific developments.

James has a wealth of experience in strategy, economics and asset allocation gained at HSBC and most recently in his role as Multi- Asset Fund Manager and Global Equity Strategist at Coutts. James holds a Bachelor of Engineering from the University of Exeter and an MSc in Geophysics from Keele University.