The Hindu Business Line : Fundamentals continue to keep crude prices firm

Flaring up
Global distillations capacity additions have fallen short of oil demand.
Spare capacity has eroded faster among upgrading refining units.
Current constraints in the service industry likely to cause delays in planned projects start-up.

Mumbai , Aug. 6

It is becoming almost impossible not to discuss geo-politics when discussing price outlook for the energy market.

Geo-political risks arising from escalating conflict in West Asia have definitely had an impact on the energy market with prices increasingly threatening to run out of control.

Justification

Although escalating conflict has catapulted the market to a higher trajectory and built a certain risk premium, fundamentals continue to justify strong prices. Continued robust demand growth, limited spare production capacity and constraints in the downstream sector in their own right justify firm prices.

Experts are now near-unanimous in their opinion that even without the geo-political risks, crude prices could well be ruling in the low $70s a barrel because of fundamental factors. The status of the refining sector provides a good reason why the energy market should be ruling firm.

Spare capacity

Global distillations capacity additions have fallen short of oil demand growth since 2001 causing spare refining capacity worldwide to roughly halve in just four years, reaching 3.2 million barrel per day (mbpd) at the end of 2005. This is the lowest level recorded for several decades.

Worse, spare capacity has eroded faster among upgrading refining units, which have been running flat out since last year. Strong demand growth combined with increasingly tight emission specifications has increased demand for light products, while the supply side has grown rather slowly as investments in new capacity have been discouraged by historically negative refining margins, according to experts.

Oil Demand

Although surging gasoline and distillate crack spreads are providing an incentive to bring on stream new upgrading units, current constraints in the service industry are likely to cause delays in the start-up of planned projects.

While uncertainty over long-term prices makes the economics for costly upgrading units look less favourable than the current price environment might suggest, assert experts.

In the light of these considerations and looking at planned and likely new upgrading capacity worldwide, it is highly likely that even if oil demand growth slows from the high levels of 2004-05, the current tightness in the upgrading refining system is likely to persist until at least 2008 when a considerable number of new projects are expected to come on stream, eventually outstripping projected demand increases.

Bio-fuels

Upgrading refining capacity additions in 2006 and 2007 are estimated to average less than 1 mbpd, which would barely match projected increase in demand for light and middle distillates products.

Meanwhile, another tenuously related sector is witnessing frenetic activity. High crude prices have accelerated the pace of capacity building for production of biofuels — both bioethanol and biodiesel.

After three years of relatively stable but firm prices, the global vegetable oil market in particular is likely to see renewed upward thrust in prices. This follows setting up of several biodiesel processing units in different parts of the world.

Vegetable Oil

Many of these units are expected to go on stream from the last quarter of this year and later. This is bound to significantly expand the non-food demand for vegetable oil.

Until the energy market shows distinct signs of steadiness at prices in the mid-60s, biofuel will continue to attract interest. Funds are reported to have become active on this front.

Both palm oil and soyabean oil have clearly demonstrated an upward bias to prices.

Experts perceive a further upside to the market as supplies, although seen adequate at present, could get tighter over time.

The biofuel fervour — a trade intermediary called it `bio-fever' — is expected to continue for at least a couple of years.

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