Interesting paper in AllAboutAlpha regarding the increase flow of funds into commodity asset class.

According to FT, Pension Investment in commodities jumped from 0.4% of all pension assets to 2 %, a whopping 5 folds increase.

Many are turning to professional money managers rather for their exposure rather than liquid futures market. The top 20 largest commodity manager run $30 billion for pension funds out of total $ 75 billion.

Keith Black of CAIA, says that only long positions have had a flat result over past decade while the “secret” is in non-directional return sources such as momentum and roll yield.

If you want long-only commodities exposure, mused Black, why not just buy the equity of commodity producers?

“…one could always implement their views on commodity prices by investing in equity securities. The prices of these stocks may be somewhat correlated with those of commodity futures. Metals firms include Alcoa and Anglo American, while agricultural firms include Archer Daniels Midland. In the energy sector, stocks such as Exxon-Mobil, Chevron and ConocoPhillips may be used as a crude oil proxy.

His answer: because you get a lot more exposure that you bargained for (think BP):

“But the problem is that existing exposure to equities means commodity-linked equities may not be the best way to express a view on commodity prices alone. To make matters worse, commodity stocks are likely to underperform commodity futures during times of high inflation. When inflation and commodity prices rise, stock prices typically decline, meaning an investor may not actually earn the anticipated return.”

On the other hand, RS Investments makes argument that commodities have become so dependent on GDP growth and in turn correlated to equities which undermine the diversification benefits of investing in commodities.

Nevertheless, the incease use of commodities in the investmnet universe menas that historcal track record may of questionable bvalue in predicting future returns.

Commodities and commodity equity provide protection against inflation and the latter provides additional returns by its leveraged nature.

A new paper published by Lloyds of London and Chatham House (pdf download) on sustainable energy security predicts a coming crunch in supply of oil by 2013.

• Oil consumption which usually was dominated by advanced countries is shifting to non-OECD (China & India) will mean increasingly oil deficit over time.

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Barclays Capital – Commodities Research (view report)

Crude oil inventories have drawn by 1.2 mb east of the Rockies, and they have drawn by 1.1 mb in the Midwest excluding Cushing. There is no excess of crude above the five-year average outside the Midwest, and two-thirds of the overall US excess is now concentrated in Cushing. With lower flows from the south and a further strong increase in Midwest refinery runs, we expect Cushing inventories to show a turn in either next week or the week after.

The oil demand renaissance has continued, with US distillate demand pushing above 4 mb/d for the first week in over a year. For May-to-date, US distillate demand is showing a y/y rise of 16.8%, with goods finally moving around the US economy in a more regular fashion.

The latest JODI data release puts the drag from OECD demand in March at its lowest level since April 2008, with a y/y decline of just 135 thousand b/d. With continuing strength from Asian demand, global demand growth has accelerated into Q2. For a few months we may have had $80 oil on $70 data flow, whereas we now seem to have $70 oil on $90 data flow. We expect prices to rebound, with the Cushing distortion diminishing and the strength in demand biting into the current elevated levels of demand pessimism.

A good paper by the Oxford Institute (download) for Energy Studies that highlights the dynamics of the LNG trade movement in the Atlantic Basin and the LNG market trends.

Alpen Capital published report on GCC Petrochemical sector (download report).  The massive investment in capacity has put GCC on the Global Petrochem map, accounting for 10% of Global supply.  The sector is undergoing tremendous change taking into account both cost and price volatility and future developments and challenges. The report is excellent and drives home the main issues, countries and companies in the region leading the Petrochem sector in the GCC.

Summary of two recent reports by Goldman Sachs and Barclays Capital on recent oil price movement and the oil markets

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Le Monde (English) reports on recent report from the American Joint Forces (JoE report) and another from the Department of Energy (EIA report). Both reports predict that by 2012, surplus oil production capacity could be entirely disappear and as early as 2015, the shortfall in output could reach 10 million bpd.

Goldman Sachs in a new report said that commodities are set for “violent price spikes” due to constraints on investment in new supplies and rising emerging market demand.  The report goes on:

“Commodity markets have faced a growing physical imbalance over the last several years resulting from a lack of investment in underlying production, distribution and storage infrastructure,” Goldman analysts said in the report. ‘Not just rising price levels, but violent price spikes likely lie ahead for much of the commodity complex.”

“Volatility is low when inventories are available but spikes as the infrastructure constraints are approached, e.g. when inventories are close to depletion or are close to filling capacity,”

The analyst also found “no empirical evidence” that oil prices / commodity prices are influenced by movements in currencies such as the US dollar. Commodities are 4 to 5 times more volatile than currencies.  (Bloomberg)

Production at Joint Venture between Huntsman Corp and Zamil Group of Saudi has started. The 50-50 JV facility that costed $ 288 million will start production with capacity of 27,215 tonnes per year of ethylene amines. The facility will add 6.5% to global ethylene amines global supply. The product will be marketed by Huntsman in Asia & Europe. (ArabianOilandGas)

Oil Monthly report (can be downloaded as PDF) main points:

• International Oil Companies over estimate / upbeat future production forecast – gives examples of Petrobras & Shell
• Bio-Fuels increasing contribution to World Oil Supply. As of January 2010, EIA estimate total biofuels production at 1.93 million b/d with USA being the largest producer with 845,000 b/d followed by Brazil 630,000 b/d.
• Increased utilization of other unconventional form of liquid fuels such as Biofuels, Extra Heavy Oil, Tar Sands, Natural Gas Liquids and Polar Oil.  Unconventional liquid fuel production constituted 15% to the world’s total liquid fuels production with remaining 85% coming from conventional crude.

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Bank of America Merrill Lynch Global Energy Weekly research report (Report PDF).  The main points of the report:

• Sees Non-OPEC production peaking in 2011 to 52.3 million barrel per day (51.8 million in 2010) and then face consistent decline threafter – OPEC to take over
• Non-OPEC Production Growth will be in selected regions such as Latin America, Russia, Africa and China.
• Iraq and Nigeria vast potential regarding production can pose risk to ML outlook. Nigeria can add another 1 million barrels a day if conflict in the country is resolved. ML is skeptical of Iraqi target to quadruple production within a decade. Still this could put a lid on prices rising above $100in the longer term.
• ML has Q3 2010 WTI Oil Price target of $90 per barrel.

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Is China the biggest bubble ? The following thoughtful presentation seems to think so.

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• OPEC in their Monthly Oil Market Report (Full PDF report) is concerned with regard to quality of Economic Recovery and will monitor closely. World demand for Oil dropped by 1.6% in 2009 compared to previous year with China fast recovery offsetting sluggish demand from OECD countries.  Forecast demand growth of 0.8% for 2010 to 85 .1 m bb/day.

• Improved distillate margins in Europe & Asia have had positive price impact on Arab Crudes (Saudi, Iraq & Iran hiked their Official Selling Price or OSP)

• Negative Dubai-Brent spread (Bearish sentiment due to increasing supply) has opened up arbitrage opportunities for West African, Mediterranean and Russian crudes to move to Asia as the price of lower-quality Middle Eastern crude (Heavy) was higher compared with higher quality crudes (Light).

• Russian new ESPO blend into Asia is also putting pressure on Middle Eastern Crudes

• Cold Weather snap has boosted bullishness on product market in early Jan but sentiment faded with milder weather in latter half of Jan. … Continue Reading

Research note by VM Group (Part of Fortis -dated Feb 2010) on the Refining sector:

• The Refining Sector continue to hemorrhage value with worldwide refining margin is down to $ 1.18 / bbl for 3 month period to mid Dec 09 compared to $ 5.19 / bbl for same period in 2008 according to BP. The sector continue to suffer from lower demand in OECD countries, high inventories and strong competition from new complex refineries in Asia and Middle East (New Complex Refineries with high capacity and lower cost structure).

• While OECD countries will see further refinery shut downs (3 m bpd of capacity irk marked for closure), additional 9 m bpd of new capacity will come on stream in Middle East & Asia according to EIA, undoing cost cutting and capacity rationalization efforts by OECD refineries.  As such, India and Middle East are anxious to become world players in refining sector and to serve large clients in OECD countries.
• Recovery in refining will take longer as demand recovers and capacity rationalized. The report suggest that this recovery may come too late for some refineries in OECD, those that will be closed permanently and may never see refining “Golden Age” again.

• The report also suggest that countries with low refining capacity or producers with large crude surplus may acquire on the cheap refineries that have been irk marked for closure.
• It would be interesting to see if any of the Middle East players would contemplate such a move taking into account the escalating cost of building new refineries.

VM Group / Fortis Research

Related articles

• Oil Refining Drags on Earnings (WSJ​.com) (alneft​.com)
• Shell to slash downstream as Q4 profits collapse (financialpost​.com)
• Essar Group Still in Talks With Shell to Buy Refineries (online​.wsj​.com)

We compiled all available forecast for price of Crude Oil (WTI) by various market participant. Both Morgan Stanley and Goldman Sachs have same average price prediction, $85 and $ 95 in 2010 and 2011 respectively. MS sees Oil Price touching $110 in 2010 and $120 in 2011 due to rising demand from China and the Middle East. VM Group (BNP/Fortis/VM Group) see prices even going further to touch $164 in second half of 2010 with average price target of $115 / bbl. It is of note that VM Group called the market correctly in both 2008 and 2009.

Both EIA & China as well as Oil & Gas sector players others have been revising their average oil price numbers for 2010 upwards. China views $80 as healthy for its refineries and not excreting pain on consumers.

On the other hand, JP Morgan and Vitol are pessimistic about economic recovery and JPM views that there is still too much oil inventory with possibility of market moving into backwardation in 2H 2010.

Taking all the data gives us an average oil price for 2010 of $ 84.25 with standard deviation of 13.7, meaning that there is 68.2% probability of prices being within a $ 70.55 to $ 97.95 band.