“We don't take unnecessary risks. We're not speculators on absolute price movements. It may surprise some of you to learn that we actually prefer lower, rather than higher prices. High and rising prices increase dramatically our working capital requirements and result in ever greater margin calls, both of which are not good for your cash flow.” –Ian Taylor, group president and CEO, Vitol Group
Truckers are beholden to petroleum and the fuel distilled from it like few other businesses in the world, so it wouldn’t surprise me in the least if they regarded oil traders with thinly veiled contempt.
After all, these are the folks buy and selling oil futures, hammering out contracts for moving it around the world into various markets, in many cases distilling and selling off the precious products produced from “black gold.”
In the end, they ultimately function as one of the biggest siphons attached to trucking’s cash flow, for the cost of fuel remains among the top three -- if not top two -- expenses on any fleet’s bottom line.
Yet in some respects, truckers and others might be laboring under some misconceptions here. The growth of the “oil trading” industry may, in many respects, be at least partially responsible for keeping up a steady supply of oil despite burgeoning demand from many heretofore dormant corners of the globe, China’s rip-roaring economic revolution being one of the biggest.
With that in mind, I’d to share with you parts of a speech Ian Taylor (at right), group president and CEO for the Vitol Group, delivered in London during the International Petroleum Week Conference.
You may not agree with many of his views, but I think you’ll find his perspective on the world’s oil markets interesting, to say the very least – markets that are at the moment quite shaky due to all the unrest swirling through the Middle East and North Africa at the moment, home to nations that control a good bit of the globe’s oil supply.
“I want to emphasize my key point that energy markets work and work well, despite what can be challenging circumstances and rapid changes,” he noted.
[Below is a short video providing an overview of Vitol’s many different energy and oil-related businesses.]
Taylor pointed out that he’s witnessed a lot of ups and downs over his 30 year career in the oil trading world, selling big VLCCs worth of oil (a term for a type of oil tanker called “very large crude carriers” weighing from 160,000 to nearly 320,000 in deadweight tons DWT) at 7$ per barrel (bbl) in 1987 and then “sadly bought” VLCCs of at 147$/bbl in 2008.
“Since then the oil price fell to $35 in December 2008 and is now today above $105,” Taylor said. “The huge global recession of 2008-09 resulted in the first fall in oil demand in 30 years. It was followed in 2010 by the second largest annual increase in demand in the last 30 years.”
Yet despite many changes, wars, hurricanes, increasing environmental pressures, frequent price hikes and collapses – “Who remembers $10 oil now? But it was a reality during the Asian financial crisis in 1998,” Taylor noted – and against a backdrop of population increase and economic growth, the energy sector has constantly met demand with rarely a serious supply shortage, he said.
“That's a tribute to the industry. It's a tribute to its dominant can-do mindset. And it's a tribute to the open market system,” Taylor stressed. “As an industry we are always under the spotlight of the politicians and the media. What impresses me most is the sector's endless capacity to handle every challenge thrown at it.”
If risk exposure is managed properly and if encouraged by governments to introduce new technologies and new ways of doing business, Taylor said he’s more than confident the global oil and gas industry can go on meeting growing energy demand to 2030 and well beyond.
“But meeting this growing demand will not be easy,” he warned. “The search for new hydrocarbon resources has taken the industry into ever-riskier places: Deeper waters, more extreme climates, more fragile natural environment, less predictable political and financial jurisdictions.”
Taylor emphasized that nothing stands still in the oil markets, and that goes for the traders themselves.
“Traders are, by necessity, at the forefront of change – we adapt to changing circumstances or we fail,” he said. “We start with a blank sheet of paper each year. Nothing is guaranteed. We have to search ceaselessly for the next deal and the next innovation. There's more competition from new players. There's greater market transparency and more regulation. There are new arbitrage plays. And we're all taking selective positions on real assets and moving into new markets.”
For example, his company ships nearly 400 million tonnes of crude and product a year. That, my friends, is an awful lot of oil to move about the world, but it pales in the face of what Taylor believes will be an explosion of demand in the near future.
“The underlying pressures driving this renewal are well enough known,” he said. “Population growth is one, with an additional 80 million new customers for commercial energy each year. Energy consumption continues to rise, especially in emerging economies, which now account for close to half of global demand. Worrying issues around climate change. Resource nationalism and anxieties about energy security also come into play.”
Now, how concerned should businesses that rely on oil be about the future given these pressures?
“The line between confidence and smugness is a fine one. Yet the reality is that time and again our sector has demonstrated its ability to rise to a new challenge. I think it will do so again,” taylor stressed.
“The last decade was characterized by tightness along the whole energy supply chain but we have currently moved into a period of surplus,” he said. “OPEC [the Organization of Petroleum Exporting Countries] has an estimated six million barrels a day of spare capacity. Iraq's capacity is growing fast, with huge reserves. There are surpluses in the tanker business. Even LNG [liquid natural gas] terminals are in surplus. But these surpluses appear to us to be cyclical rather than chronic. Indeed there are already some signs that some of the surplus in the refining industry is receding.”
What is clear, Taylor emphasized, is that markets have worked; price does its job.
“High prices have led to plentiful supply and are making some fuels more economic. New sources of energy are being discovered including recent material discoveries offshore Brazil and Ghana,” he noted. “In terms of demand, the Chinese – the key driver of global demand increase over the last decade – are diversifying their energy mix rapidly. Much greater reliance is being placed on renewables, nuclear and domestic coal options. In the medium term this will ease pressures on oil and gas supplies.”
But what about the short term, and the threat posed by civil unrest in oil producing nations such as Libya right now?
“Right now we believe that global economic conditions are positive,” Taylor said. “Energy demand is robust, mainly in the emerging economies. Stocks, though declining, are at comfortable levels. And OPEC so far shows no inclination to increase production.”
The huge and unexpected political uncertainty in most parts of North Africa and the Middle East can be expected to support prices, he stressed, and there’s also what Taylor called “significant” passive fund money invested in all commodities – with probably more to come.
“So in our view further price rises are possible in the short term. But if OPEC put more barrels on the market, prices should stabilize in the $90-100 range or even fall back a bit further,” he noted. “We all know predicting oil prices is a fool's game. And the inflow of financial funds to oil markets in the past five or six years has made that even more the case.”
Yet Taylor noted that’s one reason why Vitol does not trade the flat price of oil; the risk and volatility in oil prices means that the company hedges all of its physical trades.
“To do this we need to use futures and derivatives markets – without these we would not be able to ensure that oil moves around the world efficiently,” he said. “We are therefore concerned that some of the possible regulatory changes that are being considered will severely hamper the industry's ability to trade and deliver energy.”
[The video below details some of the “physical” investments Vitol is making in the oil business; investments that traditional players such as Shell and ExxonMobil aren’t doing much of anymore.]
Still, Taylor noted that high oil prices hurt consumers and economies. “We welcome regulation that may prevent some of the larger swings in prices that we have seen. But regulators need to be clear about where the problem comes from. It does not come from those of us in the physical markets since we are by definition short in derivatives markets,” he stressed.
“Not wishing to point fingers, but oil stocks are higher today than five or ten years ago while oil prices are five times as high. The difference to me seems to be the long-only financial money sitting on the futures exchanges and that needs to be better understood,” Taylor added. “It’s difficult to get a pure number for energy only, but we estimate that financial investments in all commodities have increased from a small amount to over $350 billion in the last 10 years.”
Finally, Taylor talked about oil prices themselves, noting that the current $11 spread between the West Texas Intermediate or “WTI” and Brent market prices – two mainstay “benchmarks” for global crude trades – falls in words “very firmly in the camp of a development that none of us would have believed two years ago.”
But the spread is entirely understandable as it is the simple result of supply being greater than demand but with no mechanism to allow demand to increase. “The logistical constraints restrict how much oil can be moved out of the price setting region. It may take many months before any logistical changes can be made that will allow demand for WTI to increase to meet supply,” said Taylor.
But while the price action can be understood it nonetheless raises significant issues for the global oil industry.
“There are essentially only three crude oil price benchmarks in the world and one of them is currently compromised,” he stressed. “In the short term it means that the more reliable Brent futures contract will take centre stage but longer term an alternative to WTI will be needed as Brent is also a small volume crude. Perhaps now is the right time for major oil producers … to allow the industry to develop the new risk management tools it will need in the future to manage the many challenges that will undoubtedly face.”
In the end, Taylor noted that change is the one sure thing everyone can expect in the future. By way of illustrating this, he said that 40 years ago the first microprocessor was invented and North sea oil production began in Norway.
“Since then the world's population has doubled, global GDP [gross domestic product] has risen by more than threefold and energy consumption increased two and a half times. Yet we coped. As an industry we rose to the challenge,” he stressed. “Today we face new challenges, for energy remains the driver of economic progress for all nations.”
