Global Growth The Big Threat To Oil Prices

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– Global growth the biggest threat to the oil price
– LNG markets offering support to oil price at present
– Oil price forecasts adjusted
– Brokers update preferred Australian energy sector exposures

By Chris Shaw

According to estimates from Barclays Capital, global oil demand grew by 2.4 million barrels per day in the March quarter and by 1.6 million barrels per day in the June quarter of this year. This is a clear slowdown from growth of more than three million barrels per day in each of the final two quarters of 2011.

Even though oil demand growth has slowed in line with a weakening in global economic growth, Barclays suggests it remains at solid levels. Risk remains to the downside thanks to the worsening European debt crisis, the sell-off in equity markets and concerns over possible issues for the global banking sector from the problems of Europe in particular.

At present Barclays continues to forecast global economic growth of around 4% in year-on-year terms up to the end of 2012. This translates to global oil demand growth of about 1.3 million barrels per day in the final two quarters of this year and between 1.3-1.6 million barrels per day in each quarter of 2012.

But if the global growth outlook was to worsen significantly, to growth of 2.0% for example, Barclays notes the impact on oil demand would also be significant. Under such a scenario global oil demand growth could fall to as low as 0.4-0.5 million barrels per day. For negative oil demand growth it would require a fall in global economic growth to around 1% in year-on-year terms.

Citi points out while the global macroeconomic environment is bearish, oil market fundamentals remain strong. While this has not stopped the oil price from falling, it does help explain ongoing outperformance by the oil price.

Support for the oil price at present is also coming from LNG markets in Citi's view, as spot LNG buying in Asia has supported European gas prices. This has led to a convergence and an overshoot of these spot prices relative to oil indexed contracts. Citi notes this offers some incentive for utilities to sell some of their gas to buy residual fuel oil, which has generated some new buying in the oil complex. 

Standard Chartered notes since the start of 2009, West Texas Intermediate (WTI) has been trading at a discount to Brent crude, at one point the spread reaching as much as US$26 per barrel. This boosted refinery margins for PADD2 (Petroleum Administration for Defence Districts) refineries and drove high production, so reducing the need for product imports into PADD2.

At the same time PADD3 has the most concentrated refining industry in the US, accounting for about half of the total US refining capacity. Higher prices have impacted on demand for PADD3 products and refining margins being achieved in PADD3. 

As the discount of WTI to Brent continues, Standard Bank expects a continued shift in US domestic product flows and a corresponding knock-on effect of more US production being exported.

Factoring in the latest oil market data has seen Credit Suisse adjust expectations, with Brent crude forecasts increased in the short-term and WTI forecasts cut longer-term. US gas price estimates have also been trimmed.

The changes factor in expectations of sluggish market growth shorter-term and a more positive medium-term outlook thanks to ongoing relative scarcity in the market. This should see the oil price push against the upper limit of economic affordability and political tolerance according to Credit Suisse, which implies prices of US$120 per barrel from the second half of 2013.

For Brent crude, Credit Suisse has lifted its forecasts by 1-9% through 2014, forecast prices peaking at US$120 per barrel in 2014. There is no change to the long-term Brent crude forecast of US$90 per barrel.

The cuts to WTI forecasts are 6% in 2011 and 5% in 2012, while Credit Suisse's long-term price forecast for WTI declines to US$84 per barrel from US$88.50 per barrel. Changes to currency assumptions mean long-term oil price forecasts have been cut 15-20% in Australian dollar terms. 

The changes to oil price assumptions flows through to adjustments in earnings estimates and price targets among the Australian energy plays covered by Credit Suisse. Post the adjustments the key picks of Credit Suisse are Woodside ((WPL)) and Origin Energy ((ORG)) among the large cap plays and Aurora Oil and Gas ((AUT)) among the small caps, the latter given the potential for significant increases in production in coming years. 

All three are rated as Outperform, while Credit Suisse also rates Santos ((STO)), Oil Search ((OSH)), Tap Oil ((TAP)), Molopo ((MPO)), Karoon Gas ((KAR)) and Australian Worldwide Exploration ((AWE)) as Outperform. 

In contrast, Caltex ((CTX)) and Eastern Star Gas are rated as Underperform, the former being downgraded from a Neutral rating previously.

Goldman Sachs has undertaken a similar review of the sector and has moderated the price profile through 2012 as a result. In general Goldman Sachs retains a bullish view on oil prices thanks to limited OPEC spare capacity.

The key risk to this call is lower global economic growth, but Goldman Sachs notes such an outcome is likely to result in only temporary weakness in oil prices. On the upside there is potential for some demand rationing but the broker suggests this would only occur at prices above US$120 per barrel.

In Brent crude terms, Goldman Sachs is now forecasting average annual prices of US$111 per barrel this year, US$120 per barrel in 2012 and US$130 per barrel in 2013. This compares to previous estimates of US$117, US$130 and US$130 per barrel respectively and reflects a gentler path for oil price increases.

As with Credit Suisse, the changes to the model of Goldman Sachs have impacted on earnings forecasts and price targets across the Australian energy sector. Key picks for Goldman Sachs are Woodside and Oil Search, both rated as Buy. 

Goldman Sachs continues with Neutral ratings on both Santos and Origin, while Caltex is also rated as Neutral. Among the smaller caps, Goldman Sachs has Hold ratings on Eastern Star, Nexus ((NXS)), AWE, Roc Oil ((ROC)) and Tap. 

 

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