Commodities | Nov 10 2011
– Supply side of oil market faces challenges
– One forecast for peak oil just above 2010 level
– Barclays suggests oil price focus is US$90-100 per barrel at present
– JP Morgan's forecasts above this level
By Chris Shaw
This week the International Energy Agency (IEA) is due to publish its long-term scenario document, the 2011 World Energy Outlook. Leading into the release, JP Morgan notes for many years the IEA has argued for the need for the sector to invest to ensure any supply gap is met. In the IEA's view the resources to lift supply are there, but investment is needed to convert enough resources into producible reserves to offset the decline of mature fields.
Equally important to the market is the path of future demand growth. As JP Morgan points out, even with significant emphasis being placed on oil efficiency and substitution and despite significant technological advances, population growth and the rise of emerging market economies means oil demand per capita has been flat since the early 1980s.
JP Morgan expects global oil demand to reach 100 million barrels per day by the early 2020s if significant efficiency gains cannot be achieved. This will challenge the supply side as there will need be a decision between conservation or lower growth in achieve a balance in the market.
This leads JP Morgan to suggest the reported World Energy Outlook's forecast of an oil price of US$104 per barrel by 2035 doesn't represent market equilibrium but what could be achieved if investment in the sector is timely and the world adopts efficiency goals.
The IEA's “current state” scenario of a real oil price of US$119 per barrel is possibly a better guide in JP Morgan's view, but the broker continues to expect volatility in prices as the market attempts to deal with meeting a further 25 million barrels per day of demand in coming years.
With respect to peak oil, UK engineering, management and automotive consultancy Ricardo PLC suggests global oil demand will peak before 2020 at no more than 4% above 2010 levels. Average oil demand for 2010 was estimates at 88.2 million barrels per day by the IEA.
The study by Ricardo suggests by 2035 oil demand will be 3% below 2010 levels. An acceleration in the use of first-generation bio-fuels could see oil demand in 2035 fall to 10% below 2010 levels in the view of Ricardo.
Ricardo expects despite continued growth in the number of vehicles around the globe, efficiency improvements in engines will more than offset the rise in fuel demand from more vehicles on the roads. As well, Ricardo anticipates production of first generation bio-fuels may increase by five to six times from current levels.
There is also scope for a decoupling in the price of oil and natural gas to encourage substitution of oil by gas in stationary uses and in vehicles. Ricardo expects this would provide a supply-side challenge to global refining operations.
Shorter-term, JP Morgan expects a return of some Libyan volumes and an expected increase in Iraqi exports as infrastructure improves in coming months. This may be needed to offset the risks of disruptions from issues such as an escalation of violence in Nigeria and problems with North Sea supply.
Geopolitical issues also remain a problem and pose an ongoing threat to supply in the view of JP Morgan. This means there is still a high risk of some incident occurring that pushes the market balance onto a tighter trajectory than is currently expected.
In the view of Barclays Capital, while the oil market has been relatively resilient to the latest macroeconomic concerns these concerns are still holding prices down. At the same time a number of new or enhanced geopolitical risks have recently emerged, this when the oil market is already operating at a high upstream capacity utilisation rate.
For Barclays, this suggests the risk of a sharp upward move in oil prices is growing, meaning the current price equilibrium is potentially unstable. With oil markets in backwardation at present the market's signal is to realise inventories into the prompt market to achieve a balance, rather than offering any incentive to take oil into storage.
Barclays notes there appears to be some more stability about perceptions of the value of oil in the medium and long-term, with a range of US$90-US$100 per West Texas barrel the main focus of the market at present.
This price range works at several levels according to Barclays, as it matches the budget-clearing Brent crude price for Saudi Arabia, the price embedded in most major oil company investment and the marginal all-in cost for oil sands and other marginal oil.
Looking at time spreads in the oil market, Barclays suggests prices at present highlight the tightness of the market in recent months. This has helped support prices, as Barclays notes the decline in the oil price in recent months has been far less relative to other commodities and assets.
With the market's supply deficit continuing to grow thanks to no improvement in non-OPEC performance and some supply and policy issues within OPEC itself, prices have flipped into backwardation.
It has taken longer for the West Texas Intermediate (WTI) market to move into such a state, as the US enjoyed high inventories at Cushing for some months, But with these inventories having been drawn down, Barclays suggests WTI is now moving closer to being aligned with the world market.
While JP Morgan expects Libyan supply will improve in coming months, these additional barrels are likely to be absorbed by domestic needs and underlying demand strength. This suggests as the market enters its seasonally strong winter demand period the supply chain will remain stretched to the end of the year, especially as geopolitical risks remain in place.
This situation may change into 2012, as JP Morgan suggests the combination of seasonal demand weakness and rising supplies from Iraq and Libya may generate a larger than comfortable inventory build for producers in the second quarter. An increase in strategic storage in China may help offset this to some extent.
In terms of demand, JP Morgan expects growth of 0.7 million barrels per day in 2011, down from a forecast of 0.8 million barrels previously. In 2012 the broker expects demand growth of 1.1 million barrels per day, rising to 1.4 million barrels per day in 2013.
The concern for JP Morgan is a limited margin for any supply shortfalls due to a recent downturn in inventories and little spare capacity in the system. But if the first half of 2012 plays out as expected there remains scope for market tightness to ease.
If producers next year are willing to adjust production back as far as mid-2010 levels to maintain price stability, JP Morgan sees scope for a short-term buffer to accommodate any demand shifts. This means relatively little adjustment to price estimates, JP Morgan forecasting Brent crude prices of US$115 per barrel for the final quarter of this year, then declining to US$110 per barrel by the second quarter of 2012.
Average annual price forecasts stand at US$112.40 per barrel for Brent crude this year, US$115 per barrel in 2012 and US$121.25 per barrel in 2013. The 2012 forecast is down from US$124 per barrel previously. For WTI, JP Morgan is forecasting average annual prices of US$94.12 per barrel this year, US$97.50 per barrel in 2012 and US$114.25 per barrel in 2013. Again the 2012 forecast has seen the biggest change, falling from a previous estimate of US$114 per barrel.
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