Commodities | Sep 12 2006
By Chris Shaw
The sell-off in commodity prices that has gained pace in recent days has not spared the oil price, as despite it being hurricane season in the US and with tensions remaining in the Middle East and Iran, oil prices have fallen significantly.
As Morgan Stanley notes, a month ago the price for a barrel of Brent crude for September delivery was US$77.60 whereas now the same barrel will cost US$14.00 less. It could be this is just another correction in what has been a volatile market in recent months, but the broker suggests it is actually something far more important – the beginnings of a structural change in the oil market.
How significant you ask? The broker suggests per barrel the oil price may fall to US$50.00 or lower over the next two to three years.
In its view the last few months have produced a reversal in the oil market in that earlier in the year the global economy was still accelerating, which combined with a lack of space capacity in the refinery sector in particular but in oil supply terms as well meant prices were more likely to rise than fall.
But things have now changed, as the apparent slowdown in the US housing sector may be a precursor to a general slowing in the US economy, helped by the increases in official interest rates that have already occurred this year. Given the US position as the world’s largest importer of energy, a slowing in its economy is significant in demand terms.
Figures from the International Energy Agency (IEA) suggest demand growth is slowing globally also, though the broker questions these figures in the sense demand is often under-stated. The broker expects global demand to remain at solid levels this year as global GDP is likely to grow at about 5%, as any fall in demand would suggest less need for oil in global terms than when world growth was lower as was the case in 2002 and 2003.
Having said that, it is forecasting global growth to slow to around 4.1% next year, meaning consumption should fall. On its estimates global consumption of oil is likely to fall by as much as 1.7m barrels per day in 2007.
At the same time there has been a supply response, even if not a huge one. The broker suggests the geopolitical risk premium associated with supply disruptions has gradually increased since 2004, meaning the world is now much better placed in terms of being able to cope with any potentially dangerous events from the key supply region of the Middle East. This is not to say disruptions there would not impact, as the broker suggests if Iran were to suspend production the crude oil price would likely spike through US$100/bbl and remain there for some time.
Additional production coming on stream should see crude oil supplies increase by 1m barrels per day in both 2007 and 2008 on the broker’s estimates, while it is also tipping an increase in refinery capacity over the same period. While this doesn’t sound like a significant increase, when combined with the likely cut in demand of more than 1m barrels daily the change in market balance is significant.
The other factor supporting the broker’s view the oil price will move lower is the fact there has been a substitution and conservation impact following the recent high prices. It points out oil consumption per unit of GDP is declining faster now than during the period in 1986 when the oil price collapsed. Nowhere is this more apparent than in the US, where it notes energy consumption per unit of real GDP has declined faster in both 2005 and 2006 than in previous years.
With the world also investing more in alternative fuel supplies, the balance in Morgan Stanley’s view is clearly shifting in favour of weaker prices. Threats remain, not least given hurricane season still has some time to run and that will be followed by the Northern Hemisphere winter and the resulting increase in demand for oil for heating.
Despite this, the broker is increasingly confident in the absence of a significant supply side shock the trend for the oil price is now down.