Commodities | Mar 11 2008
By Chris Shaw
In the last five years the psychology of the oil market has changed significantly, Barclays Capital noting it used to be US$40 per barrel that was considered a high price but now that price level seems but a fond memory and even US$60 per barrel appears unachievably low.
Taking a more investment-based view Barclays suggests long-term prices are more a function of the market’s perception of the supply and demand balance, with recent oil price gains suggesting not enough of an investment signal has yet been delivered to the market to bring capacity and demand into balance.
As a result the group suggests it is reasonable to question whether or not oil prices have further to go on the upside, as ever-higher prices over the last few years have so far failed to bring about a view among investors the market is headed for long-term surpluses.
At present the group sees the market as accepting US$90 per barrel is around the mid-point of price expectations, while US$100 per barrel is now seen as a reality going forward. This means the current consensus average price forecast of US$84 per barrel for 2008 is likely to prove far too low, while there is risk the group’s own forecast for the year of US$97.70 per barrel may end up proving to be conservative as well.
Looking at prices now the group points out many in the market are still taking the view oil prices are related simply to the state of the US economy and with the US economic outlook weak oil prices should be falling and as they are not the market is ignoring fundamentals.
A counter argument to this is if you take the view the US is not heading into recession and should in fact show signs of a pick-up in economic growth later in the year (the Barclays Capital view) the current strength in prices means other fundamentals such as actual supply and demand and capacity constraints are the key in determining prices rather than just any direct link between economic growth and oil demand growth.
As an example, the group points out the selling pressure earlier in the year on the back of an increasingly concerned outlook for the world economy stalled at prices above US$85 per barrel while prices on the longer-end of the curve hardly weakened, which suggests the market has pushed up its estimates of what are equilibrium prices.
In other words, six months ago US$90 per barrel was seen as reflecting a very tight market but now such a price reflects a view the supply-demand balance has weakened.
Further, the group notes over the last few years there has been a weakening in the correlation between US economic growth and US oil demand as strong growth has not been matched by increased demand. Barclays suggests this is proof there has been an adjustment in demand to correct what would have been a global imbalance in the market had prices remained at previous lower levels.
In terms of the future Barclays suggests there is little chance US and OECD demand can fall much further, so any focus on the demand side should be on non-OECD demand. One element here is the strength of demand growth from the Middle East, which grew at three times the overall rate of global demand growth between 2000 and 2007, while the strength of demand growth from China in recent years has also been well documented.
This means overall demand should remain elevated, while the potential remains for non-OPEC supply growth to again disappoint as it has in each of the last few years. Assuming such an outcome leads Barclays to suggest the oil market should remain fairly tightly balanced and this implies limited downside to prices even allowing for the current weakness in the US economy.