Commodities | Nov 06 2008
By Chris Shaw
As expectations for global growth have been revised significantly lower in recent months this has created a state of disequilibrium in the oil market. Barclays Capital notes not only has the change in economic conditions needed to be factored in, but so too the repricing of risk and liquidity, as this has changed overall investor sentiment.
As an example, the group notes the key pricing dynamics in the market have changed significantly in recent months, from supply side concerns early in the year given weak non-OPEC supply figures to weaker demand data and financial market problems dominating pricing issues more recently.
This re-pricing has resulted in extreme levels of volatility in the oil market. The group points out there has been a series of three, four and five standard deviation events rather than a two standard deviation event, which is generally considered a high level of volatility.
Given the speed with which this adjustment has had to occur, the group sees it as no surprise the oil price has overshot to the downside, but in Barclays’s view, this doesn’t mean investors should get comfortable with the idea prices are returning to a low level.
Firstly, the group points out there has been a very quick supply side response to the recent price weakness, as a sizable amount of incremental activity has been frozen and a number of new projects have been delayed. The speed of the change has been much faster than in previous downturns, with one possible reason being there is now less scope for generating cost savings though efficiency improvements across the sector.
The other point Barclays makes is the dis-equilibrium in the market is not new, as the oil market has not been in any sort of stable state for at least five years, particularly with respect to any long-run equilibrium position in terms of an oil price that will bring long-run demand and capacity into balance.
The latest volatility in prices has shown some interesting trends, with the group pointing out the back end of the pricing curve has had trouble staying below US$90 per barrel even while spot prices are being pushed down. While accepting it is too early to suggest US$90 per barrel is the new equilibrium level, the group suggests this stickiness in prices at the long-end indicates that in periods when prices move below this level there are likely to be additional longer-run supply challenges.
While the market is currently focused on the demand side, the group expects non-OPEC supply weakness to be an ongoing issue, as natural field decline won’t be offset by additional investment thanks to lower spot prices and the ongoing credit crisis. In addition, the fact remains new output is coming from harder to extract sources such as oil sands.
This has created a perception of a structural imbalance between incremental demand and incremental non-OPEC supply and this has pushed the oil curve higher in recent years. The group suggests this long-term imbalance will outlast the current period of demand weakness, thus supporting the back end of the curve.
Based on this view, Barclays is forecasting an average oil price of US$105.20 per barrel in 2009 for West Texas Intermediate, rising to US$126.10 in 2010. This compares to the group’s forecast for an average price in 2008 of US$104.40 per barrel.
It has to be noted that Barclays forecasts currently are the top of the market. Others, such as UBS, have significantly lowered price forecasts for calendar 2009. UBS is now forecasting an average oil price of US$60 per barrel next year. Commonwealth Bank economists concluded in their update, earlier this week, that downside risks remain to oil prices in the medium term.