Commodities | Dec 01 2009
By Andrew Nelson
It is certainly a different oil market this December than it was the last. By December last year crude oil was trading down in the US$30s/bl and investment markets around the world were dressed out in funeral attire. This was just scant months after crude prices scaled to all time highs close to US$150/bl back in July 2008, with many predicting US$200/bl was just around the corner.
But by last December the GFC was in full swing, with havoc having been wreaked on financial markets the world over in the preceding three months. The questions investors were asking about oil last December were: How long will the global recession last and how deep will it be? How far will demand fall as a result? And will the damage being done to the global economy and its financial institutions be permanent?
In such a market, liquidity became the holy grail sought by investors. Risk in any form was avoided like an infectious disease and long-cycle dynamics carried little weight in a world that had quickly become afraid of sharp discontinuities and institutional fragilities.
Yet 12 months on and the price is back above US$70/bl, and instead of discussions being focused on how far can oil fall, the predominance of current commentary is speculating on: How soon will the current recovery be consolidated? How fast will demand rise as a result? When will sub-optimal investment levels translate into supply-side crunches? When will crude oil break out of its US$70s range?
The main reason for this shift is that having more liquidity and less risk is no longer the goal of your average or even institutional investor. At the same time, the longer cycle concerns about underinvestment have also helped place a solid floor under crude prices.
Commodities analysts at Barclays Capital note that one of the key lessons learned in 2009 was exactly what happens to the international oil industry at prices below US$70/bl. Deep cuts emerged early in the down cycle for prices. Significant investments were first questioned, scaled back and then cancelled, while those companies most reliant on cash flow quickly hit the wall in an environment where there was no longer credit.
It’s this lesson that has the team from Barclays thinking that recent prices are not too high for current “fundamentals” because a main feature of the “fundamentals” is that the oil industry simply cannot operate sustainably at prices much lower than current levels. In fact, Barclays ponders whether the last year will go down in the history books as the year in which the world discovered how high the floor for oil prices needs to be in order to maintain a sustainable, balanced market over the longer term.
The bank’s current forecasts have crude oil pushing up to an US$85/bl average in 2010 then to US$87/bl by 2011.
Analysts at RBS also expect oil demand to recover over the next two to three years, as world GDP turns positive. However, the broker believes the growth in demand will be mainly in Asia/Pacific ex Japan and in the rest of world areas. In the more mature industrial regions the broker expects little or no growth in oil demand in the period 2009-2012. As such, RBS predicts flat prices over the next 12-18 months as economic recovery helps demand begin to rise.
“There will definitely be a risk of short-term pull-backs if economic data disappoints,” says RBS. However, from mid-2011 onwards, the broker expects to see consistently rising demand, which in turn will push prices over US$80/bbl and towards US$90/bbl. There is however, admits the broker, a chance that prices could spike over US$100/bbl at any time in the next three years.
Commonwealth Bank has also lifted its oil price forecasts for the coming year, noting crude prices have proven more resilient than anticipated over recent months.
While the bank doesn’t expect any strong gains in the oil price in the coming year given current prices already seem to be factoring in an international economic recovery, CBA now expects prices to start edging slightly higher over 2010 after a few flat months early in the year. CBA then sees the price moving higher again over 2011 as the international economic recovery gains more traction and markets become more concerned with medium-term oil supply-demand fundamentals.
There are some risks that the data flow from developed economies will fall short of market expectations, which could see intermittent dips in the oil price, notes CBA. But ultimately, the bank thinks that any dip in the oil price towards US$70/bl would likely just attract fresh buying, thus putting a floor under any sort of sustained pull-back.