Commodities | Dec 08 2009
By Andrew Nelson
As the global economic recovery progresses, oil demand should improve. However, there is a growing belief that while the fledgling recovery may provide a support for crude prices at current levels, there’s still a way to go for any sort of rally in prices. Inventory levels are still high and there is still significant spare production capacity that needs to be worked through.
Most experts agree the global economic recovery is going to be a gradual process and, in trend terms, oil price movements have come to reflect this view. There are still some substantial headwinds to growth on the horizon and they’re likely to hang around for a while. On top of high inventory and spare capacity, oil demand will also have to contend with what are still weak labour markets and further financial deleveraging by households and businesses.
On the other hand, there are growing signs that some of those economies most affected by the financial crisis are now definitely starting to improve. September quarter GDP data for the Eurozone and Japan were stronger than expected, although much of it had to do with government stimulus measures continuing to support expansion.
Demand in non-OECD nations is also increasing, China in particular. Analysts from UBS say they are increasingly positive on the outlook for China mostly because of the speed in the rebound of demand.
NAB Economists expect an expansion in the world economy in Q4 2009, with global growth really picking up throughout 2010. However, the bank believes the recovery will be more gradual than in most previous downturns, while it also sees the potential for a near-term run of weaker growth as the effects of government stimulus measures wear off.
As such, NAB predicts the short-term oil price will likely remain range-bound, especially as it sees the increasingly upbeat demand outlook as being already priced into oil markets. NAB doubts we will see any sort of sustained upward trend in oil prices until a significant draw down in OECD oil stocks happens, which probably wont occur until markets are more confident that the global demand recovery is actually sustainable.
Much like the oil price shocks in 1986 and 1990, the recent spike in price volatility is now being followed by some residual instability as investors remain uncertain about prospects for the market, which is keeping sentiment fragile.
However, what these previous episodes also show is that once price volatility declines, it generally does so for a number of months. As such, the team from NAB are predicting a modest rise in the oil price over the medium term as fundamental conditions steadily improve.
UBS is forecasting WTI crude oil prices of US$75/bl in 2010, and a normalized oil price of US$80/bl, with trading remaining range bound between US$65-US$85/bl. The broker expects demand will grow by 1.8%, while total supply should only increase by 0.7% in 2010. This increasing imbalance in the supply/demand metric has the broker expecting that record high inventories and spare production capacity will reduce as next year wears on.
OPEC should play an important role in keeping a floor under the oil price, notes UBS, although it admits the effort is somewhat focused on a few core countries, while overall compliance is slipping. So while OPEC has said that it will try to maintain an oil price that is consistent with production from relatively high cost reserves, NAB points out that what is substantial OPEC spare capacity means that the rise in prices is likely to happen gradually.
This is borne out by recent data, which show that production by OPEC rose during October, further reducing the group’s compliance with target levels to 61%, down from 64% one month earlier. Likewise, non-OPEC countries increased supply in October as seasonal maintenance in the North Sea ended and there was minimal hurricane activity in the US Gulf of Mexico. Thus Non-OPEC supply also remains robust, notes UBS, who is forecasting non-OPEC production of 49 MMBbld in 2010, up slightly from 2009 level of 48.9 MMBbld.
This makes the OPEC next meeting on 22 December all the more crucial for the price outlook over 2010. While analysts at CBA expect OPEC to leave oil production targets unchanged following the December meeting, the bank also notes that nothing is written in stone. CBA points out that OPEC does have a habit of putting emphasis on oil market fundamentals rather than oil prices, which it believes is affected by speculation at times.
Still, the bank’s money is on OPEC holding firm on supply, which it sees as being supportive for the oil price near-term. Much like NAB and UBS, CBA expects the oil price will continue on with its relatively flat trend for much of 2010.
Cheap money, a weak US dollar and increased risk tolerance have been the main drivers of oil price this year, and these factors have really pushed prices beyond what traditional fundamental factors would have done on their own. Thus, as inventories return to more normal levels and demand growth resumes, oil prices won’t need to rely on the tailwind of a falling US dollar for support.