Commodities | Dec 22 2009
By Greg Peel
The UBS equity strategists conclude the main drivers of the oil price in 2009 have been low global interest rates (ie “cheap money”), a weak US dollar, and an overall improvement in risk tolerance from 2008. The oil price was bottoming out at around US$32/bbl as we entered 2009 and peaked at US$80/bbl in October. It is now sitting in the low seventies.
Such a peak was beyond what traditional fundamental factors would normally dictate, suggests UBS. Inventory levels rose to record highs in the period and the level of spare production capacity has been “material”.
The strategists nevertheless see some sort of return to normalcy in 2010, but believe the oil price will remain elevated. The price of oil cannot continue to rely on a precipitously falling US dollar, they suggest, but on the flipside inventory levels should begin to move back into their normal range as the demand picture improves. UBS has forecast an average price of US$75/bbl in 2010 on range-bound trading between US$65-85/bbl.
Important in keeping a floor under the oil price will be OPEC, which always has the capacity to reduce daily production levels. However, UBS notes that while a few core countries are sticking to prescribed cartel targets, overall compliance from members is slipping. Throughout the decades, OPEC targets have been famously little adhered to by certain members who seem happy to say one thing, do another, and attempt to make more money at the expense of fellow members.
The improving global demand picture comes from the non-OECD countries, meaning the developing world, and specifically from China. UBS has become incrementally more positive on China given the speed in the rebound of its oil demand. US demand growth is currently negative, leading to the massive inventory build-up, and UBS expects only a lacklustre return to positive demand growth in 2010. All up, UBS suggests global oil demand will grow by 1.8% in 2010.
On the supply side, production outside of OPEC has been surprisingly robust, the strategists note, meaning OPEC will likely maintain its current quota restrictions at least until the OECD countries see their inventory levels fall back to normal. UBS sees this as a slow process which will take till the end of 2010.
But the strategists believe the market is currently overlooking a fundamentally important development. Since July, three redevelopment contracts for Iraqi oil production have moved towards realisation. Between now and 2015, UBS sees Iraqi production incrementally rising to 3-5 million barrels per day of comparatively cheap crude. Presently UBS sees the longer term global demand/supply balance price to be US$80/bbl, but fresh oil from Iraq will move the equilibrium point of marginal demand and marginal supply down the supply curve.
UBS sees potential downside risk to its forecast 2010 price of US$75/bbl coming from weaker than expected economic growth, perhaps as a result of the withdrawal of stimulus. A change in risk appetite would reverse US dollar flows. The strategists suggest OPEC can defend a floor price of oil at around US$60/bbl with sufficient production cuts.
Potential upside to the UBS price would be brought about by the opposite, being a swifter return to global economic growth than previously forecast.
In the longer term, UBS sees the potential for oil to rise back above US$100/bbl if the industry is unable to develop new capacity quickly enough to offset demand growth in China and other non-OECD markets. The flipside of this would be further government mandated reduction in oil use, such as through carbon trading schemes, but the strategists note governments have never had much luck in the past in reducing the world’s oil habit.
And the electric car is still some way off as viable alternative.