Commodities | Jan 18 2010
By Andrew Nelson
Wind back the clock 12-months and the last place in the world you’d want to be is in the oil business. Prices were in free-fall as the global financial crisis continued to worsen and there was no relief in sight. However, one eventful year later and the mood is significantly different, with prices now close to US$78/bbl and analysts here, there and everywhere talking about US$100 and higher.
Swinging from the huge discontinuities and disconnects from more traditional market fundamentals that characterised the oil market early last year, oil exited 2009 with the increasing belief that what happened over the past year perhaps relates more to continuities, than the lack of them. However, the commodities team from Barclays Capital Markets thinks that much of that continuity relates to the “scale and stickiness of supply-side constraints”.
The prolonged period of sub-US$70 prices in early 2009 proved that the industry is just not viable at such levels. Investment and capex were slashed as industry wide cost cutting became the catchphrase. Thus once the market priced out the likelihood of further large economic discontinuities, the team notes prices had to increase given price levels would bring about some devastating consequences for the supply side.
And now we know how high the floor for oil prices needs to be for medium-term balances to be cleared. Barclays reminds that even when the outlook for oil was at its blackest and prices at their lowest, the back end of the exchange-traded WTI curve never fell below US$70/bbl and even traded above $100/bbl in December.
Barclays expects 2010 to shape up as a year that will be characterised by much gentler dynamics in both fundamentals and prices with the emergence of a series of continuities into every sphere of oil demand and supply. This in turn will mark the building of a bridge between the demand-side weakness of 2009 and supply-side tightness, which the team thinks will likely re-appear in 2011.
The team predicts that current signs of demand recovery that began to show its face over 2009 will not only continue, but will progressively spread across regions and products. Thus after booking its biggest fall since 1981, Barclays expects that OECD demand will first stabilize and then head for its first year of growth since 2005.
The team thinks that non-OECD oil demand growth will also increase and become more broad-based, becoming less a function of the performance of China alone.
At the same time, Barclays believes that the “poor performance” of non-OPEC supply will establish itself as a key theme in 2010 after a year that was dominated by demand concerns. In fact, the team products that non-OPEC output will be back to a situation of negative growth in 2010, with last year’s large upswing in Russian and US production fading. This, in turn, will just re-expose the structural underlying weakness of the supply base.
Yet while helpful, such trends are unlikely to carry enough weight on their own to drive the market, says Barclays, who thinks that much will still rest on OPEC. Policy conduct and more especially the group’s level of acceptance of further upside price momentum will be crucial. With most agreed that the recovery is consolidating, that demand is improving and inventory surpluses are diminishing, the team thinks there is now some room for a little of relaxation on OPEC’s target for the upper end in prices.
However, Barclays thinks that any change in policy will need to be gradual and must avoid any sort of abrupt discontinuities in terms of price targets or output volumes. Thus, the team expects that prices will continue to reflect the fundamental developments of a market that is currently transitioning between the demand-side weakness of 2009 and the supply-side tightness that is likely to become the case in 2011.
Looking forward, Barclays predicts the WTI price will average about US$85/bbl this year, which will be a US$23 increase from the average of 2009. That said, this is still a ways off of the US$99.7/bbl that was rung up in 2008. Most of the gains will be skewed towards the second half of the year, says Barclays, who notes the upward momentum should continue on into 2011, with the WTI price expected to average US$97/bbl that year.
Given the fairly staid fundamental outlook at the moment, the team feels that any sort of extreme price upside over the next year is unlikely. Supply and demand aside, Barclays thinks that geopolitical developments would be the most likely drive of any sort of extreme price upside in 2010. The unpredictable nature of Nigerian Delta region raises questions at the best of times and even more so now, while existing issues in Iran and Iraq are always ever present and always hang as a cloud over the supply side.