Commodities | Jan 20 2011
By Gavin Wendt
Founding Director & Senior Resource Analyst
MineLife Pty Ltd
Despite an ever-changing and volatile financial climate, gold and oil remain the most significant of all commodities in terms of their importance, profile and capacity to influence market sentiment. As much as markets and some investors try to move away from these two supposed arcane relics, both remain mainstays that continue to be key barometers for our overall economic health. Most significantly, demand for both remains strong, despite the ongoing search for supposed alternatives.
At the beginning of 2010, I maintained a price prediction of US$100 a barrel for oil by the close of calendar 2010 and US$1,500 per ounce for gold. With oil trading at around US$91 a barrel and gold trading around US$1,370 per ounce, I was a little optimistic in my forecasts, but not too much. Encouragingly, demand for both gold and oil remains at record levels.
What’s been particularly interesting has been the positive price movement in oil, almost unnoticed by some, against the background of European debt woes, a second round of major stimulus spending by the US, and strong gold demand. In fact, global demand for oil has never been stronger, with third quarter 2010 growth of 3.7% representing crude’s fourth-straight quarter of growth.
Intriguingly, this oil consumption growth has taken place at a time of demand weakness in two of the traditionally biggest markets for oil, the USA and Europe. So, where has the demand been coming from? The answer lies in the escalating growth of the world’s burgeoning, new economies.
The following clearly shows that global oil consumption has recovered from the lows of early 2009 and now sits above pre-GFC consumption levels. However, what the chart also starkly demonstrates is that consumption in the developed world, represented in the chart by the OECD countries, has been stagnant for the past 18 months and remains around 8% below 2007 levels.
Whilst oil demand in the developed world has stagnated, emerging markets have been quickly securing a much bigger portion of global oil consumption over the past few years, clearly narrowing the usage gap between the two types of economies. And this trend is certain to continue, as reflected in the Paris-based International Energy Agency’s most recent oil outlook statement.
The IEA predicts that global energy demand will grow by 36% between 2008 and 2035, with China, India and the Middle East leading the charge. And the three biggest contributing factors for oil demand rise from the emerging economies will be economic growth, population growth and heavy fuel subsidies, which in many countries will provide a buffer against rising oil prices.
Not surprisingly, Chinese oil demand is expected to grow at the fastest rate of any country in the world at 10.4%. In coming years, outstanding growth in China’s motor vehicle demand will be the catalyst.
One of the most amazing statistics I’ve seen, which really puts everything into perspective, is that currently in the US 700 out of every 1,000 people own motor cars. In Europe the statistic is 500 out of every 1,000 people. By comparison, in China only 30 out of every 1,000 people own cars and experts believe that figure could jump eight-fold to 240 out of every 1,000 by 2035.
For perspective and guidance it’s always interesting to compare the situation in Japan, one of modern history’s greatest economic miracles. According to statistics provided by industry consultants PIRA, when Japan’s per capita GDP reached US$5,000, oil demand grew at a 15% annual rate for the next ten years. It was a similar story in South Korea.
Interestingly, China reached the US$5,000 GDP per capita mark in 2007, but oil demand has only grown at a 7% compounded annual growth rate since then. What all of this does is effectively highlight China's huge potential to play ‘catch-up’, with strong oil demand potential based on historical patterns.
During September China imported a record volume of crude oil, with purchases increasing by 11% to 23.29 million metric tons, or 5.52 million barrels a day. China’s manufacturing expanded at the fastest pace in fourth months during September, adding to signs that economic growth is stabilizing even as the government curbs lending increases and implements measures to cool its property market.
Net crude imports rose to a record 22.9 million tons during September and for the first nine months of 2010 rose by 24% to 181.16 million tons.
Turning our attention to the supply side and things are continuing to deteriorate as we have been highlighting for several years. OPEC still controls around 40% of the world's oil supply, but the organisation’s spare capacity peaked during the early 1980s and is projected to fall by an additional 2 million barrels per day during 2011, leaving the cartel with less ability to manipulate production as demand continues to grow.
In fact, OPEC's ability to control the oil market is in decline. Ten of the cartel's 12 countries will produce less oil in 2011 than they did in 2008, with Iraq and Nigeria the only countries expected to see production increases.
And I don’t share the optimism of other market-watchers and their confidence that oil production levels can not only be maintained, but significantly expanded to meet rising demand. As the chart below clearly demonstrates, most of the world’s easy, big oil discoveries have already been made. In the period 1960 to 1970 the average size of new discoveries was 527 Mb per new field wildcat. This size has declined to 20 Mb per New Field Wildcat over the period 2000 to 2005.
By 2020 and then 2030 there is every chance that oil supply will be significantly lower than it is now, creating a supply gap which can hardly be closed by growing contributions from other fossil, nuclear or alternative energy sources in this time frame. We will address the issue of supply-side problems in the oil industry in future reports.
Rising demand from emerging markets and a lack of production flexibility by OPEC should result in a very tight global oil market during 2011, which means that we expect oil prices to continue trending upwards throughout 2011.
I would anticipate prices firming above US$100 during the first quarter of 2011, particularly as we are entering into the worst of the Northern Hemisphere winter, one of the two key oil demand periods each year. Prices should then firm further to up to around US$120 per barrel by the end of 2011.
All views expressed are the author's, not FNArena's (see our disclaimer).
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