Commodities | Jun 06 2012
– Oil prices at bottom of trading range?
– Bounce in oil price likely
– Second half of year should see stronger oil demand
– Refinery margin pressures expected
By Chris Shaw
A resurgence of sovereign debt fears, with Spain now also causing significant concern, has pulled US dollar denominated oil prices lower in recent weeks. In the view of Barclays Capital, unless there is an onset of serious economic discontinuity, prices have now fallen towards the bottom of what is seen as a sustainable range.
At present, sentiment in the oil market seems to be pricing in a dark future of major economic discontinuities. But as Barclays notes, this is despite macroeconomic data suggesting global growth will still come in above 3% this year. This suggests prices of just above US$100 per barrel represent an unstable equilibrium, as price outcomes are increasingly biased towards the two tails.
If dire expectations for the global economy were proven true prices would fall, but oil demand would also fall and Barclays expects OPEC would cut back production to try and support prices around US$100 per barrel. But if current concerns fade and there is a shift towards a more confident economic outlook, then current prices would appear to be at the lower end of a trading range.
Another source of concern in the global market is slowing growth in China and here Barclays notes the direct oil demand impact from a slowdown in China is far greater than from a recession in Europe. This reflects the fact China is expected to account for around 57% of global oil demand growth this year.
In the view of Barclays, the current slowdown in Chinese growth has been mainly policy-induced and has been investment-led and uneven across industries. This suggests a recovery will depend on policies that facilitate or create economic demand. Measures to boost growth should start to become apparent in the second half of this year and this implies less downside risk to Chinese GDP growth forecasts.
While US data have also been weaker of late, Barclays continues to see a gradual improvement, to the extent it suggests the outlook for the US economy suggested by current oil market perceptions is far bleaker than the slight softness in recent economic numbers.
Assuming then the US recovery continues and growth in China picks up in the second half of this year, the expected pick up in global oil demand in 2H12 should also materialise. This swing up in demand is expected to be at least one million barrels per day but could be as large as two million barrels. Barclays suggests this implies even if the global economy continues to grow at a modest rate, then current oil prices are too low to achieve equilibrium.
Citi agrees, taking the view while the macro environment remains bearish and US economic data are returning to weakness, oil appears due for a bounce. Seasonally the supply-demand balance should improve in coming months and this is being reflected in the physical market, which the broker suggests is a positive sign for prices.
Citi's bull case is a sharp escalation in the stand-off with Iran and this is ascribed a 10% chance of coming to pass, while the bear case is based on further macro degradation, a resolution of the situation with Iran and more indications of a sharp slowdown in the Chinese economy. The bear case would see Brent crude trading down to US$90 per barrel and is given a 40% probability by Citi.
While expecting a bounce in the oil price, Citi has trimmed its price forecasts for 2013 to below US$100 per barrel for Brent crude. This reflects in part strong US production growth of an average of 20,000 barrels per day since the start of this year, thanks largely to the boom in shale oil production.
Citi notes this growth in US output has caused a reduction in imports, this trend supported by a shift to natural gas from oil in the heavy truck sector. With this trend expected to be ongoing, Citi expects oil prices to be pulled lower in coming years.
Forecasts reflect this view, as for Brent crude Citi is now forecasting average prices of US$115 per barrel this year, falling to US$99 per barrel in 2013. For West Texas Intermediate (WTI) the expectation is prices move the same way, from an average of US$95 per barrel this year to US$85 per barrel next year.
The recent build up in crude inventories in the market is, according to Barclays, a direct result of record OPEC volumes and heavy refinery maintenance. But at the same time product inventories have fallen sharply, as underlying demand has remained solid.
International Energy Agency ((IEA)) data indicate OECD production stocks fell by 10 million barrels month-on-month in April, this while crude stocks have continued to rise relative to seasonal norms and are now 28.7 million barrels above the five-year average.
In other words, Barclays notes the relative tightening in global inventories since the March quarter has been all on the product front. This makes crude inventories look fairly heavy, but Barclays expects this will change in the second half of this year.
Part of this will be due to a higher call on OPEC crude, Barclays expecting this call will be around one million barrels per day higher in the second half than in the first. As well, most of the refining expansion expected to come online this year will be in the second half, with most in Asia.
For Barclay this suggests the appetite for crude will be stronger in the second half, though at the same time product cracks are likely to come under further pressure from refinery start-ups.
JP Morgan is more cautious on the oil demand growth outlook, especially given further weakness is expected in the near-term. To reflect this the broker has lowered its demand growth forecast for the year by 0.2 million barrels to 1.1 million barrels per day.
How the refining system adapts to this change in outlook will influence refinery margins and utilisation rates in the second half of the year, notes JP Morgan. With new refinery capacity coming on stream and with previously shuttered plants returning, the expectation is margins will move lower, to be followed by a decline in utilisation.
Given an expected tight oil fuel market in the second half of this year, such margin pressure is to be expected, as refiners need some incentive to produce more fuel oil while consumers need be induced to limit consumption. JP Morgan suggests the gap between simple and complex refinery margins should in fact narrow considerably to induce these changes.
If current global growth headwinds abate or factors such as hurricanes offer support to refinery margins, JP Morgan notes its expectations for the downstream sector may shift again. However, given the recent trend of restarting idle capacity and current demand expectations, risk appears to the downside with respect to the outlook for finished products markets.
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