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Crude market fundamentals point to a weaker 2010

Now is the time to take a quick look at the year that has almost gone by -- 2009. From the crude oil point of view, it has been a roller coaster year. Interestingly, the oil markets during the year mirrored the previous decade rolled into 12 months.

Only a decade ago in December 1999, oil markets slid toward the then-unthinkable barrier of $10 a barrel and respected publications such as The Economist predicted that crude would sink below $5 and stay there.

Fast forward -- 2009 begins: After hitting an all-time high of $147 the previous summer, oil prices were once again teetering on the edge of the abyss, at around $40, the first time prices had fallen below $50 since 2005. The gloom was all-pervasive, with forecasters seeing prospects for only limited recovery. The World Bank in its 2009 economic outlook predicted oil would average $42.90 this year, climbing to $48.20 in 2010 and $50.40 in 2011.

At first, even the above forecasts seemed optimistic. In the early going, prices continued to fall and seemed poised to crash even lower in the face of the recession and the worst demand destruction since the 1980s. In fact the year marked the first time in more than two decades that global demand fell two consecutive years in a row.

However, somewhere around the start of the second quarter, the gloom began to clear and futures were once again back above $50. By the start of the second half, $70 was in sight. And by the end of the year, prices were once again flirting with $80. What a transformation indeed -- over only 12 months.

Now the question is how the crude markets will fare in 2010? A difficult question to answer. Yet if fundamentals are to be considered, markets don't appear going much ahead. Supplies are abundant. Spare capacity, so very essential to the psyche of the markets, is on a considerably higher side. It currently stands at around 6-7 million barrels per day, with Saudi Arabia alone maintaining almost 4.5 million barrels per day capacity mothballed -- of course at a cost. This is the highest point the global spare capacity has been in recent years.

The global economy continues to falter, impacting heavily on the global crude markets. The economic rebound is still in the process of taking shape. While most concede that some recovery is taking place, there are people talking of a double dip recession. Global crude demand is hence not growing as rapidly as was anticipated by some. Demand growth is well below original expectations.

Pundits are thus not optimistic of a price rebound. A mild winter in the Western Hemisphere will continue to exert downward pressure on crude markets, the London based Center for Global Energy Studies (CGES) says. In its December Monthly Oil Report (MOR), the CGES said a poor outlook for economical recovery, despite remedial measures by governments, meant oil prices would continue to slide.

In the meantime, weaker quota compliance is also hurting the demand -- supply balance. Amid fears the price may fall further and amid liquidity problems aggravated by the economic slowdown, compliance with OPEC output quotas has been uneven too. CGES reports that OPEC could be producing up to 800,000 barrels a day more oil than March when compliance was at its best.

Added to it, Russia caught up on production and therefore was adding more oil to the market. The recovery in oil prices after falls earlier in the year helped Russian companies to limit the output declines in West Siberia, allowing new fields to more than offset the losses. Production from the Caspian Sea has also been growing steadily.

And besides the rise in Russian production, production increases in the United States, Brazil and Colombia have also been noted. Non-OPEC oil supplies in 2009 have grown by around 570,000 barrels compared with 2008, the CGES estimated. Additional OPEC NGLs and Iraqi crude oil, which are not restricted by the organization's quota system, have helped to lift annual average non-quota-controlled output by nearly 1.1 million bpd in 2009.

All this extra oil is definitely influencing the demand-supply balance, still weakening the fundamentals. Unless consumption grows and draws down the stocks, pressures will continue to build up, CGES agreed.

Chinese refiners are also continuing to buy and process more crude oil than they need, with the excess products, especially the middle distillates, ending up being stored in tankers off the coasts of the major oil consuming countries. Unless these floating stocks -- now reaching 100 million barrels of products alone -- are reduced, either by cold weather or through rising economic activity, oil prices are likely to slip back in 2010, the CGES admits.

Unless something happens to start reducing the stocks of crude oil and refined products (mostly middle distillates) in onshore and floating storage over the coming weeks, market fundamentals are likely to begin to exert increasing downward pressure on oil prices in the New Year.

The geo-political scenarios also don't appear to be influencing the crude markets at this stage. In fact markets are so calm at this stage that an upheaval in Nigeria or a pipe blown up in Iraq or even the Iranian incursion into an Iraqi oil field failed to make the markets nervous -- unusual indeed when seen in the perspective of the last few years.

Price forecasting can be hazardous in more ways than one, yet one could say with some sort of confidence that indeed the circumstances surrounding the crude markets today are not ideal with which to begin a new year.

By Syed Rashid Husain

© Arab News 2009

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