Crude prices have climbed out of the $30-40/B range, but the question is whether they will remain above $50/B and eventually begin to tick upward. Despite indications that OPEC has made a successful start at removing surplus crude from the market, analysts tell MEESthat the recent price rally is due more to attempts by the US government and others to massage the global economy than by any real indication that fundamentals are in play. Furthermore, they add, there is no real reason to believe that prices will not fall again.
In their recent monthly reports, the International Energy Agency (IEA), the Energy Information Administration (EIA) of the US Department of Energy, and OPEC have forecast large declines in demand growth for 2009. Although crude oil prices have rallied above $50/B in recent days, the economic data published to date shows no real turnaround for the worlds economy. Furthermore, the more pessimistic forecasts suggest the global economic downturn could last well into 2010 and this does not bode well for oil producers.
In its latest Oil Market Report (MEES, 23 March), the IEA noted that crude oil prices posted steady gains in early March on mounting evidence of increased OPEC compliance with targeted output cuts. The EIAs latest Short-Term Energy Outlook states that the global economic contraction continues to depress energy demand (MEES, 16 March). The future direction of world oil prices in the short-term will largely depend upon the timing and pace of the recovery of the global economy, the EIA said. For its part, OPEC said in the latest issue of its Monthly Oil Market Report (MEES, 23 March) that economic indicators show that further deterioration in the global economy can be expected. Financial and macroeconomic indicators in the first quarter continue to paint a very gloomy outlook across the globe, OPEC said. With recent data releases continuing to be overwhelmingly negative, further downward revisions in growth projections for 2009 are expected.
Tchilinguirian: Cant Find A Fundamental Driver
Harry Tchilinguirian, Senior Oil Market Analyst at BNP Paribas, told MEES: While its true that oil has rallied a little bit, fundamentally youre still looking at a situation on the demand side where you have a contraction quarter-on-quarter that is going to be extremely strong and continue what we observed at the end of last year, this quarter and next. Whatever way you want to slice it, that unfortunately from our point of view is inescapable. True, OPEC has been good at complying with its targeted cuts about 80% it still has some room to achieve those targets, but nonetheless on a year-on-year basis or over the last couple of quarters it is a significant reduction in supply. However, between that reduction in supply and its impact on inventories in consuming countries, theres going to be a lag.
Mr Tchilinguirian argues that, at the fundamentals level, inventories are going to have to come down on a days-of-forward-cover basis, as this gives the clearest view of whether inventories are tight in relation to demand. Once we leave March, the seasonal support afforded by heating demand is going to vanish and all youre going to be left with is the economy. On that basis, he said, we look for more weakness in demand at the end of this quarter and next quarter, which has a mitigating affect on how much inventories on a days-of-forward-demand basis come down as a result of OPEC cuts as we move forward.
The first half of the year is going to be dominated by demand perspectives, he said, and that is intimately tied to the economy, accompanied by the feeling that it is extremely bearish, and the supply-side effects only begin to shape the trend in prices in the second half of this year. So between OPEC cuts in the making and non-OPEC setbacks, you have chances for a shallow recovery in the second half of this year. Okay, we have a rally, maybe in anticipation of OPEC, perhaps because of technical indicators because we crossed this or that moving average, but in reality oil has been rangebound between the low $30s/B and the high $40s/B. We moved a little bit above by going to $52/B, but its not a precise science. I cant find a fundamental driver for it.
Mr Tchilinguirian said: I agree that OPEC has done a good job so far in implementing cuts, but the challenge is going to be to maintain them. Something that no one is actually emphasizing is that they have removed a significant amount [of oil from the market], but the question is maintaining that cut this quarter and next quarter to bring down inventories and this has got to be not just in volume, but in terms of days-of-forward-demand cover which, given slipping demand, is going to be a more arduous task. There is going to need to be some stabilization in the economic condition. By the second half of this year a bit of the monetary push that is going on will show its effects, the fiscal stimulus programs, especially the ones that are oriented towards infrastructure spending, like in China and the US, will be supportive of demand for oil and base metals. But before we get there, I dont have a fundamental reason for the market to be sustained above $50/B.
Wittner: Prices Getting Ahead Of Themselves
Michael Wittner, Global Head of Oil Research at Socit Gnrale, told MEES: I think prices are getting a bit ahead of themselves. Our forecast is that prices will be going back into a $40-50/B range for most of the second quarter. We are bullish on the second half of the year, and I think were going to get back up to these price levels and maybe even higher in the third quarter and fourth quarter and that would be more sustainable based on fundamentals but right now I wouldnt say that prices are set above $50/B.
Mr Wittner believes the recent rise in crude oil prices is not based on oil fundamentals, it looks to be based on the US Fed plan to buy back debt and the recent announcement of the US Treasury plan along similar lines. These programs are basically improving sentiment in the oil market which boils down to risk appetite. We have a little bit of risk appetite returning for the first time in a while and there are also suggestions that the recent weak dollar has brought hedging against a weaker dollar and against higher inflation in the long term. We havent had a taste of these things for many months so I think that is whats been driving crude prices.
Mr Wittner sees the market waiting for some clear sign that the economy has bottomed out, although so far there has been no indication. There is an appetite among investors to come back into commodities and oil just because it is cheap but there is a lot of caution out there, he said. Until the last couple of weeks everything was gloom and doom and now it appears that the US government actions seem to be giving people some real hope and that might be legitimate but the point is, if the US starts to get sorted out, will that be bullish for oil demand and oil prices? Yes it will, but not this week. It will take a few months to work its way through the system. Socit Gnrale expects a counter-seasonal global stockdraw in the third quarter that will allow for sustainable prices for WTI and Brent at $55-60/B during the second half of the year: But that is still a way down the road.
Halff: Crude And Product Prices Could Face Severe Downward Pressure
The second quarter is normally a period of reduced refining activity and weak end-user demand, when OECD and US crude stocks tend to peak and product stocks bottom out, Antoine Halff, First Vice President and Deputy Head of Research at Newedge USA, told MEES. The question this year will be to what extent those seasonal trends compound the already severe impact of massive, economically-driven demand destruction and how successful OPEC cuts might be in providing an antidote to that toxic mix, he added.
The chances are that crude prices, and likely product prices, will come under renewed downward pressure, though any build-up of short interest in futures markets runs the risk of setting up a short-covering rally, Mr Halff said. In the US, dark data clouds are gathering. Crude stocks already tower at a 16-year high (19 in the Midwest) and look set to keep rising on the back of exceptionally low refinery runs. Yet despite those low runs, product stocks are withholding any sign of a seasonal draw and since early January have barely shed 3mn barrels, compared to an average 36mn barrels draw in the last five years.
Mr Halff added that uncertainty about the global economy continues to dominate the market: Even under the best case scenario, the downturn looks far from having run its course. A collapse in international trade bodes especially ill for distillate demand, last years main oil price driver. Supply constraint issues pale in comparison. Although there are concerns about a potential shortfall due to the expected adverse impact of low oil prices on investment, those worries look overstated. Costs too are falling and cash-strapped producers will come under pressure to recoup lost revenues through higher exports.
Morse: A Cushion Of Capacities Will Be Determining Price Factor
This years oil market represents a radical structural departure from what prevailed in 2003-08 and in many respects is a return to normal in terms of underlying market dynamics, according to Edward Morse, Managing Director and Chief Economist at LCM Research. Due to economic recession to a significant degree, but also due to the successful deployment of capital in new refining and production capacity particularly in OPEC, and especially in Saudi Arabia and due to the demand destruction that accompanied higher prices, the situation has changed, he told MEES. The predominant determination of prices this year, next year and perhaps even the year after is the cushion of capacities now re-injected into the petroleum sector. Excess refining capacities have taken the edge off of rising distillate demand around the globe and eliminated the situation in which rising distillate prices pulled up crude oil prices.
Excess production capacity has once again motivated the producer countries of OPEC to find ways to share the burden of adjustment to lower prices and to put an effective floor under prices, Dr Morse said: By wide agreement it appears that OPEC countries can easily protect a floor price of around $40/B unless global product demand plummets further. And with ample surplus production capacity of at least 5mn b/d and maybe more than 6mn b/d, Saudi Arabia and the OPEC countries can, if they chose, keep prices below a ceiling of $75-80/B.
The high probability for the next two years is that the oil sector will revert to the situation of the 1980s whereby OPEC can meet and decide production allocations, prices will rise, additional production will come into the market, prices will fall and OPEC will need to readjust allocations, said Dr Morse. The question on price determination is an issue that is unlikely to arise again until global growth recovers and then there will be a question of whether capital expenditures will be sufficiently ample to grow non-OPEC output once again, he added. Much depends in this regard on the pace of demand growth once economic recovery begins. Some analysts expect a return to the 1.8-2% annual global demand growth levels of the recent past, requiring 1.5m b/d of new supply year after year. Others, and I am among them, believe that the new demand growth path will likely be significantly lower, placing less strain on supply.
Dr Morse said there are two significant additional consequences of the return of surplus capacities. First, the risk premium that once helped boost prices has been eliminated and might well have turned into a risk discount. That in turn has meant, secondly, that speculative financial flows, already handicapped by credit issues in the global financial arena, can no longer play the role they have in recent years, exacerbating market tightness and creating froth in oil and other commodity prices. Financial flows, in short, are now far less important in price determination than they were in 2007 or 2008, he said.
For the time being as well there are two market structural factors that are impacting prices, he added. One of these is the build-up of inventories of commercial stocks of crude oil and petroleum products. OPEC cuts should eventually bring inventories of crude oil down, which in turn should reduce the current steep market contango in crude oil and turn the price structure into either a flatter forward path or into backwardation. The main question is when this will happen in 2Q of this year, 3Q or even later? The other factor, which is also impacted by the growth in commercial inventories, is the situation in PADD II in the mid-continent of the US and especially at Cushing, which for much of this year so far has brought WTI prices to a discount to Brent. Lower refinery throughput and higher flows from Canada have reminded the world once again of the fragility of WTI as a global benchmark truly reflecting the value of crude oil to global refiners. That situation too should disappear as inventories are drawn down, but the landlocked nature of the WTI pricing hub in Oklahoma might well continue to distort relative price values to a significant degree.
Oil Supply/Demand Outlook (Mn B/D)*
2008 | 1Q09 | 2Q09 | 3Q09 | 4Q09 | 2009 | |
IEA | ||||||
Total World Demand | 85.7 | 84.5 | 84.0 | 84.6 | 84.6 | 84.4 |
Non-OPEC Supply + OPEC NGLs | 55.3 | 55.8 | 55.4 | 55.2 | 55.8 | 55.6 |
Call on OPEC Crude | 30.4 | 28.6 | 28.6 | 29.5 | 28.8 | 28.9 |
EIA | ||||||
Total World Demand | 85.65 | 84.65 | 83.07 | 85.66 | 85.45 | 84.27 |
Non-OPEC Supply + OPEC NGLs | 54.21 | 54.04 | 54.80 | 54.74 | 54.89 | 54.62 |
OPEC Crude Oil | 31.25 | 28.56 | 28.69 | 29.04 | 29.35 | 28.91 |
OPEC | ||||||
Total World Demand (a) | 85.62 | 85.15 | 83.84 | 84.25 | 85.20 | 84.61 |
Non-OPEC Supply + OPEC NGLs (b) | 54.76 | 55.50 | 55.31 | 55.37 | 55.96 | 55.54 |
Difference (a b) | 30.86 | 29.65 | 28.53 | 28.88 | 29.24 | 29.07 |
* Data from most recent forecasts.
