day up, the next day down; markets are always moody and still somewhat
risk-averse, given the investor trauma experienced over the past couple
of years. Nevertheless, broad equities have risen nicely over the past
couple of months and that positive disposition has contributed to a step
up in crude oil prices too. West Texas Intermediate (WTI) is showing a
confident “8” in front of itself, with spot prices looking for a “9”
after closing the week at $89.19/B.
improving market sentiment it’s not surprising to hear calls for
$100-a-barrel being reiterated by analysts; it’s like listening to a
chorus singing the same refrain from early 2008, the year when oil price
last breached triple digits. The prophecy of the choir is somewhat
self-fulfilling, and I too believe that price will cross the century
line again, as early as next year. But when the herd mentality sets in
it's time to reflect on the fundamentals and consider if the indicators
listed below justify the higher prices.
Right now demand for oil is one of the biggest factors that is in the
market spotlight. Global growth this year has exceeded expectations:
year-over-year demand has risen a whopping 2.3 MMB/d, to 86.7 MMB/d.
The impressiveness of that jump is not completely ingenuous, because
it’s a rebound off the bottom of the Great Recession. New oil
consumption is heavily weighted to emerging economies, in particular
China, but there has also been a bounce-from-the-bottom in the
economically-challenged OECD countries. Next year’s more normal growth
numbers, estimated to be between 1.0 and 1.4 MMB/d, will still be robust
though exclusively concentrated on the oil appetites of mobilizing
countries such as China. In 2011, demand growth will continue to be a
dominant theme and driver.
Oil bulls point to production declines in places like Mexico’s Cantarell
oilfield and Venezuela’s political mess to fortify the suggestion that
supply can’t keep up with demand. To be sure, peak oil arguments held
valid sway no less than two years ago and there continue to be many
problem areas in the world of oil. However, new oil production from
non-OPEC countries is offering surprises on the upside. Figure 1 shows
monthly volume since 2000. The output dip between mid-2005 and 2009
helped heighten a sense of constraint and drove up prices, but note the
pickup starting in 2009. Barrels from Canada’s oilsands have been a
significant contributor alongside Russia, Central Asia and other
prolific regions. Early indications suggest that new, emerging resource
plays such as the Bakken in North America could contribute more surprise
barrels in 2011. The market is not saying much about a challenged
supply side these days, perhaps because the edge is off the story.
OPEC’s capacity to bring extra barrels to the market if needed has
ballooned from under 4.0 MMB/d during the tight-market days between 2003
and 2008, to an ample 6.0 MMB/d today. When spare capacity starts
dipping below 4.0 MMB/d, is when oil prices will legitimately gain
traction. But a tightening down to 4.0 MMB/d is unlikely in 2011, which
means that prices will be challenged to sustain upward momentum.
Most members of the oil cartel knows that prices above $90.00/B are
damaging to demand and give impetus to substitutes and demand-mitigating
government policies. Constraining supply is certainly not something
we’ll expect from OPEC in 2011. Rather the cartel will probably be
thinking of ways to hose down an overzealous market.
Crude oil and petroleum product inventories have been tracking record
levels in the United States for over a year. There is no shortage of
oil. Since the Great Recession floating tankers with millions of
additional barrels have added to an already robust surplus. However,
some products such as gasoline and distillates have started showing net
withdrawals, which is being taken as a bullish signal. As well,
“floating barrels” are said to be depleting. There is a long way to go
before inventories come down to 2008 levels, but the market is reacting
to weekly inventory numbers again and likes the direction it sees.
There is still quite a bit of noise on the oil-troubled Iranian,
Nigerian and Venezuelan fronts. These habitual antagonists of the oil
markets haven’t had much sway on price since the financial crisis.
Negative news flow from in and around these countries won’t really
excite markets until availability of extra barrels (OPEC spare capacity)
gets tight again. Of course any surprise military action against Iran
will certainly inflame oil markets, but we’ll be analyzing different
metrics if that situation comes to pass.
The black gold standard:
Increasingly, oil is being seen as an asset worth holding in uncertain
times, a vital commodity that is believed to be a hedge against
inflation and protection against a weak U.S. dollar. This investment
strategy feeds off the first factor in this list, the notion of
unsustainable demand growth in places such as China. Consequently,
financial institutions are buying exposure to oil directly and
indirectly, which will likely persist as a self-fulfilling dynamic for
higher prices in 2011. Migrating to the “black gold standard” is
probably the biggest reason why oil prices are rising when most other
indicators would suggest there is no real shortage of black gold.
indicators for oil are not nearly as compelling as they were in the
2008 dash to $100/B. Demand growth in emerging economies is the most
convincing argument the market can cite, but beyond that the chorus for
higher prices is singing off pitch. Regardless, enough noise is being
made to push oil prices higher. Look for $80/B to $100/B in 2011, with a
test above the range if momentum sticks. However, we should be mindful
that the shaky world economic order is not in the mood for higher oil
prices right now. A “10” in front of prices will elicit a swift demand