Whither the Oil Price?
While the plunge to sub-$80 oil came sooner than I expected, if current trends in the global economy and financial markets continue, oil is likely to come under further pressure, taking it towards $60 a barrel. If so, would take us to oil price levels not seen since early in 2007 and far below last years average. However if it does so, it might not stay there for long given the marginal costs of oil and perhaps short-term stabilization of financial markets
With credit markets locked up and investors unwilling to put money into any asset seen as risky, oil’s downward momentum seems likely to continue. Even if the coordinated injections and nationalizations of flailing financial institutions succeed, we will still be in a recessionary environment – bad for oil demand and probably almost all commodities except gold (which hasn’t been too shiny lately despite the flight to safety environment). Yet some of these commodities may be approaching their production costs, providing some floor in the near term.
Oil demand does keep falling – for now it is hard to see gasoline demand rising much in this environment – gasoline demand reported by the EIA has marked persistent decline from last years levels and for the week of Oct 3 (most recent data) demand was 5.3% lower. Demand for other oil products are down too. Jet fuel demand has been persistently lower this year (ranging from 5-8% lower y/y) and even diesel and distillate demand which was on the rise in H1, is now less demanded.
Recent IEA and OPEC estimates suggest that global demand growth continues to slow. The next report out later this month, will likely show yet another downward revision. With even China likely to demand less new petroleum products this year and into next year than previously thought. Though it is notoriously difficult to estimate China’s demand outlook. Either way EM demand growth is likely insufficient to compensate for falling demand from the G7, which seems already to be in a recession.
Lets look more closely at China. Recent industrial production and manufacturing data suggest a slowing. While some of this reflects Olympics related shutdowns and summer brownouts limiting electricity supply, a downward trend is visible. Already Chinese imports of tin, iron ore and copper have slowed – and slowing construction sector has reduced demand for steel which is now in oversupply, according to the concerns of the manufacturers. Private consumption seems to continue to be strong – retail sales growth exceeded 17% for the last few months, stripping out inflation, but this might be unsustainable. Chinese authorities are trying to steer the country to a slowdown and not a hard landing. We will get a better picture of China’s outlook later this week when Q3 data on GDP, foreign exchange reserves and the September trade balance are released.
In the long term, China’s energy demands will continue to grow but in the next year, slowing economic growth and reduced demand for some energy intensive products may contribute to slower demand – meaning that global oil demand growth will likely be nil. The IEA’s most recent report suggested 0.5% global demand growth in 2008 and only 0.8% in 2009, a far cry from the levels of recent years.
No wonder OPEC members are worried.
OPEC’s in a bind…this will be a key test of the cartel. They have called a meeting for November (ahead of the previously scheduled December meeting) and cuts seem almost a foregone conclusion. Some OPEC members might do so unilaterally. A meeting in November will give time to assess the demand going into the Northern Hemisphere winter and the effect of the withdrawal of supply from the most recent meeting. However, though there is a danger that as the price falls, they may compete to maintain production, to lock in revenues.
If the oil price continues to slide, some members might rather continue to pump oil to maintain revenues, despite the fact that their $/barrel revenues may fall, others will be more willing to hold to any agreed cuts. In practice as it has been for some time, Saudi Arabia’s decisions will matter most. It is the only country that has much surplus capacity and the only one that can hold back a lot of supplies, most of the other producers are much smaller.
Yet, there is a key balancing act, as too high an oil price would erode demand, especially from OPEC’s key consumers in the OECD.
Oil exporters have gotten more used to a higher dollar/barrel price. The budget reference price is now well into the 40-50 range for many producers (though some remain lower) and Russia’s latest budget assumes 80+. And for most countries, paying for the total import bill means an even higher price of oil – perhaps $60-70 a barrel on average, meaning that the combination of slower or no capital inflows (which may have been as much a challenge as a blessing in 2007 and 2008) and lower oil revenues may put a dampener on planned investment and rapidly cool some of the over exuberance.
One saving grace for oil exporters their dollar revenues now have more purchasing power. The majority of their growing imports still come from Europe and Asia not the US.
Yet even if oil enters the 60s territory it might not stay there. The same underlying macro outlook that drove prices up in 2003-7 is still there. Overtime developing economies will have more energy and commodity demands, and as CIBC notes, some of the demand growth is low hanging fruit. And with the price of oil and gas falling to levels last seen last year, some demand could rebound as behavioral changes are reversed or deferred consumption (say in asphalting streets) is completed.
Others suggest that asset markets may already be pricing in global recession and further decrease in demand, meaning that they might have little left to fall. This remains to be seen as the momentum may continue to be downward until any believable stabilization packages are put in place.
Furthermore with the oil price falling, some demand might re-emerge. The real demand destruction came after oil crossed $120 a barrel and gas rose to $4/gallon. We are now well below such levels. It is possible that some new demand may emerge even though global consumers are suffering.
Daniel Yergin suggests that when and if markets stabilize, energy players might revert to a concern about the long-term outlook, which was part of the underlying fundamental outlook that contributed to Oil’s rocketing rise earlier this year. He warns that a sustained commitment to all sorts of energy investment would not only ease the pressures consumers are facing and be a major contributor to the global economy’s prosperity.
Furthermore the credit crunch might exacerbate the long-term supply outlook. Slackening demand from slowing growth is reducing prices
Reduction of credit is freezing some projects not promoted by cash rich producers. As in other secto
rs and countries, there may be a greater divide between the cash rich and those reliant on costly financing. Eg Aramco’s projects might be less in doubt from credit crunch. However even Aramco’s expansion included more private sector funding, but likely longer term borrowing. . The net result suggests projects in early production phases may be frozen for some time. The IEA already suggested that the lack of credit is reducing investment in new supplies. And there is already evidence that refiners are deferring capex and output.
Lower oil price reduces the incentive to invest now, particularly in some of the more costly venues as producers fear they will not be able to break even. Some estimates suggest that new oil sands ventures in Canada need an oil price of 100 a barrel and that the global cost of a marginal barrel is in the 75-80 range.
Similarly many renewables may also be costly and a sustained lower oil price and tightened credit may reduce the progress towards the less hydrocarbon economy. Uncertainty is the greatest deterrent to investment, in the energy sector as anywhere – meaning that we might continue to see short term volatility and downward movement for now… and a subduing of energy investment until the climate shifts. Yet, even if the trajectory turns upward again, the situation that led to the oil boom (or bubble) of 2007/08 may not be repeated given new regulations on trading and the commodity markets capture of the injected liquidity.
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3 Responses to “Whither the Oil Price?”
Overshoot/undershoot, or as Soros calls it, “reflexivity.” The savings on 85m bbl/daydiscounted at 5% are worth much more than the recent losses in market value.
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