Oil not far away from "shock" prices, say analysts
China (Platts) -- Nov 19-23 2007
By reporters at Platts, the energy information division of the McGraw-Hill
Companies. For more information about Platts' information products in China,
contact Platts at china@platts.com, or call its representative office in
Guangzhou at (+86) 20 2881 6588.
Crude oil futures hit fresh trading highs once again last week and moved
close to the kinds of levels that could recreate the economic shocks of the
1970s, after adjusting the price of oil for inflation.
By the end of the week, light, sweet crude oil settled on the New York
Mercantile Exchange at $98.18 per barrel, a gain of more than 3% from last
week. Brent crude futures on London's ICE Futures ended the week at $95.76,
a gain of almost 5%.
Both crude futures contracts are more than 60% above where they were this
time last year, and at the start of this year.
"An almost daily occurrence of record lows in the US dollar against the euro
remains as an important trigger behind renewed commodity fund entry into the
long side of the market," Jim Ritterbusch, independent energy consultant,
said in a report.
Front-month heating oil also settled at an all-time high of $2.7042 per
gallon, up 4.5% on the week, boosted by colder-than-normal weather forecasts
for most of the US in the next 10 days.
Crude prices at $106/barrel and above, if sustained for a year, will likely
erode world oil demand, top analysts at Societe Generale said last week. The
figure is today's equivalent of price levels reached during the second oil
shock, the heads of commodity research and oil research at SocGen, Frederic
Lasserre and Mike Wittner, told Platts in Singapore.
An "oil burden index" that the analysts evolved using the oil bill as a
percentage of nominal GDP showed $85 per barrel at today's price, accounting
for the efficiency gains of the past 30 years, was the "beginning of pain"
and corresponded with the first oil price shock.
If crude averages more than $85 for a year, it would reduce the pace of
world demand growth, Wittner said. But at $106 and above levels for a year,
demand growth would likely be pushed into the negative, he added.
Crude topped $10 after the first oil shock in 1974, sparked by the October
1973 Arab-Israeli war. The second oil shock saw prices vaulting $20, spurred
by the Islamic revolution in Iran.
While it was difficult to quantify individual premiums on account of a
weaker US dollar, speculator activity, or geopolitical tensions, the SocGen
analysts reckoned the "fair value" of crude was around 70% of current
prices.
Calculating on the basis of average crude prices in October, "we found that
about 28% of the price could not be explained by short-term fundamentals
such as stock cover and long-term fundamentals such as what price you need
to give producers to invest in projects like tar sands," Lasserre said.
The dollar weakness was a relatively new factor in oil prices, Lasserre
noted, with a "high positive correlation" between the two now, in contrast
to negative or a weak correlation at best historically. Investors are
regarding oil as the best hedge against US inflation, pushing energy prices
higher and in turn fueling more inflation, a self-perpetuating cycle,
Lasserre said.
Crude and products tightness in Europe and the US was supporting the ongoing
price rally, the analysts said. Gasoline was tight in the US, while Europe
was short on crude and heating oil, Wittner pointed out. "This is driving
the Atlantic Basin gasoil and heating oil cracks." "In terms of refining
[capacity] and products supply, 2008 is not going to be a whole lot
different from 2007," Wittner said. However, the scene will change in 2009,
with a "big increment" in world crude processing and upgrading capacities,
he added.
SocGen is projecting 1.4 million barrels per day world oil demand growth in
2008, of which 1.2 million barrels per day will come from non-OECD
countries, particularly China and the Middle East. The mild uptick of
200,000 barrels per day in OECD demand would be concentrated in the first
quarter, and largely due to a relatively warmer winter in early 2007. But
removing the winter effect of a year ago, OECD will see zero growth in
demand through 2008, the analysts predicted.
Lasserre and Wittner are bullish on Chinese oil demand growth next year
despite the country feeling the strain from the current high oil prices to
expectations of an 11% GDP growth in 2008, fueled in part by the Beijing
Olympics.
Also, thanks to substantial fuel subsidies extended by the government,
demand will continue growing at a healthy clip, they said.
Despite crude's spike into uncharted territory, OPEC ministers due to meet
in Abu Dhabi December 5 "will be very careful" with their decisions, Wittner
said, noting that the cartel has in the past erred in its Q2 demand
estimates. "If prices are trending higher ... $100/b ... chances are they
will increase by 500,000 barrels per day... It would be a token hike. In
December, you are talking of January [crude] liftings, which arrive in the
US four to six weeks after."
The incremental barrels would thus not address winter demand, Wittner said.
The possible hike in target output notwithstanding, the group will keep a
tight rein on actual production through 2008, he added.
"[OPEC] production will not exceed the current quarter's 31.2 million
barrels per day in any quarter next year," SocGen said in its latest
research report released earlier this week. "OPEC likes backwardation
because it offers them a way to discourage stockbuilding and control crude
stock levels," the report said.
The group will also tend to be conservative on output in view of a projected
350,000 barrels per dayrise in biofuels supply next year, and a 600,000
barrels per dayrise in OPEC NGL output, particularly from Saudi Arabia and
Qatar, the report added.
While the producers' group says it no longer has a target price band, in
autumn 2006 it decided to cut production when NYMEX crude was around $60/b,
Wittner said, suggesting the figure could be a "floor" price for OPEC.
However, there is no number that OPEC would want to try and keep prices
under, the analyst added, after having seen that its worries about global
economic growth at $40/b crude and then at successively higher psychological
marks all proved unfounded.
Updated: November 26, 2007
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