Oil prices may see cyclical rebound next year

Oil took several adverse factors into its stride and rallied even as other commodities put up a lacklustre performance yesterday. Nymex crude for delivery in February rose 0.54 per cent to $ 74.80 a barrel. Dated Brent spot prices rose 0.59 per cent to $ 73.15 a barrel.

While oil prices have rallied in the past few days, factors that are known to propel oil prices are simply not present. The meeting of Organisation of Petroleum Exporting Countries (Opec), the apex organisation of oil exporters, decided to let oil output remain unchanged in its 155th meeting that was held in Luanda, Angola on Tuesday.

Even though Opec avoided inflicting a severe impact on oil production and prices, news is not good as far as compliance to Opec's earlier production diktats are concerned. Compliance to quotas fixed by Opec is considered to be as low as 60 per cent in cases of countries such as Iran and Venezuela. Other factors that are working against the oil prices currently include a warmer winter in some OECD countries and strong inventory levels across the world.

Analysts agree the latest support for oil prices has come from this week's Opec meet that decided to leave oil output levels unchanged. "Oil markets bid farewell to the year 2009 on a high note as crude oil prices recovered from the battering they received from the global recession in early part of the year," analysts at Global Investment House (GIH), Kuwait, said in a report.

In view of the recovery in oil prices, Opec decided to keep the output levels unchanged and almost all oil ministers attending the meeting were happy with the decision. Francisco Blanch, the head of commodities research at Merrill Lynch, confirmed that even though demand for oil in the short-term [during ongoing winters] does not look promising, the demand will rise the next year. "Despite the recent weakness in price, we continue to expect global oil demand growth to rebound to two million barrels a day in 2010. With industrial activity surveys pointing to a growing order book, we believe that a strong cyclical rebound in demand is around the corner. In addition, the cold weather front could provide a significant impetus to heating oil demand in the United States and Europe," Blanch wrote in his recent report.

"While the contango in the global oil market is unlikely to disappear, the combination of poor refining margins, cold weather, and a recovering global economy could strengthen the term structure of global petroleum markets and provide support to flat prices," he added.

Predicting a similar growth in demand for oil in 2010, Opec reasoned that a healthier economy in OECD countries could propel demand. "The world economy is forecast to grow at a pace of 2.9 per cent in 2010, following a contraction of 1.1 per cent in 2009. Government support has helped to cushion the downturn this year and is expected to remain a main driver in 2010. However, this has come at a price of unprecedented debt to GDP ratios," Opec's report for the month of December pointed out.

"While the OECD is expected to now grow at 1.3 per cent in 2010, the bulk of growth next year will be contributed by non-OECD with China and India expected to grow at 8.5 per cent and 6.5 per cent respectively. The main challenges for 2010 will be the extent of the recovery in household consumption within the OECD as well as the health of the banking sector, which still appears to need government support," the report added.

Industrial activity will continue to improve steadily in 2010, Blanch said. "While the front of the market has suffered, the back-end has had very strong fundamental support. In part, this strength reflects the expectation of a strong cyclical rebound next year, and we continue to expect global oil demand grow in 2010 relative to this year. In the United States, the speed of the economic recovery will largely dictate how fast oil demand picks up, but leading indicators point to an improved oil consumption outlook ahead," said Blanch.

In addition, US dollar strength against some G10 currencies may help to improve the oil demand outlook relative to Europe, Blanch added. "As a result, we expect US crude oil inventories to continue on their trend towards more normal levels. Capital inflows into EM are likely to translate into EM FX strength and strong EM growth, helping drive global oil demand up and inventories down. We expect long-dated timespreads to strength and the forward curve to flatten as a result."

Analysts have termed the year 2009 as one of the worst in oil's history. Not only was the demand for oil low in traditionally lacklustre summer months, but it refused to improve even in the winter.

"The year 2009 will go down in the annals of history as the most turbulent year since the Great Depression. Global economy contracted by 1.1 per cent, equity values went south, and oil prices fell below $35 per barrel mark before recovering from March onwards as governments of major countries took unprecedented steps in the form of stimulus packages to stave off a prolonged recession. Major banks and financial services companies needed government support as the sub-prime mortgage crisis wiped off balance-sheet values and clogged the financial system," analysts at GIH wrote.

Blanch and his team of analysts said the demand for oil has refused to pick up even in winters. "Oil temporarily dropped below $70 a barrel on a combination of weak end-user demand, a stronger dollar and unseasonably warm winter. While the global crude oil balance has been improving on the back of a global economic recovery, the draw down in US oil inventories has been slower-than-expected as the market faced the third warmest November in 90 years. While we still expect a net reduction in total oil inventories in OECD economies in quarter four of 2009, commercial stocks in some parts of the petroleum complex like middle distillates remain high," said Blanch.

Blanch pointed out that the levels of oil inventories have declined to subside. "A combination of weak end-user demand, a stronger US dollar and unseasonably warm winter have pushed oil back below $70 a barrel in the past few days," said Blanch.

"While the global crude oil balance has been improving in recent months on the back of a global economic recovery, the draw down in inventories has been slower-than-expected. Total OECD oil inventories, which we originally expected to remain flat, have continued to build at a rate of 114 thousand barrels per day in the third quarter of 2009," wrote Blanch.

"While we still expect a net reduction in total oil inventories in OECD economies in the fourth quarter of 2009, commercial stocks in some parts of the petroleum complex like middle distillates could remain high," he added.


Oil demand

World oil demand is forecast to return to growth in 2010 following two years of devastating declines, analysts at Opec said. "World GDP is expected to increase by 2.86 per cent with improvements in all world regions. OECD oil demand is seen bouncing back and slashing its losses by 93 per cent resulting from a recovery not only in Europe and the Pacific, but also from expected growth in the US following two years of strong declines.

The US – which represents almost one quarter of total world oil consumption – is a key driver behind world oil demand growth. Given the expected late US economic recovery next year, the majority of the country's oil demand growth is expected to occur in the second half of 2010. Recent world economic data indicates a better-than-expected outlook for next year, hence world oil demand was revised up by 0.07 million bpd to show growth of 0.8m bpd y-o-y for an average of 85.1m bpd in 2010," the Opec report pointed out.

As expected, the figures for 2009 are not that bright. World oil demand is expected to average 84.3m bpd in 2009, a decline of 1.4m [1.6 per cent] bpd in 2010, analysts at GIH wrote. "The first half of 2009 saw destruction in oil demand as the financial crisis, triggered by the collapse of Lehman Brothers in September 2008, stretched into 2009. The credit crunch and the ensuing slowdown in economic activity led to oil demand of 84.07m bpd and 83.11m bpd in Q1 and Q2 of 2009, which is down 3.51 per cent and 2.81 per cent respectively on a y-o-y basis."

Oil demand recovered in the second half of 2009 with quarter four demand increasing by 0.25 per cent on a y-o-y basis as the massive stimulus packages in the shape of government spending and low interest rates in major economies started taking effect. China and the Middle East accounted for bulk of the growth in 2009 while the North American region accounted for bulk of the decline, GIH analysts said.

The major fall in OECD oil demand is attributed mainly to the US, the world's largest economy and the biggest oil consumer. Oil demand from North American region is expected to decline by 0.85m bpd in 2009 y-o-y while demand in Western Europe is expected to decline by 0.59m bpd.

The demand in OECD countries is expected to decline by 1.86m bpd, which will more than offset the demand growth of 0.47m bpd in rest of the world. This [2009] will be the second consecutive year when the world oil demand will decline after an estimated decline of 0.3m bpd in 2008 y-o-y. The decline in 2008 was the first time since 1983 that the oil demand growth turned negative. Oil demand growth has increased at an average of around 1.9 per cent since 1983.

China's demand is projected to grow by 0.21m bpd in 2009 while the Middle East demand is expected to grow by to 0.2m bpd in 2009, the GIH report said. "China stimulated its domestic demand with a huge $586 billion (Dh2.15 trillion) package, which kept its economic wheels moving at a brisk pace while the Middle East countries were shielded by huge accumulated reserves, which mitigated the impact of the global financial crisis. Demand in developing countries, including the Middle East, is expected to grow by 0.43m bpd to average 25.68m bpd in 2009."

Opec warned that higher prices could adversely impact oil demand. "Despite the low base in world oil demand this year, which suggests a strong increase in 2010 oil demand growth, the possibility of a weak and slow economic recovery could adversely affect oil demand growth. Downward risk factors exist and might put pressure on next year's oil demand. One factor is the oil price, which will have a large impact on oil demand; another is the timing of economic recovery in the OECD. The warm weather could shave off 200,000 barrels a day," the Opec report said.

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