Spare capacity, the market term for difference in supply and demand of crude, has remained constrained despite recession and a massive reduction in oil demand in 2009, Francisco Blanch, Global Head of commodities research at Bank of America Merrill Lynch, said in his latest report.
Blanch cited the decline in supply from non-Opec suppliers for the reduction in spare capacity without giving a figure. He warned geopolitics and protectionism may play spoilsport for the oil markets.
"Last year, we estimated that global non-Opec production decline rates averaged 4.8 per cent for fields producing between 2003 and 2008. When adding 2009, we find non-Opec decline rates have increased from 4.8 per cent to 4.9 per cent. This step up shaves one million barrels a day by 2015 from our non-Opec supply projections," Blanch wrote in his report.
The global demand for oil will rise two million barrels a day this year with emerging economies accounting for three-fourth of this rise, Blanch had told Emirates Business earlier. "While the demand in emerging economies will rise by 1.5 million barrels a day, it will rise by 0.5 million barrels a day in the OECD economies."
Oil will average at $85 a barrel this year, Blanch said. "It will potentially get close to $90 a barrel by the third quarter. It will break into a hundred in the first quarter of the next year," the analyst credited for forecasting $147 a barrel price for oil almost on the nose in 2008 had told this newspaper earlier.
For most industries around the world the crisis was exceptional, but not for oil, Blanch's new report said adding that the commodity has fared the crisis with strength. Oil had already suffered two back-to-back recessions in the 80s and 90s, where utilisation rates dropped to very low levels. The first recession in oil occurred in the early 80s as increased North Sea crude production and a major switch in OECD oil demand towards natural gas and nuclear power forced Saudi Arabia to cut output by 6.7 million barrels a day. In the early 90s, the oil industry suffered a second large recession, as the economic collapse of the Soviet Union left five million barrels a day of spare capacity.
Peaking of non-Opec capacity
Blanch has predicted that the non-Opec supply will peak by 2011. "We conclude that non-Opec supply, including non-conventional oil, NGLs and biofuels, will likely peak by 2011 at around 52.3 million barrels a day. Thereafter we see steady declines in production, reaching 51 million barrels a day by 2015. The world will thus become more reliant on Opec and we see utilisation rates reaching 95 per cent by 2014," he said.
The contraction in Opec output in 2008-09 is similar to cuts implemented in the "normal" recession of 2001-02, said Blanch. "With EMs demanding increasing volumes of oil and total non-Opec supply likely to peak within two years, we think the required adjustment to the medium-term demand and supply balances will have to come through lower OECD consumption and more Opec barrels," he said.
Reliance on Opec crude will only grow from now to 2015, Blanch said. We see Opec utilisation rates reaching 94 per cent by 2014 despite large investments in Saudi Arabia, Angola and Algeria."
Blanch reiterated his opinion that the emerging markets (EMs) will drive the demand for oil until 2015. "We expect world oil consumption to increase further on the back of continuation of globalisation, urbanisation and industrialisation trends. The main drivers of economic growth – labour, capital and productivity – all point strongly in favour of a strong decade for emerging economies, and thus we see EM oil demand expanding by 9.9 million barrels a day from now until 2015," he said.
"First and foremost, low levels of indebtedness in EMs relative to other parts of the world will likely encourage increased leverage over the next decade. In addition, approximately 1.7 billion EM consumers, enjoying an income per capita between $5,000 (Dh18,350) and $20,000 are eagerly waiting to start buying cars, air conditioning units or white goods.
"Continued industrialisation and urbanisation trends in EMs will also support strong energy demand growth over the coming decade. Moreover, increased trade and people flows will likely allow for continued productivity gains in the global economy. And increased demand for energy in EMs will continue to crowd out less productive uses of energy in the OECD economies," he said.
"In stark contrast to the emerging markets, we believe that OECD demand for oil will average 44 million barrels a day in 2015 compared to a peak of 49.8 million barrels a day in 2005, driven by negative population growth rates, over-indebted economies and high oil prices."
With Opec capacity utilisation rates now running at around 81 per cent, any return to the recent demand growth path will likely eat into spare capacity sooner rather than later, Blanch said.
"We believe much of the problem is a lack of competition among oil suppliers and limited potential for efficiency and substitution among oil consumers, partly due to subsidies and high taxes. The market structure for oil is now extremely static and price-inelastic," he said.
As a result, large fluctuations in prices will likely remain the norm to bring medium-term supply and demand trends into balance. "In line with this view, we see the band for oil prices widening from $70-$85 per barrel at present, to $65-105 barrel the next year. By 2014, the range could expand again to the $50-150 barrel band observed in 2008," Blanch wrote in his report.
Unpredictable oil prices
Following two decades of exceptionally high spare productive capacity in the 80s and 90s, the global oil market tightened at a very rapid pace in the 2000s as robust demand from emerging economies stumbled against limited supply growth, said Blanch.
However, the recession brought about a substantial contraction in OECD oil demand, forcing Opec cartel members to cut supply by 3.1 million barrels a day in early 2009 and late 2008.
"While oil demand has started to recover again, the medium-term outlook for oil and the global economy remains extremely uncertain. What does oil have in store for the 2010s. A potential four-fold surge in Iraqi production, dramatic increases in oil efficiency and substitution or a demand bubble in the emerging economies could all create large swings in global oil supply and demand balances. But the departure point matters, suggesting that oil the oil markets could be very tight again by 2014," said Blanch. He sees large fluctuations in oil prices after 2014.
Economy and geopolitics
Taking the Iraqi government's announcement of raising its oil production capacity from 2.5 million barrels a day to 10-12 million barrels a day over the next decade with a pinch of salt, blanch said that such a development would keep oil prices below $100 a barrel.
"While we remain sceptical that these large increases in volumes can be achieved, a four-fold increase in Iraqi production over the coming years could be sufficient to keep oil prices from rising above $100 a barrel for much of this decade," said Blanch.
Should a surge in Iraqi production come during an economic downturn, oil prices could temporarily drop again below $50 a barrel. No forecast could have predicted the extremely volatile path of Iraqi oil production during the last 60 years, mainly a result of geopolitics."
Trade protectionism, could dampen oil trade, wrote Blanch. "Oil is mainly linked to the transportation sector, so a reversal in global trade could have a dramatic impact on demand. In this regard, increased protectionism could also have very negative feedback loops on the global economy. With most OECD economies increasingly reliant on foreign capital to fund soaring budget deficits, there are clear risks to global economic growth in the years ahead."
A rebound in global GDP will drive the demand for oil, Blanch observed. Merrill Lynch has suggested a higher global GDP growth this year and in the coming years.
"In our base case scenario, we forecast global GDP growth to rebound relatively swiftly on the back of fiscal stimulus spending and exceptional monetary policy measures. Our economics team sees a cyclical rebound in 2010 and robust global GDP growth of 4.4 per cent, led by emerging markets, which puts BofA Merrill Lynch on the upper end of growth expectations. Thereafter, we forecast global GDP growth at 4.6 per cent in 2011 and at an average of 4.2 per cent in 2012 to 2015. Thus, we see global GDP growth resume an upward trending path relatively quickly, driven by energy-intensive growth in EMs."
Demand to increase
"Given our economic growth assumptions, we maintain our average oil demand growth forecast for 2010 at two million bpd or 2.4 per cent, and we project growth of 1.5 million bpd or 1.7 per cent in 2011," said Blanch.
"In level terms, we expect global oil demand to surpass 2008 volumes by the end of 2010, a remarkable achievement given the depth of the recession. Rather than a paradigm shift in consumption trends like in the 80s, we see global oil demand growing at a relatively healthy pace on the back of relatively limited scope for efficiency and substitution gains in the short-run, and a robust outlook for the EM economies," he said.
"Looking farther out, we continue to project relatively strong oil demand growth in the medium-term. Under our base case assumptions, global oil demand (increase) will average 1.4 million bpd each year from 2010 until 2015, although we see consumption increases dropping below one million barrels a day again after 2014," Blanch forecasted.
"On a calorific value basis, oil has been substantially more expensive than competing fuels like natural gas or thermal coal for a long time. In turn, economic sectors that had the ability to reduce input costs by substituting away from oil into natural gas, like power generation and heating, have continued to do so at a rapid rate," wrote Blanch.
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