Resilient oil price lifts prospects

In correlation with equity and financial markets, the price of oil made a strong recovery in 2009. The price of a barrel nearly doubled, commencing the year at around $40 per barrel for Brent crude, and ended 2009 at just below $80 per barrel. The gain has been impressive, riding on the back of strong resource demand, particularly from China and the other large emerging markets, and in the latter half of the year as the global economic recovery began to take hold in large industrialised countries.

Over the past month, the oil price has been solid, aided by stronger equity markets and declines in oil stocks particularly in the US. Equity markets have made an impressive recovery since the lows of April, and the oil price increase since then has shown a strong relationship. More recently, improvement in a number of economic indicators, including slowing unemployment figures and higher retail sales, have boosted the belief that the global economy will show reasonable growth in 2010.

One of the more positive signs has been that the US dollar has shown strength against major currencies over the last few weeks and, despite this, the oil price has been quite resilient. Historically, there has been a strong trend of the oil price rising on a weaker dollar. Part of the reason for the oil price performance has been the fall in crude stocks in the US, where stocks are near to their lowest levels for 2009, in part due to the onset of the US winter.

Demand for oil has definitely recovered during 2009 but is still below the corresponding period level of 2008. However, US oil and fuel inventories are falling quicker than expected – not only due to winter – but as manufacturing begins to recover and companies begin to build their own inventories. Oil inventories fell 4.8 million barrels in the week ended December 18, according to the Energy Information Administration; most analysts had expected a one million-barrel decline.

With the fall in oil stockpiles, demand should remain tight, helping to support prices going into 2010. However, one of the other reasons for the fall in oil inventories have been tax driven as US companies approach the year end; companies must pay tax on oil stocks accumulated during the year. In the US, the EIA expects the price of West Texas Intermediate (WTI) crude oil will average about $76 per barrel between now and end March 2010. By end-2010, it expects the price to rise to $82 per barrel, assuming US and world economic conditions continue to improve. EIA's forecast assumes US real GDP grows by 1.9 per cent in 2010 and by 2.4 per cent in 2011, and world oil-consumption-weighted real GDP grows by 2.6 per cent. This will push US total petroleum demand higher, reaching 19 million bbl/d by the third quarter of 2010.

The Organisation of the Petroleum Exporting Countries (Opec) is set to try and maintain a tight market in 2010 in order to consolidate prices underpinned by Opec production cuts which began to take effect in early 2009. Forecast Opec crude oil production increases to an average of 29.6 million barrels per day (bbl/d) in 2010 in response to an anticipated rebound in global oil demand.

Expectations of a continued global economic turnaround have supported oil markets, and this should continue in 2010. World oil-consumption-weighted real GDP is expected to grow by 2.6 per cent in 2010, following a decline of 0.7 per cent in 2009. The expectation is that Opec crude oil output in 2010 will hold at roughly fourth-quarter 2009 levels of under 30 million barrels per day. The EIA forecasts that world oil consumption will grow in 2010 by 1.1 million bbl/d to 85.2 million bbl/d. Countries outside of the Organisation for Economic Cooperation and Development (OECD) are likely to account for almost all of this growth. Projected OECD oil consumption grows by only 0.1 million bbl/d in 2010. Futures and volatility movement also indicate a sustained higher oil price in 2010. The implied volatility last year for the February 2009 contract was double the current level, at 82 per cent per year, with lower and upper limits of $29 and $84 per barrel, respectively, for the 95-per cent confidence interval. The higher implied volatility reflected market uncertainty following a price collapse from all-time highs for the WTI futures of more than $145 per barrel in July 2008. Implied price volatility for the January 2010 natural gas futures contract averaged just over 56 per cent at a price of around $75.

A floor for the oil price in 2010 could well be $70 per barrel. Towards the later part of the year, the price is likely to head back towards three figures. As global economic growth makes further progress, with stronger emerging market demand for oil, combined with likely weak oil production growth, the oil price for 2011 should rise to above $100 per barrel.

Despite the deepest, most wide-spread economic contraction since the 1940's, and the fact that oil demand has declined for two consecutive years, the oil price has been very resilient. Although obviously aided by production cuts, the price of oil maintained reflects the underlying high demand and little alternative option. With stronger prices expected going forward, this will provide a more positive economic operating environment for the Gulf.

The author is a US-based commentator on business issues


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