JEDDAH: Looking to 2010, prospects for the oil market hinge heavily on demand developments. In view of the apparent dislocation of oil prices with fundamentals, and particularly the large stock overhang, even just to sustain current price levels there will need to be a healthy recovery in demand. This in turn depends on the path the nascent global recovery takes. While acknowledging the downside risks and prospects of a double dip recession, Samba’s baseline forecast is for a moderate uptick in global growth in 2010.
Global economy
The Samba report said global economy is now through its trough and activity is expected to gather pace over the next six months. The relative health of emerging markets, allied to the stabilization of OECD credit markets and an associated rebound in trade, should allow a reasonably strong bounce-back in economic activity during the first half of 2010. However, much of the impetus for the recent upturn in activity in the OECD has been driven by the massive monetary and fiscal stimuli undertaken in 2008-09. Once these measures have run their course then activity might begin to slow again as we move into the second half of 2010. It is worth remembering that household and corporate debt is still large and global deleveraging still has some way to run. High levels of unemployment are also likely to persist, weighing on consumption and investment activity. Therefore the recovery from recession will be weaker than comparable episodes in the past, with global growth reaching only 3.6 percent in 2010 well below its long-term average.
Oil demand growth
These growth assumptions are slightly higher than the IEA (International Energy Agency) which is projecting global GDP growth of 3.1 percent, on the basis of which the IEA is forecasting that global oil demand will rebound by 1.7 percent, or 1.44 million bpd in 2010. This puts global oil demand at 86.3 million bpd, effectively the same level as in 2008, and still lower than in 2007. It should also be noted that the IEA demand projections are amongst the most optimistic. The US government’s Energy Information Agency (EIA) is currently projecting an increase in demand of 1.26 million bpd, while OPEC is projecting a mere 0.75 million bpd increase.
The majority of the projected increase in oil demand will come from non-OECD Asia, particularly China and India where rising per capita incomes will boost consumption, and from the oil producing states of the GCC. Favorable growth prospects in Latin America should also prompt stronger demand growth too. Growth will overwhelmingly come from developing countries as richer countries continue to curb oil use through policy driven fuel efficiency and substitution measures. As a result growth in North America and Europe will be muted as an element of demand destruction constrains already weak levels of demand growth in line with their relatively anemic economic recoveries.
OPEC output
Although global oil demand is expected to pick up, the scope to relax OPEC quotas will be limited and production discipline will be critical to securing balance in the market during 2010. Under current projections oil demand will, at best, only match that of 2008. In addition, there remains a threat that non-OPEC supply could again surprise on the upside, while NGL output growth looks set to remain strong. Under current IEA projections the additional call on OPEC crude in 2010 is estimated at only around 300,000 bpd, suggesting that OPEC will need to maintain its current production targets.
This view was confirmed by OPEC at its December 2009 meeting when it agreed to leave production targets unchanged. The final communiqué suggested a growing concern with demand prospects, the uncomfortably high level of inventories, and the related potential need to restrain output further during 2010.
However, OPEC may find it hard to improve quota discipline in the current environment, particularly with prices at levels comfortable to most members. Already the compliance rates for the GCC members of OPEC are around 80 percent collectively, leaving the largest burden for further action on those least likely to comply i.e. Iran, Venezuela, and Nigeria. That said, Saudi Arabia and other GCC members would likely act if fundamentals worsen dragging prices down sharply, the Samba report said.
Current circumstances mean that OPEC will have to maintain historically high levels of spare production capacity, currently estimated at around 6 million bpd. However, such high spare capacity may not exert the type of drag on prices seen in the past given high quota compliance rates from GCC producers. For these states maintenance of spare capacity ensures geostrategic importance, and their national oil companies maintain both operational autonomy and the ability to maintain surplus capacity.
Financial markets
The activities of financial investors are currently enabling the oil market to sustain higher levels of product stocks than would normally be seen. A number of factors are contributing to this including access to tankers for storage, high levels of liquidity and low interest rates, and a relatively weak dollar. Changes in any or all of these elements during 2010 could have a significant impact on prices. In particular, developments in the US dollar will be a major theme, with any significant strengthening likely to exert downward pressure on prices. However, although forecasting such factors is hard, Samba expects the US dollar to remain relatively stable on a trade weighted basis and interest rates to stay low in the US and Europe. This should continue to encourage investors to hold oil, providing support for prices despite the still relatively weak fundamentals.
Outlook for prices
The interplay between weak fundamentals, the need for sustained OPEC restraint, the activities of investors in oil, and the still uncertain path of the global economic recovery and movements in US dollar, all suggest that prices will be uniquely vulnerable to changing sentiment going forward. In particular, any sense that the recovery is running out of steam in the second half of 2010 as the impact of large fiscal stimuli abates may prompt a strong downward correction in prices. “This is not our central scenario and, although we do expect some volatility during the year, overall we project that prices will average $75 a barrel in 2010, the Samba report said.
Markets will be closely monitoring the health of the global economy, with any setbacks likely to dampen prices. If prices were to start declining sharply, there would eventually be a response from OPEC. Thus barring another sharp decline in global economic activity and confidence, average annual prices would hold at around $50 a barrel in a low demand growth scenario, although this would need to be supported by reduced OPEC production, the report added.
Positive implications
Under Samba’s central assumption that oil prices average $75 a barrel in 2010, the economic outlook for the GCC is promising. Although there appears to be limited scope to raise production, oil revenues will still rebound strongly in 2010 in line with the projected 20 percent increase in prices. Total GCC hydrocarbon export earnings are projected to rise by close to $64 billion from the 2009 level. This will raise current account surpluses in the region, and allow for sustained fiscal surpluses despite still strong public spending plans. The major exception will be Saudi Arabia where record levels of public investment spending are expected to lead to another budget deficit of around 2.8 percent of GDP in 2010.
While real growth in the GCC oil sector will be constrained by OPEC output quotas, there will be a positive impact as output creeps up, and from new investment activity in the hydrocarbons sector. Without the drag from falling oil output as experienced last year, sustained growth in the non-oil sector is expected to be reflected in a sharp recovery in GCC real GDP growth to 5 percent in 2010. Residual strains in some real estate and financial sectors will dampen domestic credit growth and private sector activity, but this will be mitigated by a general recovery in the global economy which will boost export demand and support a revival of capital inflows. In addition, bolstered by higher revenues many GCC governments are expected to sustain robust counter cyclical policies. Higher oil revenues will also help push nominal GDP of the GCC back up to $972 billion, the Samba report said.
(Concluded)