Title: Commodity Talk: Oil price fall to bring inflation relief
Byline: Helen Henton
Length: 812 words
Link to relevant WorldOilNews blog posting here.
Crude oil prices have dropped almost 40% from their July peak. The reasons include a strengthening US dollar, deterioration in the market's view of global economic prospects and massive fund liquidation with risk aversion following the collapse of Lehman Brothers and the ensuing financial turmoil. We believe prices will find a floor at a relatively high level as the market is still fundamentally tight, global and oil demand growth is still positive and the Organisation of Oil Exporting Countries (Opec) is likely to resist a further decline.
Physical supply and demand are finely balanced. The Organisation for Economic Cooperation and Development's (OECD) demand for crude oil has been falling for some time. International Energy Agency (IEA) data shows OECD demand contracting by 0.5% in 2006 and by 0.8% in 2007. The decline for this year is forecast at 1.6%. However, this has been more than offset by non-OECD demand growth of around 4% annually. Overall global demand for oil is still expanding despite high prices, partly because of price subsidies in some of the fastest-growing economies.
Meanwhile, non-Opec supplies are struggling to expand due to high decline rates in existing mature basins, skills shortage and the rapidly rising cost of oil services. Brazil, Central Asia, the US Gulf of Mexico and Canada are the main hopes for supply growth over the next few years.
Moreover, there are still significant supply risks, not least in Nigeria, where the escalation of tensions in the Niger Delta region could seriously affect output. Nigeria currently produces almost two million barrels per day (mbd), with at least 0.5 mbd of capacity already off line because of militant activity. Tensions around Iran have move to the back burner but the issue of dealing with the uranium enrichment programme has not gone away. The hurricane season in the US Gulf of Mexico has resulted in little actual damage so far, but a substantial proportion of the region's oil production and refining capacity has been off line for the past few weeks as a precautionary measure, with a knock-on effect on inventories in the US.
Ultimately, it will be down to Opec to meet the lion's share of future supply growth as the organisation sits on roughly 76% of global reserves. At the moment, Opec accounts for 43% of global output, but this is likely to rise over time. At its meeting in September, in response to rapidly falling prices and weakening demand forecasts, Opec decided to limit output to previously targeted levels in response to rapidly falling prices. In August, Opec production (excluding Iraq) reached 30.2 mbd, 0.5 mbd above the current target of 29.7 mbd, as Saudi Arabia has fulfilled its June pledge to raise output to bring relief to the market.
The key question is, where will Opec draw the line in the sand as it has not set an explicit price target? The decision to pull back output to quotas was a signal that members were becoming nervous about the level of prices. Actions to date suggest Opec will resist any fall below $90US per barrel and seems to be currently informally targeting $100US per barrel.
The added complication is that movements in the US dollar have a significant influence on Opec's price aspirations as it affects purchasing power. As the US dollar strengthens, Opec can tolerate lower oil prices. Recent US dollar strength has been a key factor in the correction in oil prices, enforced by the withdrawal of investment funds as risk aversion increased. The general trend of US dollar weakness has been a key factor behind the commodity price boom since 2002. Our foreign exchange strategy team sees further US dollar strength over the next six to nine months as growth concerns spread from the US to Europe and Asia. Eventually, the US dollar is likely to resume its weakening trend on structural factors, but near-term strength will present considerable headwinds for commodity markets in general.
The decline in oil prices is good news for inflation and for global growth prospects, although prices are still relatively high. Given projected demand growth, particularly from Asia, it is inevitable that oil prices will need to stay high to stimulate sufficient investment. Recently, the CEO of a major oil company reported that the company needed crude oil at $70US per barrel to make an adequate 12.5% return on new developments in Angola, and $90US per barrel for oil sands. If prices fall much lower, investment is likely to be put on hold, suggesting higher prices down the line.
Oil prices are now back to February levels, suggesting the inflationary impact will drop out by 1Q2009. The fact that energy costs are now absorbing a higher proportion of household budgets is something to which everyone will need to adapt, as the era of cheap energy is probably over.
Helen Henton is head of commodity research at Standard Chartered Bank
No comments:
Post a Comment