2008 crude outlook
on January 18, 2008

I had the opportunity last night to learn current thinking within the oil industry on the current outlook for oil markets, by attending the annual lecture of the British Institute of Energy Economists, kindly hosted by BP.
A year ago, at the same event, the crude price was $51/bbl. Last night, the headlines were ‘major fall in oil price to $91/bbl’. This captures the extreme volatility that now exists in oil markets, and which makes life an absolute nightmare for anyone who buys or sells oil-based chemicals.
The consensus emerging from the discussion was that markets will remain strong, and that the activity of speculators will continue to create volatility. High oil prices are not likely to stimulate new supply in the short-term, as most reserves are in areas that are difficult to access due to politics or geography. Equally, demand will continue to grow in the Middle East and Asia, due to massive government subsidies on domestic prices.

The main speaker, Dr Paul Horsnell, is one of the most influential figures in the oil markets side of investment banking, as head of commodities research for Barclays Capital. They are one of the major players in futures markets, advising on $bns of investment by pension funds and other investment institutions.
He spent some time discussing OPEC’s current strategy. He believes this has evolved considerably since 2002:
• Initially, they tried to ‘manage’ prices around $25/bbl
• As prices rose above this level, they tried to ‘cap’ them by trying to ‘manage’ inventories.
• This policy failed, and inventories built during 2006, leading to the price collapse.
• Now, as I noted after the last OPEC meeting, they are instead trying to support higher prices by keeping inventories tight.
As a result, Horsnell is forecasting that average prices in 2008 will increase c20% to $90/bbl, from $72/bbl in 2007. He also noted that the forward curve (the futures market price for periods out to 2015) is fairly firm at around $86/bbl.
His price forecast takes account of expected short-term weakness in H1, as mild winter weather and forecasts of a US recession and global economic downturn impact psychology. He expects this weakness to be compensated later in the year, when prices might reach around $120/bbl.
Horsnell also gave the following overview of current oil markets:• Demand in OECD countries is flat to declining. The major influence is the weather. This year is seeing a mild winter, so demand will probably be down around 1mbd.
• Demand destruction does not seem to be taking place within OECD, even at today’s high numbers. US gasoline demand this month is currently 9.1mbd, versus 8.8mbd in January 2007. His explanation for this is that most of the potential demand destruction took place during previous periods of high prices in the 1970s/1980s, and more recently via the outsourcing of oil-intensive manufacturing to the emerging economies.
• Demand outside OECD is growing at around 1.6mbd/year. This is focused on China (390 kbpd growth in 2008), Saudi Arabia (150 kbpd), other Middle East (330 kbpd) and India (140 kbpd). The common characteristic of all these areas is a relatively young population, growing incomes, and heavily subsidised oil product prices.
• There seems little chance of any of these factors changing in the next few years. Governments do not want to stir up social unrest by increasing domestic prices, and have no pressing need to do so as they all have healthy fiscal positions. 2008 is also likely to see a particular boost in China in the use of transportation fuels, due to the Olympics.
Supply within OECD has been declining faster than expected in recent years. An important question is whether traditional forecast decline rates of 4% for mature OECD oilfields now need to be increased to nearer 6%. Many fields, such as the N Sea and Mexico seem to be reaching the end of their life, and the drop-off in output seems to be increasing.
• New non-OECD supply is focused on Brazil (300 kbpd), Russia (200 kbpd) and Azerbaijan (175 kbpd), with the total increase expected to be around 1.6 mbd. Coincidentally, this therefore matches demand growth outside OECD.
• The carbon price is also lending increasing support to oil markets, and this is expected to continue.
Overall, Horsnell sees no change in the underlying dynamics of the market that would dramatically change the picture on supply/demand that has operated since 2004. However, geo-political developments always had the ability to change the picture. Equally, any major collapse in the value of the US$ would lead to more buying of oil and other commodities by financial players, as a hedge against inflation and falling stock markets.
Horsnell also added an interesting insight into the behaviour patterns of financial players. He confirmed, as I noted earlier this week, that the big pension fund players are now entering the market on a long-term basis. They are likely to commit $bns to energy markets, and therefore provide long-term support for prices.
But Barclays’ research suggest most are buy-and-hold players, with only 6% being ‘speculators’ trying to anticipate the near-term peaks and troughs of the market. These are the ones who create major volatility by jumping on fundamentally-driven trends, and taking them to extremes of valuation.

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