Expect Brent oil price at USD96/bbl and WTI oil price at 85/bbl by 4QCY11
Supply side issues not too big at present; OPEC spare capacity enough to meet crude oil demand: With the ongoing MENA crisis and the resultant protest in Tunisia, Egypt and Libya, the market is keenly focused on the crude oil supply worries in the near to medium term. Libyan sweet crude supply of 1.1 million barrels per day (mbpd) is already out of the market and serious concerns about the supply disruptions from major oil producing nation – Saudi Arabia (produces 8.9mbpd or 10% of world oil demand) is gaining heat. In our view, the market has overreacted to the current MENA crisis given the fact that the Libyan crude supply is merely 1.8% of the global oil demand and the current OPEC spare capacity ex Libya at 4.58mbpd (5.1% of the world oil demand) is sufficient to meet the CY11 crude oil demand.
Current OEPC spare capacity – not as low as seen in gulf war and US mortgage crisis: The OPEC spare capacity issue in the ongoing MENA crisis is not as severe as it has been witnessed in 1990-91 gulf war (OPEC spare capacity of merely 1.8mbpd) and 2008 US mortgage crisis (OPEC spare capacity at only 3.2mbpd and reached to 2.3mbpd in July-08).
Downward pressure on CY11 crude oil demand growth – due to high crude price and Japan tragedy: International Energy Agency (IEA) expects world crude oil demand to grow by 1.5mbpd in CY11 mainly on the back of expectation of strong GDP growth (IMF estimates of 4.5% in CY11). However, with the crude price above USD100/bbl mark in CY11, we see serious threat to crude oil demand as higher prices would take the US crude expenses as percentage of US GDP to 5.1% (almost near to 5.3% mark witnessed in CY2008) and subsequent crude oil demand destruction as seen in CY08 and CY09. Moreover, since Mar-11 Japan earthquake, the country’s crude oil demand has fallen by 0.2mbpd in Mar-11 vs Feb-11 crude oil demand. We believe this would create pressure on the world oil demand as the pace and timing of reconstruction activities in Japan is still not certain. IEA has already lowered its world crude oil demand growth forecast by 0.2mbpd to 1.3mbpd in its May-11 Oil Market Report Highlights; detailed report awaited.
Expect Brent crude price at USD96/bbl and WTI crude price to US85/bbl by 4QCY11: With pressure building on crude oil demand due to high oil prices and Japan tragedy and lost Libyan supplies likely to come back to the market, we expect the Brent crude price to come down to USD96/bbl by 4QCY11 and WTI crude price to USD85/bbl. We expect Brent-WTI price differential to remain at USD11/bbl due to storage and infrastructure bottlenecks at Cushing, Oklahoma. In our view, a significant rebalancing of WTI crude price may only be after 2013 when new pipeline capacity from Cushing to the Gulf Coast (if approved) comes online. We expect yearly average Brent crude price of USD104/bbl and WTI crude oil price of USD93/bbl in CY11.
MENA crisis and crude oil supply concerns
Ongoing MENA unrest……
The ongoing political unrest in the Middle East and North Africa (MENA) region, which started on December 18, 2010 with protest in Tunisia have spread to Algeria, Libya, Egypt, Yemen, Kuwait, Saudi Arabia, Iraq and other MENA countries. Although all the major MENA countries has been witnessing protest but the severity of the unrest is different among the countries. Currently, the worst political unrest is seen in Libya, which begun with peaceful protest against Gaddafi’ government on January 13, 2011 but have now reached to the situation of civil war.
…..raised concerns of supply disruptions; however no major disruption so far except Libyan crude
The MENA unrest has raised concerns of crude oil supply disruption. Due to this 1.1mbpd of crude oil contribution from Libya in the world crude oil supply is discontinued. Currently only Libyan crude supply has gone out of the market and no supply disruptions has been seen from the other oil producing nations in the MENA region. Libyan crude supply is only 1.8% of the world oil demand.
Supply side concerns not too big at present – spare capacity ex Libya comfortable at 4.6mbpd
Crude fundamental data indicates that the there is no major threat to world crude oil supply even if Libya’s supply of 1.1mbpd is out of the market for next 12 months. The current OPEC spare capacity excluding Libya at 4.58mbpd is sufficient to meet the oil demand in CY2011 even if Libyan crude oil is out of the market for next several months.
Crisis spreading to other MENA countries – cannot be ruled as MENA countries as not independent of each other
The recent revolution in the MENA countries, have resulted in the ouster of powerful Mubarak (Egyptian president for last 30 years) and Ben Ali (president of Tunisia) by the people of the country. The unrest in Libya with strong demand to remove President Gaddafi from power (ruling Libya for last 42 years) seems to have created a situation of a civil war. The impact of these revolutions has been felt in the other MENA countries in the form of strong protest against the existing government. Hence, in our view, all the MENA countries is not independent of each other and therefore possibility of current crisis spreading to other MENA countries cannot be ruled out.
Can the current crisis spread to Saudi Arabia?
The most important question from the oil supply point of view is that whether Saudi Arabia would be able to protect itself from the current MENA unrest. Saudi Arabia is a monarchy headed by King Abdullah Bin Abdul Aziz and there limited political freedom, hence we do not rule out the possibility of unrest in the country. We have tried to analyse the Saudi Arabian government‘s initiatives for betterment of the social and economic conditions in the country.
Supply disruptions in Saudi Arabia and Iran – could destabilize the crude oil market fundamentals
Presently, Saudi Arabia is the largest oil producer in the MENA region with 8.9mbpd (10% of world crude oil demand) followed by Iran (produces 3.68mbpd or 4.1% of world crude oil demand) and Iraq (produces 2.68mbpd or 3% of world crude oil demand). A prolonged Libyan crisis, concerns over Shiite unrest in Bahrain spreading to Saudi Arabia and situation of instability in Iran, Iraq, Yemen and other regional producers could worsen the situation in the region. Under such situation, any kind of supply disruptions in Saudi Arabia could destabilize the crude oil supply fundamentals for long term.
Crude oil demand outlook
Robust crude oil demand outlook – demand to rise by 1.5mbpd to 89.4mbpd in CY11
World crude oil demand grew by around 2.8 million barrels per day (mbpd) to 87.8 mbpp in CY2010 from a decline of 1.1 mbpd in CY2009. This growth in the second highest in last 10 years (earlier in CY2004 world oil demand grew by 3.3 mbpd to 82.5 mbpd). The growth was fueled by strong oil demand across the globe (North America – 0.6mbpd, China – 1 mbpd and other Asia – 0.3 mbpd) except for Europe. World oil demand is expected to grow by 1.5 mbpd or 1.7% in CY2011 to 89.4mbpd supported by strong demand from China (0.6 mbpd or 6.4% yoy growth) and other Asia (0.2 mbpd or 1.9% yoy growth).
What can damage the crude oil demand outlook?
Japan Mar-11 earthquake
No impact on world oil demand; however timing and pace of reconstruction activities is uncertain
As a consequence of the recent earthquake, Japan’s crude oil demand has fallen by 0.2mbpd in March 2011 versus February 2011 crude oil demand. We believe that negative impact of this devastating natural disaster would last at least till the end of 2QCY11. However, we expect the crude oil demand in Japan to pick-up in 2HCY11 due to following reasons:
*Damaged nuclear power plants would result into increased utilization of power plants burning crude and fuel oil to meet the country electricity needs. This is expected to add another 0.2mbpd to the country crude oil demand.
*Reconstruction activities likely to boost gasoil demand
*Naphtha demand would recover in soon as majority petrochemical plants were not affected, being largely located in the south.
We believe that the fall in crude oil demand in 1HCY11 in Japan is due to slowdown in economic activity would largely be offset by incremental demand for crude oil from power plants and reconstruction activities in 2HCY11. Hence, we expect that Japan’s crude oil demand for CY11 to be around 4.4mbpd (similar to CY10 level). As such we do not believe that world oil demand outlook (89.4mbpd) would change due to March 2011 Japan earthquake. We highlight here that the Japan tragedy could create pressure on the world oil demand as the timing and pace of reconstruction activities in Japan is still not certain.
Crude oil price above USD100/bbl
Higher crude price leads to oil demand destruction
During CY02 to CY07, US crude oil consumption have witnessed increase (expect for small decline in CY06) despite crude oil prices rising strongly during the period. This clearly shows that US crude oil consumption was largely inelastic to the movement in the crude oil price during the period. In our view, the primary reason behind this pattern in the US crude oil consumption was that US crude oil expenses as a percentage of US GDP remained in the manageable range of 1.6%-4.1%.
In CY2008, international crude prices breached USD140/bbl mark and averaged nearly US100/bbl for the year. We mention here that the US crude oil expenses as a percentage of US GDP reached its all time high of 5.3% leading to demand destruction by 1.2mbpd in CY08 and 0.8mbpd in CY09. At current crude price of USD115bbl, we estimate US crude oil expenses as a percentage of US GDP to be around 5.9%, which is way ahead of historical threshold limits of 4.5% (based on the 2008 data points). Hence, in our view if the crude oil price remains at the current level throughout CY11, then this would definitely lead to crude oil demand destruction.
Current MENA crisis versus previous oil crisis
1990-91 gulf war
The ongoing MENA crisis is not as severe as 1990-91 gulf war mainly from OPEC spare capacity perspective. During gulf war period (which lasted for 7 months), OPEC spare capacity came down to 1.8mbpd levels from 5.9mbpd before the crisis. This resulted into sharp rise in the crude oil prices by USD24/bbl to USD41/bbl.
OPEC spare capacity during Gulf war (Aug-90 – Feb-91)
OPEC spare capacity 1.8
World oil demand (CY90) 66.5
OPEC spare capacity as % of world oil demand 2.7%
Demand destruction of 0.8mbpd
Consequently, world crude oil demand growth declined to 0.4mbpd in CY90 as compared to 1.2mbpd in CY89. This crude demand destruction of 0.8mbpd during the gulf war was mainly due to steep rise in the crude oil prices by 140%. With decline in the world crude oil demand growth, the crude prices also corrected by USD22/bbl and reached to USD19.4/bbl by end of gulf war in Feb-91.
2008 US Mortgage crisis
In 2008, the WTI crude oil prices reached all time high of USD145/bbl mainly on the back of strong demand environment, low OPEC spare capacity and weak US dollar. The OPEC spare capacity stood at only 3.2mbpd and reached to 2.3mbpd in July-08 during the crisis.
OPEC spare capacity during 2008 US mortgage crisis
OPEC spare capacity 3.2
World oil demand (CY08) 86.1
OPEC spare capacity as % of world oil demand 3.7%
Demand destruction of 1.7mbpd
The higher crude oil price resulted into total demand destruction of 1.7mbpd in CY08 and CY09 from world oil demand of 86.7mbpd in CY07. With decline in the world crude oil demand growth, the crude prices also corrected by USD101/bbl and reached to USD44.6/bbl by end of Dec-08.
Current MENA crisis – not as severe as gulf war and US mortgage crisis
The crude oil supply issues in the ongoing MENA crisis is not as severe as it has been witnessed in 1990-91 gulf war (OPEC spare capacity of merely 1.8mbpd) and 2008 US mortgage crisis (OPEC spare capacity at only 3.2mbpd in CY08 and reached to 2.3mbpd in July-08). The fact is that except for Libya, crude oil supplies from other OPEC countries are as per the OPEC oil production quotas. The current OPEC spare capacity ex Libya at 4.58mbpd (5.1% of the world oil demand) is sufficient to meet the CT11 crude oil demand estimates by IEA.
OPEC spare capacity during ongoing MENA crsis
OPEC spare capacity 4.58
World oil demand (CY08) 89.0
OPEC spare capacity as % of world oil demand 5.1%
Geopolitical crisis drove the crude price higher
Crude oil price outlook – correction imminent
We have tried to analyze crude prices outlook in two phases:
Phase I (1QCY11 – 2QCY11) – high crude price on supply side worries
*Supply side pressure as the 1.1mbpd of Libyan sweet crude oil being out of the market
*Demand destruction of 0.2mbpd from Japan’s March-2011 earthquake
We expect supply side pressure to govern the crude oil price movement during Phase I. We believe that though crude demand destruction in Japan would be a concern but not too big to dictate crude oil price. During Phase I, we expect crude prices to remain above USD100/bbl mark.
Phase II (3QCY11-4QCY11) – crude prices to correct on demand destruction worries
* High crude price to negatively play on world crude demand
* Supply side worries to ease as we expect ongoing MENA crisis to lose momentum
* Lost crude oil supply from Libya to enter the market by 4QCY11
We expect demand destruction worries to gain stream as crude prices above USD100/bbl will definitely take its toll on world crude oil demand. With MENA crisis expected to lose momentum and Libyan crude likely to enter the market by 4QCY11, supply side issues would reduce substantially or almost negligible. With demand worries dominating supply issues during Phase II, we expect crude prices to correct and come below substantially below USD100/bbl mark.
Expect Brent crude price at USD96/bbl and WTI crude price to US85/bbl by 4QCY11
With pressure building on crude oil demand due to high oil prices and Japan tragedy and lost Libyan supplies likely to come back to the market, we expect the Brent crude price to come down to USD96/bbl by 4QCY11 and WTI crude price to USD85/bbl. We expect Brent-WTI price differential to remain at USD11/bbl due to storage and infrastructure bottlenecks at Cushing, Oklahoma. In our view, a significant rebalancing of WTI crude price may only be after 2013 when new pipeline capacity from Cushing to the Gulf Coast (if approved) comes online. We expect yearly average Brent crude price of USD104/bbl and WTI crude oil price of USD93/bbl in CY11.