Have oil prices peaked for 2009?

Is demand for the black stuff going to track economic recovery and fuel oil prices or will other factors limit demand in 2009 and beyond?

Holly Cook 18.09.2009
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Almost one year on and oil prices are currently half what they were at their peak in 2008. But an increase in demand for the black stuff, fuelled largely by China, has played a key role in the recovery of the price of WTI crude oil to current levels of $74 per barrel from last year’s $30 low. Though consensus appears to be that demand for oil will rebound over the next few years—to levels of around 90 million barrels of oil per day, particularly as China’s pace of economic growth remains high, could the slow path to global economic recovery hamper this demand and, therefore, weaken the price of oil?

Oil prices may well be only half their 2008 peak of near-$150 per barrel at present, but they are still relatively high historically, having increased broadly in line with equity markets

during 2009 as the global economic outlook has brightened and risk aversion has gradually abated. Compounding these factors, China’s implied oil demand in July increased 3.5% from the same period a year ago as imports peaked.

But the assumption that a global economic recovery will drive demand is only one side of the coin. Noting that the statistics and demographics are on the side of the consensus view, Threadneedle’s Head of Commodities, David Donora, warns: “It is possible that the combined effects of weak global economic growth and persistently high oil prices, combined with technological innovation and the push towards energy security, could combine on a global basis to stabilise global oil demand in the near term and cause it to decline over the longer term.”

“The most powerful factor in the short term is anaemic global economic growth,” Donora continues, “Apart from China, the economies that face the greatest recovery challenge are those that are also the largest consumers of oil per capita.” Among them, the United States—one of the world’s largest consumers of oil per capita, which in the first quarter of 2009 consumed 18.8 million barrels of oil per day, is set to increase demand by 1.5% in 2010, according to the Energy Information Administration’s projections. However, Donora believes that “it is arguable that increasing unemployment, high levels of debt, a rediscovery of the virtues of saving and low GDP growth will create headwinds to any increase in demand from the consumer side for not just the next quarter, but for the next few years.” In fact, Donora sees scope for a further significant decline in US consumption if per capita usage trends towards the consumption levels of other developed countries.

Another factor that could inhibit demand for black gold is regulatory change. The US Commodity Futures Trading Commission is widely expected to tighten controls that will see speculators’ commodity futures positions limited. The oil price surge in 2008 exacerbated concerns over potential market manipulation, with the early focus centred on hedge funds, proprietary trading by banks and other leveraged, flexible investors with opaque portfolios.

In light of the CFTC’s lack of public communication of late, to what extent investors will face position limits is as yet unclear, but early deliberation suggest it might consider an exemption for brokers to hold large commodity futures positions so long as they are held for clients such as pension funds and foundations. Time will tell what exact steps the CFTC will take, but it was the expectation of imminent regulatory changes that led to Dresdner Kleinwort/Commerzbank analysts downgrading their oil price forecasts for 2010 last week.

In their Commodities Spotlight Energy newsletter, Commerzbank analysts cut their average oil price forecast for 2010 to $55 per barrel from $75, citing speculative investment as one of the main driving forces behind 2008’s price rally and the tightening of controls on these investors as having the potential the hamper upward price movements.

For now, however, robust sentiment surrounding a global economic recovery still provides strong support for energy prices, particularly following recent comments from both Federal Reserve Chairman Ben Bernanke and ECB President Trichet highlighting signs the world economy has bottomed.

“It has been striking how quickly the markets have looked past the current economic slump and have reinvested in equity markets and commodities,” Threadneedle’s Donora pointed out. “Of particular note has been the rapid rebound in prices of more cyclical commodities, such as base metals and energy, despite considerable idle capacity in many areas of industrial production and substantial inventories.”

Inherent in this rebound of energy prices is the notion of scarcity of raw materials and energy at some point in the future, which therefore justifies their value as a long term investment, Donora said, and in this sense, current long term investment in commodities is part of the mix that will help to ration demand, support substitution and ultimately advance technological development at a much faster rate than would otherwise be the case. “For energy markets, it suggests that with steadily increasing oil demand not necessarily being a forgone conclusion, there will be much more in the way of twists and turns than a one way bet.”

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Holly Cook

Holly Cook  is Manager, Morningstar EMEA Websites

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