Oil prices to remain range-bound

KUALA LUMPUR: Crude oil prices continue to hover around US$70 per barrel (bbl), driven by macro trends, which imply stronger future demand, and a weaker US dollar.


Standard Chartered Global Research said while China’s import demand has been strong, consumption in the rest of the world remains weak.


“The key to sustained strength is supply restraint. Output rose slightly in July but remains broadly in line with demand. We expect prices to remain range-bound until a more broad-based recovery in demand begins to deplete global stock levels.


“A recovery in industrial activity is essential to eroding distillate stocks, which are at record levels,” it said in a research note on Aug 14.


StanChart Research said it expected outright prices to remain range-bound in 3Q before moving higher on evidence of improving demand in 4Q, underpinned by a weakening US dollar and improving risk appetite.


West Texas Intermediate’s (WTI) discount to Brent should diminish once the maintenance programme in the North Sea runs its course, but sharp discounts ahead of contract expiry are probable as long as storage at Cushing remains under pressure.


The research house recently raised its Brent forecast for 3Q 2009 to US$70 per barrel (US$68 previously), but its other forecasts remain unchanged.


China imports


It said that aside from macro trends, solid import performance from China has been a key support for sentiment in the oil market since the beginning of April. July was no exception, with crude oil imports rising 18% month-on-month to 19.6 million tonnes.


This data is partly distorted by the ramp-up in refining capacity in China, which has increased the need for crude feedstock, relative to refined products. China’s large refiners have taken advantage of low domestic demand to export significant quantities of gasoline and diesel.


Gasoline exports rose 141% year-on-year in 1H, while diesel exports were up 883%. While the import figures for July were strong, the extent to which this is a reflection of underling demand will be unclear until stock and refinery throughput data are released at the beginning of September.


On China, it said the country accounts for less than 10% of global oil demand. China, the Middle East, and Latin America were the only regions to show demand growth in Q2, but together, these three regions account for just 21% of global demand.


Meanwhile, weekly data for the US, which alone accounts for 22% of global demand, continues to paint a picture of weak and falling end-use demand (although the pace of decline has slowed) and high stock levels – particularly for crude oil and distillates.


The gasoline season has been very weak. Weekly data show gasoline demand currently flat year-on-year.


In Europe, gasoil, fuel oil, and gasoline stocks are rising. Overall, OECD crude and product inventories stand at 62 days of forward demand, up from 52 days at the end of 2007.


Floating storage


The volume of crude in floating storage has fallen significantly over the last few months as the WTI contango has narrowed, but it remains substantial.


The International Energy Agency (IEA) estimates that 40 million barrels (mb) of crude were held at the end of July (down from levels in excess of 100mb in 1Q). In contrast, storage of products, mostly middle distillates of Europe, has risen to above 60mb (from 50mb at the end of June).


In its August “Monthly Oil Report”, the IEA revised up its demand estimates slightly for both 2009 and 2010 on the basis of firmer-than-expected demand from China. Next year, though, this still puts demand will 1.2 million barrels per day (mbd) below the level seen in 2007.


This is in line with our expectations of a mild recovery in 2010, driven predominantly by emerging markets.


“We expect an improvement in oil demand ex-China to begin to become evident in 4Q 2009. The level of activity in the more energy-intensive developed economies of the OECD will likely remain subdued through to 2011,” it said. .


Macro trends



While China’s demand has helped sentiment in the oil markets, macro trends and supply restraint have been the dominant factors in keeping WTI broadly within a US$60-US$70/bbl band since May.


Amid increasing signs that the global economy has bottomed, crude prices have edged steadily higher, in tandem with US dollar weakness.


The relationship of crude prices with the US dollar has strengthened relative to that with the S&P 500 index, supporting the view that the US dollar is becoming the primary driver.


Macro sentiment will continue to be important, given the implications for a recovery in demand, but the significant weakening trend for the US dollar forecast by the research house’s foreign exchange strategists will provide significant momentum, particularly once demand begins to show a wider recovery outside China from 4Q.


Supply restraint


Supply restraint has also been key to supporting prices at these levels and will be fundamental to the outlook. OPEC has effectively cut 4mbd out of the market since last September, which has offset demand weakness.



Current forecasts leave the call on OPEC crude to balance the market virtually unchanged in 2010 relative to 2009 (albeit with seasonal variation).


“We do not expect OPEC to change its output policy at its next meeting on Sept 9, but compliance has weakened a little as prices have risen, and we expect further leakage should prices move higher than US$75 or US$80/bbl.


“Non-OPEC output has surprised on the upside this year as existing projects have continued to come on stream – the impact of reduced investment will be felt in a few years’ time – but the net increment is still a very modest 0.4 mbd, with a further 0.4 mbd expected for 2010,” it added.


Price outlook


StanChart Global Research expects WTI to trade broadly in a US$65 to US$70/bbl range through 3Q before moving steadily higher in 4Q as demand strengthens in Asia and the USD weakens.


In the first half of 2010, a more ambivalent direction in the dollar should contain investor flows. Beyond mid-2010, it believes US dollar weakness will provide further impetus for prices to rise higher.


While price spikes cannot be ruled out, some OPEC members have already increased output in response to higher prices, and we expect compliance to weaken further should prices breach USD 80/bbl.


OPEC’s spare capacity is currently around 5.5mbd, so there is ample scope to expand production as demand tentatively recovers. This margin will be gradually eroded as demand growth returns.


However, it does not expect this to happen until beyond 2010, however, as it will require a recovery in developed mark

Written by Standard Chartered Global Research
Saturday, 15 August 2009 23:50