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Oil soars but 2008 spike not on cards

Jan 03 2011 10:22 Reuters

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New York - Nearly three years to the day after oil prices first pierced $100 a barrel, they are again threatening to break triple digits on a wave of fund-led optimism, but similarities between 2008 and 2011 end there.

Even the most bullish analysts are quick to recite a litany of reasons why oil will not surge to near $150 again this year. Such a sharp spike would deal the world economy a heavy blow it can ill afford.

The list is long: oil companies are stepping up spending plans before supply reaches a crisis point; resource nationalism has eased; the dollar has firmed; and concerns that oil production is near peaking have subsided.

By far the most compelling reasons, however, are short-term supply fundamentals: there is far more oil in storage, far more fuel capacity at refiners worldwide, and far more idle oil wells that Opec can reactivate when it chooses, braking the market's rally in a way it could not three years ago.

Analysts expect an additional 8% gain in average prices in 2011, according to the latest Reuters poll, although the conditions for a "super-spike" have dissipated.

"To a substantial degree, oil is not like it was then because there are bottlenecks that have been overcome both in refining and production capacity," said Edward Morse, managing director at Credit Suisse.

At the same time consumer nations have since built up crude inventories, with stockpiles from members of the Organisation for Economic Cooperation and Development (OECD) now at 60 days' worth of demand, compared with 53 days in 2008.

Oil demand growth jumped 2.2 million barrels per day (bpd) in 2010, the biggest rise in six years, with forecasts for an additional 1.5 million bpd in 2011, according to a Reuters poll.

Although those gains will boost consumption to beyond the previous record high in 2007, supply has risen far more during the recession after a host of multibillion dollar projects - which had been planned during the boom years prior to 2008 - came to fruition.

Members of the Organisation of the Petroleum Exporting Countries (Opec) currently hold 5 million to 6 million bpd of spare oil production capacity to draw on, up to three times the amount the group had at the lowest point in 2008, primarily from top exporter Saudi Arabia.

While experts debate at what price - or under what conditions - Opec would willingly begin pumping more crude, there is little doubt that doing so would douse prices. In 2008, Opec said it was effectively pumping flat out.

"It is not in the Saudi interest to have a global economic recovery jeopardised by $100-plus oil," said Jan Stuart, a global oil economist at Macquarie in New York.

"Given the spare capacity, I don't think you are going to have the same upward spiral that you had in 2008."

Saudi Oil Minister Ali al-Naimi, Opec's most influential member, in December reiterated he preferred prices between $70 and $80 a barrel, below current $89 levels and the 26-month peak near $92 hit earlier in the month.

New supply

And while supply from outside the group is set to rise a marginal 400 000 bpd this year, about one-third the rate of 2010, there have been a host of more positive signs of late. In 2008, non-Opec output actually fell by nearly 400 000 bpd.

The wave of resource nationalism that cut international oil company access to reserves in the middle of the last decade has eased, with Venezuela and Russia now seeking more investment from foreign companies.

Globally, energy companies are expected to raise exploration spending by 11% next year to the highest level in 25 years, according to a Barclays Capital forecast. That could prevent the kind of upstream supply crunch that resulted from a reluctance to invest five years ago.

Further support for non-Opec production has come from the slower decline of mature fields like Mexico's giant Cantarell, while discoveries in deepwater off Brazil have added about 26 billion barrels of exploitable reserves - enough to fuel the entire world for about 10 months.

"The big story I think in 2008 was the collapse of supply growth, as non-Opec supply failed to grow for several years in a row," said Antoine Halff, first vice-president of research for Newedge Group in New York City.

Any shortfall in 2011 could also be met by projected higher output from Opec members such as Nigeria and Iraq, which has no formal production ceiling like other members and expects to add about 400 000 bpd of output during the year, analysts said.

Mind the recovery

The fury of fresh speculative money into oil from investors eager to cash in on the commodities rally that started in 2002 has also been widely blamed for oil's 2008 record run.

Similarly speculators, excited by the prospect of higher fuel consumption as the economy recovers, hit a record net long position in December for crude contracts on the New York Mercantile Exchange.

Analysts say investors interested in energy and commodities have become more sophisticated since 2008 when many poured cash into simple, long-only funds.

According to Barclays Capital, 43% of commodities investors will invest in the asset class through actively managed portfolios in 2011 to try to cash in on recovery-driven gains.

US gross domestic product growth is expected to lead the world in the new year. It is forecast to rise 2.7% in 2011 after 2.8% growth in 2010, according to a Reuters poll, after cratering in 2008 to negative 6% at the low point.

"In 2008, there were quite a few doomsayers who were warning of storms on the horizon, but nobody paid attention," Halff said. "Now the economy has been in a tentative recovery, but the concerns about the pace and stability of recovery are more widespread."

Refinery cushion

Investments in global refining should also help keep a lid on prices.

Markets now enjoy the largest volume of spare refining capacity in 10 years due to investments in emerging economies such as India, after the buffer narrowed sharply leading up to 2008, stirring concerns about shortfalls.

Refiners have also invested in more sophisticated units, allowing them to run a wider variety of crude grades to make the higher quality, lower sulfur products mandated in the United States and Europe. Companies were forced to scramble for better quality crude in 2008 to meet specifications, adding upward pressure to prices.

The drop in demand caused by the recession also left nearly 1.4 million bpd of capacity shutdown due to refinery closures at the start of 2010, although some plants are now in the process of being restarted as demand picks up.

Even with so many cushions in place, many experts still expect oil to climb higher in 2011 - just not in such a spectacular way.

"Oil will continue to go up, it's going up at a very pleasant pace, not a violent, breath-taking manner," independent investor Dennis Gartman said. 

opec  |  oecd  |  markets  |  oil
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