Seeing the markets as sport

2011-10-11 07:29

Singapore - Watching the Rugby World Cup quarter final between New Zealand and Argentina made me think of how the weekend clash was similar to JPMorgan's view on global oil markets.

Virtually every rugby fan would have expected the top-ranked All Blacks to easily beat their South American opponents, but right up to three-quarters of the way through the match the Argentineans were within touching distance of New Zealand's score.

It was only in the last 20 minutes that the All Blacks finally lowered the blood pressure of their fans by outclassing the Pumas.

So, what has this to do with JPMorgan and oil demand forecasts?

The US investment bank isn't alone in forecasting that crude prices are heading higher over the longer term, based on a combination of modest supply increases and strong demand growth, mainly in Asia.

The bank expects Brent crude oil to average $115 a barrel in 2012 and $121.25 in 2013, levels about 8.4% and 14% above the current Brent price of around $106.

The similarity to Sunday's rugby match is that we are currently in the first three-quarters of the crude game, in that everybody expects oil prices to rise over the coming months and years, but right now things are not quite going to plan.

Just as New Zealand fans spent the first 60 minutes of an 80-minute match showing increasing signs of anxiety before their side accelerated, oil bulls are currently able to discern all the reasons why crude should be higher.

However, they are being stymied by a combination of factors that have little to do with oil supply and demand fundamentals.

Perhaps some of this frustration came out in JPMorgan's October 7 Oil Market Monthly, with the bank's analysts saying their forecast of $121 a barrel for 2013 "will undoubtedly lead some to mark us with the moniker of 'perma-bulls'."

It may be debateable as to whether JPMorgan, and indeed several other investment banks, exist in a state of semi-permanent oil market bullishness; however, their analysis of the global supply-demand situation is sound.

Basically, the argument is that oil demand in developed nations will drop slightly in 2011 and 2012 before being largely flat in 2013, while developing world demand will maintain growth rates of close to 3% in 2012 and the year after.

On the supply side, JPMorgan expects producers to pump an extra 2.6 million barrels a day by 2013, for a total output of 91 million barrels a day, with more than half of this coming from the Organisation of the Petroleum Exporting Countries.

This will only just keep the market in balance, and the lack of spare capacity drives the expectation that oil prices will have to rise by the end of 2013.

Obviously, a serious recession in Europe, prompting a global slowdown, will undermine any bullish view of oil prices, but this is still not the most likely scenario.

If anything, analysts may be too cautious on Asian demand, especially that from China.

As can be seen from Chinese oil imports during the 2008 global financial crisis, any decline is short-lived and leads to higher demand in subsequent months.

Even a renewed recession in the West won't be enough to halt the inexorable industrialisation of China, and that can only mean rising crude demand from the world's biggest commodity consumer.

This should be confirmed this week with the release of China's September trade data, with an increase in crude imports likely given the return of refineries from maintenance and the possibility of lower oil prices causing some inventory restocking.

Imports may also be boosted by lower domestic oil output, as the shutdown of the largest offshore field cut production 7.2% to 3.62 million barrels a day in September.

Over the longer term China may struggle to boost domestic output much, meaning an increasing reliance on imports, a further bullish factor for global oil demand.

Finally, China cut retail prices for gasoline and diesel by about 3% on October 8, the first change since prices were raised to a record high in April.

While this may not stoke demand by much, it will help inflation ease further and do a little bit to ensure China's industrial output remains solid, even in the face of weak growth in the nation's main export markets.

But all of the positive demand and crimped output stories matter very little when the oil market is hostage, along with other asset classes, to every twist and turn of the European sovereign debt saga.

Given that the Brent curve is currently backwardated, with December 2013 futures some $9 a barrel cheaper than the front-month contract, buying the long end of the curve would be a good idea if you subscribe to the bullish view that the oil market will inevitably tighten, driving up prices.

Like Kiwi rugby fans had to against Argentina, oil bulls will simply have to maintain the faith for a while before their forecasts should win through.

  - Reuters

* Clyde Russell is a Reuters market analyst. The views expressed are his own.