Divide Widens Across The Pond
BMI View: As expected, weak demand continued to rein in price spikes in November. The Israeli bombardment of the Gaza Strip and a temporarily solution to the Greek debt crisis saw Brent rise to US$111 per barrel (bbl), but this was quickly pulled back by weak macroeconomic fundamentals arising from a still sombre e urozone outlook and no end to a resolution of the US' fiscal cliff in sight. We expect weak demand to persist into 2013 as we downgrade our forecast for global real GDP growth from 3.0% to 2.9% in 2013, pulling down oil prices for the year as the market moves away from short-term supply fears to real demand in determining prices.
|*2012 consensus = Q4 Bloomberg estimate + Q1-Q3 2012 average price; f = forecast. Source: BMI, Bloomberg. Consensus correct as of November 28 2012|
|WTI, US$/bbl - BMI||95.00||95.00||92.00||91.00|
|Brent, US$/bbl - BMI||111.00||110.00||102.00||99.00|
|Brent-WTI Spread - BMI||16.00||15.00||10.00||8.00|
|WTI, US$/bbl - Bloomberg Consensus||92.07||89.84||89.80|
|Brent, US$/bbl - Bloomberg Consensus||111.21||106.38||101.82|
|Brent-WTI Spread, US$/bbl - Bloomberg Consensus||19.14||16.54||12.02|
|US$/bbl, Weekly Chart|
November saw a downgrade in (Bloomberg) consensus forecasts for both Brent and WTI for 2012 through to 2014 as market expectations trended closer to our projections. The revision was particularly marked for WTI, with the Bloomberg consensus price forecast dropping by more than US$10/bbl for both 2013 and 2014.
|US$/bbl, Weekly Chart|
Indeed, a key observation during the month is the persistent underperformance of WTI relative to Brent, which we had noted in our previous update. WTI's discount to Brent widened to its largest level for the year (US$25.53/bbl) on November 15 and the spread is stubbornly hovering above the US$20/bbl mark.
|Spread Hits Record For The Year|
|Front-Month WTI & Brent Crude (US$/bbl) & Spread, US$ (Below)|
Weak Demand Continues To Seize Control
Barack Obama's re-election as president of the US , the generational leadership change in China and the flare up of violence in Gaza failed to have any noticeable impact on prices, as worries about fundamental weaknesses in the global economy persist. Stronger Purchasing Managers Index (PMI) data coming out from China this month have also failed to rally oil prices. This lends support to our view that muted growth in global demand will continue to dilute short-term bullish sentiments about the oil market ( see our online service, October 3 2012, 'Weak Demand Will Battle Supply Fears In Price Control' ) .
We do not expect any major shifts in production patterns . While supply fears arising from political tensions will result in prices retaining a risk premium in 2013, they will eventually edge down as the global market steadily loosens in 2013.
In 2013, we maintain that prices will trend lower, but remain high by historical standards. We forecast Brent to average US$102/bbl and WTI to average US$92/bbl. The assumptions underpinning this view are:
Political risks to supply dynamics will keep prices relatively elevated. Iran's threat to stop crude oil exports altogether presents the biggest threat, alongside a possible outbreak of war between Iran and Israel. Although we expect that the market has already priced-in much of the disruption to Iranian supplies, escalation of tensions would still invite a market reaction.
Prices will be supported by domestic policies of OPEC states. These countries could reduce available global supply if prices fall below US$100/bbl as they are increasingly dependent on expensive social spending programmes to maintain domestic political stability.
Weak global growth will prevent any prolonged and extreme upward swing in prices. Our global production forecast shows a healthy supply picture for 2013, with an additional 2.6mn barrels per day (b/d) of new production, compared to the 1.6mn b/d rise we forecast in consumption. This theoretical surplus in the global oil markets - the first in five years - also underpins our oil price view for the coming years;
The discount on WTI relative to Brent will persist, as liquids production from the US continues to rise, thanks to shale oil and Gulf of Mexico (GoM) production.
At present, we do see upside risks to our forecast of US$102/bbl for Brent in 2013.
Iranian threat to halt crude oil exports altogether. Such a scenario would take almost 1mn b/d off the market and its psychological impact could prompt a brief spike in prices. In reality, its effect could be less pronounced than it appears; in September 2012, Iranian crude exports dropped to 860,000b/d - less than a third of its exports before oil sanctions were imposed and its lowest level since the Iran-Iraq War in the 1980s. Weak demand and output growth from non-OPEC countries will also allow for healthy supply in the market that could override concerns about Iran in the long-term.
Outbreak of war between Iran and Israel. The likelihood of this could be increased as political rhetoric deployed in the upcoming Israeli general and Iranian presidential elections in January and June 2013 respectively could see politicians drum up nationalist sentiments to raise their credentials. The election of more militant leaders would also shift preferences towards war. However, we believe that the war would be relatively contained. Although in the short-term a psychological disruption to global oil markets would support higher prices, weak market fundamentals and healthy global supply would eventually pare down sharp gains ( see 'Scenario: What Would An Israel-Iran War Look Like?', November 23 2012).
We note that significant market disruptions to crude oil supply in the past two years - the Libyan civil war in 2011 and Iranian sanctions in 2012 - saw the price of Brent peak at US$129/bbl in a weak global economy. This could likely repeat itself if a war does break out.
Underperformance from key contributors. Growing Libyan production and the return of South Sudanese crude to the market contribute to our forecast for a slight surplus in 2013. However, we recognise significant uncertainty about crude oil supplies from these countries due to political insecurity. Our cautious view on the return of Sudanese oil supply played out in November when political wrangling between Sudan and South Sudan over the disbandment of rebel troops along the two countries' borders led to yet another hold-back of crude exports. Iraqi production, which holds some of the most significant promise in terms of boosting global supply, could underperform because of technical challenges and security issues.
Resolution of the US fiscal cliff by January 2013. This could provide the necessary certainty for US economic growth to accelerate slightly, boosting oil demand. However, we hold on to our core scenario of a short-term agreement to be reached by January, with a more conclusive, longer-term solution to be postponed until later. Hence, we are reserved about any significant improvement in market demand sentiment in the first half of 2013.
Pending outcomes from key political developments - elections in the Middle East and the fiscal cliff debate in the White House - revisions to our 2013 forecasts could be in place.
WTI Pulls Further Away
WTI continued to decouple from Brent in November. While the Gaza conflict led to temporary resilience by Brent, its effects on the North American benchmark were less pronounced. Domestic factors had a stronger influence on trading as Hurricane Sandy and refinery disruptions in the US affected demand. On November 15, the discount of WTI to Brent hit a new 2012 high of US$25.11/bbl. The previous record discount of WTI to Brent was last reached in November 14 2011, at US$27.88/bbl.
|20-Year Front-Month WTI & Brent Crude (US$/bbl) & Spread (below, in US$)|
Taking the year-to-date into account, the WTI-Brent spread has increased to its widest level in 20 years. It is also notable that WTI's discount to Brent is a fairly recent phenomenon that became more persistent only from 2010.
|US Oil Boom Pulls Back WTI Rise|
|WTI-Brent Spread (US$/bbl), 2007-2012|
This discount is likely to persist in the year ahead given the US' healthy output, as crude oil production continues to trend upwards. The latest available weekly data on US production in November by the Energy Information Administration (EIA) show that output has held relatively steady at about 6.6mn b/d and about 17% higher year-on-year (y-o-y). Despite a y-o-y fall in weekly imports, crude oil stocks remained about 12% higher y-o-y, especially in the Gulf Coast and the Midwest. Clearly, strong output has contained the rise in WTI prices relative to Brent, which has also been held up by field outages specific to the benchmark.
|No Stopping Output Growth|
|US Crude Oil Production Four-Week Average (LHS) & Crude Oil Import Four-Week Average (RHS), mn b/d|
Our forecast for WTI is now above the consensus, after the market downgraded its 2013 and 2014 outlook for the crude benchmark by about US$10/bbl. Our slightly more optimistic outlook for WTI is based on the following assumptions:
Easing of infrastructure bottlenecks: In addition to existing pipeline projects that are due to be operational in 2014, creative modes of transportation - river barges, rail and trucking - will increasingly be adopted to transport crude across the US to take advantage of the regional arbitrage in prices.
Refinery runs: 2012 saw unplanned downtime from several refineries in the US, which we expect to come back online by 2013 and raise demand for crude feedstock. Refineries, especially those in the Gulf Coast, are poised to profit from exporting refined fuels processed from cheap crude feedstock. This could give further incentive to raise refinery runs.