Risk Premium Will Not Reach 'Arab Spring' Highs

BMI View: We increased ou r 2013 average price for WTI and Brent following the risk -on sentiment that has gripped the markets. Though we do not see oil prices reaching the same le vels as during the Arab Spring due to the contained nature of the escalation , we do recognise the risk premium tha t is underlying the oil prices. Tapering will be the counter-force to watch out for over September that will be able to take prices back down. We are also pricing in another sharp rise in WTI towards the end of the year when the 700,000 b/d Houston Lateral pipeline is due to come onstream.

The rally in prices over the past week has prompted us to raise our 2013 average Brent price to US$111/bbl and WTI to US$102/bbl; from US$106/bbl and US$99/bbl respectively. Supply disruptions in key producers like Iraq, Libya and Nigeria have stoked market worries about supplies, which are now exacerbated by tensions in Syria.

Political risk premium has dominated oil trading, sending the main contracts (WTI and Brent) into the highest levels since February 2013 for Brent, and for the entire 2013 for WTI. As we head into the fourth quarter of the year there will be four main events that will be able to move the oil markets, with this escalation in the Syrian civil war the most pertinent force behind rising prices. We also note key events such as the September 22 nd German federal elections, the pending decision by the US Federal Reserve on tapering monetary easing, and progress with Japan's implementation of the 'third' arrow. Of the above, the biggest counter-weight to the Syrian political risk premium is going to be the Fed tapering, which we have noted to be negative for oil prices.

Supply Disruptions Persist
Oil - Global Supply/Demand Balance, 000s b/d

BMI View: We increased ou r 2013 average price for WTI and Brent following the risk -on sentiment that has gripped the markets. Though we do not see oil prices reaching the same le vels as during the Arab Spring due to the contained nature of the escalation , we do recognise the risk premium tha t is underlying the oil prices. Tapering will be the counter-force to watch out for over September that will be able to take prices back down. We are also pricing in another sharp rise in WTI towards the end of the year when the 700,000 b/d Houston Lateral pipeline is due to come onstream.

The rally in prices over the past week has prompted us to raise our 2013 average Brent price to US$111/bbl and WTI to US$102/bbl; from US$106/bbl and US$99/bbl respectively. Supply disruptions in key producers like Iraq, Libya and Nigeria have stoked market worries about supplies, which are now exacerbated by tensions in Syria.

Spot - 02/09/2013 2013f 2014f 2015f 2016f
*BMI is part of the BBG Consensus surveys. f=forecast. Source: Bloomberg, BMI
WTI - BBG Consensus* 106.8 101.5 100 101.5 97
Brent - BBG Consensus 113.8 108 107 107 102.5
Brent / WTI Spread - BBG Consensus 7 6.5 7 5.5 5.5
WTI - BMI Forecast 102 101 101 96
Brent - BMI Forecast 111 103 102 101
Brent / WTI Spread - BMI 9 2 1 5

Political risk premium has dominated oil trading, sending the main contracts (WTI and Brent) into the highest levels since February 2013 for Brent, and for the entire 2013 for WTI. As we head into the fourth quarter of the year there will be four main events that will be able to move the oil markets, with this escalation in the Syrian civil war the most pertinent force behind rising prices. We also note key events such as the September 22 nd German federal elections, the pending decision by the US Federal Reserve on tapering monetary easing, and progress with Japan's implementation of the 'third' arrow. Of the above, the biggest counter-weight to the Syrian political risk premium is going to be the Fed tapering, which we have noted to be negative for oil prices.

Supply Disruptions Persist
Oil - Global Supply/Demand Balance, 000s b/d

We do not expect the oil market to suffer any material supply disruption as a result of the Syria conflict that would exacerbate the tightness in the markets, as President Obama has made clear that any US-led airstrikes will be limited in scope. As a result, sustained trading around the 'Arab Spring' highs of US$128/bbl - US$130/bbl seems unlikely at this stage. Reinforcing the above view is the fact that Brent is trading at US$113.4/bbl, already 2.7% lower that the peak of US$116.6/bbl on the 28 th of August. The UK rejection of military action has pared back gains for oil and the sentiment in the market seems to have stabilised, for now.

Prices Off Their Peak
Brent and WTI Prices, US$/bbl

The rise in the risk premium also fuelled the rally in WTI, which reached the highest level of 2013 at US$110/bbl. T he loss of momentum for an imminent airstrike , combined with data from the department of energy that showed total petroleum stocks (excluding the SPR) rose at the week ending 23 August, took the steam off WTI's rally. At time of writing the price is at 106.7/bbl, down 3% from its peak. Nonetheless, the rise of previous days has prompted an increase in our yearly average price. We maintain our bullish view for WTI and anticipate some further gains in the price when the 700,000 barrels per day (b/d) Houston Lateral pipeline (that will connect Cushing to the Gulf Coast) comes online.

The main force that could bring oil prices down significantly will be the tapering from US Fed eral Reserve . BMI's Global Strategy team believe that the Fed will begin 'tapering' asset purchases via its QE3 programme in September 2013, while halting the expansion of its balance sheet by mid-2014. A steady move by the US Fed towards tapering monetary stimulus has created an environment of dollar strength that we expect will persist for several quarters. US dollar strength will be a net negative for commodities, including oil

The recent surge in oil prices comes at a particularly bad time for many emerging markets, especially net energy importers such as India, Turkey and South Africa. The dramatic and ongoing depreciation of many emerging market currencies since Q113 will accentuate the negative impact of higher oil prices on balance of payment and domestic inflation dynamics. For instance, when priced in Indian rupees, Brent Crude has risen by almost 50% since mid-April (see "Oil Price Risks For EM Energy Importers", 30 August).

The risks to our forecasts are mainly to the downside at this point. The political risk environment is so tense and volatile that the risk-on sentiment of the previous weeks could return rapidly in the case of an escalation or seemingly regional spill over of tensions from Syria. In addition, the underlying tension in the markets (albeit seemingly subsided for now) will exacerbate the reaction to any further disruptions to the oil supplies.

Read the full article

This article is tagged to:
Sector: Oil & Gas
Geography: Global, Global
×

Enter your details to read the full article

By submitting this form you are acknowledging that you have read and understood our Privacy Policy.