- Economic growth, particularly in non OECD areas, and how the credit crisis impacts these areas and ultimately energy usage.
- Movement toward low sulfur distillates and lower carbon emission and its impact on prospective demand.
- OPEC's ability and willingness to make additional supplies available to the market in September.
- Weather
- Future repercussions over the availability of supplies due to the Iranian impasse over nuclear weapons, Nigerian civil unrest and Iraq war.
- Growing nationalism in Venezuela and Russia.
- Growing environmental activism and its impact on energy usage and the adoption of alternatives to petroleum products.
- Refinery capacity restraints and its impact on product availability.
- Availability and pricing of specific crude grades and the associated impact on the crude slate.
The list is far from all-encompassing but includes areas that are likely to provide shocks to values, both up and down. With what appears to be stagnant growth in crude supply, strains will quickly become apparent on sudden supply shortfalls or if demand growth fails to stagnate. Given the increasing volatility in financial markets, the crude outlook will hold plenty of risk and opportunities as we move toward 2008.
Price structure in backwardation: Betting on supply/demand equilibrium
The spread relationships between the nearbys and Dec 2008 say a lot about the expectations for the market. As the spread shows for the Dec08-Oct07 crude, these expectations have changed rather radically over the past few months from contango (or carry) into backwardation (or inversion). With the nearbys trading at a premium, the market appears to be expecting 2008 demand growth to slow and new projects, including alternative resources, to come into production and provide an expansion in supply.
The Global supply/demand statistics seem to paint a different picture. Undoubtedly the course of the world economy and even weather will play a roll, but the question remains as to whether the markets current inversion is sustainable.
Will the world move to surplus or will it continue to live on the edge as inventory levels tighten, "peak oil" kicks in and production stagnates? The willingness and/or ability of OPEC to keep a handle on prices will be a key as we approach the September 11, 2007 Ministerial meeting. Demand growth looks set to slow, but is it enough? Will prices need to advance to ration supply? The following forecasts are strictly that. As data becomes available, fresh adjustments will need to be made. Nevertheless, the world supply/demand scenario looks poised to dramatically tighten assuming global economic activity does not grind to a halt.
2007 supply/demand prospects
World oil demand in 2007 is expected to reach 86 mb/d with normal weather and the continuance of current growth rates. If adjustments are made, it will likely be on the downside shaving .1-.2 mb/d off the total. Even at a slower rate of growth, world demand will have expanded by 1.3 mb/d over the past year to 85.8 mb/d. Given OPEC restraint earlier in the year, the crude oil supply should reach 85.5 mb/d. This rate assumes a 750 tb/d increase in their fourth quarter quota. These rates suggest a draw in inventories of approximately .3 mb/d.
For 2008, we see the supply situation getting progressively tighter as non-OECD demand continues to grow at a 3 percent plus rate. We see world demand at 87.8 mb/d against the current forecast of 88.2 by the IEA. World crude supplies in 2008 are expected to reach 86.9 mb/d, an increase of 1.5 mb/d. This is again assuming the increased OPEC quota mentioned above and a .5 mb/d increase in supplies from outside of OPEC.
A major variable in this forecast is OPEC's production levels. Given the surge in prices to 78.00 this summer and the resulting outcry, as well as the volatile situation in the credit markets, we suspect OPEC, and in particular the Saudis, will be reluctant to continue holding back on production. They will continue to play the political fence as not only a U.S. ally but also as a power within the Arab world.
Price Outlook: Short term risks on downside but longer term bullish bias
In the near term, tightening liquidity could force liquidation on the part of large speculative interests, in particular hedge funds. This could be a catalyst for a break in nearby crude toward the 66.00-67.00 area, particularly if crude stocks begin to build at Cushing. If resistance at 75.00 basis the nearby contract is not decisively penetrated, this downside move will likely persist through the September 11 OPEC meeting, when they move toward a production increase as we suspect. We see the impact of lower prices now as the foundation for a bull market in the coming year. December 08 crude should present a buying opportunity in the 67.50-68.00 range risking 64.50 with an objective of 85.00-90.00. At current levels demand will not be rationed enough to come in line with supplies. Only with sharply higher prices can demand be stifled sufficiently to impede the prospective stock drawdown forecast currently for 2008.
If you have questions or comments for Steve, please contact him at 1.877.377.7931 or stephen.platt@archerfinancials.com.
The information and comments contained herein are provided as general commentary of market conditions and are not and should not be interpreted as trading advice or recommendation. The information and comments contained herein are not and should not be interpreted to be predictive of any future market event or condition. The information and comments contained herein is provided by ADM Investor Services, Inc. and not Archer Daniels Midland Company. Copyright © ADM Investor Services, Inc.
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