Updated Oil Price Forecast – Blurry short-term outlook

Baseline scenario: Long term oil prices still trending up, but blurry short-term outlook

Low growth scenario: Slowdown can push oil prices below USD 85/barrel threshold 

Base line scenario: Blurry short-term outlook

Sovereign debt worries, a growing mistrust in politicians and a weaker underlying economic environment on both sides of the Atlantic Sea will continue to weigh on demand for oil. Waves of risk aversion may trigger temporary sell-offs and the oil price may dip below the underlying long-term upward sloping trend.

Oil price forecast – baseline (Brent – USD/barrel)

We expect the oil supply/demand balance to continue to tighten over the forecast period, but at a slower pace on the back of the gloomier outlook for the world economy. OPEC spare capacity will remain at low levels in the forecast period as global oil demand is expected to continue to pick up at a faster rate than non-OPEC supply growth.

We think non-OPEC oil production can surprise on the upside. Higher oil prices trigger investment in deepwater production and unconventional oils such as Canadian oil sand and US shale oil. Marginal production costs are expected to continue up from around USD 85/barrel in 2011. Investment has picked up markedly since the sharp fall in 2009 and we expect this trend to persist. Higher exploration and production activity is expected to increase demand for equipment, steel and labour. Cost inflation indicates that oil prices will find higher support levels going forward. OPEC capacity expansion plans are struggling with project delays and underinvestment. Even Saudi Arabian capacity expansion plans may develop too slowly to be able to keep a sufficient buffer capacity and meet the rapidly rising domestic oil consumption in the future. OPEC oil production has taken a hit from the shut-down of around 80% of Libyan oil production. Strong geopolitical tensions in the Middle East and North Africa region (MENA) will continue to put oil production, refineries and the infrastructure at risk. In addition, the political climate in vital oil producing countries outside MENA such as Nigeria, Venezuela and Sudan/South-Sudan heightens the risk of supply-side disturbances and oil shortages.

Oil demand is closely correlated to growth in economic activity, increasing living standards and population growth. The lion’s share of future oil demand growth is expected to come from emerging economies, especially China, India and the Middle East. Power sector problems in China and the long-term effect of the earthquake in Japan on the nuclear power industry may boost demand for oil. The transportation sector is expected to be the primary driver of future oil demand growth, accounting for more than 50% of total consumption. Although higher oil prices also will trigger investment in competing fuel sources such as natural gas and electric cars, we do not expect this to make an impact on transportation fuel demand over the forecast period.

Risk scenario: Slowdown can push oil prices below USD 85/barrel threshold

 A severe slowdown in global economic activity will cut oil demand markedly and thereby trigger a sharp fall in oil prices. During the financial crisis the Brent oil price fell by 75% to USD 36.6/barrel in December 2008 from USD 146/barrel in July. If we assume that the recent increase in uncertainty and the weaker economic perfor­mance of the US and the Euro zone will push the world economy into a prolonged period of low economic growth, do we expect a new collapse in the oil price?

 Oil price Brent – low price scenario (USD/barrel)

 Assuming that global GDP growth will be 0.5% lower in 2011 and 2% lower in 2012 than in our baseline scenario, oil demand is expected to be reduced by 400k in 2011 and 1.4mb/d in 2012. A new economic downturn will clearly trigger a sharp fall in oil demand, but in our opi­nion a few recent developments in the oil market may have a counterbalancing effect on the fundamental situation, thereby preventing oil prices from falling to the lows seen in 2008.

First, OPEC has not changed its official output quota since January 2009 when the cartel agreed to cut 4.2 mb/d. The cartel does not need to coordinate new production quotas before it can start reducing its output if demand conditions deteriorate to a level where the market becomes oversupplied. Second, we expect OPEC to cut oil production at an earlier stage of a new recession cycle. Huge spending packages to try to prevent further uprising in the MENA region have in our opinion pushed up OPEC’s breakeven price of oil – the price at which its budget is balanced while accommodating greater public spending.