Oil Reboot

I am seeing oil prices at US$50-55 this year, then US$60-65 in 2010 and US$70-80 in 2011, guided by stability in demand, working off the inventory pile and fear of depletion whittled away at OPEC’s spare crude capacity.

There are signs that the worst is over in some markets, but the data is inconclusive as the global stockpile needs to be worked down to flatten NYMEX contango. Now, US gasoline prices relative are back in-line with the 18 year period of cheap gasoline from 1986-2004 – conditions are in place for positive price elasticity. Its role in dragging down the global oil demand will now likely fade. Gasoline is the dominant oil product in North America but 55% of oil consumption is made up of diesel, heating oil, jet fuel, residual fuel oil, plus propane and various chemical feedstocks.

China’s oil demand has generated its fair share of headlines over the years. If China can successfully stimulate its economy, the period of sharp year-on-year declines could be relatively short. Coastal provinces like Guangdong have lead the declines in oil demand just as they have lead declines in general industrial activity. I think China demand could be in the process of bottoming. The recent China PMI survey recovered to 49 from 34 at its lowest point, suggesting that China’s oil demand should improve from the Jan and Feb low point.

I argued that China’s strategic reserve building could provide support to demand. The first phase of the strategic reserve tanks – about 13.6mn tons or 100mn barrels – have already been built. Recent data suggests that China added about 7.3mn barrels (1mn tons) of inventory in late 2008 and recent comments by officials suggest that the Phase 1 of strategic reserves may in fact already be full and I believe China is now planning for Phase 2 of its strategic reserve with a target completion in 2011, with an indication of 8 sites with a total capacity of 23mn tones or 169mn barrels.

And the Middle East, which is generally analyzed as a key player for oil supply, in the past few years has been an important source of demand growth. Middle East oil consumption is dominated by Iran and Saudi Arabia, which together make up over half of the region’s demand. Saudi Arabia has accumulated a good amount of surplus capital and is expected to direct this towards large scale public works in this challenging time.

The good news is that OPEC is taking fairly aggressive measures to prevent inventories from building further past the normal 2Q rise. From a peak of over 32MBD in August 2008, OPEC’s February output looks to have fallen to somewhere around 28.5MBD – the sharpest reduction in recent years. I expect global oil inventories to peak at some point in 2Q09 before drawing down gradually in 3Q09 and more meaningful throughout 2010.