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Several factors contributed to the recent rally in oil prices including tighter physical oil supply and demand fundamnetals, loose monetary policy and a weaker US dollar.The global economy is bouncingback after the sharpest recession in the post World War II period. According to a Bank of America-Merrill Lynch (BofAML) analysis GDP growth is recovering strongly to 4.3% and 4.5% in 2010 and 2011 from an abysmally low figure of -0.8% in 2008.
Economic recovery is sure to spur global oil demand growth at 2 million barrels per day (b/d) from 1.4 b/d previously which in effect means demand in 2010 is expected to overtake the demand in 2008, BofAML analysis said.Activity has turned around surprisingly quickly in emerging markets but fiscal spending programs and very loose monetary policy have also floored the rate of contraction in developed economies. Key leading indicators for the global manufacturing cycle—such as exports out of Korea and Taiwan, business confidence in Europe, the United States and China and industrial orders in Germany—have recently surprised to the upside. While the recovery might be choppy and jobless in the United States, business cycle effects, re-stocking and fiscal spending makeus significantly more bullish on the recovery relative to consensus, BofAML analysis said.
Almost every single country around the world has been showing signs of improvement. Final demand is recovering, the global inventory cycle is turning up and the implosion in global trade that pulled down the global economy is reversing
On the supply side, Non-OPEC capacity is set to surge by 244000 b/d in 2010 from the present level of 323000 b/d. New capacity addition comes from fields in Brazil, Kazakhstand, Russia, Norway, West Africa and the Gulf of Mexico which have gone onstream in the past few months. The deceleration in global oil demand growth is easing. From -3.3% in the first quarter this year, the demand growth has gained at -1.5% during the past two months. However, BofAML report said that real oil consumption continues to display cyclical weakness. Demand for gasoil remain in doldrums. But positive growth in expected in fourth quarter of 2009.
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Non-OPEC oil supply growth is increasingly tilting towards deepwater production and a recent arrival of ships and floating platforms has facilitated this trend. Moreover, rising oil prices have helped to lift crude oil output in Russia where production has hit a record high in the past three months. In Brazil, Petrobras is expanding crude oil production by 10% over last year, also setting new record highs.
Going ahead, Emerging Markets will drive demand as its growth is oil-intensive. BofAML expects EM demand to grow 6.1% in 2010 to 1.5 mn b/d from 2% this year.Countries like Brazil, Turkey, Indonesia and to some extent Middle East could lead the oil demand recovery.
Meanwhile, oil demand will expand by 510 thousand b/d in the OECD countries,following on from a 2 million b/d contraction this year. Though driven largely by base effects, that expansion signals the first increase in OECD demand since 2005. Still, continued fuel substitution towards natural gas and coal as well as efficiency improvements make the OECD region an unlikely driver of oil demand growth going forward.
Global biofuels output has surprised to the upside recently as higher oil prices have raised profitability. Moreover, condensate and gas liquids1 output from OPEC countries, which does not fall under production quotas, is set to increase by 600 thousand b/d next year. Global production of this category of light hydrocarbons currently stands at 9.4 million boe/d, equivalent to over 11% of world oil production, and is increasing rapidly due to higher investment in the production of natural gas. While some of these liquids will be turned into liquid petroleum gas (LPG), sold to petrochemical companies, others go to oil refineries as light feedstock, competing directly with light crude oil.
Still, technological challenges are huge for conventional crude oil. Steep decline rates in existing fields are dampening the rate of aggregate non-OPEC oil supply growth. In the UK and Norway, production is likely to fall by a steep 300 thousand b/d this year and 430 thousand b/d next, despite the start-up of new projects The Cantarell field in Mexico now puts out just 580 thousand b/d, from 950 thousand b/d a year ago and over 2 million b/d four years ago. Even in Russia, the production increase is likely to be rather temporary as a lack of clarity over the longer-term fiscal regime is curbing drilling and investment
On the negative side, non-OPEC output growht is stifled by increasing control of governments over oil sector imposing more taxes and blocking acess to foreign investment and expertise. Although non-OPEC output is set to increase, it will fall short of global demand growth.However there is plenty of excess capacity in OPEC countries to raise output. With roughly 6 million b/d of spare capacity and a ramp-up of new fields in Saudi Arabia, Iraq and Angola, there is certainly plenty of excess capacity to raise output next year. Still, an OPEC supply increase coming so shortly after the recession could be seen as bullish sign, as excess crude oil productive capacity will be just 6% of demand.
Sharp depreciation of US Dollar has contributed significantly to rise in global crude oil prices more than supply-demand fundamentals.Moreover, extremely loose monetary policy around the world is supporting physical oil demand in countries like China, where car and housing sales are through the roof, and also driving tactical asset allocation into oil, BofAML analysis said.
BofAML has revised its long term oil price assumptions to $85 for 2011 and $80 for 2012 as long-term price dynamics are determined by the marginal cost of supply and focus is on Canadian oil sands that provide a major stream of new-long term production capacity. Moreover, they are located near the world's largest consuming market and there are numerous projects in the pipeline from which to assess costs and available returns
Despite the extreme volatility of spot crude oil prices over the past couple of years, BofAML analysis said the the marginal cost of supply remained in a relatively narrow band of US$70-90/bbl, depending on the level of cost inflation. Anecdotal evidence together with the sharp drop in steel prices points to a 20-25% reduction in capital intensity from the peak in 2008. With input costs starting to show some stabilisation, BofAML estimates integrated mining-upgrading greenfield oil sands projects in Canada will require $80/bbl oil to generate double-digit after tax internal rate of return.
