A world of $80-90/bbl oil

Sam Fletcher
OGJ Senior Writer

It is “now quite definitely a $80-90/bbl world” for crude prices, “and within that world $90 may well prove to be a relatively elastic upper bound,” said Paul Horsnell, managing director and head of commodities research at Barclays Capital in London, on Apr. 9.

The market certainly hasn’t rushed into the higher price range. “In the current cycle, front-month West Texas Intermediate prices first showed their head above $70/bbl as long ago as June 5, and they first moved above $80/bbl on Oct. 20,” said Horsnell. The subsequent rise from $80 to more than $86/bbl within the last 6 months “is not exactly a rush of exuberance,” he said.

The May contract for benchmark US sweet, light crudes started the month by advancing $1.11 to $84.87/bbl Apr. 1 on the New York Mercantile Exchange ahead of the long Easter weekend that saw markets closed Apr. 2 for Good Friday. When regular trading reopened Apr. 5, the contract climbed to $86.62/bbl—“the highest settlement since Oct. 8, 2008, as the market continued its optimism for an economic recovery and higher demand growth for fuel in the US market,” said analysts at Pritchard Capital Partners LLC in New Orleans. It crested at $87.09/bbl in intraday trading Apr. 6 before closing at $86.84/bbl. On Apr. 7, it traded as high as $87/bbl but closed at $85.88/bbl, in its first decline for the month. It continued its retreat to $85.39/bbl Apr. 8 and $84.82/bbl Apr. 9 on NYMEX.

The late downturn in NYMEX crude futures prices in the week ended Apr. 9 does not damper Horsnell’s outlook for higher oil prices. “The last time that prompt-month WTI did not put its head above $80 at some point during the trading day was Feb. 18,” he said. “However, the more decisive break out of prices to the upside this month does seem to have removed the basis for any remaining suggestion that the effective range had not shifted upwards.”

In the months it has taken traders to become comfortable with a higher price range for crude, Horsnell said, “It seems as if quite a few different boxes have had to be ticked, from seeing a follow-through in the economic recovery, to clear evidence that non-Organization for Economic Cooperation and Development oil demand is growing more than robustly, through to evidence that there are solid enough indications that OECD oil demand is on some sort of a recovery path, albeit a slow one.” He said, “Rather than the market being affected by any sudden nonfundamental rush of blood to the head, price developments have been very cautious—indeed, in our view, perhaps too cautious and too suspicious of the robustness of the recovery process.”

Contested contentions
There are “two frequently repeated contentions” about the world oil market with which Barclays Capital analysts disagree. “First, there is a widely held contention that [higher] oil prices will destroy the economic recovery. In our view, the causality has been the other way round—i.e., that a strong economic recovery has (perhaps rather belatedly) allowed oil prices to move a little above their bare minimum floor values,” Horsnell said. “Current prices are less than 15% above their average in third quarter 2009, which is a very limited price appreciation given the scale of the recovery.”

Barclays Capital forecasts global growth in 2010 at 4.3%, with the US recording 3.5%, emerging markets 6.7%, and China 9.6%. “The recovery is certainly well entrenched and strong enough to cope with the relatively gentle and slow evolution of oil prices,” said Horsnell.

The second contention is current prices are primarily the result of economic optimism. “The suggestion behind that contention seems to be that prices are unrelated to the current situation, and are purely forward-looking towards an outcome that is inferred to be overly optimistic,” Horsnell said. “In our view, prices are actually only now catching up with economic developments that have already happened, rather than being reliant on any overoptimistic stance about the future of the global economy. The follow-through in the recovery in coming months may well be one element behind the creation of a base for a further shift up in prices. However, the very limited recent increases in prices seem justified; indeed, they are perhaps remarkably modest given the pace of global recovery over the past two quarters in particular.”

Meanwhile, Horsnell sees “slow but steady progress” towards potential sanctions against Iran, with indications gasoline imports “will play an important role.”

(Online Apr. 12, 2010; author’s e-mail: samf@ogjonline.com)

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