Oil market divergences

Aug. 13, 2007
There have been a couple of interesting divergences concerning the oil market recently.

There have been a couple of interesting divergences concerning the oil market recently. First, two high-profile forecasts of worldwide demand for oil are receiving a bit of attention from market analysts. The recent outlooks differ as to how much oil the world will need in the next few years. What lies behind these differences are the assumptions of economic growth.

Also, there recently has been a divergence in the price of crude oil and the price of gasoline at US pumps. Retail prices of the fuel fell in late July at the peak of driving season in the US, while crude prices rallied above $70/bbl. What lies behind these differences is the same problem that has been the bottleneck in the market for about 2 years now: refining. Also, anticipated and real oil production disruptions and a fair amount of speculation in the futures markets have elevated the crude price.

Future demand

Last month the International Energy Agency released its Medium-Term Oil Market Report. IEA’s estimates call for worldwide demand for oil products to average almost 92 million b/d in 2010 and nearly 96 million b/d in 2012.

And the Organization of Petroleum Exporting Countries released its latest World Oil Outlook in June. The group looks for global oil demand in 2010 to be just 89.7 million b/d.

This difference in forecasts deserves noting. With the more conservative outlook, OPEC is being cautious, keeping an eye on refinery operations and not wanting to see prices sink as it puts what it would consider too much oil on the market. If the organization is correct, then prices may be more stable than if it is wrong. In the case that the world does need much more oil, then prices will spike in a very tight crude market.

How strong the global economy is during the next 3-5 years will heavily affect the amount of oil the world consumes. And especially important to demand growth will be the strength of the economies in large developing countries, including China and India.

Even the two groups’ forecasts for 2008 are quite different. IEA forecasts demand next year will average 2.18 million b/d more than this year. Meanwhile, OPEC projects a 1.34 million b/d climb from this year’s average worldwide demand, as economic growth slows.

IEA assumes that the global economy will be strong enough to sustain oil demand growth and that weather will play a role. The agency expects global oil product demand to rise by a robust 2.5% in 2008, largely due to a weather-related rebound in the member countries of the Organization for Economic Cooperation and Development and to strong demand in non-OECD countries.

In its forecast for next year, OPEC says that on the supply side we need to look at the entire supply chain, as the downstream sector is a key element for market stability.

“Any easing in refining tightness will depend on the evolution of refinery capacity expansion and demand growth. In this regard, however, more needs to be done to make sure the downstream sector does not lag behind, particularly given recent announcements indicating policy pushes for an expanded use of biofuels, furthering unease amongst downstream investors,” OPEC said.

But OPEC is likely to continue to protect its crude export revenues by holding the reins on output.

Price differences

Crude and product prices typically move in the same direction, but this was not so over the past 2 months.

Crude reached an all-time high on the New York Mercantile Exchange last month. On July 31, the front-month contract closed at $78.21/bbl for September delivery.

Retail gasoline prices were headed lower, though. This decline came with a long-awaited uptick in refinery utilization, which surpassed 92% by the end of July after hovering below 90% for most of 2007. Refinery outages indeed have been responsible for bolstering prices throughout 2006 and 2007.

The average regular unleaded self-service pump price in the US on Aug. 1, 2007, was $2.918/gal. This is the lowest since late-April, according to OGJ statistics. Pump prices peaked at an average of $3.176/gal on May 30, 2007, OGJ statistics show.

At the start of this month, crude futures began to dip only after fears grew that economic growth was slowing more than previously expected, as equities markets weakened, and lending activity, especially mortgages, continued to deteriorate.