Volatility Until Policy Uncertainty Ends
BMI View: We maintain our expectation of broadly sideways trade in oil futures over the coming months and see demand-side factors weighing market sentiment down. Since we formulated this view in June 2012 our view has played out , with the bounce from the June lows losing steam in the end of August, and now looking like it will settle in a volatile, defensive, sideways trade over autumn. Based on these expectations we reiterate our forecast that WTI will average US$95/bbl and Brent US$110/bbl in 2012 and US$102/bbl and US$92/bbl respectively for 2013. We expect additional monetary easing o n both sides of the Atlantic - priced into our forecast . However, there is a very heavy cloud of uncertainty cast over upcoming policy responses, which has prompt ed us to stress pertinent downside risks to our forecast.
|* 2012 consensus = Q3 and Q4 Bloomberg estimate + H1 2012 average price . f=forecast. Source: BMI, Bloomberg|
|Brent - WTI Spread||16||15||10||8|
|Brent - Bloomberg consensus||108.8||110||110|
|WTI - Bloomberg consensus||93.6||96.4||101|
|Brent - WTI Spread Bloomberg consensus||15.2||13.6||9.0|
Our view that Saudi Arabia would cut output in Q3-Q42012 has played out well (see our online service, 27 July 2012, 'Uptrend In Prices Set To Continue In H2 2012') ; Reuters reporting that it has cut production from a 10.1mn barrels per day (b/d) in June to 9.7mn b/d in July. Other assumptions underpinning our view remain unchanged: .
Monetary stimulus will provide support for commodities, including oil prices;
Slow recovery in US product demand;
North Sea technical issues;
Reduction in Iranian shipments;
Resilient Asian demand, especially from Japan
The rally in prices that followed the slump in June was steeper than we expected, though volumes driving it were relatively thin, making it ultimately unsustainable. WTI and Brent have since traded off their mid-August peak and could be embarking on a downward trend. Markets even shrugged off the effects of Hurricane Isaac on GoM production (which was ultimately limited, though we could see a temporary rise in products prices in coming weeks). We see this as an indication that Q3 buying was overextended -especially when one considers external market conditions- and markets have their gaze fixed on upcoming policy decisions from central banks. The outcome from the US Federal Reserve and ECB monetary policy meetings will be decisive for equity, commodity and currency markets.
|Front-Month Brent Crude, US$/bbl and Volumes Traded|
|Rally Fades (cont.)|
|Front-Month WTI, US$/bbl and Volumes Traded|
BMI's global strategy team expects monetary easing from the ECB and Federal Reserve, which will boost markets, including oil. For commodities, including oil, the key dynamic will be additional US dollar weakness following any announcement. Although BMI, and latterly the market, has priced this outcome in to our forecasts for the coming months, a stronger than expected bounce represents an upside risk to our end-year averages.
Since expectations for monetary easing have been in the air for a few months now we believe that its effects - particularly that from the Fed - have already been priced-in to a certain extent. This would account for the rise in prices over the summer. The ECB has 'cried wolf' too many times creating a lot of scepticism around its intentions and ability for a big monetary stimulus, which may ultimately be reigned back. In other words, markets will believe it when they see it and as such, we do not believe that a significant additional ECB monetary stimulus has been fully priced in yet by oil markets.
However, we believe that an upward climb in oil prices will be kept in check by a weakening global economy, with the most precarious signs coming from China. Our bearish view on the Chinese economy is playing out as its slowdown gathers momentum. China's PMI data in August hit a 9-month low, teetering on a contraction, while the National Bureau of Statistics leading indicator indicated a contraction in the economic activity in July (see our online service, 29 August 2012, 'Chart Of The Day: No Signs Of A Recovery'). Global trade has slowed and Chinese goods exports have slumped in the face of weakening demand in the developed world. The US continues on a tentative and precarious recovery, while the Eurozone is muddling through.
Volatility, With Significant Downside Risks
We therefore believe that volatility is the name of the game for the coming months. While our core scenario is that policy makers will provide an expected backstop for the global economy , we cannot discount the strong downside risks to our forecasts from policy 'errors' that do not meet market expectations. This could send markets into a free fall (see our online service, 28 August 2012, ' Global Assumptions - Q4 2012 Update '). The ECB's actions would be ones to watch on this front. The German Constitutional Court's decision due on September 12 th on the legality of the European Stability Mechanism (ESM) is widely expected to rule in favour of the mechanism. A surprise ruling against would send the markets into freefall, dragging oil below US$100 and possibly much further.
While broader macroeconomic and policy developments will drive prices in the next couple of months, there are esoteric supply factors that could have a net positive effect on prices. Failure of western pressure to ramp up production in Saudi Arabia, which has the most spare capacity in oil output the world, will provide support for prices. Iraq's output, which were expected to make up for lost Iranian supply in the market, has been less than anticipated, due to a combination of infrastructure inadequacies and over-estimation of production capacity by the government.
Field maintenance through August and September in the North Sea will also see production losses from crucial fields, such as Buzzard, that feed into the Brent price benchmark. We could see further disruptions later this year caused by strikes by Norway's offshore oil workers that would put further upside pressure on Brent prices.
There are fewer supply-side upside risks to our forecast for WTI; on the contrary it seems like most risks are weighted to the downside. Our forecasts for US and Canadian oil production point to a bullish picture. Current infrastructure bottlenecks mean that much of this abundant output will continue to be fed into WTI's pricing point at the Cushing hub. This downside risk will only be alleviated when the necessary expansion of pipeline capacity between Cushing to the Gulf Coast has been approved of and carried out in the US. and therefore we anticipate that the US crude inventories (excluding the SPR) will remain healthy. Finally, there have been calls for a release from the US SPR to cushion the blow from the hurricane.
|US Inventories, Excluding SPR and US Oil Production|