Global: Oil Update: Easing Has Started, but Mind Short-Term Risks
Eric Chaney (London) and Richard Berner (New York)
The decline of crude oil and refined products has accelerated over the past few days: One month ago, Brent for delivery in September was priced at $77.6/bl. As we write this note, Brent for immediate delivery is priced $14 lower. Oil markets are so volatile that this could be just another dip in what is fundamentally a bull market, as has happened systematically since early 2004. We take a different view. We think that the current correction, although probably calling for some reversion in the winter season, is the beginning of a structural change in the market that should bring crude quotes down to around $50 in the next two-to-three years, if not significantly lower.
Earlier this year, as the global economy was accelerating, the lack of spare capacity in the global supply chain of oil products convinced us that markets would ask for a heftier risk premium and that prices were more likely to rise than to decline. In our oil price update of April 21, we pencilled in a peak at $80/bl in August-September, during the hurricane season in the Gulf of Mexico. On August 8, the price of dated Brent reached $79/bl, after BP shut down the Prudhoe Bay field in Alaska. Since then, neither spot nor future markets has revisited the $80 region. Not that geopolitical risks have suddenly vanished: Not only has Iran continued and is still continuing to enrich uranium but, in addition, the tension between Hezbollah militias and Israel at the Lebanese border turned into a full-scale war. In our view, the message from the markets is two-fold:
1. On the demand side, the main piece of news is the cooling of the US housing market, inasmuch as it could foreshadow a significant slowdown in the largest oil importer in the world;
2. On the supply side, the geopolitical risk premium associated with risks of supply disruptions that has built up since 2004 is now large enough to cope with potentially dangerous events in the Middle East.
Although risks remain, we now think that the $80 peak we had called is indeed the peak and that the ebb of crude oil and refined products prices has started. While risks are probably tilted to the upside over the next six months, as we enter the heating season in the Northern hemisphere, with a global economy still growing at a rapid pace, we have marginally revised down our baseline price trajectory, by 8.7% and 12.2% for 3Q and 4Q 2006, and by 4.3% for next year. We feel vindicated by market developments in our medium-term view, i.e., crude quotes ebbing toward $50/bl in 2008, if not even considerably lower, as we will describe in one of our alternative scenarios.
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