Given the world’s economy is so dependent on oil, one would expect the oil price to have fallen much further during this economic collapse than it has. The fact that oil is currently range-trading around $50 per barrel could, at first glance, seem rather unusual.
Is this the natural course of supply and demand? In our view yes, the latest figures from the EIA (Energy Information Administration) suggest demand from China and other emerging markets continues to rise whilst being offset by a fall in demand from developed markets.
In our view, even a marginal return of global growth is likely to send oil prices higher. Hence, we hold a long-term (12 month) positive view on oil.
From a supply perspective, discoveries of oil reserves have steadily been declining since reserves peaked in 1980. That said, we are far from running out of oil in the near term. Nevertheless, the question is how much more marginal supply there is. In our view, we are getting ever closer to “peak oil” – the point when global productivity of oil reaches its maximum rate.
Couple this with a demand outlook which is unlikely to wane in the short term and oil supply is likely to come short of fulfilling global demand. For example, oil demand in 2007, in line with the growing world economy, grew 2.4%, whilst supply grew only 0.9% leading to a deficit in world supply to the tune of 1.7 million barrels of oil produced a day, the largest since mid-2003.
The economic decline witnessed over the last year has had a big impact on oil demand, falling 1.4% globally for the latest figures ending 2008.
Supply over the same period remained static, leading to a period of oversupply in mid-2008 but ending the year with a deficit of 0.6 million barrels of oil produced a day as demand ticked-up again in the final quarter. So, even under the most depressed economic scenarios there is a shortage of oil.
The potential for further increases in oil demand from China can be estimated by looking at the number of barrels consumed per capita. At present 2.2 barrels are consumed per person in China every year and is rising at an annual rate of 5.5% a year. If this annual rate is compounded annually to 2020 our estimations suggest that China’s share of demand would increase from its current 10% to 18%.
As a closing note, please remember that some upside has already been priced into longer dated futures. For example, the price for oil with delivery in 2013 is currently $74.26 compared to a spot of $57.00 (Bloomberg as at 11 May 2009). Despite these higher long term prices we believe longer term contracts may be more appropriate for investments as the slope of the futures curve is very steep at the near end.
Frederik Nerbrand is head of global economic strategy at HSBC Private Bank and an occasional Citywire blogger.