17 June 2011 16:33 [Source: ICIS news]
By Nigel Davis
LONDON (ICIS)--The sharp drop in the oil price on Wednesday rang alarm bells. Concerns over China’s inflation policy and the Greek debt crisis once again drew focus.
Oil has been buoyed, some feel miraculously, for many months with futures market prices climbing close to $100/bbl for West Texas Intermediate (WTI) benchmark crude and even higher for the Brent crude basket.
Commentators have long predicted a downward correction. Oil industry executives have suggested that the price of oil based on supply and demand fundamentals should be $60-$80/bbl. WTI fell $4/bbl on Wednesday and rallied marginally on Thursday.
Since the downturn, chemicals players have become adept at passing on their most important raw material costs, particularly so in the most recent run-up in crude. Naphtha based cracker margins, as an example, have been strong in recent weeks as the oil price has regained ground lost a short while ago and prices of propylene and butadiene have firmed.
But on Friday it looked less certain that oil could regain the ground lost earlier in the week. By mid-afternoon London time, the WTI front month price had lost 1.2% of its value from an opening market price of close to $95/bbl.
The multi-billion dollar question is where crude prices go next.
The sharp tightening of oil supply as Libya dropped out of the market and continued non-OECD growth have held up prices, it said.
On release of the report, IEA executive director Nobuo Tanaka expressed the widespread concern that high-cost oil will drive a hard landing for the global economy.
Tanaka welcomed the news that Saudi Arabia will increase supply but it is clearly a question of how fast that new supply can hit the market.
Refineries in Europe are coming back on-stream following maintenance, pushing demand up by about 1m bbl/day in the second quarter compared with quarter one, the agency says.
Credit tightening in China is slowing economic and industrial growth - chemical prices have fallen since the end of the Lunar New Year as it has become increasingly difficult to get letters of credit.
The IEA would certainly like to have more data on China’s oil stocks and Tanaka admits that that lack of numbers makes forecasting difficult.
The IEA, however, expects oil demand growth to be 1.2m bbls/day on average out to 2016. Gas demand, it suggests could grow by the equivalent of 2.4 times Russia’s current gas estimates, or by about 500bn cubic metres.
In its monthly oil market report, released on Thursday, the IEA estimates global demand at 89.3m bbl/day in 2011, with increased gasoil use in non-OECD economies – such as India and China – driving the demand.
New crude supplies could be unlocked given its medium-term oil price assumption, the IEA believes. And there would be a shift to unconventional oil on shore in the US, it suggests, as well as growth in biofuels and natural gas liquids in the oil/gas energy mix.
In its base-case scenario demand reaches 95.3m bbls/day in 2016. A low-GDP growth scenario puts demand 2.4m bbl/day lower.
“In both demand scenarios, China, Asia and the Middle East together generate around 95% of net growth, with buoyant gasoil/diesel growth and major increases expected from the transport and petrochemical sectors,” it says. “Persistent end-user subsidies and buoyant economic growth allow non-OECD demand growth to stay robust, despite high international crude prices.”
The IEA’s Tanaka adds: “This report shows that oil’s twilight as an industrial fuel continues, and it becomes ever more concentrated in the transport and petrochemical sectors.”
The concern in petrochemicals has to be, however, that any further rapid falls in the oil price will damage already fragile market sentiment and make covering feedstock costs more difficult. Downstream demand remains weak in Europe and in the US. The sector is buoyed by demand from China (which is under threat) and from other emerging economies.
But as costs have risen in some of the world’s fastest growing economies, chemicals demand growth has been put under pressure. Pulling away the underpinning of high oil prices in such an environment could lead to a particularly difficult time of rapidly falling chemical prices.
We are not there yet but the expectation of lower prices already has a grip on chemicals. In weak markets, spot prices are falling.
Certain chemicals market prices are down between 9% and 15%, since the end of April, ?xml:namespace>
“These are major declines, especially over just six weeks. We are also unlikely to see much improvement over the summer months, so it may be September before we get a chance to properly assess the real state of end-user demand. Unlike most CEOs, the blog is also not optimistic about what we will then discover,” he said.
Sharply lower oil this week is another sign that the liquidity-fuelled boom of the past two years is coming to an end, Hodges said on Friday.
“Fundamentals of [oil] supply and demand are starting to become important again,” he added. “There is no current shortage of crude and there hasn’t been for two years. A price of $60/bbl is not impossible.”
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