Crude oil tipped to bubble over $100 a barrel

| Friday December 10, 2010 00:00

The bulls' push comes as the oil market is experiencing a 'demand shock', with consumption growth this year accelerating to almost its highest rate in 30 years.

This unexpected boom in demand has lifted benchmark oil prices sharply higher, to a 26-month high of more than $90 a barrel on Tuesday. Some traders believe the market could jump to $100 within weeks.

For the Opec cartel of oil producers, the jump in demand, as the global economy has started to recover from the worst recession in decades, is a headache. The group, which meets on Saturday to review member states' production quotas, will examine whether the strength in oil consumption is likely to last, requiring it pump more crude.

Traders and analysts are divided on the outlook for oil, even if the bulls are in command.

The bullish sentiment contrasts with the mood in oil markets three months ago, when physical traders - who arguably have better intelligence than anyone else - thought prices were unlikely to rise further in 2011 and felt consumption growth was lacklustre.

Since then, the International Energy Agency, the western countries' oil watchdog, has lifted its estimate of global oil demand growth in 2010 to a hefty 2.3m barrels a day, the second highest level in recent history, surpassed by the huge 3m b/d surge in 2004.

Francis Osborne, analyst at Wood Mackenzie, the Edinburgh-based oil consultancy, estimates the recent strong growth means that oil consumption in the third quarter of the year, at 88.3m b/d, surpassed an 88.0m b/d quarterly record in 2007.

'Global oil demand has recovered its pre-recession peak,' Osborne says.

The strength of oil demand has caught some by surprise, with traders debating what is behind it and, more importantly, whether the boom will continue into next year. The IEA, taking a cautious view, forecasts an increase of 1.2m b/d next year, just above the average growth for the last 15 years of 1.1m b/d.

Some traders argue that the current strength of demand heralds a period of heady consumption growth, akin to the 2003-2007 boom - and the return to triple-digit oil prices early next year.

Lawrence Eagles, head of oil research at JPMorgan in New York, is among those who believe prices will rise. 'We think $100 a barrel will be breached on a spot basis in the first half of 2011,' he says.

Bulls and bears agree that the recovery in demand to pre-crisis levels is happening earlier than expected, on the back of strong economic growth in China, India, Brazil, the Middle East and elsewhere in emerging markets. But consumption - and economic growth - has also been stronger than expected in developed economies, notably the US, the UK and Germany.For example, the US Department of Energy estimates that the country's oil consumption growth in September, in the latest revised data available, posted the biggest monthly increase since November 2004, up by 913,000 b/d year-on-year.

But there is disagreement on the impact of other significant influences. Ed Morse, head of commodities research at Credit Suisse in New York, argues that a closer look at what is happening in physical crude oil markets suggests market fundamentals are weaker than the bulls believe and the outlook for prices in 2011 is therefore softer.

'What is happening reflects a series of one-off reinforcing factors that, coupled with winter seasonality, have tightened product and crude oil markets far more than might have been expected,' Morse says, predicting oil prices at $85 a barrel in 20011. Philip K. Verleger, energy economist at the University of Calgary, also says one-off factors are the main factor behind the surge in demand and the rally in prices.

'Their removal should reverse the process and crude prices should fall.'The one-off factors started with a heatwave over Japan and South Korea in August, September and early October. The persistent heat stoked demand for residual fuel oil and direct crude burning for power generation, as electricity consumption soared to meet air conditioning demand in the region. As a result, Japan saw the biggest jump in year-on-year demand since September 2007. Then, just as the Japanese spike was starting to fade in late October, demand fired up in China.

Beijing is rationing electricity supplies as it rushes to meet ambitious energy and environmental targets by the year's end. The power shortage has forced companies and families to run on diesel-fired portable generators, boosting oil demand.

The IEA estimates the surge in diesel demand will add about 70,000 barrels a day to the country's oil consumption from October to February - equal to about 8.5 per cent of the country's total oil demand growth forecast of 818,000 b/d in 2010.

Chinese refineries responded to the unexpected, policy-driven boom in demand by buying more crude oil in the international physical market, boosting the premiums of crude oils in the Middle East and west Africa.The final demand push came from Europe, the weakest region in terms of oil demand until recently. But as cold weather engulfed western Europe, with temperatures dropping below freezing in Paris, London and Berlin, consumption of heating oil and fuel oil surged. For now, these factors are supporting the bullish outlook. But as electricity supply returns to normal levels in China and the northern hemisphere winter ends, some traders say the bears will emerge from hibernation to profit handsomely.-(Finanacialtimes)