Ten years ago, we found ourselves entering a new century and a new decade worried about the Y2K computer glitch and predictions of impending chaos in a digital world. This year, as we enter what some are calling “Y2.1K,” we are also facing a large number of unknowns on both the political and economic fronts that could have dramatic impact as the year unfolds. It seems to be true that we are emerging from a deep and troubling global financial crisis and one of the worst economic recessions since the 1930s. After the experience of the past two years, people want to be optimistic about the economic recovery, and while there are many good reasons for being so, not everything is well on the economic front.
The Economy. According to the World Bank and others, global real GDP contracted by approximately 1.5 percent in 2009. Hopefully the worst is behind us. Expectations now put global real GDP growth at around 3.2 percent in 2010, but the growth is likely to be very uneven, with the BRIC countries (Brazil, Russia, India and China) and emerging markets rapidly establishing their dominant position in the global economy. High and rising government deficits, high unemployment and growing protectionism increase the possibility of a slower than normal economic recovery in the Organisation for Economic Co-operation and Development (OECD) nations.
The positive initial effects of the G-20’s coordinated response to the financial crisis and the ensuing economic meltdown may not be sustainable in all countries. Many problems persist, particularly in the developed world, in housing, autos, household expenditures, and public sector balance sheets. This coincides with a rapid rebound in economic activity in the emerging economies in the past two quarters. This growth has already sparked fears of a new economic bubble in some areas and talk of mounting international imbalances. Just how these divergent paths will interact to steer global economic prospects is largely unknown and a major source of uncertainty for the year ahead.
Oil Market. The oil market has weathered another boom-and-bust cycle, and global oil demand, after declining for two years in a row (the first time in 25 years), appears set to grow once again. Commercial oil inventories are high, and there are comfortable margins of unused production capacity both upstream in crude oil production and downstream in the refining sector. Peak oil fears about supply constraints have been pushed to the back burner for the time being, and there is enough supply around to fuel even the most wildly optimistic economic growth scenarios for the next two to three years at the very minimum. How peak oil scarcity plays out in the medium- and long-term is still an open question, but in the absence of some outside shock to the system, it shouldn’t be a factor in 2010.
On the basis of market fundamentals alone then, 2010 should be a fairly calm year for the oil market. Demand prospects should gradually turn around and are likely to strengthen throughout the year. Oil prices (average NYMEX closing price for the front-month WTI contract), which were about $62 per barrel on average in 2009, could be expected to gradually strengthen further as the global economy continues to transition from recession to renewed growth.
While the demand side could be expected to exert some upward pressure on prices, high inventory levels and ample margins of spare production capacity should keep any price increases to moderate levels. Oil futures prices indicate that investors generally expect oil prices to rise in 2010, but in the absence of any major unexpected shock to the system, which could turn out to be an understated qualification, an oil-price spike seems unlikely.
The market appears set to support an oil price this year that is higher than 2009’s average of $62 per barrel, but not as high as the $99 per barrel average seen in 2008. Prices at the higher end of this range may not be sustainable. They could undermine the economic recovery and oil demand. They are also likely to provoke additional regulatory responses aimed at restricting “speculation” in the oil-futures markets.
Other Views. As economic growth and oil demand recover, most large investment banks expect oil prices in 2010 to average between $75 and $92.50 per barrel, a 20 percent to 50 percent increase year-on-year. The latest U.S. Department of Energy Short Term Energy Outlook predicts prices will average about $79 per barrel in 2010, which is close to but higher than the pre-crisis average of $73 per barrel of 2007. Most analysts expect the first half of the year to be weaker than the second half.
The more bullish members of this group see the market’s preoccupation with weak demand and surplus inventories gradually turning, once more, into supply-side concerns about the oil market’s ability to fuel rising global demand in the years ahead. They believe that traders and investors will begin positioning themselves to take advantage of tighter markets in the future, and that supply-side concerns will again dominate market expectations and oil price formation. The most bullish of these analysts say they would not be surprised to see oil prices make a few, brief excursions to $100 per barrel or more in 2010.
The role that geopolitical concerns and other developments play in these forecasts of potential price spikes in 2010 is unclear at best. In addition, while it is clear that a transition is underway and that demand is set to resume its overall growth path, the strength of this transition and its exact arrival will depend on a number of factors. The timing and magnitude of inflows to oil and commodity futures markets in the period ahead will mark the strength of investors’ belief in future supply tightness and higher prices. These flows of funds will depend not only on the forecast for the recovery itself, but also the outlook for major geopolitical upsets, inflation, the status of the dollar, and equity and bond market performance across a diverse group of investment vehicles.
Expect the Unexpected. Most forecasts are predicated on the absence of unforeseen developments or unexpected shocks to the global oil market, of which there could be plenty in 2010. In the first few days of trading in 2010, oil prices broke out of their fairly stable trading range and rose to a 15-month high of more than $83 per barrel. Prices were being driven by news that Russia had cut off oil shipments to Belarus, that production in China’s industrial and manufacturing sectors was exceeding all growth expectations, and that persistent, colder-than-normal temperatures had overtaken much of the Northern Hemisphere in North America, Europe and Asia. A declining dollar and expectations of a stock market correction also fueled the flow of funds into oil futures.
These day-to-day fluctuations are to be expected, but they accumulate and affect our view of the long-term outlook. The volatility in the first week of trading could be only a sneak preview of the uncertainties that lie ahead in 2010—uncertainties that could turn what otherwise might be a fairly stable-but-growing market into a wildly schizophrenic, volatile ride.
On the economic side, 2010 is likely to be affected by persistent declines in home prices, tight credit, and high unemployment, which will plague household balance sheets, particularly in the U.S. and the European Union. Business investment and confidence will continue to be shaken by uncertainties over high and rising government deficits, and unresolved political issues related to future taxation, revenue shortfalls, social entitlements, carbon mitigation policies, financial sector regulatory reform, and growing protectionism in trade policy. G-20 governments all face issues regarding the future timing and pace of their fiscal and monetary stimulus programs. On the political side, upcoming elections in Iraq, Brazil, the U.S., U.K. and many other countries are looking more and more contentious, with outcomes that are highly uncertain.
On the geopolitical side, even the unthinkable is quickly becoming possible in 2010. Most of the uncertainty here stems from escalation of the war in Afghanistan, and the start of new efforts to rein in terror, not only in Yemen, Pakistan, Iraq and other parts of the Middle East and Africa, but across the globe. Potential developments in Iran are likely foremost on everyone’s mind. Negotiations over its contentious nuclear program could come to a head in 2010 and possibly lead to responses as diverse as increased sanctions and outright military confrontation, which could have direct and possibly severe consequences on global oil markets. Growing dissatisfaction with the clerical government could also lead to major internal strife, a leadership crisis, possible regime change, and a temporary crippling of Iran’s already weakened economy.
Depending on how all these things play out, 2010 could go from being an orderly transition from recession to growth to a wild, volatile ride. That’s the question, and it all depends on a large number of unknowns that more than stretch human ability to see around corners and into the future. While admitting that anything can happen, and that 2010 will bring its own share of surprises to the market, it is nevertheless useful to review what we think we do know about the things most likely to affect the market in business as usual circumstances.
Economic Outlook. World real GDP now appears to have contracted by 1.5 percent in 2009, with the industrialized OECD economies contracting at –3.5 percent and accounting for most of the decline. Global growth is expected to return to positive territory in 2010, and register real GDP growth of around 3.5 percent, which is fairly anemic when compared with past recoveries. Again, BRIC countries and emerging markets are expected to lead the expansion in both the timing and pace of recovery, with real GDP growth rates of 5 percent to 6 percent for the group. China is expected to grow by 9 percent or more in 2010. The Middle East, parts of Africa, and Asia (except Japan) are all expected to experience the most robust growth.
The OECD recovery is expected to begin a bit later, with real GDP growing somewhat slower than in past recoveries, at less than 2 percent in 2010. The U.S. is expected to grow the fastest, at nearly 2.5 percent, with EU growth of less than 1 percent and Japan somewhere in between. If anything, we entered the New Year on a positive note, with fresh reports of inventory rebuilding and industrial output around the globe generally exceeding expectations. Unemployment in the OECD is likely to remain persistently high in 2010. Views about the strength of the economic recovery in the OECD nations shift almost daily from optimism to pessimism and back again, depending on the latest economic reports. Expectations of a double-dip back into recession or a prolonged L-shaped recovery still abound, but they’re not as prevalent as before.
Oil Demand. World oil demand reached a peak in 2007, and has declined for two years in a row in 2008-09—a first in 25 years. Most forecasts expect world oil demand to turn around and grow in 2010 by somewhere in the range of 0.5 to 1.5 million barrels per day (mmbd). If demand grows at the midpoint of this range (1.0 mmbd), global demand in 2010 will rebound to about the same level last seen in 2006, but it will still be about 1.0 mmbd below the previous peak in 2007.
The BRIC countries alone were responsible for almost 60 percent of the entire growth of world oil demand in the last decade. Together the BRIC countries and emerging market economies are the new epicenter of oil demand, and they are expected to account for virtually all of the growth in global oil demand in the years ahead. It is interesting to note that more than 13 million new cars were sold in China alone in 2009, compared with about 10 million in the U.S.
Oil demands in the U.S. and in the OECD as a whole have been declining at a rate of just over 1.0- percent per year for the last four years from the peaks reached in 2005. Some forecasts expect this long-term trend away from oil to continue in 2010, with OECD demand falling by 0.2 mmbd, in spite of the projected economic recovery. Others expect demand to recover and grow by about 0.2 mmbd. Most forecasters see demand in Europe and Japan continuing to stagnate or decline, so the disparity is largely due to differences in opinion about the strength of U.S. oil demand in 2010. We are inclined to take the middle road and assume that OECD oil demand (and U.S. oil demand) will remain flat in 2010.
Oil Supply. Non-OPEC supplies of all conventional and non-conventional liquid fuels rose about 0.5 mmbd in 2009, and are expected to grow by about 0.2 mmbd in 2010. Biofuels and other non-conventional fuels have managed to slightly offset the trend decline in non-OPEC conventional crude output for the past five years. Near the end of 2008 and early 2009, biofuels briefly lost some ground during the oil price collapse, but appear set to recover in 2010 and beyond.
Exploration and development expenditures are on the rise again, stimulated in part by the decline in the prices of oil field equipment and services. Natural decline rates in many oil-producing countries are a force to be reckoned with. Nevertheless, the eventual production of new offshore reserves in West Africa, Brazil and many other places, plus planned expansions of biofuels and unconventional resources, could hold the overall non-OPEC supply curve level for some time to come. Brazil is set to pass Venezuela as Latin America’s largest producer this year. They have been invited to join OPEC but declined.
OPEC crude oil production fell by about 2.2 mmbd from 2008 to 2009, while its overall production capacity, as a result of ongoing investment, continued to rise. As a result, OPEC’s surplus crude oil production capacity rose to near 4.5 mmbd by the end of 2009, a level not seen since the beginning of the last decade. OPEC’s crude oil production capacity is expected to rise again in 2010 and beyond, due to ongoing expansion projects in Qatar and Angola, and new contracts in Iraq. Extra production from Nigeria is also possible as a result of the cease-fire in the Niger Delta. In addition, OPEC production of natural gas liquids (NGLs), which falls outside its production quota system, has been rising by about 0.5 mmbd per year in the past few years.
This trend is expected to continue in 2010 and beyond as OPEC members exploit their gas reserves for both domestic consumption and liquefied natural gas (LNG) exports. Total liquids production capacity (crude and NGLs) in OPEC, including Iraq, could rise by 1.0 mmbd in each of the next several years. This would just about meet the expected increases in world demand over that period while allowing OPEC to maintain its current level of spare production capacity.
OPEC. As expected, OPEC Ministers meeting in Angola on Dec. 22, 2009, on the heels of the Copenhagen climate talks, decided once again to roll over their previously agreed production quotas and keep output for the OPEC 11 unchanged at 24.845 mmbd. In the communiqué issued following the meeting, it was clear that OPEC believed that the world economic recovery and the demand for oil was still weak, saying that its decision was intended to strike a balance between oil price stability and the needs of a growing world economy.
Declining compliance with the quotas was one of the major topics of the meeting, and the Members once again pledged to do their share for the common good. They also called upon non-OPEC oil producers to become more involved in the process and undertake cooperative action with OPEC. The non-OPEC countries of Egypt, Bahrain, Indonesia, and Oman attended as observers.
For the most part, OPEC members were happy to see a resumption of gradual and steady growth in oil demand, and most were satisfied with the price recovery that took place in 2009. Saudi Minister Ali Naimi said after the meeting that the market was good and that “the price was excellent.” It seems clear that as long as the price stays in a comfortable range above $70 per barrel, most OPEC Members are unwilling to risk the appearance of unity for an internal fight over compliance. It also appears that rising production in Iraq, Angola, Qatar and Nigeria may eventually push the group to revise its quotas, but with some luck and growing demand, this is unlikely to happen in 2010. OPEC’s own forecast expects the demand for OPEC oil to rise slightly in 2010.
Copenhagen and Carbon Mitigation. The failure of the Conference of the Parties (COP) to agree on binding targets for carbon mitigation provided many oil producers with a temporary sigh of relief. The upcoming elections in the U.S. are also likely to forestall any congressional action on cap and trade or new energy taxes this year. Nevertheless, the energy policies already in place to promote energy efficiency and the development of new and renewable energy resources will continue to nibble away at the demand for oil and other carbon-based fuels this year and in the foreseeable future.
The automobile companies are slated to introduce plug-in electric and electric hybrid vehicles this year, and government incentives to scrap less efficient vehicles (like “Cash for Clunkers” in the U.S.) are ongoing in many countries. In the medium- and long-term, a race is developing between rising oil and other energy demands, and the ability of the global economy to both improve efficiency and develop clean and affordable supplies of conventional and new energy. In this environment, global oil demand is likely to grow more slowly than it has in the past.
Admittedly, the outlook contains a large number of unknowns on both the political and economic fronts. Depending on how these factors play out, 2010 could turn out to be anything from a calm orderly transition from recession to growth to a wild, volatile ride.
Analysis by Abraham Energy Report Contributing Editor John Brodman
Key Concepts:
- The global economic recovery is underway, but growth is likely to be very uneven between the emerging and developed countries. The possibility of a slower than normal economic recovery in the OECD is a major concern for the outlook.
- On a business as usual basis (that is, based on the assumption of no major, unexpected economic or political shocks to the system), global oil demand should recover and grow once again in 2010, with virtually all the gains registered by the emerging markets.
- Commercial oil inventories are high, and there are comfortable margins of spare production capacity in both crude production and refining. In the absence of some outside shock to the system, peak oil concerns should not be a factor in 2010.
- The market appears set to support a price higher than 2009’s average annual price of $62 per barrel, but not as high as 2008’s average price of $99 per barrel. Prices could wind up somewhere in the $80 to $90 per barrel range on average for the year.