Crude oil has underperformed the commodities space in the most recent rally, despite the fact that the benchmark U.S. crude oil price will average around $81 a barrel in 2010, up from last year's average of $61 per barrel; 15% higher than the beginning-of-year consensus of $71 per barrel; and around 5% higher compared to the previous Energy Information Administration's outlook for $78.67 per barrel.
The price of crude oil stands at a historic juncture. The demand picture continues to be mixed. Despite the moderation in the Chinese economy, crude oil imports are still higher than in recent years. In contrast, U.S. oil demand is well below historical averages. Crude oil inventories in the U.S. are still running above historical averages, which have capped oil prices. But broad U.S. dollar weakness and gradually improving risk appetite should support oil.
On the negative side are the renewed concerns on the eurozone peripheral debt situation, interest rate hikes in Asia, and some lingering risk aversion, as well as increase in supply from OPEC (Iraq, Kuwait and Saudi spare capacity) and non–OPEC (gas liquids, Brazil) sources. Also, as and when there is a decline in inventories to below the five-year average, the liquefied natural gas story will start playing out.
The key question which may determine crude oil price may not be exogenous factors such as those mentioned above, but crude oil’s effect on a nascent global recovery and what crude oil price the global economy can absorb without going back into recession. Don’t forget that despite the earlier slowdown and apparent signs of a sub-prime crisis, it was the $140 per barrel crude oil price that tipped the world into recession.
As expectations of an intermediate- to long-end of a forward curve keep determining the spot prices, our macro-pricing model suggests that the price of crude oil may average around $86 per barrel in 2011. Further, we used an estimate of risk premium / discount and relative investment value compared to our commodities to arrive at our quarterly / 2011 estimates. We expect crude oil prices to challenge $100 per barrel in 2011.
Our crude oil price ceiling is determined by an estimate of price which the global / U.S. economy can absorb without going back to recession. Our crude oil price expectations are based on current estimates of the intensity of global demand, end-user demand, and possible substitution by other forms of energy; we consider that ceiling might be in the range of $110-115 per barrel, as spare production capacity may still be available from Canadian shale, Saudi, Iraq, and Kuwait.
If crude oil prices rise beyond this point, there may be an adverse reaction from the most defensive demand segment, U.S. gasoline demand (estimated at eight million barrels per day). We expect a modest decrease in market tightness as Q1 2011 progresses due to seasonal factors, and expect the markets to tighten in Q2 / Q3 2011. We expect crude oil to rise towards $100 per barrel by the middle of 2011. Using current 90 days normalized volatility of 25% (currently 32%), the fan estimate may range from $70-$100. Option-implied volatility of front-month contracts may rise from its current level of 32% with a positive skew of 22% (a normal in stable-to-trending markets).
Simple analysis of support and resistance levels over the past few years gives some clues as to key levels. A strong support lies at $70 per barrel. If prices should falter, this will be one level where prices could stabilize. Another resistance is at $100. Prices may have a difficult time breaking through to the triple digits; however, if they do, this will become a new floor of support. We are bullish on crude oil prices in the long term, even factoring in the substitution at higher prices of crude oil use as a percentage of global energy use -- which may drop with a rise in crude oil prices. Spare production may face a crunch in 2013, as demand reaches around 90 million barrels per day.
Crude oil has underperformed the commodities space in the most recent rally, despite the fact that the benchmark U.S. crude oil price will average around $81 a barrel in 2010, up from last year's average of $61 per barrel; 15% higher than the beginning-of-year consensus of $71 per barrel; and around 5% higher compared to the previous Energy Information Administration's outlook for $78.67 per barrel.
The price of crude oil stands at a historic juncture. The demand picture continues to be mixed. Despite the moderation in the Chinese economy, crude oil imports are still higher than in recent years. In contrast, U.S. oil demand is well below historical averages. Crude oil inventories in the U.S. are still running above historical averages, which have capped oil prices. But broad U.S. dollar weakness and gradually improving risk appetite should support oil.
On the negative side are the renewed concerns on the eurozone peripheral debt situation, interest rate hikes in Asia, and some lingering risk aversion, as well as increase in supply from OPEC (Iraq, Kuwait and Saudi spare capacity) and non–OPEC (gas liquids, Brazil) sources. Also, as and when there is a decline in inventories to below the five-year average, the liquefied natural gas story will start playing out.
The key question which may determine crude oil price may not be exogenous factors such as those mentioned above, but crude oil’s effect on a nascent global recovery and what crude oil price the global economy can absorb without going back into recession. Don’t forget that despite the earlier slowdown and apparent signs of a sub-prime crisis, it was the $140 per barrel crude oil price that tipped the world into recession.
As expectations of an intermediate- to long-end of a forward curve keep determining the spot prices, our macro-pricing model suggests that the price of crude oil may average around $86 per barrel in 2011. Further, we used an estimate of risk premium / discount and relative investment value compared to our commodities to arrive at our quarterly / 2011 estimates. We expect crude oil prices to challenge $100 per barrel in 2011.
Our crude oil price ceiling is determined by an estimate of price which the global / U.S. economy can absorb without going back to recession. Our crude oil price expectations are based on current estimates of the intensity of global demand, end-user demand, and possible substitution by other forms of energy; we consider that ceiling might be in the range of $110-115 per barrel, as spare production capacity may still be available from Canadian shale, Saudi, Iraq, and Kuwait.
If crude oil prices rise beyond this point, there may be an adverse reaction from the most defensive demand segment, U.S. gasoline demand (estimated at eight million barrels per day). We expect a modest decrease in market tightness as Q1 2011 progresses due to seasonal factors, and expect the markets to tighten in Q2 / Q3 2011. We expect crude oil to rise towards $100 per barrel by the middle of 2011. Using current 90 days normalized volatility of 25% (currently 32%), the fan estimate may range from $70-$100. Option-implied volatility of front-month contracts may rise from its current level of 32% with a positive skew of 22% (a normal in stable-to-trending markets).
Simple analysis of support and resistance levels over the past few years gives some clues as to key levels. A strong support lies at $70 per barrel. If prices should falter, this will be one level where prices could stabilize. Another resistance is at $100. Prices may have a difficult time breaking through to the triple digits; however, if they do, this will become a new floor of support. We are bullish on crude oil prices in the long term, even factoring in the substitution at higher prices of crude oil use as a percentage of global energy use -- which may drop with a rise in crude oil prices. Spare production may face a crunch in 2013, as demand reaches around 90 million barrels per day.
