As the recession takes hold and increasingly looks to be a nasty affair, analysts are quickly revising forecasts to levels that would have seemed barmy a mere month ago. The latest is a new Merrill call that oil could drop to $50 a barrel, although the report waffles hugely by deeming a global recession “unlikely”. Have the authors not been reading the news, or is it house policy to underplay mention of how bad things look likely to get?
From Bloomberg (hat tip reader Michael):
Crude-oil prices may fall as low as $50 a barrel next year, about half current levels, in the “unlikely” event of a global recession, weighing on shares of petroleum producers, Merrill Lynch & Co. said.
Such a scenario, where global growth in Gross Domestic Product falls to 1.5 percent, isn’t the base-case forecast, the bank said today in a report. Merrill cut its 2009 average price estimate for West Texas Intermediate, the U.S. benchmark oil grade, by 16 percent to $90, citing falling demand and the start of new fields in Organization of Petroleum Exporting Countries…. U.S. oil use is declining faster than expected, while European consumption is falling “rapidly,” and OPEC production capacity is “just about to soar,” Merrill said.
“Combined, these factors represent significant short-term headwinds for both upstream and downstream companies alike,” Merrill analysts Mark Hume and Alexis Clark said in the report. “Notionally it is conceivable that in a worst-case scenario global oil demand actually contracts in the near-term as it did back in the 1980s post the Iranian Revolution.”
Yves here. Demand then didn’t just fall, it fell by about 1/6.
Oil demand growth in China and India, the world’s fastest- expanding major economies, may slow down in 2009, Merrill said….
“Against our initial expectations, some of the emerging markets are not keeping up either,” the Merrill analysts said.,,,
A “string” of fields in Saudi Arabia, Qatar and elsewhere within OPEC is set to increase capacity within the exporting group by about 3 million barrels a day in the next 18 months, the analysts said. In addition, refinery expansions and new projects will add about 900,000 barrels a day of distillate and 700,000 barrels a day of gasoline production capacity, they estimate.
The long-term cycle for oil prices “remains intact” because of under-investment in the industry, the Merrill analysts, based in Sydney and Melbourne, said.
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Yves, off topic , but note that the Dutch state has just nationalized Fortis/ABN AMRO completely.
Wasn’t it just a couple of weeks ago that GS was calling for 150?
Does this mean we scrap our alternative fuel initiatives?
Wasn’t OPEC remarking before the bailout that they were going to STOP production?
things keep getting “curiouser and curiouser”.
– Alice in Wonderland
Yves here. Demand then didn’t just fall, it fell by about 1/6.
I think that’s a little high. A small drop in demand can account for a large drop in price. Even here, I think gasoline demand is down 4-5%.
“[UBS] plans to close most of its commodities business, with the exception of precious metals, and will also substantially cut back…proprietary trading operations” – UBS cutting 2,000 more jobs
Wouldn’t be suprised if this added to downward pressure.
Classic bubble analysis, price and time, rate of change and pattern recognition all suggested earlier in the year, when crude was trading $130-$140, that $50-$60 was in the cards. The only question then, would it reach $170 first.
Prices tend to return from whence they started in about 1/3 the time putting us at a low in about 1 1/2 years.
The same analysis was successfully used in the tech and housing bubbles. Said analysis is usually dismissed by the fundamentalists primarily because it does not correspond/stands against the news of the day and the top is always in hindsight. Not to mention it is Technical analysis–voodoo as they say!
To adherents however, what is known is the outcome and what it is going to look like as it unfolds. Sadly when bubbles burst there is absolutely nothing that can heal the splatter except for time and contraction.
Apart from Ed Morse at Lehman, EVERY major investment bank oil team/strategist was bullishly forecasting year end oil in a range of $130-200 back in July when it peaked; yet many shrewd bloggers (myself included, I was short from June onwards) had dissected the Peak Oil mania and investment bubble surrounding it. Commodities always gravitate to their marginal production cost in a demand downswing, which is $60-80 for crude.
What if the biggest swing producers, at about 10MM
barrels each, Russia and Saudi, one of which is awash
in an excess of soon to be junk currency, decided to
leave some oil in the ground? It’s not like they need
the extra revenue. They may have learned, in the past year, that they can get more producing less. And for all the supposed supply increases coming, there are
a lot of fields dropping precipitously, like Mexico, and
slowly, like Venezuela and the North Sea. Just a thought.
Oil prices will definitely remain ‘low’ in the short term, but for the wrong reasons (global recession). Supply capacity growth from Opec in the short term looks guaranteed, but non-opec growth has stalled and will decline in the near term (Russia, Mexico, North Sea oil all peaked). After 2012 oil production will go into freefall.
Anon @ 304: “What if the biggest swing producers, at about 10MM
barrels each, Russia and Saudi, one of which is awash
in an excess of soon to be junk currency, decided to
leave some oil in the ground?”
I think this is the exact type of uncertainty that should mandate a scarcity premium above and beyond the marginal cost of production. Scarcity premium was actually a discount for much of the 80’s and 90’s. So if I’ve learned anything in the last 5 years, its that finite things need to have a scarcity premium, regardless of how abundant they may seem at any one time.
Matt Dubuque
Just a thought, but if you parse Merrill’s “unlikely event of a global recession” you COULD reach the alternate phrasing:
“we view it as 49% likely that there will be a global recession”.
Just a thought.
If Merrill IS saying that there is a 49% chance of a global recession, that change in their position would be noteworthy.
Matt Dubuque
mdubuque@yahoo.com
Oil has a crazy short-term inelasticity. The elasticity is something like 1/15, so a 4% drop in demand produces a 50% drop in price. Especially in combination with long-term demand destruction from the big spike, a global recession could get oil to $50 easily.
When UBS says it plans to close commodities business except precious metals, by cutting 2,000 jobs, they are essentially saying: "we believe so much that Ag & Oil were a bubble, whereas precious metals were not, that we are ready to base our corporate HR policy and our restructuring on this prediction". So if you wanna hedge against inflation, it's probably wise to go for precious metals, not oil and other ag/industrial stuff.
Last time I looked, oil was an oligopoly, not an enterprise subject to the “laws” of perfect competition.
Yes, there are some small producers who will pump so long as revenue exceeds cost, and a few “poor” nations who will produce in the same way. They just do not control the margin between too much and just enough.
>> Commodities always gravitate to their marginal production cost in a demand downswing, which is $60-80 for crude.
True enough. And consequently investment dries up, future capacity atrohpies, and when the kettle runs dry, the price quintuples. And then they blame the speculators.
>> Supply capacity growth from Opec in the short term looks guaranteed, but non-opec growth has stalled and will decline in the near term (Russia, Mexico, North Sea oil all peaked). After 2012 oil production will go into freefall.
Where is marginal Opec supply coming from? Saudi has been pumping like badgers, destroying their fields in the process. Lower demand will allow them to take a breather and survey the damage. That could be a 3m bbl/d reduction right there. Non-Opec supply is falling off a cliff, and that was at $100++ prices.
>> So if I've learned anything in the last 5 years, its that finite things need to have a scarcity premium, regardless of how abundant they may seem at any one time.
See my comment above. The market is a dumb, blind beast and never learns.
There are a lot of smart people at UBS. George Magnus comes to mind. But if I were to bet my future,
in the middle of the biggest banking debacle in a long long time, I wouldn’t cast my lot with the management of UBS. Not after $40B and counting.
The operating cost for synthetic oil from Alberta bitumen is just a hair under $50 at the moment. Capital costs are running around $150,000 /bbl/day so if you amortize that over an 8-year period you’re looking at about $100/bbl total.
A spot price of $50/bbl would start taking a lot of supply out of circulation, both right now and future investment.
US consumption is down 7.5 % year-over-year now, so yeah, it could happen.
P.S. shouldn’t those analysts be working for Lynch-America-Countrywide now?
This is from memory, which is why no link above, but in the oil shock, demand fell from something on the order of 69 million barrels a day to 57 million barrels a day. I am pretty certain the delta was 12 million barrels a day, not as clear whether the peak was 69 or 67 million.
I am certain I read this, but it must have been a non-web source, presumably an analysts’ report I can no longer locate.
According to EIA
http://www.eia.doe.gov/emeu/ipsr/t44.xls
world production dropped from 66.9 in 1979 to 57.9 in 1983, 9 million bpd drop of 13%. If the economy slows more than early 80s, so to will oil consumption.
Thanks for a very informative blog.
Drill Baby! Drii……oh never mind.
>> This is from memory, which is why no link above, but in the oil shock, demand fell from something on the order of 69 million barrels a day to 57 million barrels a day.
Yes, but this was when western countries accounted for the vast bulk of consumption. It's a different story now and a large haircut in US consumption won't be nearly as meaningful globally.
On a related note, I asked you earlier if any of the 124 countries cited in the IMF report on banking crisis, apart from Japan, did not at least in part dig their way out through reflation/devaluation. I suspect the hit rate here will approach 100%. If so, look at what the oil price did in local terms. For example, Argentina paid a lot more for oil after their banking crisis. So, probably, did Djibouti.
Then again, the research out of Merrill has had deflationary tilt since the inflationary trend started some 8 years ago.
joe c,
Thanks a lot. I’m not as familiar with commodity market sources as I am with financial markets sources. I was off in my recollection, but not horrifically so.
SlimCarlos,
Western countries still in aggregate are the biggest consumers, although obviously to nowhere the same degree as before. The delta in demand has come from emerging countries, which is why they were a focus of discussion in the price spike. And since in turn much of their increase in demand has been export driven, that is gong to fall in a global recession too, possibly not to the same degree.
Moreover, there were cuts in subsidies in emerging economies, in Vietnam, India, China, Thailand, indonesia. That impact is still rippling through. China in particular has basically indicated it intends to move to market pricing, since it belatedly recognizes that subsidizing energy makes its manufacturers energy inefficient, which will put them at a competitive disadvantage in the long term. The fall in prices gives them leeway to move faster on that front if they choose to.
Gold also peaked this year and both markets should be in a correction mode for at least two years probably longer. The correction in gold may be much less recognizable but it too will pause.
Youtube “Lindsey Williams” $50 and find your answer
If oil is going back to $50, I’ve got a chain of ghost towns in the inland empire you should be snapping up.
EIA indicates that world Consumption fell from 65.22 mbd in 1979 to 58.78 in 1983, not recovering the ’79 level until 1988 at 64.97 mbd.
http://www.eia.doe.gov/emeu/aer/txt/ptb1110.html
which, from a price perspective, is somewhat besides the point given the shift in price formation regimes from OPEC to futures markets.
should it develop, crisis forced decoupling, as a breaking down of global assembly lines and world trade should not be seen as conducive to higher crude oil prices, even within a futures centered price regime.
OT, but important…
http://mrmortgage.ml-implode.com/2008/10/03/wells-fargo-absolutely-did-subprime-stated-no-ratio-etc/
“The CEO of Wells was just on CNBC in a lengthy interview with Maria Bartaromo and he said “we never did stated income, low document, no document, interest only or subprime loans.” That is not accurate.”
Does someone know any person in CNBC that can be asked to look at this, and bring that ass back on…
The Merrill analyst must not have been covering mid-east oil production for long, because without needing to check I can tell you that even if oil were $150 and rising that they could not produce new net 3mn/bpd
New supply is coming from outside of OPEC, Saudi Arabia was going to add 1, maybe 2, million new barrels by early 2009 for the first time in a decade. Russia may export a lot but they are exhausting their reserves faster than any other country in history.
A significant portion of that _marginal supply_ that was added actually came from the American midwest where small pumping stations were reactivated and their average basis was $80/barrel.
From a former leader project manager/engineer in the Alberta tar sands: 10 years ago anything above $8/barrel was gravy. Capital, operational, and tax costs accounted for.
What has changed there is the tax structure, operational costs are probably triple, and capital costs 5 times what they were 10 years ago. All of those costs are rather sticky and so cutting production will happen. For all of their publicity the synthetic crude derived from the tar sands were 2mn/bpd and supposed to rise to 4-5mn/bpd in the next 5-10 years. That is enough market size to set the market price in the US today without further declines from the Gulf of Mexico
I like the idea mentioned above of measuring the oil price delta associated with financial crises.
Oil demand could drop 10% globally and crude oil would not drop below $60/barrel due to recent investment and operational costs. Also sovereign governments that control/produce three quarters of the world’s oil have realized that it doesn’t hurt to leave the oil in the ground to get a better market price — and they know personal greed if nothing else.
Yves (dude),
This caught my attention and I hate to bury it here, but WTF?
Many Banks and Thrifts Overly
Reliant on “Hot Money” Deposits: http://www.weissgroupinc.com/FDI…/ FDICReport.pdf
October 3, 2008
>> Among 7,689 reporting banks, total deposits are $6.09 trillion. Of these, $1.06
trillion, or 17.43%, are deposits in accounts exceeding $100,000, considered “hot
money.”
If the dollar is down 10-15%, and oil is traded in dollars (please don’t excoriate me if I’m wrong), doesn’t that me that today’s oil price of about $93 dollars a gallon is the same as last months price of $102-108 per gallon? Many reasons this may have happened (inflation finally hiiting produced goods, thus core, and thus US convincing partners to aid, etc.). Will be interesting to see late Novenber.
patrick neid: “Classic bubble analysis, price and time, rate of change and pattern recognition all suggested earlier in the year, when crude was trading $130-$140, that $50-$60 was in the cards….The same analysis was successfully used in the tech and housing bubbles.”
Bzzzzt! Wrong. Oil is consumed at the rate of 88mbbl/day. Can you say the same of houses or tech stocks?
Reality (aka the fundamentals) always has the final say. Always.
Sean Maher: “Commodities always gravitate to their marginal production cost in a demand downswing”
You’re forgetting scarcity rents. Introductory Natural Resource Economics.
Merrill, Goldman, et.al. are playing
pin the tail on the donkey. There
are too many variables at play in
the energy markets to accurately
predict future prices. Some
geopolitical mishap can blow the
fundamentals out of the water.
Said he from the inland empire.
So EvilHP, my back of the cranium number was $60/bbl, so I’m glad to see some actual analysis to support that ‘pattern recognition’ in the apt phrase of a commentor above. I do think that will be the bottom, but we’ve go a good chance to bounce off it while all the various trajectories—up, down, and twistwise—in the financial space re-jigger themselves.
When the book gets written on the cocaine-paced commodities bubble of 07-08, it’ll be a great read. I suspect we’ll find the same ibank and hedgie villains at the bottom of that heap as with all the rest of our woes.
Oil demand could drop 10% globally and crude oil would not drop below $60/barrel due to recent investment and operational costs.
If oil demand drops 10%, the price will drop to whatever, and then all this super-expensive oil you mention would sit in the ground until demand (and price) crept back up again.
Another alternative is that if demand drops precipitously, and drags the price down elasticly, the owners of all this super-expensive oil, not wanting their investment to idle for a long period of time, will gather their people together and say “make this operation efficient!”. The engineers will return to their labs, the lobbyists will start lubricating the politicians, and so forth.
The benefit of the latter approach is that not only do you extract some return when the price is low, you get much more return in the future when the price cranks up again (as it inevitably will).
But of course, these are only the words of simple computer programmer whose only exposure to the oil market is a gasoline pump. Ohhh, to be mouthpiece of Merrill’s position on the oil market! How much do these analysts make, anyways?