Oil Prices: At Home in Their Range
Readers often ask about my forecast for crude oil prices in 2012, likely because opinions in the popular press diverge widely: Some pundits call for crude oil to hit $200 per barrel because of an outbreak of hostilities in Iran; others expect oil prices to collapse because of weakening global demand.
Neither scenario is likely. Brent crude oil should average between $110 and $115 per barrel in 2012, while West Texas Intermediate (WTI) should average $100 per barrel. Based on this outlook, both Brent and WTI have approached the top of their respective trading ranges.
Weak economic growth should keep a lid on oil prices, while omnipresent geopolitical risks and a tight supply-demand balance will limit downside.
The Demand Side
Demand for oil remains weak in the developed world. Although the US no longer drives growth in global oil demand, the economic power is still the world’s largest consumer.
US economic data have surprised to the upside since last summer, and the recent dip in initial jobless claims suggests that the domestic labor market has started to heal. Nevertheless, US consumers have reacted to elevated oil prices by taking steps to conserve fuel. Check out this graph tracking the four-week moving average of US demand for oil and petroleum products.
Source: Energy Information Administration
US oil demand never fully recovered from the 2007-09 Great Recession, in part because elevated prices have curbed gasoline consumption.
General Motors (NYSE: GM) recently announced that weak demand had prompted the automaker to halt production of its gas-electric hybrid vehicle, the Volt, for five weeks. In February 2012, General Motors sold only 1,023 Volts, well off the pace needed to meet annual sales of 45,000 cars.
Critics have trotted out this failure as evidence that Americans don’t care about buying fuel-efficient cars. Nothing could be further from the truth; check out this tracking US truck sales as a percentage of total vehicle sales.
Americans in recent years have stepped up their purchases of small cars. Consumers’ growing preference for fuel-efficient automobiles suggests that purchasers are factoring in rising energy prices when selecting which type of vehicle to buy.
Subpar economic growth, coupled with the recent spike in gasoline prices, could cause US oil demand to surprise to the downside in 2012. This outlook represents a bit of a departure from the second half of 2011, when I consistently argued that the US economy was in better shape than many investors believed.
Although the US is unlikely to slip into recession in 2012, the recent rally in the stock market suggests that investors have grown to bullish about the economy’s growth prospects. My forecast calls for the US economy to expand at an annual rate of 2 percent to 3 percent for a prolonged period. Sluggish growth will weigh on US oil demand.
Meanwhile, the economic situation continues to deteriorate in Europe; we expect the EU to suffer a mild recession in 2012, as fiscally challenged governments rein in spending. According to the International Energy Agency (IEA), Western Europe’s oil demand in December 2011 tumbled 4.7 percent from year-ago levels, led by a 7.6 percent decline in Italy’s oil consumption and 7.4 percent drop in Spain’s oil demand. This weakness should persist into 2012.
Japan remains the one center of demand growth in the developed world, primarily because the country idled most of its nuclear reactors after the March 2011 disaster at the Fukushima Daiichi power plant. To offset this lost capacity, Japan has leaned heavily on petroleum- and natural gas-fired power plants.
Although the developed world accounts for much of global oil consumption, China, India and other emerging economies will continue to drive aggregate oil demand. In 2011, for example, oil demand surged by 1.27 million barrels per day in the developing world, more than offsetting 530,000 barrels per day of lost consumption in developed nations.
Global oil consumption will grow in 2012, albeit at a relatively modest pace. Emerging markets will lead the way, but China and other major oil consumers deliberately slowed their economies over the past year to quell inflationary pressures.
Moreover, the outlook for global economic growth weakens with each week that Brent crude oil goes for $130 per barrel; higher oil prices inevitably lead to some demand destruction. As I explain in the Feb. 24, 2012, issue of Personal Finance Weekly, Rising Oil Prices Threaten the Economy–But Don’t Panic, Brent crude oil has approach prices that historically have caused economic growth to soften meaningfully.
Bottom line: Modest growth in oil demand limits the likelihood that Brent crude oil will eclipse $130 per barrel.
The Supply Side
Although weak demand growth should constrain oil prices, limited supply increases should prevent crude oil from becoming much less expensive.
The IEA’s current forecast calls for global oil consumption to climb by 830,000 barrels per day in 2012 and for non-OPEC oil production to increase by 900,000 barrels per day. In January 2012, non-OPEC oil output declined on a year-over-year basis.
Robust production growth in North America, especially in unconventional oil fields such as North Dakota’s Bakken Shale and Texas’ Eagle Ford Shale, accounted for a good portion of the IEA’s projected growth in non-OPEC oil supply. These output estimates include volumes of natural gas liquids (NGL) such as propane, ethane and butane, which can’t replace oil in all applications. (NGLs are a common substitute for oil derivatives such as naphtha in the petrochemical industry.)
At the same time, geopolitical tensions in the Middle East could inhibit supply growth. Although EU sanctions against Iran won’t go into effect until summer 2012, some customers have already started to source their oil supplies from elsewhere, disrupting the flow of crude oil from the nation.
If a military conflict were to break out in Iran and threaten oil shipments from the Persian Gulf, crude oil could soar to $200 per barrel overnight. These fears should continue to support oil prices.
Meanwhile, OPEC’s spare productive capacity–incremental oil supply that could be brought online to offset supply disruptions–hovers around 3 million barrels per day, a thin buffer in a global oil market that consumes 90 million barrels per day.
These supply factors should prevent Brent crude oil from slipping to less than $100 per barrel and WTI from tumbling to less than $90 per barrel.