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March 28th, 2012


Oil prices softened in New York trading Wednesday as France joined talks among governments in developed nations* to release petroleum reserves. Prices moved lower still following the Energy Information Administration’s weekly inventory report showing an outsized (7.1-mln barrel) increase in crude oil stocks; it was the largest 1-week gain in 50 months. Meanwhile, in an op-ed piece in today’s Financial Times, Saudi Arabia’s minister of petroleum and mineral resources pledged that even though inventories in his country “and around the world are full – 100 per cent full”, they would step up production to offset any losses from a supply disruption. Regardless of the evidence suggesting ample supplies of crude petroleum, dealers remain deeply concerned that the burgeoning global recovery is poorly insulated against an oil price shock.

* The current consortium includes Japan, France, United Kingdom and United States


Dismissing any long-term positives associated with the unexpectedly large weekly gain in crude inventories, the Commodities Strategy team at Citigroup Global Markets said, “Nationwide imports were the driver, spiking to 9.2-m bpd, back within the 2005-10 range, due to the backup of vessels at the Houston Ship Channel over the last weeks (clearing last Tuesday as weather improved), but also with increased Saudi volumes into the Gulf Coast and some of this for the Motiva Port Arthur expansion project.” Similarly, BMO Capital Markets noted that key petroleum product stocks overall declined by 4.3 million barrels, which the dealer ascribed to improved demand. “We believe that this week’s report is slightly positive for crude oil prices.

Goldman Sachs & Co believes the oil market, and by extension the global growth outlook, is “very vulnerable to supply disruptions from the Middle East (or elsewhere).” Although our oil price outlook is relatively benign from current levels with an end of year target of $127.50/bbl and an average price forecast of $130/bbl for 2013, there is still considerable upside from the forward price levels due to backwardation and risks remain significantly skewed to the upside despite the low level of volatility. The combination of low inventory cover and a high level of capacity utilization with Saudi Arabia producing at 30-year highs, leaves the market with nearly no ability to compensate for a supply disruption in the Middle East or elsewhere. Given the likely negative implications of a supply shock-driven oil price spike on other assets, we continue to view long positions in Brent as a hedge to this downside risk.”

For its Q2 2012 Global Economics newsletter released Wednesday, HSBC Global Research listed five reasons “why stagnation is here to stay.” Fourth on that list: “Higher oil prices threaten to trip up the world economy this year in much the same way they did last year: Iranian tensions show no signs of fading any time soon while QE may have inadvertently led to higher commodity prices more generally.” Further into the 102-page report, HSBC says, “Of course, oil prices may start to moderate as China takes measures to cool demand (by raising retail fuel prices) and Saudi Arabia shows willingness to increase oil supply to bring prices back in line with ‘sustainable’ levels, which they have stated to be closer to USD 100 per barrel. But we think risks persist.”

If oil were to increase by 10% owing to supply disruptions, the economics team at J.P. Morgan Securities expects developed market and emerging market GDP growth would dampen by 0.1% and 0.2%, respectively. Economists there wrote, “The good news is ex-oil inflation is benign. We expect the trend in core inflation to continue owing to weak commodity demand in China in 2012. Our current strategy assumes that lower inflation (than 2011) supports real income growth and boosts margins.”

Agreeing that “oil-related headwinds place downside risk” to the current economic outlook, economists at Bank of America Merrill Lynch similarly estimate that “every $10 a barrel increase in oil prices reduces [U.S.] GDP growth in the year ahead by 0.2 to 0.3pp.” Citing slower-than-expected growth in supply from OPEC and non-OPEC sources, BAML’s global commodity research team last week raised their price forecasts for oil; the team boosted their 2012 Brent and WTI price forecasts to $118 and $106/bbl, respectively, from $110 and $103/bbl prior, and now see Brent averaging $120/bbl in 2013. Instead of the 820,000 barrel per day (bpd) year-over-year increase in non-OPEC supplies in Q1 that BAML in its end-2011 forecast, the commodities team says, “Now we will likely end up observing 150,000 bpd due to a barrage of supply disruptions in the North Sea, Sudan, Syria and Yemen.” Offering a glimmer of hope, the commodities team believes that, in the absence of a geopolitical event “there is a natural cap on further oil price gains.”


To assess how a 25% spike in the real price of crude oil affects output across four developed markets, economists at CIBC World Markets ran a simulation using vector autoregression (VAR), allowing them to take into account the historic interrelationships between GDP, resource prices, interest rates, exchange rates and inflation. The Canadian dealer published those results on Tuesday, showing that the U.S. takes the biggest hit, followed by Japan, then Eurozone and finally Canada. The analysis suggests Canada sees an initial economic benefit from an oil price shock and even in the second year of the shock, Canada’s simulated GDP declines only modestly relative to the baseline. “Canada appears to be one of the most sheltered regions in the face of rising energy prices, and the nation’s net energy export status, rising prominence of oil-price-sensitive energy investments, and skew towards renewables consumption could be key contributing factors to that outcome.” Of the four regions in the CIBC study, Canada is the only net exporter, though the US is better than the remaining two regions when it comes to net energy exports as a share of consumption. Nevertheless, its growth remains the most susceptible to an oil price shock.

As one dealer’s statement of risks disclaims, “Oil prices are extremely volatile in the short, medium and long term, as they are frequently affected by inherently unpredictable events, including natural disasters. In history, oil prices have proved consistently unpredictable because so many political, geological, and economic trends and events affect the supply of and demand for oil.” Amid those clear warnings, dealers appear to agree that oil prices are set to go higher before going much lower. Likewise, there are widespread concerns, most likely shared by central banks, that the delicate global recovery is not adequately insulated against another shock.

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