- Oil prices set to decline further
- Brent/WTI spread narrowed, more to come
- Lower energy prices good for consumers and the economic recovery
Oil prices still down…
The pressure on oil prices continued during recent weeks. The decline, which started in mid-February, continued and as a result Brent oil prices dropped below USD 100 per barrel (bbl) for the first time in ten months in April.
The main reasons for the ongoing pressure on oil prices were: 1) disappointing economic data, mainly from the US and China. 2) US inventories near record levels. 3) Adjustments in demand expectations by the main energy organisations (EIA, IEA and OPEC) and the IMF triggering investor worries on future demand. 4) Closure of commodity long positions (especially after the sell-off in gold). 5) A lower risk premium on Brent oil, as geopolitical tensions regarding Iran eased somewhat with new negotiation talks scheduled. WTI crude prices also declined for these reasons as well. However, the fact that an increase in US crude production leads to lower crude imports by US refineries led to a lower discount to Brent oil. As a result, the Brent/WTI spread dropped below USD 10.
…with the Brent/WTI spread narrowing
We believe that the Brent/WTI spread will continue to narrow and hover between USD 5 -10. The two main reasons are 1) Transport of crude via rail or truck from Canada or US oil rigs to the refineries on the US Gulf Coast is significantly more expensive than pipeline transportation. With more pipelines being built or coming into play, the discount will decrease somewhat further. However, there should be a discount of at least USD 5 or else refiners would prefer to buy cheaper foreign crude instead. 2) There remains a risk premium on Brent oil, as a result of possible geopolitical tensions due to the coming Iranian elections in June, the Syria conflict not showing improvements and North Korea threatening nuclear attacks. Although Syria and North Korea are not major oil producers, an escalation could trigger a spillover to the region or at least hurt investor sentiment.
Pressure on oil prices could continue in Q2
Normally, Q2 marks a drop in demand. The heating season is over and maintenance at refineries leads to a drop in demand for crude oil. From an economic perspective, global demand for oil will also remain weak. We expect Brent prices to decline to USD 90/bbl, before stabilising and rising again in the second half of the year. Similar to Brent, Q2 WTI demand is lower than during the winter heating season. As a result, the WTI price should continue its decline, which started in February. However, the opening of pipelines between Cushing, Oklahoma, and the Gulf of Mexico refineries should protect the downside in WTI prices. Q2 also marks the start of two seasonal patterns in the US, the driving season and hurricane season, which may impact demand for and the price of WTI. We expect WTI to ease towards the USD 80/bbl low before bottoming out in Q3.
Longer-term forecast also set for lower oil prices
Swings in risk appetite will continue to dominate the direction of oil prices in 2013. The market’s focus will switch between hope for economic recovery and disappointment as a result of weak data, higher non-OPEC oil production/lower OPEC output and geopolitical tensions. As a result, the Brent oil price will continue trading within the existing wide trading range (USD 90-120/bbl), similar to the pattern in 2012. We expect the talks with Iran to continue in a constructive manner after the elections in June. The main question is if, and for how long, the US and Israel accept only talk and no action by Iran. Overall, with demand remaining soft (with the impact of weak European conditions being balanced by stronger Asian demand) and supply to increase even further, the longer-term outlook trend is set for a further decline towards USD 100/bbl and USD 90/bbl in 2014 and 2015, respectively. As production in the US and Canada is also expected to continue rising, the upside potential for WTI prices seems very limited in the coming years and should even lead to continued pressure instead. We expect WTI prices to decline to USD 90/bbl and 85/bbl in 2014 and 2015, respectively.
Also US Gas prices finally start to decline
European gas prices (NL TTF) already returned to normal levels during the first week of April (Figure 2), following the UK gas prices (NBP) which already declined at the end of March. The US gas price continued its rally on below- average temperatures and stock levels dropping below the five-year average. But finally, during the last week of April, US gas prices also ran out of steam and even started to decline somewhat on the news of improving weather conditions. Also for gas, Q2 marks a period of lower demand, which results in rebuilding of stocks and easing gas prices.
Lower energy prices good for consumers but bad for the energy mix
The lower oil and gas prices are good news for consumers. After all, direct costs of fuel and electricity will decline and this will stimulate the overall economic sentiment. Furthermore, since oil is used for many products in the chemical industry, there will be an indirect impact as well in the form of cost advantages. Also in the longer run, this will have a positive effect. With oil and gas prices declining, inflationary pressures will also ease.
This will support the global economic recovery. A calculation teaches us that for every USD 10 drop in oil prices, around 0.5% of world GDP shifts from producers to consumers of oil. As consumers have a higher propensity to spend than producers, the net impact on the global economy is positive. So, since Brent oil dropped from USD 120/bbl in February to below USD 100/bbl already, this would mean an extra growth of 1.0% (year-on-year) already if oil prices remain at current levels. For Europe and the US, the positive effects on the economy are even larger as both continents are net importers of oil. With our forecast of further pressure on oil prices, more economic stimulus can be expected.
There is another side of the coin as well. Lower energy prices will result in a decline in investment in renewable energy. Development of and investments in renewable energy are already pressured by the US shale revolution, the rise of coal usage in combination with the low carbon prices in Europe, and the boom in energy demand in emerging markets. Lower energy prices will reduce the immediate economic need for further development of a wider spread in the energy mix.