-- John Kemp is a Reuters columnist. The views expressed are
his own --
By John Kemp
NEW YORK, March 4 (Reuters) - Spot oil prices are trading
at some of the highest levels since October 2008, but strength
at the front end of the curve is not being matched by increases
at the back end, belying forecasts of another dramatic rise in
prices in the next few years.
While spot prices have risen more than $10 since
early December, five-year forward prices have actually
come down by more than $1, and the time spread has halved from
$20 to a little over $8.
The same pattern has been true for most of the last year,
with much of the firming in prices concentrated at the front
end of the curve. While spot prices have risen $39 (94 percent)
since March 2009 forward prices have gained just $23 (34
percent) and have been basically range-bound for the last six
months.
Firmer spreads are a natural consequence of reduced output
from OPEC and a gradual recovery in demand across the advanced
economies. These factors have pushed the market closer to
balance, stabilising and now drawing down excess inventories of
crude and refined products.
But several analysts have gone further, suggesting tighter
spreads and renewed front-end strength are signs the market is
transitioning from over-supply in 2009 to a narrower
supply-demand balance in 2011. In their view, the market is
building a foundation for a significant upward move to $100 per
barrel next year and on towards $120-140 by the middle of the
decade.
The problem with this argument is the lack of any
supporting evidence in the forward market. Prices for Dec 2015
have been broadly unchanged since June last year. If
anything they have softened recently, peaking at over $96 in
January before falling to just $90 in early March, and show no
sign of rallying. Once expected inflation of 2.5-3.0 percent
per year is taken account, real forward prices are the same as
today's spot market.
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For a graphic on spot and forward NYMEX light sweet oil
prices, pleae click on:
http://link.reuters.com/nyp33j
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FORWARDS AND SPOT
Those forecasters who are most bullish at present -- based
on the rise in spot prices and firming spreads -- have
previously argued that investors and other market participants
should focus on the movements at the back end for a clearer
view about long-term supply-demand fundamentals and market
direction.
The focus seems to be (arbitrarily) shifting depending on
which market segment is more consistent with a basically
bullish story about the need for rising prices to ration supply
and incentivise faster growth in supply in the medium term.
While there are three elements to the market (nearby prices,
forward prices, and the time spread between them) no more than
two can move independently; the third is fixed by the others.
So the question is whether forward prices drive the spot market
or vice versa -- which acts as the cart and which as the
horse.
Recent studies suggest increased participation by financial
investors and the lengthening maturity profile of positions
have made the market more "forward-looking". They conclude that
heightened volatility at the back end of the price curve since
2004 indicates long-term factors based on expectations have
become more important in price formation " [ID:nLDE61218F].
In this view, prices are reacting more to changes in
expected future fundamentals than imbalances in spot supply and
demand that are expected to prove temporary. In the past,
prices were determined nearby, with the spot market driving the
forwards via the level of inventories and the time spread. But
the direction of causality has been reversed, with expectations
about the future brought back to the spot market via the
possibility of financing and storing physical inventory.
PEAKING OIL DEMAND
Oil bulls see prices rising significantly above $100 per
barrel over the next five years, while bears see prices
remaining range bound at $65-85. The difference is really one
of emphasis. Bulls see a need for substantial price rises to
ration demand and force greater efficiency, especially in
emerging markets; bears believe recent price increases have
already set in train enough demand destruction to ensure the
market remains well supplied.
Spiking prices between 2006 and 2008 have already
eliminated a substantial amount of consumption in the advanced
economies. Demand for liquid fuels has already peaked in the
advanced economies, according to projections by the US Energy
Information Administration (EIA) and International Energy
Agency (IEA).
But the full effects will only be visible over the next
decade as policy responses such as the ethanol mandate (passed
in 2005 and stiffened in 2007) and required increases in
vehicle efficiency (approved in 2007 and accelerated in 2009)
are implemented.
Although consumption continues to grow rapidly in China and
other emerging markets, they have significant scope to limit
the rate of increase by phasing out remaining use in power
generation and by boosting engine efficiency in new motor
vehicles. As a result, some observers have begun to forecast a
peak in global demand sometime between 2020 and 2030.
ADEQUATE SUPPLY TO 2015
For bears, OPEC's challenge is to minimise policy-driven
demand destruction and keep its production competitive with
natural gas, coal, and clean energy sources. To maintain oil's
position in the energy mix, the cartel will need to limit
further real price increases and avoid price spikes that would
spur further switching to cheaper, cleaner burning and more
reliable gas, or to coal twinned with carbon capture and
storage (CCS) technology to limit emissions.
The forward market's stability at $90-95 per barrel for the
last nine months suggests investors have largely bought into
this view, expecting demand growth worldwide to slow
substantially from the previous decade while continued
increases in output and strong growth in competing fuels
ensures adequate supply through the middle of the decade.
While no one should rule out the possibility of another
price surge brought by stronger-than-expected consumption in
emerging markets, the bears arguably have the better arguments
at present. The stabilisation of forward prices below $100
suggests the market is with them for the moment.
(Editing by David Gregorio)
((john.kemp@thomsonreuters.com; reuters messaging:
john.kemp.reuters.com@reuters.net; +44 207 542 9726))
Keywords: COLUMN OIL/
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