HIGHLIGHTS

• Non-OECD oil demand grew at a healthy 5.1% clip in Q4; OECD demand still in the red at -3.4%
• Growth in oil production picked up steam in Q4, outpacing consumption
• Global inventories remain elevated at 95 days supply

The Great Recession had quite an impact on the crude oil market, with demand and prices plunging in late-2008 and early-2009. And even though the global recovery got underway during the second half of last year, this blow to the crude oil market is going to continue to be felt for some time, as the fundamental picture remains quite weak.

The recovery in the global economy has been led by emerging markets, and the story is similar for the crude oil market. Demand from non-OECD countries - China in particular - picked up steam in the fourth quarter, growing at a 5.1% (Y/Y) clip. Meanwhile, any economic improvement seen in OECD economies has yet to translate into a significant rebound in crude oil demand, as consumption in developed nations was down 3.4% (Y/Y) during the final quarter of the year. But, while still in the red, this is a marked improvement from the 6.1% (Y/Y) contraction seen during the second quarter. Put together, total world demand for crude oil ended 2009 slightly (0.3%) above year-earlier levels. But compared to 2007 levels, which is a more accurate ‘pre-recession' benchmark, global demand finished the year down by about 2%.

With consumption still quite weak, there is plenty of oil to go around. Nonetheless, as prices rose closer to the US$70 per barrel mark, OPEC compliance rates began to slip, and ended the year at only 49%. So after curbing output by 7-8% during the first three quarters of 2009, OPEC production was down by only 2.6% in the final three months of the year. And with non-OPEC growth accelerating to 4.9% during the same period - with increased production seen in Brazil, U.S., Canada, and the Former Soviet Union - total global output increased by 1.6% in the fourth quarter, and was 1.3 million barrels per day greater than demand. In fact, after showing great improvement through most of 2009, the supply-demand balance shot up dramatically during the last two months of the year. This doesn't bode well for the already elevated global inventories, which at 95 days supply, are well-ahead of the 5-year average of 86 days supply.

So while demand for crude oil is improving alongside the economic recovery, supply has been rising at a faster pace, preventing the market from working down inventories and moving back into a more balanced position. What's more, OPEC spare capacity jumped from 1.5 million barrels per day to 4.4 million barrels per day in 2009, and is expected to continue to increase through 2011 to nearly 6 million barrels per day as new capacity comes online. Hence, even once the rebound in crude oil demand is in full swing, the supply overhang, combined with growing excess capacity, will limit any upward pressure on prices. The U.S. dollar, however, is likely to have a positive influence on prices this year, as we expect it to depreciate against the euro and a basket of currencies through most of 2010 (USD/EUR to be 1.45 at year-end). As a result, we expect oil prices to remain in a relatively tight range, averaging about US$80 per barrel this year. Next year, once global economic activity picks up steam, oil prices are likely to head a little higher, averaging US$85 per barrel.

TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.

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