Oil prices have risen significantly lately, boosted by an improvement in macro data, high OPEC compliance, a weaker dollar and strong investor sentiment. Prices are now close to 75% higher from the bottom reached at Christmas last year. The performance is even stronger for gasoline, which has more than doubled as the gasoline crack spread has improved as well.

We have on several occasions pointed to high OPEC compliance as pivotal for the oil market. According to the latest info from the IEA, compliance is now running at 85%. But as always the number is highly uncertain. OPEC’s attention has now turned to the next OPEC meeting n 28 May. As usual, the price hawk Iran is calling for a new production cut at the meeting. Iran argues that the closely-watched OECD stocks have risen to the equivalent of 61 days of consumption. OPEC prefers a level of 52-53 days. However, we doubt that the more influential OPEC members like Saudi Arabia will agree to further productions cuts if the current price level is sustained. But it is quite likely that OPEC will repeat that the goal is 100% compliance, which in fact would take another 600-700k barrels off the market per day.

IEA has already warned OPEC against another production cut as they argue it would jeopardize the fragile recovery of the global economy. But looking at the stock situation it is easy to see why some OPEC members are a bit worried about the stock overhang. The latest EIA weekly crude oil numbers showed that stocks are now running at a stunning 15% above the 2008 level. Also, the US demand numbers continue to disappoint. The preliminary EIA numbers showed that daily fuel demand (implied) averaged 18.2 mb in the four weeks ended 1 May, down 7.9% from a year ago. Yesterday, the EIA report also contained a new downward revision to demand growth. The EIA expects global demand to contract by 1.8 mb/d in 2009. The IEA expects 2.2mb/d.

But we still argue that we will see a tightening of the global oil market in the course of 2009. In our view OPEC will start to tighten the market in the next couple of months. It is no surprise that stocks rise in Q2, when demand is seasonally weak. But when we enter the summer period we estimate that current OPEC production (not least if compliance is improved) will be well below “call on OPEC”.

The development in the market balance will of course also depend on global demand and non- OPEC production. Regarding global demand, the latest “green shoots” in the global economy such as rising PMIs point to a quicker recovery in the global economy and henceforth in oil demand than forecast by e.g. OECD and the IMF. We forecast growth of -2.7% in the US and Euroland in 2009, whereas IMF expects -2.8% and -4.2%, respectively.

Regarding non-OPEC production, we still argue that both 2009 and 2010 will see a long list of disappointments. The IEA refers to spending surveys that envisage upstream spending down around 15-20% in 2009. Major cash rich oil companies and national oil companies will be least affected, whereas independents and smaller oil companies are likely to reduce investment heavily in the next two years. We expect non-OPEC production to fall at least 0.5mb/d in 2009 and would not be surprised to see even weaker production. Also, future OPEC production capacity is at stake. According to the OPEC Secretary General Al-Badri, the impact of low prices over the last six months, the financial crisis and the severe production cutbacks are now having a major impact on the investment projects of OPEC members. According to OPEC, 35 out of 165 planned projects have been delayed.

Hence, we continue to expect oil prices to trade between USD 60 and USD 70 a barrel in Q4 2009. However, short-term we are a bit more cautious. Oil prices have surged despite growing global stocks as the market has looked towards a possibly tighter market in the second half of 2009. It seems that near term weakness is being completely ignored. But the optimism might not last forever, and we would not be surprised to see a correction of 5-10% in the near future in the oil price. Hence, given that we expect oil prices to recover again in Q3 and Q4, we recommend that risk-averse clients hedge oil exposure for 2009 and 2010. But due to the relative steep contango and the current stock build, the less risk-averse client might consider awaiting a possible correction in prices.

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Danske Bank
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