2010 Mid-year report — ‘cautious optimism’

OPEC Bulletin Commentary June 2010

There is an air of cautious optimism about the oil market outlook as we reach the middle of the year.

However, the robustness of the market during the third and fourth quarters is by no means guaranteed and the situation is finely balanced.

Since last autumn, the market has been enjoying a period of relative stability, particularly after the turmoil of 2007 and 2008. The $/barrel price of the Reference Basket remained in the 70s for half a year across the autumn and winter. But the market became more volatile in the spring, with the Basket settling in the 80s for a month before plunging 20 per cent in just three weeks to stay below $70/b for nearly a week. Finally, the price returned to its present 'lower 70s'.

What do we read into all of this?

Let us start with a brief rundown on the recent drivers. April's price rises were spurred by a new burst of optimism about the global economic recovery and higher oil demand expectations. However, the drop in oil prices in May seemed to reflect a shift in sentiment about the recovery, following the emergence of the sovereign debt crisis in the Eurozone and initial signs of moderation in the pace of economic growth in China, with the government seeking to prevent overheating. All this was happening at a time when crude oil fundamentals were sound, with the market well-supplied with crude and inventories well above five-year average levels. This highlighted the continuing impact of the financial sector on crude oil prices.

One is then led to ask what has actually happened since 2008 with regard to the reform of the financial sector. Much has been promised by consumer governments and other authorities, and the introduction of regulatory measures of one sort or another seems to be on the doorstep on both sides of the Atlantic.

As we stand on the crest of the second half of the year, we are faced with much uncertainty about the market outlook. While the world economy has experienced an encouraging level of growth so far, it is unclear about how this will pan out in the coming months, with, among other things, the Eurozone's sovereign debt problem, the ability of China to avoid overheating and the still-high levels of unemployment in OECD countries.

A moderation in the pace of the economic recovery will almost certainly reduce the rate of oil demand growth. But, on a brighter note, the forecast world economic growth rate has been revised up frequently since the start of the year, from 2.9 per cent to the present 3.8 per cent, and this in itself serves as a positive signal for the rest of the year.

Shifting to the other side of market economics, over-supply from increasing oil output at a time of already high stocks remains another downward risk. Gasoline inventories in the OECD are currently at a very comfortable level of five per cent above the five-year average. As a result, the gasoline sector is not expected to be strong enough to lead the market this summer. Also, spare refinery capacity across the globe appears sufficient to cope with any disruption in the United States, for example, as we enter the hurricane season.

Therefore, when we review the outlook for July-December 2010, we find ourselves asking: Which way is it going to go? What part will speculation play if there is a significant change in market trends? Answers to these questions are difficult, if not impossible, to provide at the present time.

However, what OPEC can say is that it will continue to monitor market developments very carefully and will respond accordingly in the interests of market stability, if changing conditions require this. Otherwise, we are content to adopt an approach of cautious optimism about the outlook for the rest of the year.

OPEC Bulletin June 2010

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