By Wiktor Bielski of VTB Capital



We are initiating our coverage of the crude oil market, with Brent price forecasts of $85/bbl for 2010, $100/bbl for 2011 and $110/bbl for 2012. Our long-term forecast (2015+) is $90/bbl, based on the expected marginal cost of Canadian oil sands (now the world’s second largest oil reserves).

We believe the oil market will move back into deficit in 2010 as global GDP growth recovers to about 3% Year-on-year, resulting in a 2.4% Year-on-year increase in oil demand to 86.5mbpd. This is modestly higher than the latest IEA forecast of 85.7mbpd, and almost entirely due to our more positive view of growth in Asian demand. Additionally, we expect further deficits in 2011-12.

We forecast supply growth of 1.8% in 2010, largely due to our expectation of OPEC supply back to 30mbpd in 4Q10, up from 28.8mbpd in 4Q09. Non-OPEC supply is forecasted to rise just under 1%, in line with the latest IEA estimate.

In our view, oil prices will increasingly triangulate between supplydemand factors, investment/speculative demand, and long-term marginal costs. We believe this will accelerate price discovery as forward-looking investors become as important as supply-demand in determining market direction. As the debate about potential supply shortages and peak oil is re-ignited, we believe it will be a powerful force in driving oil prices back above $100/bbl and towards the 2008 peak.

The key risks to our outlook are a slower than expected recovery in global GDP growth, with constrained bank lending and highly indebted US/OECD consumers refusing to spend and providing increased headwinds for oil prices. Furthermore, a sooner-thanexpected increase in OPEC supply, or a large slippage in OPEC compliance, could reduce our price expectations.

Strong oil market recovery

After one of the most powerful bull runs in history, which saw oil rise from $28/bbl at the beginning of 2003 to a peak of $147/bbl in early July 2008, prices collapsed back to $34/bbl in February 2009 (Figure 2). It is still unclear if oil largely precipitated the global recession of the past 12 months, or whether it was just a contributory factor, with the collapse of Lehman Brothers the main event (as prices had already fallen below $100/bbl before 15 September). Nevertheless, the evidence is compelling that record oil prices in both real terms (Figure 3) and in nominal terms at close to $150/bbl had a profound effect on consumer activity, particularly in the US. On the other hand, it is also clear that the global recession truncated a secular tightening of the market which was on course to potentially generating the first ever physical oil shortages.

At the start of 2009 the outlook for prices was therefore the most bearish since 2001-02. Against this negative backdrop, oil prices have outperformed all expectations rising more than 100% from the February low of $34/bbl to a consistent range of $60-75/bbl over the past four months. Although partly a reflection of OPEC forecasts in 2Q09 of a $75/bbl price at the end of 3Q09, the primary drivers have been strong Chinese demand, a weak $and a significant increase in investment/speculative buying.

We believe the market has now created a strong base from which to mount a powerful 4Q09 rally, and we expect the combination of a number of positive factors to drive prices through the $75/bbl resistance, towards our year-end target of $85/bbl:

• Demand recovery to gather pace as global economic data continues to improve, with more consistent declines in US inventories as the peak winter demand season approaches.

• Increasing expectations of a tighter market ahead as renewed discussions focus on the risk of potential supply shortages in 2011-2012, and beyond.

• Ongoing $weakness.

• A further increase in investment/speculative buying.

• OPEC maintaining quota cuts at its December meeting and most likely presaging no quick return to higher output levels in 2010.


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