‘Supply-side risks’ may drive oil above $100 in 2011

Surging demand for oil, particularly from China, India and West Asian countries, coupled with a ‘supply-side risk’ — with supply likely to be lower than expected - could drive oil prices higher, back beyond $100 a barrel in 2011, according to analysts.

The Paris-based International Energy Agency raised its outlook on oil demand in the next five years, which along with a shrinking of spare production capacity in member countries of the Organisation of the Petroleum Exporting Countries (Opec) could leave energy markets “jittery”. 

“Upward demand revisions have outstripped those for supply,” IEA notes in its November market report. It now expects demand to reach 93.4 million barrels per day (bpd) by 2015, from 85.4 million bpd this year. It also revised up global oil demand for 2010 by 130,000 bpd to 87.4 million bpd, and for 2011 to 88.9 million bpd.

But oil market analysts reckon that even IEA’s higher-than-expected numbers don’t adequately foretell a coming squeeze on supplies that could drive oil prices in 2011 back beyond $100 a barrel.

IEA’s estimates of non-Opec crude production and Opec natural gas liquid production in 2011 “are on the aggressive side” and there are “several downside risks to the supply growth numbers,” notes Nomura global oil market analyst Michael Lo.

On average, adds Lo, IEA has “over-estimated” supply by 0.7 million bpd since 1997. “Based on our analysis, IEA could be overestimating 2011 non-Opec crude supply and we could see downward revisions to its estimates as we move through 2011.”

On the other hand, consumption in 2011 could be even higher than IEA’s projection, by some estimates. Rising consumption, particularly from the key demand centres — China, India and the Middle East — will likely raise demand in 2011 to 88.5 million bpd, reasons Cheng Khoo, head of the Asia oil & gas research team at Nomura.

While crude oil prices had been trading in the $70-80-a-barrel range for most of the year after trading below $40-a-barrel in 2009, the range is now moving up, notes Cheng. In her estimation, “tightening fundamentals”, particularly above-trend oil consumption growth, underscore her “bullish call” on oil prices for the next two years.

Additionally, the second round of quantitative easing will likely increase money supply, fuel inflation expectations, and drive oil prices higher, she reckons. “$100 a barrel is within reach in the coming year.”

Other analysts point to the significant surplus capacity of 3.8 million bpd over the past two years — arising from demand destruction following the slowdown of the global economy along with capacity addition. Opec spare capacity in fact rose from 3 million bpd in 2007 to 6.6 million bpd in 2009.

But, reasons Cheng, Opec spare capacity will likely trend lower in the coming two years as demand will outpace supply growth.

And while both crude and product inventories remain above their five-year averages, inventories in the developed economies of the OECD showed a downward trend as demand rebounded in the second half of 2009, outpacing supply growth.

“We expect a decline in inventories towards the second half of 2011 as demand outpaces supply,” adds Cheng. “Further backwardation could accelerate drawdown in the coming months.”

One other factor that could drive prices higher is the heightened speculation and increased fund flow.

Physical demand is a mere fraction — barely 1% — of trading volumes in oil, which makes for increased volatility and speculation — which would be accentuated by a weaker dollar and the accumulation of oil and commodities by funds that are gearing up for a global economic recovery.