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15 January 2012

Oil price forecasts for 2012

This week a friend of mine asked about oil prices for 2012. As usual by this time of the year newspapers and investors alike thrive to have an outlook for the following twelve months, more or less trying to devise how their portfolios may fare. I always find this a bit awkward, the dynamics underlying markets like that of crude oil have little relationship to the rhythm of the Earth's revolution around the Sun. But somehow there is this idea that markets have a sort of fresh start in the beginning of a new year. Hence, usually well informed people put out their forecasts around this time, so as to prove how well informed they are. It just happens that for 2012 the most disparate projections exist, either of a fall in oil prices or of a price boom.

Instead of pointing out who is wrong or is right in this story, the importing thing is to understand that both visions can be correct, both can develop through out 2012.

The major negative factor on crude oil prices is the austerity policy in Europe, the Eurozone is going into economic recession and can drag with it some other large economies. Naturally this will result in a demand reduction that pushes down prices for immediate and short-term delivery, thus opening the contango, promoting the expansion of commercial/strategic stocks. Another important element can be the political stabilization of Lybia, allowing the full return of European (and other international) oil companies; though this last hypothesis is more remote in my view.

On the upward pressure is above all the embargo to Iran. With the USA, EU, China and Japan apparently coordinating themselves to prescind of iranian oil, demand shall certainly increase for other crude sources. The 2.6 million barrels that Iran exports every day make up more than 6% of the international market, if it disappears it'll certainly leave a trace. But beyond this direct impact the uncertainty remains on the impact the embargo can have on the internal politics of Iran, and of course, on the regular flow of oil through the Strait of Hormuz. Mounting tension around this key oil route, even if military action doesn't materialize, will certainly have a relevant effect on prices. There's also a rapidly developing situation in Nigeria, that could reduce exports from this important supplier of oil to Europe. At this time I'm not yet certain of how serious this situation is or can be, but certainly it would be better if it didn't exist.

It is thus possible to conceive a scenario in which oil prices fall during the first half of the year in consequence of the austerity policy to later on rise on the hardening of sanctions against Iran, when the recently passed legislation in the USA comes fully into place. An important aspect of this dynamics is that the deeper the oil price dive in the first half of the year the more tempted will the OECD members be to harden their position towards Iran.

This sort of roller-coaster prices of a commodity is typical of a context of constrained supply. It is something we should get used to, for it will haunt the international oil market for as long as the long term dynamics stays in place: limited to declining supply meeting a demand heavily pressed by the large emerging economies.