From the February 01, 2009 issue of Futures Magazine • Subscribe!

What’s next on the energy roller coaster?

Obsessed with oil demand growth prospects? Isn’t everyone these days?

Volatility in oil markets remained at scorching levels at the onset of 2009 due to spillover from the previous year’s near cataclysmic meltdown in the financial sector and an unstable global economy.

But a steadier global economy will dictate prospects for oil demand growth, the primary price driver for petroleum markets the past six months in comparison to the first half of 2008 when supply side issues dominated. And oil demand growth will likely continue to be the focus for petroleum markets through the first half of 2009.

Both the International Energy Agency (IEA) and the U.S. Energy Information Administration (EIA) released their monthly oil reports the second week of December with each containing mild downward revisions to petroleum demand growth estimates for both 2008 and 2009 in comparison to alterations earlier in the year that were eye-popping, to say the least. There were two glaring standouts in these reports. The first was a 1.02 million barrels per day (b/d) difference in oil demand growth estimates for 2009 with EIA at the lower end of the forecasts. The second was IEA projecting positive demand growth year-over-year while the U.S. agency estimated another drop-off in 2009.

The IEA’s monthly oil market report released Dec. 11 projected total global oil demand at 86.28 million b/d while the EIA’s short-term energy outlook on Dec. 9 estimated 85.30 million b/d for 2009 (see “Demand destruction/construction”). Still, for 2008, the two sets of estimates were showing a difference of one million b/d IEA projected total global oil demand at 86.75 million b/d while EIA estimated 85.75 million b/d. IEA’s estimate for 2009 indicates demand growth of 440,000 b/d while EIA’s suggests a decline of 450,000 b/d, an 890,000 b/d swing that could not possibly go unnoticed.

“The global demand contraction expected in 2008 will be the first since 1983,” the IEA report states. The downward demand adjustments by IEA were concentrated in the United States, Europe and Japan, which should come as no surprise because those are the regions suffering from a severe slowdown in their economies.

The EIA’s forecast would mark the first time in three decades that world consumption would decline in two consecutive years.

But these demand growth estimates are in all probability predicated upon drastically different GDP growth projections for both 2008 and 2009. The IEA is modeling oil demand growth estimates based on the International Monetary Fund’s (IMF) GDP forecasts. The IMF revised downward its estimates for global GDP growth Nov. 6, changing its projection to 3.7% from 3.9% for 2008 and 2.2% from the original forecast of 3% for 2009 (see Weakening expectations,” page 28), EIA expects global GDP growth in 2008 of just 2.7% and 0.5% in 2009. The GDP growth estimate for 2009 represents a downward revision from EIA’s previous baseline scenario of 1.8%. Given the current malaise that economies are suffering, a lower baseline case for GDP growth in 2009 appears to be the likeliest to play out. And EIA has a lot of company in its slow-growth scenario for 2009.

Deutsche Bank recently cut its global GDP growth estimate to 0.2% from 1.2% for 2009, while economists at Merrill Lynch are forecasting 1.3% for 2009 with a rebound to 3.1% in 2010. Merrill’s economists said that 1.3% growth for the global economy would represent the weakest since 1982. Merrill also expects U.S. GDP to decline 2.3% in 2009 with a rebound to just 0.5% in 2010. Deutsche Bank expects the U.S. economy to contract by 2% in 2009. Economists at Barclays Capital were projecting global GDP growth of 0.8% in 2009, “the weakest annual growth rate in over half of a century.”

While America no longer drives global GDP growth the way it did eight years ago, it still accounts for about 22% of total oil demand, based on both IEA and EIA projections.

In 2000, America had a $9.82 trillion economy, which drove two-thirds of global GDP growth. Presently, based on IMF estimates, the $14.334 trillion U.S. economy accounts for only 7.05% of global GDP growth.

Long before demand growth stops its near vertiginous fall, OPEC supply cuts and disappointing non-OPEC output will tighten global balances for crude oil, not products. OPEC lowered its production targets by 2.2 million b/d Dec.16, effective Jan. 1, on top of two million b/d of supply reductions between September and November 2008.

The decline in supply will not be nearly as steep as the freefall in prices on global futures markets seen in 2008. The crude contract on the New York Mercantile Exchange (Nymex) finished 2008 with a year-to-date loss of $51.38 per barrel to settle at $44.30, down 53.53%. Front-month Brent crude on the Intercontinental Exchange ended 2008 at $45.59 per barrel, a decline of $48.26 and a depreciation of 51.42%. In between, both benchmarks surged to all-time highs in July and at their peak were up more than 50% from the previous year’s settlements. No forecast could have foreseen a rise and fall as spectacular as the one that global oil markets underwent.

In between, the Nymex crude contract experienced its largest one-day gain and its biggest one-day decline over a two-day time span. Nymex October crude surged $25.45 on Sept. 22, the October contract expiration, and settled that day at $120.92, up $16.37. The following day, the front-month crude contract settled $14.31 lower at $106.61.

And even as 2008 closed, volatility in February crude options with 13 days to expiration was up at 113%, signaling tumultuous market conditions during a period normally notorious for apathy and lack of liquidity.

It is unlikely crude will experience such dramatic swings in 2009; volatility can be expected to remain high. While volatility may remain at a fevered pitch, the crude market is apt to range trade in the first half of 2009 until a clearer picture emerges for global economies.

CHEAP GAS

One of the largest percentage declines in commodities in 2008 occurred in the Nymex RBOB (unleaded gasoline) contract, having settled the year at $1.0082 per gallon, down $1.47, or 59.28% on the year after hitting an all-time high of $3.6310 July 11 and a five-year low of 78.50¢ Dec. 24.

The decline in product prices globally will provide the underpinning for revived demand growth (see “Relief at the pump”). But additional spare refining capacity compared to the past several years that were characterized by a lack thereof, and a counter-seasonal stock build in the fourth quarter of 2008 will temper rallies in 2009 and prevent product prices from reaching the dizzying heights seen the previous year. U.S. gasoline stocks climbed 28.463 million barrels to 208.103 million barrels during the fourth quarter of 2008, eradicating steep deficits against the five-year and one-year average levels. And that was with refiners in the United States throttling back output in the face of weak demand readings.

While the decline in implied demand appeared to be arrested by year end, based on the preliminary weekly data from EIA, the first and second quarters are notoriously a time when demand eases. This will probably not happen in 2009, since the falloff has already occurred and retail prices have declined so precipitously. Prices at the pump averaged $1.6130 across America the week ending Dec. 29; $1.44 below year-ago levels, according to data from EIA. This is the lowest retail gasoline prices have been in about five years. There has been enough evidence to suggest that U.S. consumers have opted for mass transportation, smaller cars and less miles traveled as high prices earlier in 2008 and a weak economy caused demand destruction. Without any upswing in demand, the U.S. could start the driving season with a comfortable stock cushion, which will prevent new price spikes.

While demand for diesel was a primary price driver in 2008, the same may not be true this year. Last year’s searing prices for distillate, which outpaced crude and gasoline, were the result of an abnormally cold winter in the southern hemisphere, a loss of gas production in Australia and stock-piling by China ahead of the Olympics. These are factors that will not play into diesel prices this year.

DISTILLATES & NATURAL GAS

Diesel prices averaged $2.3270 per gallon the week ending Dec. 29, $1.01 below levels the same time one year ago and a three-and-a-half year low. But demand for middle distillates is the most closely correlated to the economy. Container traffic in West Coast ports suggests international trade has slowed considerably and rail traffic is down. How quickly global economies can rebound in 2009 will determine the fate of middle distillates.

And part of middle distillates is heating oil. A mild winter thus far along the key-consuming Atlantic Coast has kept demand for heating oil at modest levels and allowed stocks to build at a time when they normally would decline. With margins for middle distillates running at an extreme premium to gasoline, refiners will maximize output of diesel and heating oil, which also will moderate any rally in the futures market.

Like heating oil, natural gas is highly reliant upon weather patterns. Natural gas inventories have eroded as a Canadian cold blast blanketed the U.S. Northwest and Great Plains in late December.

At 2.877 trillion cubic feet, U.S. working gas in storage was 2.3% below year-ago levels the week ending Dec. 26, according to EIA, but 2% above the five-year average. Like diesel, demand for natural gas may suffer due to a weak economy. What natural gas bulls have working in their favor; however, are price comparisons to heating oil for those where fuel switching is an option. The front-month natural gas contract on Nymex settled 2008 at $5.622 per mmBtu compared to heating oil, which settled at $1.4057 per gallon, or $10.135 per mmBtu.

Like the petroleum sector, natural gas is closer to a bottom at this point, but much will rely upon the economy. But unlike petroleum, natural gas is a domestic market and less susceptible to geopolitical factors and the fortunes or ills of economies other than the United States.

The primary centers for petroleum demand growth have been China, India and the Middle East. How insulated these countries are from the current downturn in the mature industrialized economies has been the basis for much debate. Both the IEA and EIA still project these countries as the epicenter for oil demand growth in 2009, even if their economies slow from the rather torrid pace of expansion seen the past several years.

Don’t be surprised if 2009 is another year of mega-revisions in oil demand and GDP projections as economies teeter, but try to find a sounder financial footing. The one certainty is that oil and natural gas prices are apt to grind higher, but will not even come close to challenging the record-setting numbers seen in 2008.

Linda Rafield is a senior oil analyst at Platts and editor of the weekly publication “The Futures and Derivatives Review.” For more information on the weekly publication go to www.platts.com.

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