Oil sketches :The usual suspects

Summary Commodities Research – 25 january 2012

Barclays Capital

Geopolitical risks are still high, although the areas of immediate interest have moved from North Africa to the Middle East. The obsession with WTI and the pipeline and rail infrastructure of the US Midwest continues, as does the euphoria around US oil shales. Yet, despite the continuation of these broader themes, some sub-themes, or rather different nuances to the themes, have started to emerge already. The extreme tightness of Q3 has now been removed, and a much better supplied prompt market has started to exert downward pressure on time spreads. At the same time, geopolitical tensions related (but not solely confined) to Iran have ratcheted up. While we have been listing the Iranian situation as a source of upside risk for a decade, there are some new factors at play now that make for a far more potentially dangerous outcome, as the current drift of policy on both sides creates the risk of a significant escalation, in our view. And to confuse matters further still, though oil demand growth has slowed considerably (although not due to sovereign debt issues but primarily on the back of warmer weather), macroeconomic indicators around the world have started to look healthier.
Currently, there are simply too many moving parts for the market to process in a logical and timely manner, and the result has been the effective freezing of oil prices in largely range-bound trading.

In the very near term, as long as the warm weather persists, the seasonal winter demand for oil will be capped and, with the improvement in supply, prompt spreads will remain under pressure. However, with the cold spell of Q4 10 easing in Q1 11, the y/y comparisons should become far more benign. Add to that the recent macroeconomic data flow which seems to suggest that, not only are outcomes better than oil market participants expected, but they may not be that poor in absolute terms either, and some interesting dynamics are already at play here. Indeed, while the market remains fixated on geopolitical risks and sovereign debt, we would watch out for key parts of the world economy that might outperform relative to the pessimistic view embedded in most oil price outlooks and provide a key source of upside to oil prices later in the year.