Saturday, March 20, 2010

Crude Oil Fundamentals: Better Because of Maintenance $USO

• Oil market balances have continued to improve, though we contend (again) that prices may be getting ahead of themselves. Inventories increased slightly ahead of the 5-year average in December; however, weekly data point to slight draws through February.

• We believe the market’s strength of late has been largely product-led. While product balances have undoubtedly improved, this improvement has resulted from reduced production, on lower refinery runs, and not demand. In the OECD, though stable, demand remains weak and still below year-earlier levels. With the added fillip of a colder-than-normal winter now fading, and refiners exiting maintenance, we doubt products will lend the support needed to keep crude prices at today’s elevated levels.

• Despite our near-term concern, our estimates continued to point to steep stock draws in 2H10, and we remain steady with our $95/bbl target for year-end and our 2011/12 average price forecasts of $100/bbl and $105/bbl, respectively. Specifically, we model global demand growth of 1.7 mmb/d, which together with our non-OPEC supply forecast of 320 kb/d points to the need for increased OPEC production and/or steep inventory draws in 2H10. In 2011/12 we see spare capacity dwindling, forcing prices to level demand.

The improvement of the crude term structure has left many asking when the curve will move into backwardation. Our estimates suggest that should OPEC leave production unchanged at February levels, inventories will draw in 2H, and as a result, backwardation could return in 4Q10 (see slide 6).

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