Oil prices have recovered since the end of last month, when prices had been dampened by the release of emergency oil stock. In the first few days of this month, Brent crude hovered around US$111-112 per barrel before rising to US$117-119 over the last few days as fears about the macroeconomic outlook receded, investor confidence grew and US stocks declined.
WTI prices also rose to a high of around US$98 per barrel in the last few days, although as prices did not rise as much as for Brent the differential between the two prices has widened further.
We had expected oil prices to recover following the initial dip after the IEA's sanctioned release of oil stocks. But oil prices have bounced back quicker than anticipated and, as a result, we have raised, very slightly, our 2011 forecast since last month. For the year as a whole, oil prices are now expected to average US$111.7 per barrel. This assumes that the current rally will be short lived. Projections for 2012 and 2013 remain unchanged at US$109.2 and US$102.7 per barrel respectively, the fall in prices the result of a falling oil risk premium as tensions in the Middle East ease. Demand growth to slow in 2011
OECD oil product demand fell 1.9% year-on-year in May, according to the IEA. Declines were widespread across the OECD with only Germany and Australia registering rises. Meanwhile, non-OECD oil demand rose 4.8% in the same month, driven by strong consumption in the BRICs.
With economic activity expected to grow at a slower pace than last year in many of the key oil-consuming countries, oil demand is also expected to grow at slower pace this year. However, Chinese demand will be boosted by power cuts and restrictions that are likely to lead to an increase in the use of diesel electricity generators. Japanese demand will also be boosted to some extent by a substitution of nuclear for fossil fuels.
Over the longer term, robust economic growth in emerging markets will continue to support demand, thus world oil demand growth will be increasingly dependant on activity in developing countries. Saudi oil output rises
Following the OPEC meeting in June, Saudi Arabia stated it would continue to raise oil production despite the cartel failing to agree an increase in production quotas. The latest oil supply figures from the IEA seem to confirm Saudi Arabia's pledge. World oil supply rose by 1.2 mb/d in June compared with May, with OPEC production rising 0.8 mb/d largely due to a sharp increase of an estimated 0.7 mb/d in Saudi production. OPEC spare capacity has dropped to 3.2 mb/d following the increase in production. Libyan production is believed to be running at very minimal levels although we expect it to pick up through the second half of the year. Indeed, inclusion of the eastern oilfields into the current no-fly zone, should it happen, would be positive for Libyan oil production. Non-OPEC production also increased, by 0.4 mb/d, as maintenance finished at several plants.
The risks to the forecast are on the upside. Our projection for a decline in prices over the next couple of years depends crucially on an easing in political tensions in the Middle East. However, there is a greater chance that the unrest will be more prolonged than in the base case. Should tensions persist beyond the base case assumption, the risk premium would remain high and supply side tightness could pressure oil prices higher. Spot iron ore prices pick up
Spot prices have begun climbing once again as Chinese buyers return to the market. Buying activity is still cautious however, as stockpiles remain high and the reliance on imported iron ore is lower in summer than in winter when Chinese mines shut. More resdily available credit is likely to have helped this pick-up in activity. By July, domestic banks will have completed their half-yearly assessment and now appear to be lending more than earlier in the year.
Global steel prices, meanwhile, have shown little upward movement over the past month. This is partly due to some seasonal weakness, while underlying demand has also been soft, although high iron ore and scrap prices have put a floor under prices. US flat prices appear to be falling although long prices may find support from a pick-up in construction activity. The European market has also seen prices fairly static despite announced price increases while a steady flow of imports boosted by the strong euro has not helped either. In China, steel prices fell in June but are likely to remain unchanged in July.
Iron ore consumption - steel production - has recently softened a fair amount. Crude steel output is likely to have either declined or slowed markedly in Q2 2011 in most of the key producing countries as seasonally adjusted world production fell in April and remained flat in May. Nevertheless in the developed world, activity in key steel consuming sectors in the US and Japan is expected to accelerate through the rest of the year, considerably so in the latter, while European demand is expected to be growing strongly by Q4.
Meanwhile, in emerging markets Chinese steel production was flat on a seasonally adjusted month-on-month basis in May. The Chinese government has recently increased its target for the closure of excess steel capacity by year-end which may hamper steel production. Previous attempts to curb excess capacity have had limited success owing to the resistance of provincial governments to close down or consolidate factories that provide much welcome employment and tax revenue. Therefore, it is unlikely that Beijing will be able to meet these targets. However, over the past year, production has been scaled back as a result of government policy so we expect steel production to be affected by the clampdown.
Weaker crude steel production in China is likely to lead to downward pressure on iron ore prices in the second half of the year while at the same time boosting steel prices. Our baseline forecast is for iron ore prices to fall gradually over the remainder of the year. However, as mentioned earlier, Beijing's policies to clamp down on excess capacity in the past have had limited success so there is considerable risk attached to the steel production forecast and therefore its implication for iron ore prices. Iron ore prices are expected to decline over the medium term also as new capacity comes on stream, although delays to some of these new projects have resulted in a faster decline than in our last report. Base metal prices volatile
Base metal prices have been fairly volatile since the start of the month. Positive economic news from the US, coupled with a weakening of the dollar, boosted investor sentiment and prices early in the month sending prices for some base metals up to levels not seen since April. Soon after, however, concerns about the European debt crisis and a hike in Chinese interest rates pushed prices lower.
LME stocks for most base metals have fallen over the past month, which is also likely to have provided support to prices. Copper prices have further been boosted by industrial action at copper mines, which is likely to continue to support prices in the short term. Moreover, Chinese buying activity appears to have picked up, although China is still believed to be holding high levels of copper stocks and therefore the pick-up in buying may only be short-lived, particularly if tighter monetary policy chokes off end-use demand. Copper price projections for the rest of the year have been revised up owing to industrial action at mines, with prices expected to steadily climb through the rest of the year.
Prices for most other base metals are predicted to fall in Q3, dampened by the prospect of new capacity coming on stream while in the case of tin, production and export disruptions which were supporting prices earlier in the year have now eased. Prices will however, receive a boost in Q4 once reconstruction efforts in Japan get under way.