Scotiabank predicts oil rebound

Mohr says tight supplies should support crude prices in the second half of next year.

Oil prices have become so oversold that they will stifle investment in new production and eventually lead prices back up near $100 (U.S.) a barrel, said Bank of Nova Scotia commodities expert Patricia Mohr. However, it may take a couple of years to get there.

In an interview yesterday, Ms. Mohr predicted the price of crude would hover in the current $50-a-barrel area “for the next six months,” as the slowing global economy keeps a lid on demand. However, she said that with tight credit conditions and a lack of government funding likely to result in slowing production from cash-strapped Russia, and with the Organization of Petroleum Exporting Countries to consider output cuts as early as its meeting this weekend, a slowdown in supplies should support oil prices in the second half of next year.

More importantly, she said, prices in the $50 range make many investments for development of key new oil sources uneconomic - meaning the prospects for significant increases in oil production will be put on hold as long as prices remain relatively low. The resulting slowdown in capital spending on new production, she said, would leave the market looking undersupplied once the global economy recovers, something she believes could begin in the second half of 2009.

“That’s going to set the stage for a strong [price] rebound,” she said - predicting that average prices could top $95 a barrel in the 2011-13 period.

Ms. Mohr’s outlook came as she released her monthly Scotiabank Commodity Price Index report for October - in which plunging oil was the leading factor in sending the index down 15.6 per cent in the month, its worst performance in its 36-year history. The index measures price performance across Canada’s key exported commodities.

The oil and gas subindex tumbled 21.8 per cent from September, and Ms. Mohr noted that prices have continued to fall in November, which should further weigh down the overall index.

Ms. Mohr’s views on oil investment prospects, which were highlighted in the report, got some timely support yesterday from Royal Dutch Shell PLC. The energy giant put its proposed Carmon Creek oil sands project in Alberta on hold, while it looks at ways to bring costs down to improve the project’s economics.

But while the relative bargain oil prices may serve to constrain new supplies, analysts at Merrill Lynch argued this week that they should do little to spur demand - which they predicted would slump 0.5 per cent globally next year.

Merrill commodity strategist Francisco Blanch estimated that each 10-per-cent drop in the price of crude results in only a 0.1- to 0.5-per-cent rise in demand, depending on the region of the world in question. He said the economic cycle has a bigger impact on demand than price, as consumers’ reduced purchasing power largely offsets the benefits of lower oil prices. “Oil demand growth almost always found a trough with the business cycle, in every recession since the 1970s.”

However, Mr. Blanch said in a separate report that volatility in the energy futures market has eased in the past week, implying that the oil market might at least be stabilizing after its sharp declines - which were brought on by the “credit shock” that triggered a massive liquidation of energy futures by hedge funds.

Ms. Mohr noted that while hedge funds have exited many long positions in oil amid the credit crisis - in some cases permanently, as some hedge funds were wound down - other hedge funds have been piling into short positions in oil futures in record volumes, to profit on the downturn.

“Those positions can be unwound at some point when the market turns around,” she noted - which implies that the hedge funds could still provide fuel for a rebound in oil prices.

Looking at the commodity market as a whole, Ms. Mohr predicted that the Scotiabank Commodity Index won’t bottom until next spring, as existing long-term pricing contracts governing some commodities expire and are replaced by lower-priced new contracts. However, she predicted the index will have a “very strong rebound” in 2010, driven by a revival in the fast-growing emerging-market economies.

In particular, she said base metals could be poised for a speedy recovery, largely because major metal producers have slashed production much quicker than in most downturns, thanks to the unusually rapid price declines. “Once emerging markets pick up again, the markets will tighten much quicker than they have normally,” she said.


The Scotiabank Commodity Price Index slipped 15.6 per cent in October from September - the deepest drop in the index’s 36-year history - as the global credit crisis and the deepening economic slowdown triggered a rapid exodus from commodity markets. Few commodities were spared the carnage.

Oil & Gas The index’s oil & gas component tumbled 21.8 per cent in the month, as average crude oil prices plunged to $76.72 (U.S.) a barrel in October from $103.76 in September. Since then, prices have continued to tumble, to below $50 a barrel last week. Natural gas prices have also slumped 23 per cent from their September average.

Metals The metals & minerals component dropped 15.9 per cent, led by sharp declines in key base metals. In late October, nickel and zinc were at prices barely above average cash production costs, but have since recovered slightly. However, potash prices rose to record levels, as Canpotex, the Canadian potash industry’s exporting arm, negotiated rich new sales contracts with Japan and South Korea for the first half of 2009. Potash supplies remain tight and concentrated in a handful of producers, Scotiabank’s Patricia Mohr said.

Forest products The forest products segment fell 5.5 per cent, amid weakening lumber prices, which have been driven down below many sawmills’ cash cost levels amid the sharp downturn in the U.S. housing sector. Newsprint makers are pushing through new price increases, but falling advertising sales are poised to strangle demand and weigh on prices next year, Ms. Mohr predicted.

The agriculture segment slumped 15 per cent in October, as hedge funds unwound big long positions in grain and oilseed futures. However, grain prices have begun to edge higher this month.

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