Citi - Oil Tail Risks
Citi is raising its oil price expectations for 2012. In our base case we now expect
Brent to trade in a range of $100 to $120 and to average $110 for the year. This is in
line with the bull case in our previous forecast, which has come about due to better
than expected demand and much worse than expected supply. Going forward, our
global supply and demand balances are moderately bearish for 1Q12, as is our price
outlook, but from then on we expect stronger balances and prices. We are not very
optimistic on oil demand growth, modeling just +0.8-mb/d in 2012 and +1-m b/d in
2013, based on Citi’s GDP expectations of 3.0% and 3.6% (PPP-adjusted) respectively.
We are, however, optimistic on supply, forecasting 1.1-m b/d of non-OPEC supply
growth, and coupled with the return of Libya this requires a cut by OPEC of some 500-k
b/d if they want to keep the market tight and prevent a return to inventory builds. We
think OPEC recognizes this reality, and take recent statements from OPEC members
about how high their recent production has been as posturing in preparation for the
upcoming quota reallocation.
Beyond supply and demand, our base case expects oil prices to be supported by
several other factors: geopolitical risks, Russian domestic demand, the rise of
the non-OECD, higher macro correlations, and inflation tail risks. Citi’s views
warrant cautious optimism on risk assets (our global equity strategists are targeting a
20% gain in the MSCI AC World equity index, which should be supportive for oil).
Monetary expansion would be supportive for commodity prices in general, and Citi is
expecting QE3 in the US, rate cuts in Europe and a return to an easing cycle in China;
and finally geopolitics, which we expect to be a dominant theme in oil markets
throughout 2012 and 2013.
We think the world is operating with about 2.5-m b/d of spare production
capacity. Virtually all of which is in Saudi Arabia, with the rest scattered around
other core Gulf OPEC members. Absent any supply disruptions, we expect to see a
marginal increase in spare capacity, but the margin remains so slim and the potential
disruptions so numerous that we believe risks are slanted heavily to the bullish side of
the ledger. Tensions between Israel and Iran top the list, but en EU embargo on Iranian
oil, sanctions on Syria, succession and the possibility of strife in Saudi Arabia, elections
in Venezuela and Angola and ongoing violence in Nigeria and Yemen are on the list but
do not complete it.
Our base case is constructive for oil prices. Our bull case, to which we assign a
25% probability, is that one of the many possible geopolitical risks to supply comes to
fruition, in which case we expect oil prices to spike higher and to take a real toll on the
global economy. Our bear case comes from a disintegration of the Euro (something our
economists estimate is a 5% probability event), or a hard landing in China. Either of
these would take oil down more than a peg or two.