Weekly Focus

Commodities: Economy in focus

Following a start to the week with risk “on” and decent commodity price rises after the
Chinese announced that they would allow the yuan to appreciate, commodities retreated Weekly changes
again towards the end of the week as the market was spooked by the softer tone struck by
economic data out of both the US and Euroland. Oil rose close to USD80 and copper hit
USD6,700 on Monday on speculation that a rise in purchasing power in China would fuel
imports of commodities. Simultaneously, gold prices hit new record highs as safe-haven
demand was replaced by inflation fears.
Although we think that USD80 will be tested again, it is worrisome that US crude stocks
continue to see build at a time of year when an increase in refining operations should start
to take its toll. However, one of the reasons of the lack of seasonal adjustment in
inventories is that refiners have extended the maintenance period this year, leading to
weaker-than-usual demand for crude. However, the uptick in refining margins as
highlighted by higher distillate and gasoline crack spreads recently suggests that refining
capacity utilisation could be on the rise. This should lead crude stock to come down but in Source: Bloomberg, Danske Markets.
order for oil prices to move firmer into the USD80-90 range, product demand would have
to show more pronounced strength.
IEA: economy to remain key driver for oil prices US crude oil stocks keep rising
This week the International Energy Agency (IEA) published its Medium-Term Oil
Market Report in which two oil-demand scenarios are assessed: a higher- and a lower-
GDP scenario (with the former the IEA’s base case based on IMF growth projections).
The report stressed that the shape and extent of the economic recovery is likely to remain
the primary driver of oil market balances in the years to come, and also emphasised that
the unusually uncertain economic environment could add to price volatility.
In the higher-GDP outlook, demand growth averages +1.4% y/y after 2009 but oil
intensity is expected to gradually improve as efficiency gains take effect. As a result of
Source: EcoWin, Danske Markets.
waning non-OPEC supply, the market tightens substantially and OPEC spare capacity is
projected to fall below 5% in 2014. While this scenario has the potential to lead to higher
prices, the IEA stresses that a diminishing price elasticity of demand means that income
effects will likely outweigh any price effects on demand. Total consumption is thus Crack spreads widening
forecast to average 89 mb/d by 2014 (vs. 83 mb/d in 2009). In contrast, the lower-GDP
scenario entails significantly lower demand growth of below 0.5% y/y. But, at the same
time, non-OPEC supply is lower as investment declines as well. On balance, the IEA
estimates that OPEC spare capacity would in this case be close to current levels of around
8%. This situation would lead to a relatively comfortable market which could imply lower
price volatility.
In any case, demand growth is likely to be driven mainly by the non-OECD region and to
arise predominantly from transportation and petrochemical sectors, with the latter leading
to a rise in relative demand for lighter fuels. Refining is expected to adapt to these Source: EcoWin, Danske Markets.
structural changes as new upgraded capacity is coming on stream. The IEA also sees
global usage of biofuels bounce back after having been pushed down the energy agenda
during the recession, notwithstanding the ongoing “fuel vs. foodstuffs” debate. Regarding
financial flows, the agency stressed the lack of firm evidence that speculators drive prices
but warned that regulatory crack-downs may add to volatility.
Although we largely agree with the IEA on the demand outlook and see risks to our case
for crude prices to head into the USD80-90 range towards the end of the year as chiefly
on the downside in the short term, we also think the oil cost curve has seen an important
upward level shift following recent restrictions on deepwater drilling. Thus, longer term,
we probably have to become used to USD70+ oil prices.
Senior Analyst
Christin Tuxen
+45 4513 7867
tux@danskebank.dk

| 25 June 2010
www.danskeresearch.com
Weekly Focus

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