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Oil prices over 2011-12

Brent crude oil prices rose sharply from $90 pb to around $110-120 pb between January and May 2011. The main reasons were an increase in the precautionary demand from the major oil consuming countries and the higher risk premiums in response to the disruption to oil supplies that followed the political unrest in the Middle East and North Africa.

Brent oil prices rose sharply from around $90 pb at the beginning of the year to around $110-120 pb in May 2011, the highest level since August 2008. This rise reflected an increase in precautionary demand from the major oil-consuming countries and higher geopolitical risk premiums in response to the oil supply shock that followed the political unrest (the so-called ‘Arab Spring’) in the Middle East and North Africa (MENA) region that started in Tunisia in January and then spread to Egypt, and the Gulf states, culminating in the ongoing military action in Libya and the virtual cessation of its oil exports from March. Meanwhile short-term oil price volatility, as measured by the implied volatility on three- and six- month oil futures call-options remained low, despite the increased risks of a disruption to oil supplies, and close to the average levels recorded before the global financial crisis broke in 2008.

However, towards the end of 2010, even before the onset of unrest in the MENA region, oil prices had already moved and stayed above the $70-80 range that had moderated price fluctuations through most of the year. This earlier rise in oil prices reflected a number of factors. Global oil demand rose by 2¾ mbd (3¼%) in 2010, the fastest increase since 2004, as the world economy, led by the emerging economies, grew more rapidly than had been forecast earlier in the year. Oil-specific factors also contributed to the growth in oil demand. This included shifts in Chinese energy policy that reduced the supply of electricity to some sectors and led to higher consumption of diesel. Oil demand also grew more quickly than had been expected in the major advanced economies, notably the US, and in Japan where there was a shift to oil use in power generation to offset the loss of nuclear output due to maintenance problems.

Although global oil production increased in 2010 by 3¼%, largely due to higher-than-expected non-OPEC oil supplies, this was not sufficient to meet demand as OPEC crude oil production, which is subject to quotas, rose by only 1¾%, contributing one-quarter to the increase in global supply. OPEC production of natural gas liquids (NGLs), however, rose more strongly by around 10%, contributing another quarter to global supply growth in 2010. With the growth in world oil production outpaced by the increase in demand, this led to a sharp reduction in oil stocks held by the major consuming countries and contributed to the upward pressure on oil prices towards the end of 2010.

The outlook for oil prices over the short term (2011-12) depends crucially upon the prospects for greater stability in some oil exporters in the MENA region, and the interaction between the strength of the global economic expansion, the response of oil demand in the advanced and emerging economies to the persistence of high oil prices and the supply response. According to the central forecasts in the IMF's April 2011 World Economic Outlook, world economic growth is expected to moderate over the short term, suggesting a slowing in the pace of growth in global oil consumption. In addition, the IEA’s May 2011 Oil Market Report (OMR) indicated that there was evidence of slowing growth in demand for petroleum products particularly in North America where consumers are facing high petrol prices at around $4 per gallon. This slowdown in growth should be reinforced by a partial unwinding of the overshoot in global oil demand that, the IMF analysis suggests, typically characterises the early stages of recovery in global economic activity.

On the supply side, only a modest expansion in capacity is expected in non-OPEC countries, reflecting the high rates of output decline already seen in mature oil fields (notably, in the North Sea and Mexico) and the sluggish increase in capacity over 2006-08 that was caused by barriers to investment in many countries. As a result, the ‘call’ on OPEC (ie the difference between global demand and non-OPEC oil supplies) is expected to increase markedly in 2011 under the IMF’s central projections. OPEC production decisions will therefore play a key role in determining the evolution of oil prices over the short term. OPEC members have already started to draw on their spare capacity and increase production to partially offset the losses due to disruptions in supply from other producers in the MENA region. Although OPEC’s production response so far in 2011 has helped to reduce the risks to global oil supplies, the IMF believes that the relative stability in oil prices over the short term will probably not be ensured unless OPEC increases crude oil production beyond the level necessitated by the supply disruptions in the MENA region, particularly if global economic growth is more robust than currently forecast.

The IEA's May 2010 OMR forecasts a slower increase in global oil consumption of 1¼ mbd (1½%) in 2011 to around 89¼ mbd, reflecting the forecast of a slight slowdown in world economic growth to 4½% in 2011. However, the average 'call' on OPEC supplies is expected to be around 29¾ mbd in 2011 unchanged from 2010, but almost 1 mbd above its production in April 2011. This increased reliance on OPEC is expected, despite the rise in non-OPEC production by around 1 mbd to reach 53¾ mbd in 2011, as a result of higher output from oil fields in Latin America, China and a growing contribution from global biofuels.