Is Oil Overvalued?
Posted January 13, 2010 at 6:02 am 
Filed in: This morning WTI crude traded at above $80 per barrel. A year ago they traded closer to $40 per barrel. The OECD oil demand projection is set to fall by 4.3% (-2.0 mb/d) year-on-year in 2009 and remain flat in 2010. Notably, a continued contraction in Q1 2010 is expected to be offset by a modest return to growth in the following quarters. Despite a faster return to growth in non-OECD countries (China and India in particular), demand is forecast to rise just 1.8% in 2010 to 40.8 mb/d (IEA data).
Graph 1 (below) shows data on prices and spare capacity from January 2007 to the present (EIA data). The most noticeable aspect is the consistent inverse relationship between the two variables. However, since the start of 2009, the trend has been somewhat different. While spare capacity has remained largely unchanged, prices have more than doubled. Graph 2 (also below) shows global oil demand in 2009. After falling by approximately 1 mb/d during the first part of the year, demand rebounded strongly. It appears that producing nations have been fairly successful reducing output to meet lowered levels of demand. This has enabled prices to mirror demand as opposed to falling further or remaining flat as a result of excess market supply.
However, given that spare capacity is still so high (EIA and IEA estimate it at approximately 4 and 6 mb/d respectively), if called upon OPEC could produce enough extra oil to satisfy significant demand growth. With no severe concern over supply in 2010, fundamentals suggest that prices are unlikely to remain relatively stable (by historical standards) this year. Reduced volatility will be welcomed by nations, politicians, businesses and consumers alike. Yet let us not assume our problems are solved. OPEC will restrain supplies when necessary and growth in China and other nations will, as mentioned, gradually raise demand. Oil prices will stay high.
Previous Post
