Oil in 2008: Still strong but not at $100 says UBS

The year 2007 saw crude oil break free and march towards the USD 100 mark on the back of continued strong demand from Asia, low crude oil stocks in the US, and geopolitical tensions across the Middle East.

Andreas Hoefert, Analyst, UBS Financial Services Inc.remains positive on the crude oil cycle but the big question is whether the current oil price is justified. Hoefert expects oil demand to average 87 million barrels per day (mbpd), an increase of about 1.8% over estimated 2007 figures. In his view, OECD demand is showing mixed patterns. While demand from North America could see some contraction, especially from the housing and transportation industries, Japan is likely to witness good demand growth in the short run as nuclear facilities that lay idle in 2007 will not be back on stream until mid-2008.

The non-OECD countries continued to experience robust demand in 2007 despite high oil prices. Currently, governments in Asia and Latin America are using administered prices and are therefore not passing the real price of crude oil on to the consumer in full. However, China has already gone ahead with an initial price hike and other Asian governments are under tremendous pressure to do the same. This could affect oil consumption somewhat, though we estimate the effect on overall demand would be rather limited since emerging markets are likely to continue growing strongly in 2008.

 

Imbalance in favor of demand

We expect non-OPEC oil supply to fall marginally by 1.7% to 51.1 mbpd, says Hoefert. Western European production should decline but Brazil, Canada and Russia will make up for some of this shortfall in production. UBS’ forecast for OPEC supplies is 30.2 mbpd, in line with its 2007 production. Two important events could send this number higher; firstly, Ethiopia may join the cartel and secondly, the situation in Iraq could improve.

Overall therefore, 2008 will again see an imbalance on the oil market in favor of demand. Based on an analysis of supply and demand over the past couple of years, this sort of imbalance would justify a price around $70 per barrel, in our view. We think that the rally over the last three months towards $100 has been primarily speculative and does not reflect fundamental changes in demand and supply expectations. Moreover, our forecast that oil prices will average $70 in 2008 is even more strongly underpinned when you

consider that the risks to demand are clearly on the downside and the risks to supply more on the upside.