Oil price to hover at $58-$66/barrel in 2007

Julius Baer is forecasting an oil price of $58-66 per barrel for 2007, with a mid point forecast of $62/b WTI (West Texas Intermediate), which seems reasonable after the recent weakness in prices at the start of the year, according to Dr. Leo Thomas Schrutt, Managing Director Bank Julius Baer & Co Ltd.

Schrutt was the guest speaker at a presentation organised by Sharelink Securities & Financial Services Ltd on “The Price of Oil and the World Economy” Tuesday evening in Nicosia.

Schrutt  added however, that it could be argued that the market is not pricing-in a significant supply side disruption. OPEC production cuts have stopped the price slide and passive money flows also seem to be having an impact.

Also, expect continued issues in Nigeria in the lead up to the elections in April (this was one of the reasons for Shell reducing it’s production guidance for 2007) and Iraqi exports have been getting worse owing to refinery/pipeline attacks in the south.

“The Iranian situation is not expected to improve in the near future,” Schrutt said.

“However, if oil prices hit $70 /b again then this could cause demand concerns to kick in again.”

 

— China and India

 

While oil demand has eased since 2004, it has not collapsed. Some market forecasts for demand growth are around 1.3%-1.5% slightly higher than 1% last year, according to the International Energy Agency (IEA).

The market seems to have focused on the warm weather at the start of the year, although GDP growth in the US and China has slowed, it still remains robust (U.S. GDP growth for 2007 is forecast at 2.9% by Julius Baer and then flat trend growth for 2008, i.e. 3%).

Also, Chinese oil imports are not slowing, however, the demand pull from China, while still robust, has fallen from 7-8% to 5%-6% as a result of the Chinese Strategic Petroleum Reserve (SPR) having already taken place. Likewise, India should continue to show robust demand.

“Our house view is that the market is already very tight and with delays to non-OPEC production in 2007 (i.e. Mexico, U.S., U.K., North Sea), any OPEC spare capacity will soon become eroded throughout the year. Unless there is a significant oil price drop ahead of OPEC’s meeting on March 15 then there will be no further cuts announced,” Schrutt said.

 

— Hedge funds

 

Hedge funds do have an impact on the price direction, and clearly were hurt in early January when passive rollover trades were losing money into the contango curve … (successive future prices gradually becoming more expensive). That could still be an issue, but the bigger issue in early January was the impact of major producers selling in the physical market and a reluctance for consumers to step in and buy oil. Hence the rapid downward moves. According to some oil traders in London, the market feels more in balance now.
“The speculative impact will always be there at the sidelines but the major re-positioning of passive portfolios was likely made at the beginning of the year … I would expect the impact to be more muted from now on,” he said.

With respect to speculative funds, according to Schrutt such follow rather than lead the market in a causal effect.

However, it is clear that a $1-2 per barrel movement on a day could be speculator activity and oil market liquidity has increased to promote this fact, but fundamentally prices have moved up over the last few years owing to the lack of spare OPEC production capacity.

In the absence of a Middle East political destability, Schrutt  said an investor may assume that oil and copper should move in the same direction, as both clearly direct plays on GDP growth … However don’t forget the impact of the OPEC cartel in being able to manipulate higher prices in falling demand environments through supply management.

 

— Oil funds

 

Investors can buy ETF’s (Exchange Traded Funds) in London linked to the price of Brent if they wish to dabble in oil related financial instruments, but for portfolio diversification, Schrutt says the portfolio mix depends on investor views on oil prices going forward.

“I would recommend having an equal weight or overweight position now as I believe there is more upside risk to the current price level especially as we go into 2Q /3Q and start talking about the driving season and hurricanes.”

“The official Julius Baer house view is ‘over-weight’ in the U.S. energy equities and ‘neutral’ in Europe. However, our research strategist has a slightly different view, he moved from under-weight in the U.S. energy in December 2006 to a more neutral view. His reasoning is that most negative surprises are already priced in, in terms of earning revisions this was one of the weakest sectors in Q4 2006, and now the valuations are beginning to look positive.”

“I would suggest a bias exposure via oil service / oilfiled asset names … The big market cap integrates (major oil companies), while cheap relative to historical multiples are struggling to replace reserves, they also are suffering from rising costs, lower returns and are generally struggling to grow… so, go into the majors with caution. Meanwhile, free cash yields at $55/b oil are only in line with the broader market.”

 

— Sharelink seminars

 

Charalambos Papanicolaou, Deputy Managing Director and Head, Private Banking,
Sharelink Securities &  Financial Services Ltd said the comapny is organizing such presentations to bring high calibre professionals from reputable foreign institutions to share their experiences and knowledge in specific subjects with the Cypriot business community.

“We believe that oil and its price is of interest to the Cypriot investor due to the fact that the Cyprus economy is very sensitive to oil prices as a net importer of oil and its by-products. Also the energy sector is often part of a diversified global equity portfolio. And last but not least is the buzz that has recently been created with the oil exploration efforts within the Cyprus economic interest zone.”

“Julius Baer & Co is one of the main sources  from which we get investment research for a more accurate and realistic view on the international financial markets and the global economy. This is our second event in cooperation with Julius Baer. In 2004 we organized a presentation on pension and provident funds investments,” concluded Papanicolaou.