London, 3 January 2012

SEB Commodity Research see three bulls and two bears for crude prices in 2012. Bearishly, demand growth is uncertain due to weak macroeconomic conditions and increasing oil production by Libya, Iraq, the US, Canada and Brazil.

Bullishly however, supply risk has risen due to the Iranian nuclear issue, religious conflict in Nigeria and continued high uncertainty in the MENA region generally. In addition, global inventories are low following their reduction in 2011, increasing the risk of an oil price spike in the event of supply disruption. European oil stocks are currently at a post-2003 low. Downside price risks are limited due to OPEC reuniting with a total quota of 30 mb/d, and because Saudi Arabia is expected to reduce production as Iraq and Libya gradually increase output.

"We mainly assume that as long as oil demand does not suddenly decrease due to, for example, Euro-zone disruption, oil monopolist OPEC (Saudi Arabia) will be able to adjust oil production to keep prices above $100/b. Thus weaker demand by itself is not enough to lower prices this year. However, there is clearly a risk for both supply and demand disruptions in 2012 calling for substantial tail risk both higher and lower in 2012.

"Iran continues to progress its nuclear capabilities which Europe and the US counter with increasing sanctions. Those emanating from the US target financial transactions involving the Iranian Central Bank with the objective of reducing the country's crude oil revenue but not production. Europe however favours an oil embargo. However, Iran is well positioned in this particular stand-off, exercising substantial control over the Strait of Hormuz through which some 17 mb/d of oil pass to meet global market demand, equivalent to around 35% of all seaborne traded oil ( EIA). Iran does not need to close down the Strait.

"It only needs to threaten to do so through verbal threats and military drill exercises thereby increasing the global oil price substantially and Iran's oil revenue accordingly. With sanctions increasing Iran now has good cause to execute such threats. The Iranian issue will not be resolved quickly or easily. The US and Israel have stated that they cannot rule out military action if a diplomatic solution to Iran's nuclear program is not found. Israel will need US approval to launch military strikes. Currently, Iran is trying to re-open diplomatic channels to Europe while at the same time providing no evidence to suggest it is willing to halt its nuclear activities. The Iranian nuclear issue looks set to intensify further in 2012."

European oil product markets

The European oil product market began to converge in late 2011 with light end cracks recovering and middle distillate cracks falling back. "Overall refinery economics improved in all major areas except Europe. Currently, we see no major potential demand drivers with northern hemisphere temperatures abnormally high and projected to remain so during Q1-12, a bearish scenario for heating demand. In addition, economic worries centred on the European crisis and potentially slower Chinese growth are depressing demand expectations. Instead, European product prices are being supported by crude oil supply worries. These circumstances are clearly dangerous given also the start of refinery maintenance, the credit crunch risk in the refining sector and low inventory levels," say SEB Commodity Research.

Light ends: Naphtha cracks have recovered from multi-year lows due to Asian petrochemical industry restocking. However, both in Europe and elsewhere demand remains lacklustre. The best hope is that restocking demand could continue to lend support. The European gasoline crack has turned positive again, supported by arbitrage flows to the US and other destinations. European naphtha inventories ended 2011 at multi-year highs while gasoline inventories are relatively low.

Middle distillates: Generally, European middle distillate cracks continued to retreat in December on weak demand. Warm weather remains a major bearish issue, both in Europe and elsewhere. While normalized Rhine water levels are once again enabling cargoes to start flowing from the ARA region into Germany arbitrage cargoes are arriving from the US. Supplies of diesel and gasoil from Russia and jet fuel from the Middle East and India are also exerting pressure on European middle distillates. Jet fuel (kerosene) prices are being restricted by low heating demand and weak air traffic activity despite support from holiday travellers. Outside Europe, demand for diesel in South America is strong due to a drought in Chile. Also, Chinese refiners have increased production to record highs to fight local deficits. Rumours that authorities in China may scrap the fixed product pricing system have bullish implications for product supply growth.

Heavy ends: Fuel oil prices remain stable with most demand strength still from Asia and arbitrage cargoes consequently heading east from Europe now and then. However, Asian demand is insufficient to drive prices much higher at the moment. The high-low spread has begun to narrow once again after widening in late 2011. European fuel oil inventories ended the year at a relatively normal level.

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SEB Commodity Research