Global oil prices are likely to peak at around $120/barrel in mid-2011 but the pace of any retracement depends on how OPEC responds to key market supply and demand fundamentals, Leo Drollas, chief economist at the Center for Global Energy Studies, said Friday.
Under a base-case scenario, Brent oil prices could begin to trend below current levels of around $110/b in early 2012, ending the year at around $95/b, according to a presentation given by Drollas to an oil conference in London.
"What happens to the price of oil depends very much on how OPEC responds to global oil supply and demand pressures," said Drollas.
"These are reflected in the world's changing stock cover positions, and how the paper markets perceive the potential risks attached to the demand growth, especially in the Far East and supplies from North Africa and the Middle East," he said.
While global oil demand is currently at higher rates than before the oil price spike of mid-2008, Drollas said a number of key oil market fundamentals remain more bearish, such as global stock cover and global spare production capacity.
"We are unlikely to reach the [oil price] averages that we reached in the second quarter of 2008, but we're not far off and pressures are still there," Drollas said.
Spare OPEC capacity stands at around 5 million b/d, according to Drollas' presentation, but the economist cautioned that it is a question is "whether they will use it."
Drollas said the recent loss of some 1.4 million b/d of Libyan oil production has not been fully filled by other oil producers, including OPEC kingpin Saudi Arabia.
Although OPEC's biggest producers has offered additional crude grades to make up some of the lost Libyan output, its overall production levels have fallen since January, he said.
"There has been a marginal response to the loss of Libyan oil... it's a classic supply problem that has not been fully solved," Drollas said.
SAUDI BUDGET
Drollas said Saudi Arabia's failure to fully replace the lost Libyan barrels could be partly explained by a need for the Middle East producer to cover its fast-growing spending plans.
The Saudis need average oil prices of around $91/b to cover their current budget spending plans this year, up from $74/b in 2010, Drollas said.
Drollas described Saudi Arabia's spending plans and their influence on its oil production levels as a "vicious circle," adding that only global interest rates and swings in key currency values -- triggered, perhaps, by Chinese action on its foreign currency reserves -- could break this cycle.
Drollas also flagged the relationship between "cheap money" and oil prices, noting that low yields on US Treasury bills have historically preceded or been accompanied by a run-up in oil and commodity prices.
"I suggest that this cheap money policy will underpin, to some degree, the strong oil prices unless there some substantial change in the world growth rate in the near future," Drollas said.
Brent crude futures were trading around $114.30/b midday London time Friday and US NYMEX crude futures at $100.0/b, well below the July 2008 peak for the US contract of more than $147/b.
