A leading Australian broker sees no respite for us from oil prices at or above their current levels for the next three and a half years.
As the world oil price was dropping more than $US4 a barrel to just under $US134 a barrel on news of price rises in China and possible higher production from Saudi Arabia, Goldman Sachs JBWere lifted their forecasts for oil prices to $US150 a barrel in 2010 and boosted their inflation estimates this year and 2009.
The new forecasts went to clients around the country overnight. Goldman said however it did not expect the higher inflation it now sees to force the Reserve Bank to further lift interest rates.
In the note to clients the firm said that driving the change in inflation estimates “has been further upgrades to our oil price assumptions — average of US$119 and US$140 for CY08 and CY09 respectively (from US$108 and US$110).”
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Additionally the 2010 price forecast was lifted to $US150 a barrel from $US120 a barrel and the 2011 estimate was $US140 a barrel ($US120 a barrel):
We now expect headline inflation to average 4.2% and 3.4% in 2008 and 2009 respectively. This compares to our old forecasts of 4.1% and 2.9%. Despite this coming as surveyed measures of inflation expectations breach a new record, we continue to believe that the RBA will refrain from raising interest rates again this cycle.
This is not to suggest that the RBA is not attentive to inflation expectations. Rising inflation expectations played a key role behind the RBA’s 100bpts of hikes since August. However, a subtle shift is detectable in central bank thinking. As long as sharp price increases in commodities like oil are associated with demand destruction and subsequent weaker economic growth, then higher near-term inflation can be tolerated temporarily.
This is the position that the RBA now finds itself in. With such a broad array of economic data suggesting that economic demand growth is faltering and no evidence that high inflation expectations are being transmitted through wage claims, we expect the RBA to look through the inflationary impacts of higher oil prices.”
Goldman said “the key drivers of our oil price upgrades are as follows”:
Lower than expected non-OPEC supply: Non-OPEC supply has declined in 1H 2008 versus 1H 2007.
Continued strength in non-OECD oil demand, most notably for diesel fired power generation.
Continued recognition that in an environment where global crude oil supply is barely growing prices will have to continue to rise to ration demand in OECD regions particularly the United States.”
Incredibly, non-OPEC crude supply is actually down about 1% in 1H 2008, well below our expectations that had called for 1% growth. To the extent nearly a decade of rising capital spending is yielding negative non-OPEC crude oil supply growth this year, oil market participants are naturally assuming that future supply growth is unlikely to be much better.
The related challenge is that global economic growth has typically yielded oil demand increases at a ratio of about 0.5% of oil demand growth for each 1% of GDP. To the extent supply is no longer growing for a variety of geologic and geopolitical reasons, the sharp oil price rise this year can be fully explained by the need to sustainably lower future demand growth down to the levels of available supply.
Without any substantive public policy actions in key oil consuming regions (United States, China, and the Middle East being the most important today and India longer term) to encourage the greater use of fuel efficient cars and mass transportation, oil market participants are naturally bidding up the oil price as a means to ration demand back down to the level of available supply. Given price regulations in China and the Middle East, the brunt of the demand rationing exercise is occurring in OECD countries most notably the United States.
There seems to be a fundamental misunderstanding on the part of many observers that since there are no observed shortages, oil prices must be artificially high and divorced from supply/demand fundamentals. We think this view is off base.
In our view, there are no shortages for the very reason that free markets are working; limited oil supply is being rationed to those willing to pay current prices.
The only way the United States would be likely to see actual gas lines would be if a large supply disruption happened, which heretofore has not occurred, or if price controls returned. Despite heated political rhetoric in a presidential election year, fortunately the United States does not appear to be on-track to repeat the failed policies of the 1970s which included price controls that did result in gasoline shortages and gas lines in the late 1970s.
We note that if there is a distortion in current oil markets, it is likely in the price regulations that exist in China and the Middle East; notably, China has experienced physical shortages and gas lines.
Goldman does see the price falling to $US85 a barrel in 2012 and 2013, but those forecasts are both up $US10 a barrel for each year.