Crude oil prices have plunged for the third time in three months

Crude oil prices have plunged for the third time in three months, reviving all the old clichés about roller-coaster volatility. In passing, we note that just as a certain asymmetry in pump prices is often remarked upon, so too policy makers seem rather less concerned with price volatility when it is to the downside (although arguably there are bigger problems to worry about with financial meltdown on the horizon).

Brent and WTI futures at the time of writing are flirting with lows near $100/bbl and $80/bbl respectively. Brent at $125/bbl back in late-April seems a long time ago. Concerns over debt levels in Europe and the US, and signs of slowing economic growth in China and India have spooked the market and raised fears in some quarters of a double-dip recession.

From an oil market standpoint, perceived wisdom is that this must inevitably mean weaker oil demand to come. With extra crude volumes now hitting the market after OPEC boosted supply and the IEA released emergency stocks, this has been sufficient to sharply weaken prices. Lower energy input costs are well and good, but not if they are achieved at the cost of another economic crisis. Arguably, political paralysis has played a greater role in the current situation than has the financial sector. Either way, earlier bullish oil market prognoses are being hastily re-examined.

Our own base case demand trend remains remarkably unscathed, partly since our view of 2011 demand growth was already below that of some of our peers. That said, our global 2011/2012 GDP growth assumption in excess of 4% might seem optimistic in the present climate. Downward adjustments to recent US and Chinese demand data carry forward through 2012. But there are inter-fuel substitution offsets, notably in Japan.

Our analysis suggests Japanese nuclear outages will see oil-burn for power generation in 2011 and 2012 around 250 kb/d higher than normal, and higher than first thought when the Fukushima disaster struck in March. However, recognising emerging economic storm clouds, we also run a lower, 3% global GDP growth scenario, which more than halves base case 2012 oil demand growth to only 0.6 mb/d. Such an outcome could conceivably push the ‘call on OPEC crude and stock change’ below 30 mb/d, all other things being equal.

Of course, only in forecasters’ imaginations are all things ever equal. The unforeseeable 1.5 mb/d Libyan supply disruption rumbles on. Non-OPEC supply remains prone to unexpected outages. OECD industry stocks, despite a potential top-up in August from rising OPEC supply, SPR oil and renewed market contango, now look tighter at around five-year averages, and could go lower still if the near-700 kb/d of current non-OPEC outages proves deeper or more prolonged than we assume here.

Aside from UK field problems, political instability in a number of MENA and sub-Saharan African oil producers also risks curtailing supply further in the next 18 months. And although higher prompt OPEC supply is welcome in the face of seasonally rising demand, it has inevitably curbed OPEC spare capacity, down now to 3.3 mb/d, fairly meagre in comparison to the totality of currently perceived supply-side risks.

The above caveats to currently bearish market sentiment explain why we will continue closely monitoring the market this summer, with emergency data reporting by IEA member governments ongoing in August and September. The IEA did not extend the original 60 mb collective action during its 30-day review in late-July, with most SPR barrels from the initial phase still reaching the market in August. But nor was the action formally terminated.

By September, market direction may be clearer if the economic outlook itself has become more clear-cut. The so-far benign Atlantic hurricane season has largely spared US Gulf and Mexican energy infrastructure. Then again, August has a habit of springing both geopolitical and meteorological surprises, so the big dipper ride may still have further to run.