IEEJ: August 2010
404th Forum on Research Works
Report Summary

July 14, 2010

Recent International Oil Situation and Prospects for Crude Oil Prices
Ken Koyama, PhD
Director
Strategy and Industry Research Unit
Institute of Energy Economics, Japan<Research Objectives>
In the first half of 2010, the West Texas Intermediate (WTI) crude oil futures price (thedaily closing price of the front-month contract), a benchmark international market price for crude oil,averaged $78.5/barrel. Its peak during that period stood at $86.8/barrel and its bottom at $68.0/barrel.
The price range represented a middle range between 2008 average and 2009 average. The fluctuation
range (the gap between the peak and bottom) was relatively smaller. The WTI price remained
range-bound in the first half of 2010, approximately $68-87/barrel range.
Behind the crude oil price trend were effects imposed by the world economic and financial
situations, by oil supply/demand fundamentals, by money inflow into and outflow from crude oil
futures markets, and by various risk factors. These effects were intricately intertwined to lead to thecrude oil price trend.
The future international oil situation and crude oil prices may change dramaticallydepending on developments regarding the factors cited above. Since the international oil situationand crude oil prices have a significant impact on future global developments to include the Japanese
economy and the international energy market, it is vital to grasp their trends regularly and analyze
their future outlook based on the latest situation. Under the above recognition, the report explores theprospects for the future international oil situation and crude oil prices by examining the trends of theworld economic and financial situation, money inflow into and outflow from crude oil futures
markets, and other financial factors such as oil supply/demand factors and the like.
<Key Conclusion>◆ Future Crude Oil Price Outlook
1. Unless there are major changes in market perceptions and expectations that have led to the present
range-bound trend, the trend may continue in the second half of 2010. In such case, crude oil
prices will be influenced most by the world economic and financial situation and move in linewith stock prices that mirror the situation. Our “reference case” given in December 2009 for crude
oil prices (the average WTI price for 2010 is estimated at around $70/barrel plus or minus up to$10/barrel) is likely to stand. But the benchmark price may move around $75/barrel in the second
half of this year.
2. However, we see various uncertainty factors emerging in the international oil market. The mostimportant are uncertainty factors regarding the world economic and financial situation. Depending
on future developments regarding European economic turmoil and sovereign risks triggered by theGreek budget crisis, the world economy may be greatly affected. Attracting attention will be thetrend of the Chinese economy that has increased its presence as the world’s growth center. The
macroeconomic and financial situation may also change dramatically depending on developments
regarding these factors. Crude oil prices could move in line with changes in the world
macroeconomic and financial situation. On the supply side, both OPEC and non-OPEC oil
producing countries are expected to continue a moderate growth in their production. Meanwhile,the recent oil leak problem in the Gulf of Mexico may adversely affect deepwater oil drilling not
only in the gulf but also in other regions. Depending on the world oil demand trend, the possibility
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could affect the international oil market. If a future expansion in world oil supply is dependent on
deepwater oil development, we may have to pay attention to relevant future developments
including the effects on market psychology anticipating an oil supply expansion.
3. Under such conditions, if downside risks emerge in a manner to cause global economic
turbulences, downward pressures may work on crude oil prices. The benchmark WTI price maythen decrease to around $60/barrel. If the effects of the Gulf oil leak problem and other factors arefeared to affect an oil supply growth in the absence of major global economic turbulences, theWTI price may range from $80/barrel to $100/barrel.

◆ Major Factors Attracting Attention (supplemental comments)
4. Importance of expectations in price formation and range-bound prices: Futures markets playa leading role in pricing crude oil. Trading factors in the market include oil supply/demand
fundamentals, financial factors, and risk factors. They influence each other mutually and closely.
A recent important feature is that the world economic and financial situation has become acommon driver of these factors. Another feature is that expectations or forecasts regarding thesefactors, as well as their present conditions, exert great influences on price formation in futures
markets. In this sense, we may be able to interpret the recent range-bound crude oil prices as anindication that market participants have built on their experiences in 2008 and 2009 to commonly
perceive that excessively high or low prices are not sustainable.
5. World economy: The world economy has recovered faster than expected since 2009. The IMF
World Economic Outlook forecasts the world economy to score a fairly firm growth rate of 4.6%
in 2010. Under the economic recovery, global stock prices followed an upward trend until
mid-April. Since the Greek budget crisis grew in the second half of April, however, fears overfuture economic conditions have emerged. As credit fears emerged on Greek default fears andspread throughout Europe, the euro and stock prices declined altogether. A fundamental factor
behind such situation is that major countries have seen a substantial increase in their fiscal
burdens through their large-scale economy-boosting measures (including fiscal expansion andmonetary easing) since the 2008 Lehman shock. The slump in the European economy thatoccupies a key position in the world economy is now feared to affect the entire world, including
the United States and Asia, through a decline in the export market for these regions and otheradverse effects on their real economies, as well as adverse financial effects such as increasing
nonperforming assets, credit fears, falling risk tolerance and deterioration of fund-raising
environments. Furthermore, the Chinese economy, which has driven the world economy, now has
seen the emergence of uncertainty factors including adverse effects of the European economicproblem, asset bubble fears, and upward pressures on the Chinese currency of renminbi known as
RMB. While steady world economic growth is forecast as noted above, market participants havegrown conscious of downside risks.
6. Financial factors (including money inflow into and outflow from futures markets): Money
inflow into crude oil futures markets has expanded amid the world economy’s recovery andmarket participants’ increasing risk tolerance. Open interest on the NYMEX crude oil futures
market increased from about 1.16 million contracts at the end of 2009 to about 1.4 million
contracts at the beginning of May 2010 (and declined to about 1.26 million contacts at the end ofJune). In futures markets at present, various financial players have actively participated with theirunique investment strategies and approaches. Key points include how pension funds known forlarge-scale investment would be involved in trading in crude oil and other commodity futuresfrom now on, what measures would be taken in response to the so-called contango of futures
prices amid financial players’ growing participation in futures markets, and how market
participants would balance portfolios in markets where risk tolerance is falling again. As crude oil
futures markets are expected to structurally remain smaller than markets for traditional assets class2

IEEJ: August 2010
(including stocks, bonds and currencies), money inflow or outflow based on financial factors may
remain as an important factor to accelerate crude oil price fluctuations.
7. Oil supply/demand factors: The faster-than-expected economic recovery has led world oil
demand in 2010 to increase by 1.68 million barrels per day from the previous year (according toIEA statistics). The demand increase centered on China, other Asian developing countries andMiddle Eastern oil-producing nations. A steady expansion has been seen in oil supply in 2010.
Non-OPEC and OPEC NGL (natural gas liquid) production has increased by about 0.8 million
bpd respectively. As a result, Call on CPEC crude oil (demand for OPEC crude) has almost
leveled off. OPEC actual output has increased slightly since the first half of 2009. The
supply/demand balance in the international oil market has seen no major change. OPEC spare
production capacity and OECD inventory levels indicate a sufficient supply surplus in the market.
Therefore, judging from the “fundamental side,” crude oil prices are likely to remain weak in thesecond half of this year unless turbulence factors emerge and expand their influences.
8. Effects of Gulf of Mexico crude oil leak: On April 20th, a crude oil leak started on an accident at
the Deepwater Horizon drilling rig in the Gulf of Mexico. The leak formed from a ruptured pipe
1,500 meters below sea level and had been extremely difficult to stop or accurately measure. Afterseveral unsuccessful attempts to stop the leak, the Lower Marine Riser Package method has been
adopted to place a containment cap on the pipe while leading an oil-drilling ship to pump up
leaking crude oil. Efforts are also underway to collect leaked crude oil. Work has begun to drill a
relief well to intercept and seal the existing well that is leaking crude. While going ahead withinvestigations into causes of the accident in the face of possible heavy damage on the environment,
tourism and fishing, the U.S. government has considered and introduced new offshore oil
development safety standards and regulations, suspended oil acreage auctions, declared an oil
drilling moratorium, and led Congress to consider relevant bills (including a measure to raise
maximum oil spill liability). It has also asked BP, the operator of the oilfield involved in theaccident, to create special fund of $20 billion for oil spill compensation. The government and BP
agreed through their negotiations to create a special fund administered by a third party to pay
damage claims. One major concern is the accident’s possible impact on offshore oil development(particularly, deepwater oil development). The Gulf of Mexico has been the center of the U.S. oil
output growth. Particularly, a deepwater oil output growth there has played a major role. Even on
a worldwide basis, deepwater oil development is expected to play a central role in expanding oil
production in the future. The accident is expected to bring about deepwater oil development
delays and production drops due to higher costs under tougher safety standards, greater operation
risks and less access to deepwater oilfields under the drilling moratorium. At present, any impact
is still left uncertain due to lack of data for judgment or analysis. But the IEA has estimated oil
production in the world could decline by 0.9 million bpd by 2015. If spillover effects of theaccident lead to an oil output decline, it may work to tighten the oil supply/demand relationshipdepending on demand trends. In this sense, we will have to closely watch future developments
including the accident’s effects on market psychology. The accident is also expected to become atrigger to discourage oil demand (by triggering the enhancement of alternative energy
development promotion) and hurt the financial health of BP due to heavy accident-related costs,
affecting the entire oil industry. Due to such a wide range of possible effects, future developments
are attracting much attention.
9. China’s economy and oil demand trend: The Chinese economy achieved a V-shaped recovery
from the bottom in the first quarter of 2009 mainly due to a 4 trillion RMB stimulus package
including investment in public infrastructure. In 2009, the Chinese economy grew 9.1%. Growth
accelerated to 11.9% in the first quarter of 2010. China’s oil demand includes diesel oil (about40% of total demand) and gasoline (slightly less than 20%) and has close relations with economic
growth, industrial activities, and income levels. According to monthly APEC statistics, apparent
consumption of petroleum products (oil refinery output plus imports minus exports) in China3

IEEJ: August 2010
indicates that oil demand centering on diesel fuel has been increasing from a year earlier
substantially since the autumn of 2009. The oil demand growth may be attributable to heavy
public investment and infrastructure development as the economic growth driver in 2009, arelevant expansion of transportation demand and a vehicle ownership expansion under a domestic
demand expansion initiative. In addition, the promotion of infrastructure investment has worked to
expand oil refining capacity, oil pipelines and oil stockpiling, creating demand for oil for“infilling” into the above mentioned infrastructure. Since the oil demand trend is closely linked tothe macroeconomic trend in China, the future Chinese economic situation is also attracting
attention. Despite the recent double-digit economic growth, we see various macroeconomic
management problems and uncertainty factors, including effects of the economic crisis in Europe
as a major export destination, responses to and results of asset bubbles emerging as a “side effect”
of economic stimulus measures, responses to growing pressures on the RMB to be revalued amid
increasing trade imbalances, and effects of recent manufacturing industry strikes and emerging
wage-increasing pressures on industry competitiveness. In addition, if China can attain an energy
conservation target (of improving energy-GDP intensity by 20% by 2010 as compared to 2006)
under the 11th five-year development program, (in other words, China’s actualenergy-conservation efforts and performance), it may also affect China’s energy demand including
oil as the Chinese government has given top priority to the energy conservation target. Without
any major turbulence in the above factors, the Chinese economy may score a high growth rate ofaround 10% in 2010, with oil demand increasing by 6-8% (0.5-07 million bpd). If downside risks
emerge, however, the economic growth rate may be one percentage point lower in 2010 (and fallfurther later) with an oil demand increase slowing. We must take note of the possibility that aslowdown in China’s oil demand growth could exert a stronger psychological impact on themarket than any actual demand decline.
Contact: report@tky.ieej.or.jp

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