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Crude Oil/USD Forecast

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A simple classroom forecast of Oil price (done 26/Oct/2010)

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Crude Oil/USD Forecast

  1. 1. Crude Oil/USD
  2. 2. Agenda 1.Introduction 2.Supply & Demand 3.US Economy & Dollar Devaluation 4.Paper Trading 5.Risk Premium 6.Forecast 7.Will OPEC change USD denomination of oil? 8.Key Takeaways
  3. 3. Crude oil, commonly known as petroleum, is a liquid found within the Earth comprised of hydrocarbons, organic compounds and small amounts of metal. Crude oil is refined into diesel, gasoline, heating oil, jet fuel, kerosene, etc. Classification by: • Origin (e.g., West Texas Intermediate, WTI or Brent) • Weight (light, intermediate or heavy) • Sulfur content (sweet /sour).Crude oil production: • Extraction/ drilling from oil reserves. • About 80% of the world's readily accessible reserves are located in the Middle East. • Top 5 oil producing countries: Saudi Arabia, Russia, United States, Iran, and China. What is crude oil? !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  4. 4. Types of Transaction Spot Transaction Futures Contract Major Trading Platform: Intercontinental Exchange (ICE) New York Mercantile Exchange (NYMEX) Major Oil Price Benchmark London-based Brent US-based West Texas Intermediate (WTI) OPEC Contract Trading of Crude Oil !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  5. 5. 1. Balance of Supply & Demand 2. Dollar Strength 3. Paper trading 4. Risk Premium 4 Key Determinants !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  6. 6. Oil Supply OPEC •!Cartel of 12 countries : Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, UAE, Venezuela •!To regulate supply and price of oil •!Produced 42% of the world's oil production •!Account for 78% of world’s proven oil reserve •!OPEC Production Allocation Oil Producers •!Russia and Saudi Arabia produced 25% of world’s oil production !"#$%&'()%"* +,-*.'//-0* 1*2345"&* 2%--5$* .#$3"6#7* 85/3$* 9$5&,"6* :,;<* 8$34,'4* 9,43*9$3"&* ="5-0;,;* >%$3(5;#* ?30* 95<35@50;*
  7. 7. Oil Supply Factors affecting Supply •!Oil Demand •!OPEC policy •!Unforeseen Situations (E.g. Damage Oil Facilities, War) !"#$%&'()%"* +,-*.'//-0* 1*2345"&* 2%--5$* .#$3"6#7* 85/3$* 9$5&,"6* :,;<* 8$34,'4* 9,43*9$3"&* ="5-0;,;* >%$3(5;#* ?30* 95<35@50;*
  8. 8. Production cut by OPEC Unforeseen Situation Pipeline Closure !"#$%&'()%"* +,-*.'//-0* 1*2345"&* 2%--5$* .#$3"6#7* 85/3$* 9$5&,"6* :,;<* 8$34,'4* 9,43*9$3"&* ="5-0;,;* >%$3(5;#* ?30* 95<35@50;*
  9. 9. Oil Demand Factors affecting Demand GDP growth Seasons of the Year Demand for Petroleum-based product (e.g. Heating oil, Gasoline) !"#$%&'()%"* +,-*.'//-0* 1*2345"&* 2%--5$* .#$3"6#7* 85/3$* 9$5&,"6* :,;<* 8$34,'4* 9,43*9$3"&* ="5-0;,;* >%$3(5;#* ?30* 95<35@50;*
  10. 10. Oil Demand World GDP 0.7166 Developed GDP 0.6757 Developing GDP 0.7617 Emerging market GDP 0.7770 World Production 0.5646 Opec Production 0.5384 Non-Opec Production 0.5319 World Consumption 0.5815 OECD Consumption 0.3489 Non OECD Consumption 0.7229 World Reserves 0.5184 OPEC Reserves 0.3367 World Inventories (Year end) 0.6299 Average Inventories 0.6224 GDP •!Strong positive correlation (r =0.71) between World GDP and oil price •!Emerging countries has a higher correlation, r = 0.78 !"#$%&'()%"* +,-*.'//-0* 1*2345"&* 2%--5$* .#$3"6#7* 85/3$* 9$5&,"6* :,;<* 8$34,'4* 9,43*9$3"&* ="5-0;,;* >%$3(5;#* ?30* 95<35@50;*
  11. 11. US Economy & Dollar Devaluation
  12. 12. •!GDP! •!Unemployment rate! •!National debt! •!Interest rate! •!Inflation rate! •!Trade! Dollar Value Determinants US Dollar Strength !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  13. 13. - Increased 1.6% in Q2! - 9.6% in Sep 2010! - Over $13 trillion! - 89% of GDP in Q1! US Economic Growth !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  14. 14. US Economic Growth - Benchmark interest rate: 0.25%! - Inflation rate last reported at 1.1% in Aug 2010, down from a peak of 5.6% in Jul 2008! !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  15. 15. US Trade Main Imports! •!Fuels! •!Non-auto consumer goods! •!Production machinery & equipment! •!Non-fuel industrial supplies! •!Motor vehicles & parts! •!Food, feed, beverages! Main Exports! •!Machinery & Equipment! •!Industrial Supplies! •!Non-auto consumer goods! •!Motor vehicles & parts! •!Aircraf t & parts! •!Food, feed, beverages! Main Trading Partners! •!Canada! •!European Union! •!Mexico! •!China! •!Japan! !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  16. 16. US Trade - Increased to $123 billion in Q2 from $109 billion in Q1! -!Trade deficit dropped 14% to $42.8 billion in July 2010! -!Total July exports rose 1.8% to $153.3 billion! - Total Imports fell 2.1% to $196.1 billion! !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  17. 17. Expansionary monetary policy results in an economy based largely on debt Increase in money supply leads to dollar decline To bring trade imbalance under control Leads to higher commodity prices Recent Federal Reserve rate cuts to boost US economy accelerated dollar devaluation Investors move capital out to avoid losses leading to further dollar decline Recent FOMC meeting: Fed may add new stimulus measures to boost sluggish economy (quantitative easing) High unemployment rate at 9.6% Weak housing market US Monetary Policy !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  18. 18. •Heavy reliance on fiscal policy during latest recession •Huge stimulus bill: American Recovery & Reinvestment Act (2009) •$787 billion in personal & corporate tax cuts •Increased federal aid & direct federal spending •Federal revenues falling due to recession & ARRA tax cuts •Increased fiscal deficits associated with depreciating exchange rate US Fiscal Policy !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  19. 19. The Dollar Index !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  20. 20. Impact of Dollar Devaluation I/ SHORT TERM IMPACT •Increased speculation and investment in oil futures: •Hedge against weakening dollar •High profit potential !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  21. 21. Impact of Dollar Devaluation !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:* II.! LONG TERM IMPACT! Reduces purchasing power and increases domestic inflation! Reduce real income! Lesser investment in additional capacity and maintenance! Reduced oil production! Varying impact on OPEC members! •!Countries that import more from US stand to lose less! Cheaper oil in countries with appreciating currencies! Higher demand for gasoline in US due to reduced number of US tourists abroad! Increased oil demand!
  22. 22. Impact of Dollar Devaluation !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:* EFFECTS OF SUPPLY & DEMAND! Reduced oil supply! Increased oil demand! Increase in oil prices! Higher oil prices! Higher US trade deficits! Weaker dollar!
  23. 23. What caused the abnormalities in price?
  24. 24. Consumption: ~ 86 mb/d Production: ~ 86 mb/d USDX: decrease ~ 12% Oil Price: Quadruple - 400% Oil futures traded volume nearly quadruple from 4.5 -> 15.3 !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:* The Bubble? (dual characteristics)
  25. 25. ICEemployed partial electronic trading on November 1, 2004 and shifted its benchmark ICE Brent crude to an all-electronic format on April 7, 2005 NYMEX started electronic WTI futures in 2006 !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:* Oil Futures Contracts
  26. 26. !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:* Oil Futures Curve
  27. 27. The burst of oil bubble? !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  28. 28. The burst of oil bubble? !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  29. 29. Crude Oil Price ($/barrel) Risk Premium = Stability Level of Geopolitical situation !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  30. 30. !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:* •Oct 5, 1973: Yom Kippur War started. The United States and many western countries showed support for Israel •Embargo on the countries supporting Israel curtailed production by 5 million barrels per day •Other countries were able to increase production by a million barrels Net loss of 4 million barrels per day extended through Mar 1974 and represented 7% of the free world production.  •The market price for oil immediately rose substantially, from $3 a barrel to $12. •The extreme sensitivity of prices to supply shortages became all too apparent.   Any doubt the ability to control crude oil prices had passed from the United States to OPEC was removed during the Arab Oil Embargo.  Arab Oil Embargo – 1973 Oil crisis
  31. 31. •In 1979 and 1980, events in Iran and Iraq led to another round of crude oil price increases. •Iranian revolution resulted in the loss of 2 to 2.5 million barrels per day of oil production between Nov1978 and Jun 1979.  At one point production almost halted. •Sep1980, Iran was invaded by Iraq. By Nov, the combined production of both countries was 6.5 million barrels per day less than a year before. •Consequently worldwide crude oil production was 10% lower than in 1979. •The combination of the Iranian revolution and the Iraq-Iran War cause crude oil prices to more than double (from $14 in 1978 to $35 per barrel in 1981). 1979 Energy Crisis !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  32. 32. •Declining world oil demand and increasing non-OPEC production OPEC cut output significantly in the first half of the 1980s to defend its official price •Saudi Arabia bore most of the production cuts (from over 10 million barrels per day for the period Oct 1980 through Aug 1981 to just 2.3 million by Aug 1985) •Late 1985, Saudi Arabia increased production, and aggressively moved to increase market share. •In response, other OPEC members also increased production and offered netback-pricing arrangements to maintain market share and to offset declining revenues. •These actions resulted in a glut of crude oil in world markets, and crude oil prices fell sharply in early 1986. 1986 Oil Price Collapse !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  33. 33. •Iraqi invasion of Kuwait •Followed 6 months of extreme turbulence in world oil markets. •3-year peaks in Jan1990 and then plunged to levels comparable to their 1986 lows by Jun (primary cause: overproduction by Kuwait and the UAE) •Gulf war •Waged by a UN-authorized coalition force from 34 nations led by the US and UK, against Iraq. •6/Aug/1990: UN imposed an immediate and nearly total embargo on oil exports from Iraq and Kuwait, which Iraq had by then absorbed removed almost 5 million barrels a day from the world market. •Government’s Reaction: •Emergency Programs failed •Market interference drove prices even higher. •Prices rose from $21 per barrel at the end of July to $28 on August 6, reaching $46 by mid-October. Gulf War - 1990 Oil Crisis !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  34. 34. •OPEC 10% increase in production quota coupled with Asian currency crisis which reduced demand low point of oil price in 1999 •9/11 attack had no major effect on oil price •2005: Damages by Hurricane Katrina led to sudden drop in oil supplies and sent oil price to a high. •Financial crisis 2008 and the ensuing economic recession held down demand Other events !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  35. 35. 24-month Crude Oil Spot Price !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  36. 36. One-week Forecast Support Resistance !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  37. 37. One-week Forecast Price: $83.00
  38. 38. One-month Forecast Support Resistance !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  39. 39. One-month Forecast Price: $82.66 76.4% (81.91) !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  40. 40. One-year Forecast Alquist and Kilian (2010) found that no change forecast is more accurate than most forecasting models. Random Walk Model y(t)=y(t-1) +ε(t) !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  41. 41. “Changes in the spot price are unpredictable, so the best forecast of the future spot price of the crude oil is simply the current spot price.” Price volatility: SD = 17.67 Price Range: $47.72 - $118.40 Price: $83.06 !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*
  42. 42. “It’s an ideal situation we are in now,” says Ali Naimi, Saudi oil minister. “Consumers are happy, producers are happy. Companies are investing.” "Energy developments in 2009 were dominated by a global recession and, later in the year, a tentative recovery and we can't know how durable this recovery will be," said Tony Hayward, BP's embattled chief executive Voser warned of a challenging year ahead. ‘So far in 2010, oil prices have remained firm, and demand for petrochemicals has increased, but refining margins, oil products demand and spot gas prices all remain under pressure,’ he said. Société Générale SA cut its oil price forecast $88 a barrel for 2011 to $85 as demand growth slows and production outside OPEC expands.
  43. 43. Will OPEC denominate oil price not in USD?
  44. 44. •Oil prices are highly volatile and are affected by supply & demand, dollar strength, oil speculation and risk premium •Oil is politically driven as it is an essential commodity and it is unequally distributed in the world •Oil has emerged as a separate asset class due to its negative correlation with the dollar and stock markets •In recent years, oil prices are becoming more “forward looking” as speculators increased their share of trading dramatically Key takeaways !"#$%&'()%"* +',,-.*/* 0123"&* 0%--3$* +#$1"4#5* 63,1$* 7$3&8"4* 98:;* 6$128'2* 7821*7$1"&* <"3-.:8:* =%$1(3:#* >1.* 73;13?3.:*

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