Demand for crude will continue

Merrill Lynch predicts the oil market will remain tight, contradicting forecasts from other analysts.

The rising thirst for oil in emerging markets will keep supplies tight to the end of the year at least, Merrill Lynch said yesterday. A view that contradicts analyst predictions that shrinking demand in industrialised countries will see a continued decline in the price of crude. Experts are divided on how big an impact the fall in appetite for oil in the West and Japan - caused by an economic slowdown and the high price of oil itself - will have on the price. Merrill's findings contrast with the conclusions reached by Lehman Brothers analysts yesterday, who argued in their own report that oil prices have peaked for the next few years.

"Barring any physical disruption that may temporarily spike prices, we judge that oil prices have peaked," Lehman said. However, Merrill's report said others had recently overestimated the weight of traditional markets and underestimated the role that growing demand in emerging economies like China and India has on the oil price. The investment firm maintained its view that prices would hold at an average of US$124 per barrel in the third quarter of the year. "Even if US demand stays negative in 2008 and 2009, the rate of global oil demand growth will depend a lot more on EM [emerging market] economic growth than on North America over the next five years," the report said.

Oil demand in China and the Middle East has continued to rise amid high prices, in part because those countries shield their citizens from the record cost of oil with high energy subsidies. The authors of the Merrill Lynch report noted that consumption of cars and energy-intensive products in Asian countries continued to push up oil demand, despite signs that export-led growth in China may be starting to slow slightly.

"While the upside risks on prices may not be as acute as in the first half of 2008, we still believe that strong EM economic performance will keep oil markets relatively tight in the coming months," the report said. Expectations for strong demand are bolstered by the fact that the appetite for oil in emerging markets outside of the former Soviet Union has not fallen once in 40 years, the report noted. Several economic studies have previously found that the demand for oil in developing economies has been historically inelastic, meaning it is fairly unresponsive to price changes.

Underpinning this increase in oil demand is economic growth in countries like Brazil, China and India, which the authors attribute in large part to the expansion of credit and growth in money supply. The Merrill Lynch authors were less willing, however, to extend their bullish predictions beyond the end of the year, largely because of fears that turmoil in financial markets in the West could extend to emerging markets.

"We remain a bit more cautious about 2009," the report said. "We believe volatility will stay very high, and we see oil prices responding abruptly to changes in monetary policy around the world, particularly those coming from the Fed and the PBoC [People's Bank of China]." The price for September delivery of West Texas Intermediate crude fell $4.82 to close at $115.20 in New York on Friday. The contract reached a record price of $147.27 on July 11.

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