Why Citigroup Inc (C) Thinks Oil Is Going To $20

The net positive impact on global GDP could be sizeable, adding to the potentially stimulative effect of a number of looser monetary policies globally announced in January. The low oil price impact on economic performance should be stronger on consuming countries, more than offsetting challenges faced by producing countries. Even with the sharp drop in prices starting in the middle of 2014, Brent prices still averaged $99.5/bbl last year. Hence, a nearly 50% drop in price in a more than $3 trillion market is expected to raise consumers’ disposable income, lower input costs and ease government finances for those with large-scale demand-side subsidies. Economic performance later on could exceed current forecasts. The negative impact on producers may not have as sizeable an effect as subsidies or support tend not to be cut immediately, while the slowdown in petrodollar recycling, which is mainly channeled through the asset markets, also has less of an immediate effect on consumption. However, a currency war due to competitive devaluation and further monetary stimulation could start to weigh on the global economy. Nonetheless, at this point, impacts from oil and monetary loosening still look to be positive.

Taken together, a sharply lower oil price level should boost demand through two channels: (A) the direct impact of lower prices, and (B) the support given to global economic activities as a result of lower fuel costs.

(A) Direct impact on oil demand: transportation fuel consumption, especially in countries with no or very small subsidies, should see a greater rebound in demand, as the cost savings are directly passed to consumers. OECD countries are major beneficiaries, especially those in North America. In contrast, some non-OECD countries have retail price controls or provide subsidies that enable consumers to be partially shielded from higher prices in recent years; with the oil price drop, some countries have only reduced retail product prices by a smaller magnitude, so that governments could cut subsidies and reduce their fiscal burden. Non-transportation fuels could see smaller growth y/y as a direct result of lower prices, where sectors such as industrials, power generation and other miscellaneous uses dominate this segment of oil demand. These sectors would only use as much oil as needed to meet the ultimate demand of their own products (or electricity generated.) Hence, lower oil prices could stimulate a slight, but not large increase in demand from these sectors.

However, as Citi expects Brent prices to rise from $54/bbl in 2015 to $69/bbl in 2016 in our base case, the decline in OECD demand could partially resume. The initial phase of nuclear restarts in Japan should also reduce fuel oil demand more than LNG demand. This explains why global oil demand growth should be smaller in 2016 versus 2015.

(B) Indirect impact on oil demand: Lower oil prices should provide a boost to economic performance globally by reducing the cost of fuel and feedstock through two transmission mechanisms. First, it generally takes time for better economic performance to progress through to increases in real oil demand. Although the increase in consumer disposable income should lead to a more immediate increase in the consumption part of the GDP equation, the price impact on GDP and GDP-induced oil demand gain is expected to be stronger in 2016 than in 2015. Consumers could adopt new habits in oil demand; businesses, after seeing possibly stronger consumer sentiment and lower cost structures, should look to raise production and investment, especially in countries with strong manufacturing/industrial/export sectors. This benefits many non-OECD countries. The wait for industries to ramp up is also where the delay in oil prices impact on GDP comes in, but this also means that the ripple effect on the economy from lower oil prices could last for many quarters with stable prices.

Beyond secondary and tertiary stocks, primary crude storage should play a central role in how prices could rebound. Just as an oversupplied market shifts prices to incentivize storage, a rebalancing market that starts to draw on inventories will also affect prices in its own right. As markets work through stored barrels and unwind the storage trade, the reverse dynamics apply. Prompt prices should rise to close the storage arb, collapsing the contango curve structure. This dynamic can create the conditions for a V-shaped recovery as oversupply wanes and demand catches up.

Thus, in our balances, global oil inventories are on the rise into 2Q’15, but begin to draw down from 3Q’15 onwards as summer demand kicks in, and as supply pulls back sharply from 4Q’15.

In the US, 2Q’15 sees tank-tops potentially challenged, though prices likely move to forestall this, which could adjust US production, imports and exports to draw down stocks, and should correspond with a widening of the Brent-WTI spread as both Brent-LLS and LLS-WTI widen to flush out stocks from Cushing to the Gulf Coast, and from the Gulf Coast out into the Atlantic Basin.

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In short, it looks as though there should be a sharp recovery in prices by winter 2015/16, and as a result of that, there should be an enhanced stimulus for US shale production growth going forward. This could well overwhelm demand growth and bring prices down again, in a ‘W’ shape.

This is the first experiment with dealing with shale supply, and the first time in which the world is getting used to a new oil order, with a “call on shale” replacing a “call on OPEC” as a new market benchmark. As a result, the likelihood is that the sharp price recovery should stimulate more production growth in North America again, and all other things being equal, bring about another decline in prices, after which US production growth is likely to moderate.

This article is brought to you courtesy of Tyler Durden From Zero Hedge.

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