Oil prices are projected to average $85 per barrel next year and they may jump above $100 by late 2010 or early 2011, according to a revised global energy forecast by Bank of America-Merrill Lynch.

Earlier the investment bank forecast $75 a barrel for oil in 2010, but revised its expectations higher on anticipation that continued weakness in the US dollar will push commodities higher next year and gold may jump to $1,500 an ounce.

"In 2010, we believe dollar weakness will give way to gold appreciating against all currencies. As emerging markets' central banks increase their allocations to gold and push prices above $1500/oz, oil prices should follow. WTI crude could break $100/bbl by late 2010 or early 2011," it said.

The forecast showed loose monetary policy and a weaker dollar should put upward pressure on crude oil prices next year. In addition to the monetary factors, a stronger than expected cyclical rebound in the global economy should lead to tighter physical oil supply and demand fundamentals next year. "We forecast WTI to average $85/bbl," it said.

Long-term prices

Moreover, the BofA-Merrill Lynch oil and gas equity research team now believes that long-term oil prices will average $85/bbl for 2011 and to $80/bbl for 2012+.

Though a combination of loose monetary policy and dollar depreciation on a trade-weighted basis is expected to push oil prices above $100/bbl , a tightening in physical oil supply and demand fundamentals could play a significant role in propping prices up next year.

Merrill Lynch also expected oil inventories to fall next year despite the current increase in crude oil and petroleum products inventories.

"The global economy is bouncing back from the sharpest recession in the post World War II period. Following a bout of growth surprises, our economics team now sees global GDP growth recovering strongly to 4.3 per cent and 4.5 per cent in 2010 and 2011, respectively, from –0.8 per cent in 2009, above consensus and the IMF. This will lend support to a strong rebound in global oil demand. Activity has turned around surprisingly quickly in emerging markets," it said.

It highlighted the recovery in final demand as most world countries showed signs of uptrend. The global inventory cycle is turning up and the implosion in world trade that pulled down the global economy is reversing. Key leading indicators for the global manufacturing cycle – such as exports out of South Korea and Taiwan, business confidence in Europe, the United States and China and industrial orders in Germany – have recently surprised to the upside. "While the recovery might be choppy and jobless rates still high in the United States, business cycle effects, re-stocking and fiscal spending make us significantly more bullish on the recovery relative to consensus."

These developments had eased the deceleration in global oil demand growth, it said. From -3.3 per cent year-on-year?(y-o-y) in the first quarter this year, the rate of change in global oil consumption has recovered to 1.5 per cent y-o-y during the past three months.

"No doubt, real oil consumption continues to display cyclical weakness. Demand for gasoil or diesel remains in the doldrums. Looking ahead, we see oil consumption trailing the cyclical recovery and expect oil demand to return to positive growth in Q4 2009."

"Driven by our above-consensus call on global GDP growth, we now see global oil demand growth at two million bpd. That would put average 2010 oil demand above average 2008 oil demand in terms of levels," Merrill Lynch said.

However, it said the ensuing recovery would be driven by emerging markets, where growth is oil-intensive. "We expect emerging markets to grow at 6.1 per cent in 2010, from two per cent this year. Within the emerging world, Asia is expected to lead growth at 8.1 per cent, driven by China at 10.1 per cent and India at 7.6 per cent. We see Asia, the Middle East and parts of Latin America as the main drivers behind oil demand growth next year.

Vicious cycle

The investment bank highlighted its expectations about a rally in commodities prices early last month. Since October, a vicious cycle of capital inflows into emerging markets, G10 and EM FX currency appreciation, and higher EM commodity demand has triggered a significant depreciation of the trade-weighted dollar, pushing oil above $80. In turn, low elasticity of both demand and supply in the petroleum markets and constant recycling of petrodollars into euros kept oil prices and the trade-weighted dollar trading in sync.

However, BofA-Merrill Lynch said the link between currency markets and oil could be breaking down because the US economy needs a weak currency to address its large deficits.

"But the weak dollar has sent dollar-denominated commodity prices higher. Commodity and FX markets worked under the assumption a weaker dollar is synonymous with higher gold and oil prices. However, India's large off-exchange purchase of gold was enough to send prices higher despite a stronger trade-weighted dollar on the day," it said.


Opec crude supply to increase next year

The supply side of the equation could remain a limiting factor on demand growth expectations, said Bank of America-Merrill Lynch.

"Broadly, we expect physical supply constraints to return to the market during 2010, prompting Opec to raise oil production. With roughly six million barrels per day of spare capacity and a ramp-up of new fields in Saudi Arabia, Iraq and Angola, there is certainly plenty of excess capacity to raise output next year. Still, an Opec supply increase coming so shortly after the recession could be seen as bullish sign, as excess crude oil productive capacity will be just six per cent of demand."

BofA-Merrill Lynch said a significant amount of new capacity had started up so far this year in non-Opec producers, with a peak capacity of 2.3 million bpd. New fields in Brazil, Kazakhstan, Russia, Norway, West Africa and the Gulf of Mexico have come on stream over the past few months, with surprisingly little delay or complications. "Some of that production ramp-up will be felt in 2010, where we see non-Opec production expand by 244,000 bpd, following on from 323,000 bpd this year," said BofA-Merrill Lynch.

Non-Opec oil supply growth is increasingly tilting towards deepwater production and the recent arrival of ships and floating platforms has facilitated this trend. Rising oil prices have also helped to lift output in Russia and Brazil, where production has hit a record high in the past three months. Global biofuels output has surprised to the upside recently as higher oil prices have raised profitability.

Moreover, condensate and gas liquids output from Opec countries, which does not fall under production quotas, is set to increase by 600,000 bpd in 2010. Still, technological challenges are huge for conventional crude oil. Steep decline rates in existing fields are dampening the rate of aggregate non-Opec oil supply growth.

In the UK and Norway, production is likely to fall by a steep 300,000 bpd this year and 430,000 bpd next, despite the start-up of new projects. The Cantarell field in Mexico now puts out just 580,000 bpd, from 950,000 bpd a year ago and more than two million bpd four years ago. Even in Russia, the output increase is likely to be rather temporary as a lack of clarity over the longer-term fiscal regime is curbing drilling and investment.

Meanwhile, resource nationalism is flourishing again. The grip of governments around the world on the oil sector is getting tighter with rising taxes and access to foreign investment, said BofA-Merrill Lynch.

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