Crude oil outlook: Floor not too far from current levels

Oil demand has been revised downwards by International Energy Agency (IEA) for 2014 by 200,000 barrels a day (b/d) as downward revisions were made mainly to the OECD, Europe and the Asia-Pacific. For seasonal reasons, 2014'Q4 is usually the strongest demand quarter in the year. An additional 500,000 b/d in demand on a sequential basis is expected in the last three months. Hence, reducing the difference between total call-on-Opec (Organization of the Petroleum Exporting Countries) and what Opec is currently producing. Unplanned outages in Opec members and any small cut-backs from Saudi Arabia could help to balance the market over the remainder of 2014.

As refineries return from their seasonal maintenance, we would expect demand for crude oil to improve, and further support could come from colder than expected winter weather. We continue to believe the complete removal of risk premia from oil prices has made markets very complacent relative to the geopolitical risks still emanating from the MENA (Middle East and North Africa) region. Brent prices have fallen significantly since September, and though there are still some downside risks (Iranian resolution, no OPEC cuts at the November meeting, mild winter), we believe that the floor should not be too far.

Next year, alongside a gradual improvement in demand as the global macro picture improves (helped by lower oil prices) we still expect Opec to make the necessary cuts as low oil prices are highly detrimental to most of Opec members' government finances. Weighted average fiscal break-evens for the five key Opec producers (Iran, Iraq, Saudi Arabia, Kuwait and UAE) are close to $100 a barrel for next year. Opec partners such as Venezuela and Libya require higher oil prices to balance their budgets without incurring significant social unrest. In contrast, the bulk of US oil companies are either hedged until at least 2015 or have their break-evens lower than the current spot price of $81.50 a barrel (WTI).

Saudi Arabia recognises that lowering oil output unilaterally will only help other producers. Such a move might not be a sustainable solution anyway, as other Opec and North American producers would be likely to maximise oil production, thereby neutralising modest Saudi Arabian oil production cuts.

With the market inevitably facing a period of potential oversupply due to higher non-Opec output, we would expect Saudi Arabia to put pressure on its peers to look for a more sustainable solution, even if it ends up taking the largest cut.

For West Texas Intermediate (WTI), the downside risks are greater due to the ongoing rise in US crude production and difficulty of raising exports significantly in the near term. This could lead to extensive stock building next year, as crude from the Gulf Coast will eventually get backed up at Cushing. The bulk of US investments are likely to be scaled back only if oil prices fall below mid-$70s a barrel for a duration of at least four-six months. In Canada, however, investment in new oil sands output is more likely to be challenged by current price levels.

Thanks to these fundamentals, we have revised the average Brent price for 2014 and 2015 down to $103.5 a barrel and $99.3 a barrel, respectively, and average WTI prices to $96.6 a barrel and $93.5 a barrel, respectively. We remain bullish on oil prices, as we expect support from improving demand as the global economy recovers, scaling back of production and increased geopolitical risks.

The author is lead oil markets Analyst, Natixis Commodities Research, London