Prices driven by fundamentals not speculation

    TORONTO, June 5 /CNW/ - CIBC (CM: TSX; NYSE) - The TSX will hit a record
high of 15,200 by year-end on the strength of sustained high prices for crude
oil, forecasts a new CIBC World Markets report.
    The report finds that the near doubling of oil prices over the last year
has been driven by supply and demand fundamentals and not by speculation or
the weakness of the U.S. dollar as others have suggested. CIBC World Markets
is calling for the West Texas Intermediate (WTI) price for oil to average
US$115 a barrel for the year. So far in 2008, WTI has averaged $107 a barrel.
    "We estimate that accumulation of 'paper' barrels of oil in the hands of
speculators has been, at most, one fifth of the increase in Chinese demand for
actual barrels of oil over the last five years," says Jeff Rubin, Chief
Strategist and Chief Economist at CIBC World Markets in his monthly Canadian
Portfolio Strategy Outlook report. "And even if denominated in a
trade-weighted basket of world currencies, the price of oil has still risen to
over US$100 a barrel."
    Mr. Rubin notes that, at nearly US$4 trillion per year, the global oil
market's sheer scale - about twenty times the value of global commodity index
investment - is itself a barrier of some significance to market-moving
speculation. He says that one way of gauging the role of speculation is to
look at the effective diversion of physical supply that would be needed to
match the historic rise in speculators' holdings.
    Non-commercials (speculators) long positions for crude oil and oil
products have risen by the equivalent of 848 million barrels in the last
5.25 years. Impressive as that number may sound, Mr. Rubin notes that it works
out to only an increase in exposure of about 500,000 barrels daily - a fifth
of the rise in Chinese demand or about six per cent of the total pressure on
oil supply from some major identifiable factors over the same period.
    "If hoarding were raising prices, inventories should be rising but in
fact they are not," adds Mr. Rubin. "According to the IEA, oil inventories
remain within their longer term range of 50-55 days of supply while exchange
stocks for key metals like copper are as much as 40 per cent below normal.
    "The claim that the rise in commodity prices is largely just the inverse
of U.S. dollar weakness also seems dubious, since oil has risen strongly
against other currencies. Indeed, we estimate that oil would still cost US$100
- five times its 2002 level - even if the U.S. dollar had not declined against
a trade-weighted basket of other currencies."
    The report notes that global oil demand continues to grow. The drop in
oil consumption in North America, Japan and Europe due to high prices will
continue to be more than offset by growth not only from the BRIC (Brazil,
Russia, India and China) countries, but also from highly subsidized consumers
in many Middle Eastern countries. China's policy to partly subsidize domestic
oil prices will also continue to boost demand in that country. CIBC World
Markets also expects that infrastructure damage from the recent earthquake in
China will boost the need for diesel power and oil demand there, potentially
for the next several years.
    "The latest data appears to add substance to our earlier fears that
runaway domestic demand is cannibalizing production in the traditional
oil-exporting countries, limiting their ability to meet the needs of an
increasingly thirsty world," adds Mr. Rubin. "According to the U.S. Department
of Energy, shipments of petroleum products by the world's top 15 oil exporters
fell 2.5 per cent in 2007 and the weakness appears to be carrying over into
the present year."
    CIBC World Markets also remains bullish on the prospects for natural gas,
calling for prices to average US$12.50/MnBtu this year and US$14/MnBtu in
2009. Mr. Rubin bases the forecast on the fact that liquid natural gas imports
to the U.S. are failing to materialize which leaves the American market
critically dependant on Canadian supply.
    At the same time, he notes that gas will play an increasingly significant
role in electricity generation in North America. "Outside of a few isolated
places like Alberta, there is no new coal generation being licensed in North
America. Virtually all of the increase in power capacity over the next decade
will be gas-fired, sending North American gas prices well into the teens over
the next several years."
    Given these factors, CIBC World Markets' portfolio strategy remains
seven-percentage-points overweight in energy stocks. Mr. Rubin believes energy
stocks are still being valued on a per barrel crude price of around US$90, far
below the prevailing spot price making them the top candidate for exposure.
    This overweight position remains the foundation of the bank's strategy
and is the major reason its model equity portfolio has outperformed the TSX
benchmark by 138-basis points so far this year.
    Mr. Rubin has reduced exposure to interest rates this month, both in
terms of a cutback in fixed income weighting, as well as a point reduction in
interest-sensitive utility stocks. He believes that while the Bank of Canada
may still have one more rate cut left, he expects a minimum 100 basis points
of tightening next year as Canadian inflation rates double.

    The complete CIBC World Markets report is available at:
    http://research.cibcwm.com/economic_public/download/psjun08.pdf.

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