Report from BofA Merrill Lynch Global Research - 2010 Energy Market Outlook

Published November 24th, 2009 - 12:33 GMT

Gold could lead oil above $100/bbl in 2010 or early 2011
We argued throughout this year that a weak USD against a basket of floating G10 and EM currencies could contribute to higher energy prices in USD. In turn, low elasticity of both demand and supply in the petroleum markets and a constant recycling of petrodollars into EUR kept oil prices and the trade-weighted USD trading in sync, pushing oil above $80/bbl several times. In 2010, we believe USD weakness will give way to gold appreciating against all currencies. As EM 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.

Crude oil will average $85/bbl in 2010 as the cycle picks up
Loose monetary policy and a weaker USD 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, and we forecast WTI to average $85/bbl. 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+.

Middle distillates should outperform other petroleum fuels
A synchronous resumption of idle industrial capacity and trade around the world should support a big up-tick in demand for middle distillates. We are raising our 2010 average forecasts for heating oil and gas oil crack spreads to $10.60/bbl and $13/bbl respectively. Meanwhile, gasoline crack spreads should under-perform distillates on the back of the cyclical recovery, although rising crude prices will eventually put upside pressure on the gasoline crack next summer. Residual fuel oil cracks will likely weaken somewhat, resulting in slightly wider spreads between light and heavy products at refineries around the world.

Some upside to US gas in 2H10, but no re-coupling with oil
Natural gas prices at the Henry Hub have come off sharply in recent weeks on the back of record storage levels and warm weather prospects. Still, we believe there is value opening up in 2H10 despite the high volatility, and we stick to our 2010 forecast of $6/MMBtu relative to a forward of $5.40/MMBtu. In 4Q10, we see US nat gas prices rising to an average of $7.60/MMBtu, 27% above the forward.

Economic recovery may push thermal coal above $100/t
The demand outlook for the thermal coal markets could improve significantly going forward, and the market is likely to tighten pretty quickly in 2010. Chinese and Indian demand for coal is already growing strongly, and global industrial production is tracking the path marked by the surveys. With a demand recovery on the way, increased demand coupled with stronger "coal currencies", could push European API-2 coal prices above $100/mt by the middle of next year.

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