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Where are the oil markets headed to?




Published: Dec 11, 2010 22:59 Updated: Dec 11, 2010 22:59

OPEC is sticking to its position to open up taps further only if the current market spike is driven by real demand and not mere speculation. Secretary-General Abdullah Al-Badri said ministers want to see real evidence of extra demand and would not raise output, even at $100, if they felt price rises were led by speculation.

Oscillating at around $90 per barrel, markets are straying into perilous zone. The question remains: What is driving the markets and where is it heading?

Demand is definitely on the rise. However, the debate about the real state of economy is on too. There are analysts still treading cautiously — underlining the global economy is not yet out of woods. And this conservative columnist continues to be on this side of the divide.

Yet the overall mood is positive –- one has to concede. The debate is revolves around about the extent of recovery. Releasing its view of the outlook on the eve of the ministerial, OPEC’s report estimated demand will grow this year at 1.47 million barrels per day (bpd) on the 86 million-bpd. The IEA is much bullish, saying it expected global demand growth to average 2.47 million bpd for 2010 as the consumption in the third quarter surged by 3.3 million bpd.

World oil demand is headed for a record this year, surpassing the all-time high reached in 2007, a recent Wood Mackenzie report said. Based on provisional data for the third quarter, the average global oil demand this year would be 86.7 million bpd. It forecasts even higher demand next year, averaging 88.1 million bpd, rising to nearly 90 million bpd in 2012.

Last week, JP Morgan projected the oil prices going above $100 per barrel in the first half of 2011, reaching $120 per barrel by the end of 2012. Other banks also raised their oil price forecasts last week due to “rising demand in emerging markets, faster global economic growth, and OPEC’s reluctance to boost output.”

The overall mood is bullish – to say the least — keeping the markets buoyant.

Analysts blame the rise to a variety of factors. The US Federal Reserve’s plan to buy Treasury bonds to stimulate the economy; the ramping up of new refineries in China this fall and an unusually cold start to winter in Europe and Asia, leading to a drawdown of petroleum inventories, all seemed contributing to this spike.”It’s a winter wonderland,” said Edward Morse, a veteran energy analyst at Credit Suisse citing the cold snap.

Auto sales statistics also illustrate demand firming up. The Chinese are expected to buy 18 million cars already in 2010 — a 32 percent jump from 2009. In the US, about 11.5 million cars are expected to be sold this year; a 10 percent increase for the country from dismal 2009.

Alexander Pasechnik, an independent oil analyst blamed speculation and “inflationary factors” for the recent rise. “The share of speculative contracts, not backed by the commodity on hand has reached 90 per cent.”

Yet the big question remains — is this gong to stay? Are we into another round of price spiral —with prices attaining new peaks?

That remains a billion dollar question — yet a number of analysts do not appear that optimistic on this score. And this is worrying — for the producers in more than one ways — one could say with some level of certainty.

US crude oil futures prices turned negative in choppy trading on Thursday, pressured by the dollar bouncing back and rising and the euro slipping.

The rising inventory of refined fuel stockpiles in the US also helped cool down the oil markets. OPEC quota compliance is of late emerging as another crucial issue. The compliance of the 11 members involved in the quota system has been eroding. Downward pressure on crude prices is building up. Although it could be professionally hazardous, yet one feel like pointing out that the overall conditions seem conspiring against any further upward movement on prices.

Oil traders and investors appear worried that China’s moves to rein in inflation could lead to a slowdown in its rapid growth rate. On Friday, the People’s Bank of China boosted financial reserve requirements for its banks, a step aimed at curbing lending. China’s central bank said it will raise the reserve requirements for Chinese banks by another 50 basis points, the sixth increase this year and the latest attempt to curb rising inflation.

Stephen Schork, an analyst and trader in Villanova, Pennsylvania spots a strong correlation between inflation in China and the oil prices. “Measures taken by China to rein in inflation inherently mean lower oil prices,” he said.

And the Russian Finance Minister Alexei Kudrin warned on Wednesday that the oil price could fall to $60 per barrel within the next three years for a period of about six months.

Analysts are also pointing to the sluggish economic growth in developed countries, saying it may not justify high prices for commodities such as oil. “The threat of bubbles is greatest in commodity markets,” Capital Economics said in a report. “If commodity prices are going to be sustained at these levels, final demand from consumers has to be consistently strong too.”

“Since the major developed economies are only gradually recovering from recession, this is placing an awful lot of weight on the rebound in emerging economies.”

Oil markets seem to have also benefited from the US Federal Reserve Bank decision to issue and buy up $2.3 trillion in US Treasury Bonds after the 2008 meltdown, essentially printing money so as to spur lending and making US exports cheaper abroad.

The policy, called “quantitative easing,” decreased the dollar’s value against other currencies and boosted the price of oil.

It also encouraged the Chinese to buy and store more oil because it’s better to invest dollars that are losing value, said Phil Flynn, an analyst at PFGBest in Chicago. Flynn sees, however, “a couple of storm clouds on the horizon that could slow the higher energy prices.” One is the abating effect of quantitative easing.

A second factor is the European debt crisis. Oil prices dropped 10 percent in just a few days after Greece nearly defaulted in May and the EU extended it emergency bailout loans. Then they rebounded. If the European debt crisis worsens, that could put further downward pressure on the price of crude. And the limited cooperation OPEC gets from non member oil-producing nations, specifically Russia, in keeping prices where they are, could also hurt.

Roger Diwan of PFC Energy, says that despite a rise in consumption, there was plenty of oil supply, refinery capacity and transportation available.

“There are seasonal issues and money allocation issues,” he said, “but I don’t think there’s the making of a big bubble.”

As markets tend to be ‘at the upper limits of what the markets could bear,’ there is also a growing feeling within the analysts that the OPEC heavyweight Saudi Arabia is unlikely to let the prices rise much.

“I don’t believe the Saudis will embrace $90 oil with the economic minefield ahead of us,” said Gary Ross, CEO of PIRA Energy Group.

“There would be a lot of pressure on the Saudis and OPEC in general to raise production as $100 oil would be viewed as injurious to economy,” says Phil Flynn, of the PFG Best Research in Chicago.

Despite the spike, fundamentals don’t point to a continued bull run — one feels like underlining at this stage — despite the dangers of forecasting in this cat and mouse game.


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