After plummeting from nearly $150 per barrel in July 2008, to as little as $35 per barrel in December the same year, this week has seen crude price hold above $60/bbl.
At $63/bbl, in Thursday trade, it is now up about 80% from its December lows outperforming almost every other asset class over the period. Despite this the IEA has noted that demand for oil could actually decline this year for the first time in a generation, with the volumes in inventory at all time highs. The US Energy Information Agency says consumption fell 50,000 barrels a day during 2008 and is expected to fall by 7.2% between 2007 and 2010, making it the first three-year fall in oil consumption in history.
Dollar slide has upside for crude price
Analysts point to the U.S. dollar as the key to the rise in prices, despite sliding demand. Unlike late 2008 where the greenback become the safe haven for global investors fleeing carnage in almost all markets and asset classes, 2009 has seen a marked change in sentiment toward the American currency.
The incoming Obama administration has embarked upon further massive economic stimulus to push the worlds largest economy out of recession, and unveiled further supports for the beleaguered financial system. This is seeing forecasts for the U.S. Budget deficit, which stood at 41% of GDP at the end of 2008, rise as high as 80% in 10 years time. The move by the U.S. Federal Reserve to purchase long term treasuries, effectively monetizing debt, has further undermined sentiment, and triggered expressions of concern from large holders of U.S. debt such as China.
With oil priced in the U.S. dollar, the recent slide has seen oil become an effective hedge, despite a poor demand outlook, and more crude in inventories than there has been in a generation. Finam Analyst, Alexander Eryomin sees this as the major factor behind the recent surge in oil prices.
“We think the recent jump in oil prices is mostly based on speculative interest and a falling dollar. Actually, there are no fundamental factors, as demand is actually falling now.”
Jeffrey Woodruff, Senior Director FitchRatings, also notes that the trend could run further.
“Although the trend has started again with the dollar weakening, you have to bear in mind that today the dollar is trading roughly at the same level as in mid 2007. So we still have room for the dollar to weaken before it touches its lowest that we had in 2008.”
Long term dollar hedge
The combination of weak short term demand, and a slide in confidence in the currency it is priced in, is seeing the number of long term positions taken on rising crude prices jump significantly. Natalya Shulyar from Info Fuel and Energy Consulting, sees this phenomena meaning that fundamental supply and demand is less relevant to the crude price than in the past.
“Since the beginning of the crisis fundamentals, like supply and demand, no longer influence the oil price. Today the volume of so – called “paper trade”, I mean futures market, is 10 times higher than that in the real market. This weakens the influence of global organizations as OPEC, for example. Their decisions are no longer that important as before. Today the information factor has become the most powerful one. They lobby interests of the countries that are the largest consumers of oil through internet and Mass Media. The oil market has turned into the “World casino.”
A wager on global recover
A large part of that investment into the longer term revolves around a pickup up in the global economy and attendant rise in crude demand. Most analysts and commentators are starting to price in a rebound in global economic growth either in the second half of this year or in 2010, with talk of ‘green shoots’ already make the press.
When demand does start to turn, another key effect of the credit crunch and economic downturn will start to make itself apparent, with the cutbacks in capital expenditure by major oil producers likely to see delays in projects which will be needed to meet future demand. World production peaked at 74.8 million barrels a day (mbd) in July last year and has since declined to about 71mbd. Although this is currently leading to surplus of supply over demand. World production peaked at 74.8 million barrels a day (mbd) in July last year and has since declined to about 71mbd. Although this is currently leading to surplus of supply over demand, any turnaround is likely to see return to the headlines about ‘Peak Oil’ which proliferated as oil spiked to more than $147/bbl in July 2008.
Amidst warnings that the emergence of China and India as economic drivers – both of which are faring better through the global downturn than the major developed economies – means that the outlook on the supply demand balance over the longer term is exceptionally tight. Jeffrey Woodruff, of FitchRatings believes prices could rise significantly over the longer term.
“In the longer term period we could see substantially higher prices than we have currently. This is because of the coming OPEC meeting – and they think prices could again reach $150 per barrel once the global economic recovery is there – primarily because they seem to feel not enough investment is being made in extraction and development to meet a greater demand.
Nobody knows how far the oil price might go. The general thinking is that the prices are going to be slightly higher than today in the coming 2-3 or 4 years from now, because even in the midst of the recession we see oil prices of more than $60 per barrel. So if it’s true that that investment is not being made into the oil sector and it will be hard to find, and demand for oil again increases like in India and China, I think we will have substantially higher oil prices than we have now. It could be $80 – $100 per barrel.”
With regard to the very near future the consensus seems to be that OPEC will hold production levels where they are and not cut despite the glut in storage, with comments from leading OPEC players supporting the contention. This could mean that with crude prices having risen sharply in recent weeks to beyond as high as $63/bbl there is likely to be a retracement, although the cartel could still look to cut when it meets in September, should prices fall back under $50/bbl, meaning a further slump towards the levels of last December is unlikely.
James Blake, Anastasia Kostomarova: RT Business