Non-fundamental forces still shoring up oil

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After a drop of roughly eight percent, international benchmark US crude futures last week traded around $66 a barrel, at the bottom end of a trading range of $65-$75 in place since around July.

Analysts said selling would be limited unless equities, still in sight of their highest levels this year, weakened significantly or the dollar rebounded as investors continued to view oil as part of a financial portfolio and were wary of taking short positions.

“If you continue to see rising fuel inventories without any appreciable signs of any pick-up in demand, then the oil market could face increasing downward pressure that could break us out of the range we have been in for the past couple of months,” said Gene McGillian, analyst with Tradition Energy in the US.

“This could be more difficult if you continue to see rising equities prices and a falling dollar. Those could buoy prices long enough for demand to eventually recover.”

The Organisation of the Petroleum Exporting Countries (OPEC), which has kept output unchanged all year even though inventories are above the five-year average, has also voiced some confidence oil markets can ignore swelling stocks, pending an upturn in demand.

But ministers have not anticipated any price surge.

“I do not think oil prices will see major changes before the end of 2009,” Algerian energy and mines minister Chakib Khelil said last week.

Analysts have also kept predictions around steady. Even the most bullish, Goldman Sachs, maintained its price targets, although it was upbeat about fuel demand.

“The lack of a clear trend in fundamentals has created a sell-off, which we believe will prove very temporary. Relative to expectations, demand has surprised to the upside,” it said in a research note.

Powerful demand growth was a major factor in propelling prices to their record of nearly $150 in July last year, although speculation was blamed for exaggerating the rally.

Equally, a collapse in demand that coincided with the financial crisis was instrumental in the plunge to December’s low of less than $33 a barrel, its weakest in nearly five years.

OPEC then implemented deep supply cuts to kick-start a price recovery that gathered momentum as all markets began to look to the same macroeconomic data for signs of economic growth, with implications for increased fuel consumption in future.

The tendency for markets to move together, rather than focus on their own fundamentals, is to an extent typical of the early stages of economic recovery, analysts have said.

“US crude has been behaving more like an investment asset and less like a consumption asset,” said Harry Tchilinguirian, BNP Paribas’ senior oil analyst in London. “As such, while oil fundamentals would suggest lower prices, US crude’s strong positive correlation to equities and inverse correlation to the US dollar implies limited downside scope to any fundamentally-driven correction.”

As many financial markets have moved upwards, the dollar, seen as a relatively safe haven, has dropped to around the lowest levels this year against a basket of currencies.

That has been another spur for dollar-denominated oil, which is relatively cheap for investors holding currencies other than dollars.

Some analysts have estimated that oil prices could be as much as $10-$15 cheaper to be a true reflection of swollen fuel stocks and bearish fundamentals.

But away from the headline price of around $66 a barrel, the market structure is reflecting the large volumes of oil in storage on both land and on oil tankers moored out at sea.

Contango, or a market structure in which front-month crude is cheaper than that for later delivery, reflects surplus prompt supplies.

Futures for unrefined crude and gas oil — used as a benchmark for diesel and heating oil — have been in a steep contango for most of this year.

The more specialised traders focus on buying and selling spreads between various oil contracts or on deals based on refining margins, which have been historically weak and could now be low enough to provide a good entry point
for investors.

There could well be less upside potential at the most visible, front-end of the price curve, but even there traders remain reluctant to take any short positions.

“No one wants to be short,” said one trader who asked not to be named. “Anyone that gets short will get run over.”

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