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Sat 18 Jul 2009 01:59 PM

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Oil prices: Factors to watch out for

Check out some of the main bearish and bullish factors in the market that can sway the prices of oil.

Oil prices: Factors to watch out for
PRICE FALL: Oil prices fell from a high of $147.27 last July to a low of $32.40 in Dec. (Getty Images)

Oil prices fell from a high of $147.27 last July to a low of $32.40 in December, the weakest since early 2004.

They recovered to a peak of $73.38, the highest this year, at the end of June, but have since fallen to around $60.

Check out the main bearish and bullish factors in the market:

Falling demand

Major forecasters, including the Organisation of the Petroleum Exporting Countries, the International Energy Agency and the US government's Energy Information Administration, have all said demand this year will be lower than last year.

They expect consumption to begin growing again next year, but demand for OPEC crude is expected to stay low. In its medium term outlook published this month, the group said it did not expect demand for its crude to recover to approximately last year's levels until 2013.

Inventories

Weak demand has generated huge stockpiles. Even well into the US summer driving season, inventories of motor fuel have been climbing.

US distillate stocks, which include diesel, are at their highest levels for 25 years and gasoline stocks have risen to the top of their five-year range, according to US government data.

In addition to the large amounts of fuel storage on land, traders have built up fleets of floating of storage at sea.

The latest estimates peg the amount of crude held on tankers at 57 million barrels, down from 82 million at the beginning of June, but the amount of refined products held on vessels at sea has risen.

Shipbrokers last week estimated the amount of distillates held on tankers had climbed to 50 million barrels in early July from 34 million barrels at the start of June.

The oil has been stored on vessels rather than on land as traders have taken advantage of cheap freight rates and market structure.

High volumes of crude at sea coincided with a deep contango on the crude futures market - meaning prompt contracts were cheaper than those for later delivery and traders could make a profit from buying oil now and selling it later.

The contango on the crude market has narrowed, but distillates are still in a deep contango.

OPEC

Faced with rising stocks and weak demand, OPEC agreed to reduce supply by 4.2 million barrels per day compared with last September's output.

At its most disciplined earlier this year, OPEC compliance was around 80 percent. It has since slipped to nearer 70 percent, according to analyst estimates.

At its meeting in March, the group said it would limit its action to tighter compliance with existing curbs, rather than introducing new ones.

To help heal the world economy, it said it was willing to accept a price lower than its preferred level of around $75 a barrel.

At a follow-up meeting in May, it said the world could be ready for prices of around $75 later this year, but some analysts have said insipid US gasoline demand has shown how price sensitive consumers have become. They argue around $70 is too expensive for now.

OPEC next meets in Vienna on Sept 9 to reconsider its output policy.

Correlation

Last December's slide to the lowest oil price for nearly five years coincided with a massive de-leveraging by some market players.

Investors fled oil and other risky assets and in some cases moved into the relatively safe havens of gold and the dollar.

As all asset classes focus on risk and the prospects of economic recovery, assets that typically behave differently have tended instead to move in tandem, diluting the traditional value of commodities as a portfolio diversifier.

The recovery in oil prices in the first half of this year coincided with a recovery in equities, as stock markets looked to a stronger economy and oil markets assumed that would translate into rising fuel demand.

Nervousness since the start of July that such confidence was premature pulled both oil and equities lower. The US dollar has traded in a narrow range against a basket of currencies. Should it stage a convincing rally, that would make dollar-denominated commodities less attractive to investors.

Swine flu

The new H1N1 swine flu virus has spread rapidly and could mutate into a more virulent form, the World Health Organization has said.

To assess the possible demand impact, Deutsche Bank in a note looked to the world's experience of SARS as a guide.

Between Nov. 2002 and June 2003, there were more than 8,000 SARS victims world-wide, including 775 who died from the illness. The greatest impact for energy was on the use of jet fuel, which dropped sharply.

Regulation

Last year's run-up to record oil prices and the financial crisis led to renewed calls for tighter regulation.

US regulator the Commodity Futures Trading Commission (CFTC) is working on new rules to curb speculation, which analysts say could drive traders away from the main futures markets and have a bearish impact on prices.

Major market participants, such as Goldman Sachs Group Inc, have said their energy trading is for hedging purposes only and should be exempt from the CFTC's proposed new position limits.

Political risk

Militant violence in OPEC member Nigeria has forced the shut in of thousands of barrels of oil.

Analysts says it remains to be seen whether the release of rebel leader Henry Okah and the promise of a 60-day ceasefire will have a permanent impact on improving security.

China

The demand surge associated with the record price rally was led by an economic boom in China, which, according to IEA data, in 2003 overtook Japan to become the world's second biggest fuel consumer after the United States.

As most of the world has sunk into recession, Chinese growth has stayed positive at around 8 percent, but the pace of expansion - and its commodity demand - has slowed.

"The market appears willing to believe a 6-8 percent GDP growth level in 2009 is positive (for China) - a subdued growth rate by recent standards and not a sustained driver of commodity prices in the years ahead," said Richard Batty of Standard Life Investments. Forecasters predict any recovery in oil demand will be led by Asia, although reduced subsidies could have some impact on consumption.

At the start of this month, China raised pump prices to the highest ever.

Investment in new production    

Oil companies as well as OPEC members have said that to ensure investment in the most costly new production, an oil price of around $75 a barrel is needed.

Some projects have been shelved because of the poor economics associated with weaker oil prices, although the biggest oil companies have said they have continued to invest.

The IEA and other forecasters have said underinvestment in new supplies means prices will rally sharply once an economic recovery stimulates consumption.

A counter argument is that some demand has been permanently destroyed by last year's record prices.

Political will to pursue environmental alternatives to oil has also strengthened. (Reuters)

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