OIL – ALL’S NOT WELL

The southward movement of oil prices continues. NYMEX crude slipped last week below $52 a barrel before rebounding to $53 on Friday. While mild weather has been the prime driver in the recent downward movement, future direction will depend on a host of forces, including the stance OPEC is going to take (also the OPEC’s capacity to deliver production cuts and influence prices - OPEC's credibility has been on the wane), hedge fund speculators (a number of funds are taking short positions, on bets that prices will fall) and the strength of the global economy (which will affect the demand going ahead). Also on the market’s radar will be the geo-political developments especially in the middle east, though worst of the fears are already discounted.

The prices are expected to go below $50 very soon. Some analysts are even predicting the drop to extend to $40 a barrel, a price not seen since 2004. Crude oil has been in an eight-year bull market until last summer’s high above $78 a barrel. In 1998, oil traded as low as $10.35.

Oil Prices South-Bound

First week of the New Year marked the sharpest fall in two years for crude oil prices – a weekly loss of about 8%. The fall comes amidst continued mild weather in the north-east coast of the US and ample supplies of petroleum products. On Friday, the prices recovered slightly, helped by a better-than-expected US jobs report for December. US light crude oil settled 72 cents up at $56.31 a barrel in New York and London's Brent crude rising 53 cents to $55.64. The overall sentiment, however, looks to be bearish.

The crude prices have been falling despite two production cuts agreed on by OPEC members - 1.2 million barrels a day in November and 0.5 million barrels per day beginning February next. The continued price fall reflects the market belief that members of the oil cartel are not adhering to the agreed production cuts.

While weather has been a key driver of sentiments in recent weeks, the drop in oil prices is accompanied by a simultaneous drop in other commodities as well. With global outlook for commodities being not-so-bullish, significant shifts in asset allocation of investors is expected in the year ahead. This may mark a halt in the bull run in commodities. The informal 'floor' price for crude oil that OPEC wants to defend - understood to be $60 a barrel - has been convincingly breached and next few weeks may even take the price below $50, as little support is seen forthcoming at current levels.

Is OPEC ready for further cut?

Oil prices have risen in the recent weeks, amidst growing uncertainty and speculation on deeper production cuts from OPEC. The oil producers’ cartel which controls about 40 percent of the world's oil production is worried about a surplus of global crude-oil inventories and has been trying to stem the fall in prices after they fell from a peak of $78.40 a barrel in July to below $60 in October. According to latest estimates, the US has inventories of 340 million barrels, 14% more than average. Similarly, stocks held among the 30 OECD members stood at 2.76 billion barrels at September end, the highest level in almost eight years and 4.5 percent higher than a year ago.

The production cut of 1.2 million barrels a day agreed by the OPEC members in October has helped a rebound, although there were doubts about the actual cuts when the decision was announced. Crude prices have now come back to well above $60 a barrel.

And, now another cut is being contemplated by OPEC. OPEC President and Nigeria's oil minister Edmund Daukoru has been quoted as saying that he's “not comfortable” with current prices and is in favor of a further trimming in production. OPEC oil ministers are to meet next week in Nigeria. Will they deliver further cuts? While many members support deeper cuts, some believe that the current price levels are acceptable and can be maintained without further cuts.

Related post:

Of opaque flows, cuts and prices http://aktonmarkets.blogspot.com/2006/10/of-opaque-flows-cuts-and-prices-oil.html