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Are Crude Markets In For A Free Fall?
By Syed Rashid Husain

When seen in the background of the worsening global, economic fundamentals, a free fall in oil prices cannot be ruled out altogether. There are definite ominous clouds on the crude horizon that one can't deny. Indeed when the [global] economy slows, so does demand for oil. And this carries price repercussions.

The wobbling state of the global economy, the very prospects of the economy slipping into a recessionary mode once again, are beginning to have ramifications. As the weekend approached in the northern hemisphere, markets were seen hovering around $80 a barrel after touching the lowest level in more than six weeks on Thursday of last week.

Crude for November settlement rose two cents to $80.53 a barrel at 1:50 p.m. on the New York Mercantile Exchange. Earlier, it touched $77.55, the lowest price since August 9. Futures are down 8.4% this week, headed for the biggest drop since the five days ended August 5. Prices have fallen 12% this year.

And as per a Bloomberg News survey of analysts, crude prices are expected to fall further. Twenty-two of 40 respondents, or 55%, forecast oil will decline through Sept. 30, while nine, or 23%, predicted prices will increase. Nine estimated there will be little change. Last week, 45% of the surveyed analysts projected a drop.

As oil markets continued to plunge, investors were seen running for cover as the fears for the world's two biggest economies, the United States and China, added to the tensions surrounding the Euro zone debt crisis.

And it is not just the state of global economy impacting the crude markets. Liquid fundamentals are adding to the woes of the market. "Energy demand is going to be very poor," says Michael Lynch, of Strategic Energy & Economic Research.

"The oil market is on a downside momentum with serious lack of risk appetite," said Myrto Sokou, at Sucden Financial Research. "In addition to the weak macroeconomic data, we have to acknowledge the lack of oil demand from the U.S. and emerging markets, amid ongoing concerns about growth opportunities in the medium-term," he underlined.

And as concerns over the macroeconomic outlook began gaining steam, both the Paris-based International Energy Agency (IEA), and the Vienna-based OPEC, revised their demand estimates lower for 2011 and 2012. The IEA projected oil demand will rise 1.36% to 89.3 mbpd [million barrels per day] this year and then 1.57% to 90.7 mbpd in 2012, compared with previous forecasts of 89.5 mbpd and 91.1 mbpd respectively.

The IEA also trimmed non-OPEC supply due to outages. Non-OPEC output is now forecasted to reach 52.8 mbpd (August: 53.0 mbpd) in 2011 before rising to 53.8 mbpd in 2012 (August: 54.0 mbpd), the IEA said in its report released earlier the month.

OPEC forecast global oil demand will only grow by 1.27% to 88.0 mbpd this year and then by 1.48% to 89.3 mbpd in 2012, compared with corresponding estimates of 88.1 mbpd and 89.4 mbpd made last month, dropping the demand growth by 1.1 million barrels per day - 150,000 barrels fewer than its earlier forecasts.

As non-OPEC and OPEC NGL outputs are expected to remain unchanged, the call on OPEC was also reduced for both the years by the agency.

Both agencies addressed the Libya issue as the civil war is now coming to an end. The IEA raised the Libyan crude production capacity to 350K-400K bpd by the end of 2011 and then to 1.1 mbpd by 4Q12 (Libya's pre-war production was estimated to be 1.6 mbpd). OPEC appeared more optimistic on the resumption of Libya's production capacity. It projected Libyan production to reach 1 mbpd within the next 6 months and 'the restoration of Libyan oil production to full capacity in less than a year-and-a-half appears to be realistic.'

OPEC also trimmed back its oil production outlook, saying it still expects output to increase, but by a slightly smaller - 500,000 barrels per day in 2011 = 80,000 barrels below its prior forecast.

Weaker-than-expected demand from China and "ongoing economic uncertainties" were reflective of a global slowdown in industrial activity in most major economies and this was reflected in the downgrading of demand expectations in the coming months, as the OPEC forecast for global economic growth too edged down to 3.6% for 2011. Previously it was projected at 3.7%. Similarly the 2012 projection was brought down to 3.9% from the previously expected 4%.

Yet despite the beating, Goldman Sachs in a note last week maintained that Brent would average $130 a barrel in 2012 due to tight supply.

However, the bank did revise down its projected price of U.S. benchmark West Texas Intermediate in the next three months due to the disconnect that has emerged between the U.S. crude marker and its European counterpart.

Logistical issues at WTI's delivery point of Cushing Okla. have led to a buildup of oil in the region, pushing down its price relative to Brent. Despite evidence of stock-draws in recent months, the price gap between the two crudes has hardly narrowed. "While we continue to expect WTI-Brent spreads to narrow in 2012, it is likely that the WTI-Brent spread will remain wide in coming months." The bank however, lowered its forecast for WTI significantly to $97.50 a barrel from $115 a barrel.

Prices "remain strong despite the market's concerns that rising sovereign debt issues and a significant slowdown in economic growth could push the US economy back into recession," said Goldman analysts in a weekly energy report.

Goldman Sachs said the "tight" oil supply has been alleviated somewhat by the release of 600,000 barrels per day, over the last seven weeks, by the Strategic Petroleum Reserve. But this won't last forever.

"We therefore expect that the market will tighten further for the remainder of the year and going into next year as this source of supply disappears, effectively drawing down OPEC spare capacity and pushing prices higher," wrote Goldman analysts David Greely and Stefan Wieler.

Global economy is passing through a turbulent phase. And when the economy melts, the prospect of crude markets surging becomes too tenuous.

Added with the growing emphasis on efficiency all around and the emergence of new frontiers in the search of new resources, oil markets are expected to be in for a bit of battering in the short to medium term. The oil scene supports the argument that neither is there any dearth of resources, nor is the demand going to increase fast enough to outpace supplies - at least in the short to medium term. The global oil demand - supply balance is thus expected to stay in a comfortable zone for some time to come. The current scenario is to ensure balanced fundamentals for some time to come. Hence despite the Goldman projections, oil markets are expected to continue to wobble and stay around the $100 mark - at max - for some time to come, one could dare say.

Crude markets are in for a rather arduous time.

Source: Arab News, Saudi Arabia, September 25, 2011. Changes were made in keeping with the editorial policy of www.memrieconomicblog.org

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