Oil price surge not good for market

Oil prices have soared to their highest level in nearly three years and could smash through the $100-mark, putting further pressure on the already fragile recovery in the global economy, a UAE think-tank has said.

After a period of relative improvement and stability, crude prices swung to their highest level in nearly three years at the end of 2010, with spot prices inching towards $100 a barrel, the Abu Dhabi-based Emirates Centre for Strategic Studies and Research (ECSSR) said in a comment.

It said prices soared despite a supply overhang, around two per cent growth in demand and a somewhat uncertain economic outlook – factors that should have neutralized each other instead of causing a spike in oil prices.

It warned such a large increase in prices could jeopardize possible global economic recovery, fuel inflation and have other major repercussions.

ECSSR, one of the region’s most prestigious strategic centres, said consumers may have to pay more for fuels and commodities while air travels may become expensive as airlines re-impose fuel surcharge fees to cover rising jet fuel cost.

On the other hand, for an embattled country such as Iraq, this will mean rise in revenues and minimizing deficit, it said.

 At a policy level, it can lead to even greater emphasis on renewable energy and conservation while there was also that inevitable impact on the Arab stock markets that ended 2010 on an upbeat note over rising oil prices.

Citing official and independent reports, ECSSR said the sudden rise is attributable to various short-term factors, including extremely cold weather conditions in the Northern Hemisphere.

But perhaps the biggest influencing factor is the US Federal Reserve or Fed pumping money into its economy, it said.

According to some economists, additional liquidity making it to the markets by the Fed’s Treasury purchases is reaching commodity markets and is causing spike in oil prices. Weaker US dollar, which is also a direct consequence of the ultra-expansionist monetary, supports dollar-denominated commodities such as oil.

“Whichever way one looks at it, oil prices are bound to become a barometer of investor sentiment on the state of the global economy. Reactions vary depending on which way the graph is headed. Consuming countries typically cry foul over the rise while producers and the industry call it fair,” it said.

“This is probably because both realize that market sentiments and not pure fundamentals are determining its course…. since high oil prices could also impact the global economy, on which oil producers are equally dependent, it is not quite a win-win situation for any.”

The report warned that all those factors may combine to carry the price of crude beyond $100 a barrel. “Added to this is Opec’s decision to hold production quotas at present levels – even though the demand has recovered to 2008 levels – and there is only one way the price is headed for the moment.”

The report noted that the influence of financial demand for oil is evident in the fact that financial futures have grown from twice the size of physical oil markets 15 years ago to almost 12 times the size now.

“With futures trading essentially based on anticipation, market sentiment about the direction of the global economy is likely to override supply and demand fundamentals…….as a result, oil prices will remain sensitive to investor sentiment on global economy during 2011, apart from exchange rate movements and China’s battle to control inflation,” it said.

“Opec too is sensitive to oil prices responding to non-fundamental factors. The Organization believes it should not pump more if the hike resulted from speculation rather than any supply shortage.”
The report cited Opec’s data showing the rise in oil demand is mainly emanating from China, India and the Middle East itself.

“Saudi Arabia is now the second fastest growing oil market after China. Things are not very different in other GCC countries as well. In fact so rapid has been the recent expansion in domestic oil and gas consumption in GCC that authorities here are looking to curb demand to ensure a steady energy supply over the long-term,” ECSSR said.

“However, there appears to be a consensus over oil crossing $100 a barrel during 2011. As the world watches the oil graph with bated breath, those in the financial markets would see it as the next big trend.  Oil is hot investment for 2011 and, whichever way one looks at it, the words to watch this year with regard to oil prices will be bulls and bears and not demand and supply.”

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