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23 April 2024

No easy upstream flow for oil prices

By Shashank Shekhar
At a meeting of petrochemical producers held recently in Dubai, Laique Rahman, Director of United States Petrochemical Industries, said he expected a turnaround in oil demand (and therefore petrochemical products) around Christmas.

On December 25, crude prices listed by Bloomberg suggested that Rahman and his colleagues did not celebrate as merry a Christmas in their Houston homes as they did last year.

Nymex crude meant for February delivery, Brent spot crude and West Texas Intermediate (WTI) spot crude dropped between 3.38 and 10.51 per cent.

Oil forecasts went awry for all quarters in 2008 and predictions continue to be confusing. This is how they stand for 2009. The World Bank in its latest report titled Global Economic Prospects – 2009 predicted that oil will stabilise at what the Opec giant Saudi Arabia recently termed a "fair price". "Oil prices are likely to average about $75 a barrel next year," the report said.

Rating and analysis company Moody's in its new forecast predicted that oil will average at $50 a barrel – $25 below the World Bank's prediction. Other institutions that analyse energy resources (including Merrill Lynch, PFC Energy and Standard Chartered) have predicted oil prices will fluctuate between $50 and $60 a barrel. Predictions have been revised, re-revised and, in some cases, re-re-revised.

Why is oil so unpredictable when producers can control every barrel that flows out? The ongoing economic crisis has played a large role in making prices so unpredictable.

"Oil prices are generally unpredictable because, in the short term, supply and demand respond little to price. Obviously prices have fallen substantially, but that's a consequence of the economic crisis and sharp fall in demand, which likewise took people by surprise," said Robin Mills, a Dubai-based petroleum economist.

The crash of financial markets the world over have had an impact on the oil markets as well, another analyst said. "Oil prices have been unpredictable recently because of uncertainties surrounding the fate of the world economy. We have seen turbulence in the financial system that has affected the oil prices severely," said Dheeraj Shahdadpuri, an energy analyst with Dun & Bradstreet.

What has particularly been surprising in 2008 is that prices have dropped every time Opec announced a production cut. The most surprising of it came just about a week ago. As Opec announced a 2.2 million barrel cut at its meeting held in Oran in Algeria on December 17, oil prices fell to below $40 a barrel level. This price was last visible on the oil radar in 2004.

Mills said the fall would have been even steeper had there been no cut in production. "Opec cuts have failed to support prices, but prices would have fallen further without them. Partly worries about compliance levels have dampened the impact of the cuts. But partly prices were inevitably going to fall and continue falling as bad demand figures, firstly from the OECD and now China, keep coming in," he said.

Before Opec began its 151st meeting in Oran, analysts had been of the opinion that any decision to reduce production would be aimed at reducing the building up contango (future prices above spot). But the desired impact has not emerged and oil futures continue to be traded handsomely above the spot prices at all the commodity exchanges that trade oil.

"The current spot price being below the future prices indicates that the market expects the future supply/demand balance to be tighter than it is today. This should happen as the impact of the Opec cuts feeds through to the market, non-Opec output is hit by lower prices, and demand stabilises and begins to recover. The current contango is exceptionally steep," said Mills.

It has largely been unnoticed that oil, which once threatened to touch $200 a barrel, began sliding down the price charts with the collapse of leading financial institutions such as Lehman Brothers. "With the collapse of Lehman Brothers the liquidity in the system also is no more easily available, which has affected all classes of assets," said Shahdadpuri.

Since it is the US where the collapse began and as it is the US benchmarks that reflect on prices the world over, oil faced a cascading impact.

"With the deepening of financial crisis, the stock levels of oil in US, which is the world's largest consumer, have increased over the last couple of months, giving clear indications of slowing demand for energy in industries and by the general public," said Shahdadpuri.

The Gulf currencies are pegged to the US dollar and collect their sale proceeds in dollars. This makes oil highly susceptible to the greenback's performance. The US dollar has gyrated in 2008 and likewise oil has danced to a similar tune.

Opec countries repeatedly blamed speculators as they received requests from oil consumers to hike production in July. Their allegations apparently were not far from true and money from pension funds in the US is said to have been thrust into oil markets in June and July. Analysts said there was a sharp decline in prices the moment this money was taken away.

"Oil being a dollar denominated commodity attracts a lot of hedge funds, especially in cases where equities have been battered, which we have seen over the past one year. In my view, during the first three quarters of the year, oil has risen because of falling stock markets (as oil and gold act as perfect hedge for equities) and weakening US dollar. But as we have seen the financial crisis has affected many other nations as well, the dollar has regained its shine due to which we have seen declining interest from the hedge funds," said Shahdadpuri.

Anything from a storm to bad weather can impact spot and oil prices for an immediate future. Even an oil spill or a major announcement of a hike or shaving off of production by major refineries can impact oil prices. News agency reporters have cited incidents wherein they have seen an immediate impact of reporting a major oil industry related announcement on price charts.

However, in 2008 even though such developments kept taking place at regular intervals, the effects where stymied in from of the global economic slowdown.

Things have been particularly frustrating for Opec whose efforts to check crude prices have repeatedly gone in vain. Opec, which accounts for 70 per cent of the world's oil reserves and 40 per cent of its production, has found it increasingly difficult to control prices. Adding all the reductions that have been made since September, a total of 4.2 million barrels of oil will stand slashed from the markets this month. However, that has neither helped in its prime objective of raising the spot prices nor has it impacted the demand.

"Opec cuts will become more difficult and compliance will become increasingly difficult. In the longer term, Opec has to be patient and wait for the cuts to take effect and the world economy to recover," said Mills.

Besides, Opec needs to pull its socks up as far as ensuring compliance to cuts is concerned. What has deeply offset Opec cuts recently was a tremendous decline in demand in the US and Western Europe. The organisation understands this well and is said to have closely analysed winter demand of oil and gas in the US and Europe before announcing its recent cuts.

Russia, which can single handedly determine the effectiveness of the impact of the Opec reduction, has of late been reluctant in standing on its promises.

Gas to average $5.50 this year

Using Henry Hub as the benchmark, Moody's forecast that for 2009 North American natural gas will average $5.50 per million British Thermal Units (BTUs).

"For 2010, this rises to $6.00 and over the near to medium term we assume gas will average $6.50," Moody's said in its latest oil and gas industry report.

The recent Gas Exporting Countries Forum (GECF) saw the Russian Prime Minister Vladimir Putin reiterating the warning that gas will not remain a cheap commodity

any more. The warnings have come time and again with the last one having been made in Doha in 2007.

Though gas prices are increasingly being linked to oil, gas has not taken a beating similar to oil during the ongoing crisis. Gas contracts apparently are long term, lasting for as long as 25 years. This keeps the gas exporters immune (to some extent) from short-term market fluctuations.

The current gas scene looks brighter as compared to oil. On December 25, natural gas futures in New York rose for a second day after a government report showed that the US (gas) stockpiles dropped more than expected last week as a cold snap in much of the US lifted demand. Natural gas for January delivery gained 17.3 cents, or three cents, to settle at $5.91 per million BTUs. UK natural gas and electricity for delivery next month rose on forecasts of cooler weather that may boost heating demand. It rose 1.7 per cent and was selling at $8.86 per million BTUs.