Oil market not driven by supply or demand

[LRE]

By Saadalla Al Fathi, Special to Gulf News
Published: August 30, 2009, 23:03


I have been writing a monthly postmortem commentary on the performance of the oil market, but this month I really thought I should not do so. The reason is the lack of adequate explanation for the price behaviour during the month. Analysts have been expecting a downward correction for some time now but, apart from a modest price drop in July, the market has regained the buoyancy witnessed since March this year.

The average price for the Opec basket of twelve crudes in August is likely to be over $71 per barrel, thereby wiping out the decline in July ($64.59 per barrel) over June ($68.36 per barrel) and going further ahead. In fact the recovery started at the end of July and the August market started its first trading day at $68.59 per barrel. Although prices varied in a range of $68 to $73 per barrel during the month, the market is thought to be less volatile compared with previous months. So what is driving this market and is there a definitive answer to this question?

On the positive side, both Opec and the IEA have made small upward adjustments to their 2009 oil demand estimates in their August oil market reports which now stand at 83.91 and 83.94 million barrels a day (mb/d) for Opec and the IEA respectively. Considering their often reported differences in non-Opec supplies, the call on Opec crude would average 28.45 and 27.78 mb/d for Opec and the IEA respectively. Opec is still more optimistic than the IEA but the difference really should be narrower at this time of the year. Both organisations also expect demand growth in 2010 though there are wider differences in the numbers of both organisations.

Also on the positive side, the statements coming from governments and central bankers are encouraging in the sense that the recovery is under way and that higher investor activities in commodity markets are a clear sign the economy is healing. Ben Bernanke's statement that the economy is "on the verge of recovery", his appointment for a second term in his post as chairman of Federal Reserve, and also rising house sales and durable goods orders in the US drove West Texas Intermediate crude to trade briefly close to $75 per barrel on August 20, the highest in 2009, which is also driven by rising share prices on Wall Street, higher Chinese demand for stockpiling and weak dollar.

On the negative side, however, there is still concern about the magnitude and the pace of world economic recovery, especially in the dominant industrial countries of the OECD. In spite of all the positive signs, unemployment is still rising, though at a lower pace, and heavy government borrowing to stimulate the economy may generate future inflation and the need for more taxes.

Also on the negative side are rising stock levels and Opec overproduction. The latest numbers suggest that OECD stocks are sufficient for 96 days of forward coverage or 16 days more than what they used to be in 2004.

Even petroleum products stocks are high and refineries in the US and Europe are cutting rates to support refinery margins. The cracks between gasoline and distillate prices on the one hand and crude oil prices on the other are lower and worrying refiners, forcing them to cut rates. No wonder attention is turning to the coming Opec meeting in September in Vienna. Here again and because of the numbers discussed above, the meeting is not expected to make major production decisions up or down.

All in all, no one is attributing development of oil prices in August to fundamentals of supply and demand. Demand is weak, supplies are more than adequate and inventories are at an all-time high and therefore stability of current prices would, according to Opec, "mainly depend on clearer signs of improvement in the global economy".

The writer is a former head of Energy Studies Department at the Opec Secretariat in Vienna.

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