The Hindu Business Line : Crude consolidating; to trade in wide range

Crude prices have retreated from their record high levels of over $145 a barrel to around $125 a barrel in recent days. A notable part of speculative froth has perhaps vanished as tactical investors have liquidated their exposure; but, surely, there is nothing to suggest a further deep correction from the current levels.

Many factors

The recent fall in prices can be attributed to more than one factor. For one, concerns over global economic growth refuse to go away. Growth is clearly slowing, as confirmed by the latest OECD leading indicators. As a consequence, consumption demand for commodities in general and energy products in particular is set to decelerate.

Another reason is the strong possibility of government intervention in commodity markets, especially to trim the role of speculation.

Investigations, largely inconclusive, have been going on. There is an apprehension the regulators may take precipitate action to curb speculative activities in the market.

It is also highly probable that investors have migrated to other markets such as equities which have begun to perform better of late, in the US, in particular.

In some sense, therefore, market fundamentals have caught up. The sell-of in crude and resultant price action may be seen as fundamentally justified. But where markets have moved - either up or down - in disregard of fundamentals, a correction is inevitable, sooner or later - sooner rather than later in many cases.

Crude in one market whose fundamentals are tightly balanced which actually heightens the price risk, should the market get into clear surplus or deficit. If anything, the crude market is unlikely to get into a surplus anytime soon. Crude oil stocks globally are low. Projected growth in demand and supply in the coming months do not suggest inventory build up.

Supply vulnerable

On the other hand, the supply side looks vulnerable. The non-OPEC supply has underperformed in H1 2008; and there is nothing to suggest an improvement in H2 of the year. The extra oil that Saudi Arabia can supply can be easily absorbed by the market.

Importantly, experts assert there is little spare capacity across the supply chain. Geopolitics, particularly, the potentially explosive situation in the West Asia is a cause for worry.

Slowdown in demand

On the demand side, there is a clear slowdown. OECD demand, especially the US, is weakening. OECD consumption, year-on-year shrunk in H1 2008. However, it is largely offset by consumption growth in non-OECD countries such as China and India. This will mean little slack in the system. So, what’s the likely price scenario for crude oil? Interestingly, there is no consensus over the long-term equilibrium price for oil; but there is a widespread belief that the market is now in the consolidation mode.

On current reckoning, and given the current market fundamentals and likely changes, for the next quarter, it seems highly likely that crude will trade in a wide range of between $115 and $140 a barrel.

The recent correction together with continued fundamental tightness would suggest volatile conditions in the crude market. A fall below $120 would provide the buying opportunity. Government policies and the role of the regulators to curtail too much money flowing into the derivatives market need to be watched.