Where Is the Oil Price Going?

A combination of factors has come together to depress not just the price of oil, but a wide swath of commodity prices this year. According to the FT, the benchmark Reuters-Jefferies CRB index, a basket of commodities from wheat to copper, fell to a 20-month low of 281.13 points.

The index is down 10 percent for the year to date and roughly 40 percent below the all-time high set in mid-2008. ICE July Brent, the global benchmark for oil prices, fell $2.76 a barrel last week to a 5-month low of $105.65 from a peak of $128 a barrel in early March, while US oil prices fell through the $90 key support level, with Nymex July West Texas Intermediate falling $2.14 to $89.71 a barrel.

So what has engineered such a fall? Is it just a reflection of a depressed global economy?

Well, in part of course it’s a result of slowing demand from Asia, although buying has remained strong even as demand has softened. China in particular appears to be building stocks, probably for security reasons more than an expectation prices will rise. Europe’s woes have added to the sense that the global economy only has one way to go in the near term — certainly investors are having trouble seeing how a Europe with or without Greece in the single currency can achieve any significant growth in the next 18 months, with worse-case scenarios painting an even more dire picture.

Another reason is negotiations between the West and Iran over the latter’s nuclear ambitions have progressed; if slowly, at least (so far) without drama. The easing of tension as a result has taken some of the pressure of prices that had factored in a Hormuz Crisis premium.

The less well-acknowledged reason for the price fall is, well, the Saudis wanted the oil. Saudi Arabia’s influence over the oil price is not what it was back in the 70s when OPEC was the price setter and every word spoken by the Saudi oil minister was followed by the industry, but that does not mean the kingdom does not still hold significant influence.

Production was deliberately raised to counter the threat of oil loss from Iran and Aramco is currently pumping in excess of 10 million barrels per day. Indeed, the International Energy Agency estimates Riyadh pumped 10m b/d in April, the highest in 30 years, according to the FT.

Oil traders anticipate a slightly higher production figure for May and June after Saudi Arabia slashed prices by levels exceeding expectations for crude delivered to Asia, which traditionally accounts for roughly 60 percent of the kingdom’s oil exports. Meanwhile, in the US crude stocks have surged to over 382 million barrels — the highest since August 1990 — as Saudi Arabia seeks to over-supply the market.

Is this a trough or does it have further to fall? As part of a wider fall in commodity prices, most expect prices to continue to come off. Ali Naimi, Saudi Arabia’s oil minister, has said the kingdom favors a price of around $100 per barrel, but the perceived wisdom is they would be willing to let the price under-shoot (maybe $90 per barrel) to encourage inventories to be filled and, the FT’s editorial column says, to avoid the risk of getting embroiled in the US presidential campaign with gas costs becoming an issue.

Certainly, having enjoyed the benefits of oil prices around $120 for several months and with high output, Saudi Arabia can afford sub-$100 prices for much of this year.

While no predictions are made of an end to the super cycle or even price levels 2-3 years out, an oil price of sub-$100 for Brent and sub-$90 for WTI probably will prevail for the coming months.

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