Oil Price Bull

Since mid-February, oil has staged an impressive rally, soaring 42% in little more than a month to above $50 a barrel. There are people that asking me if prices will retreat further amid sluggish demand.

Here is my reply:-

There is no question that downside risk remains. On April 13, the Paris-based International Energy Agency (IEA) lowered its demand forecast by 1mn barrels a day and now expects the world will use about 83.4mn barrels per day in 2009. That would be 2.4mn barrels a day or 2.8%^ less than last year. So far, dwindling demand has failed to contain oil prices.

Having said that I take comfort for the fact that OPEC has made substantial progress in reducing the amount of oil on the market. It has issued three production cuts totaling 4.2mn barrels per day or nearly 12% of its capacity since September 2008. While this has yet to bring back oil prices to desired level of $60-$70 a barrel, the cartel abstained from making any further reductions at its latest meeting in March and even voiced optimism that crude would reach $60 a barrel by the end of the year. OPEC’s discipline has proven many critics wrong, despite foot-draging from Iran and Venezuela. OPEC has gotten about 80% compliance of the 4.2mn bpd production cut. Historically, the cartel only gets about 60% compliance on such cuts.

Also the fact that the US dollar has been made vulnerable by the US Fed Reserve’s aggressive policy of quantitative easing. From July 2007 to July 2008, the dollar plunged 16% against the euro and as the dollar became less valuable the cost of commodities around the world skyrocketed. The Fed’s cut in benchmark rate to a range of 0-0.25% and the $300bn purchase of longer term Treasury securities and $750bn of MBS, along with a corresponding rise in equities, this has been the driving force behind oil’s recent rally.

Last but not least, low oil prices and tight credit have reduced global energy investment, putting future supply at risk. Tighter lending conditions and a trough in oil prices have badly crimped investment and jeopardized future supplies. More expensive energy projects such as oil sands have been put on hold and the number of drilling rigs at marginal shallow-water fields around the world has been scaled back to a three-year low. Oil drilling activity dropped 43% in the 12-months through March, with year-on-year oil exploration in the United States alone down 38%.