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Bourses and crude oil declining in tandem
With price-inelastic supply and demand, even a modest fall in demand can exert downward pressure on prices.
- By Dalton Garis, Special to Gulf News
- Published: 23:41 November 15, 2008
Abu Dhabi: On Friday afternoon, the Dow Jones Industrial Average went from modest gains to another broad sell-off, falling 337.94 points. Related markets also sold off. The Chicago Board of Options Exchange is now seeing business in $30.00 a barrel (Dh110.22), or options to sell oil at $30.00.
That price has not attracted traders for almost two years. And Brent, against which 60 per cent of the world's crude is priced, is now $53.85, with the Dubai Mercantile Exchange's Oman futures contract, which the previous week stood at $56.17 for the OSP, now sits at $48.30, anticipating a Far East economic slowdown from reductions in exports to Western consuming nations. Just five months after hitting the all-time high of $141.20 for DME Oman, local crude prices have shed 66 per cent of their value.
The next technical support price in crude oil hardly matters now, as we are in uncharted territory with respect to price behaviour, either on technical grounds or based on the fundamentals.
The crude oil risk premium that existed when surplus production was in short supply was taken out of market prices weeks ago.
What is pulling prices down now are the realities of diminishing demand and increasing surplus supply.
The US in particular, the world's largest oil consumer, has reduced consumption by about two million barrels per day. With price-inelastic supply and demand, even this modest demand decrease exerts large downward pressure on prices.
The world is experiencing the largest change in consumer behaviour in three decades: Up to now, world demand has been driven by consumption, utilising large amounts of revolving and rolled-over credit in the developed economies and export-driven growth in developing economies such as China, Brazil and India. Now, that assured source of growth will diminish significantly.
With the change from spending to savings, all sectors dependent on consumer activity are shrinking.
The CBOE's OVX volatility index for crude oil remains in historically high territory, indicating continued anxiety by traders as to what crude markets are likely to do in the near future. But now, the back contracts, those for delivery in months and years into the future, are also shedding value as more certainty exists for longer-term recessionary forces to exert downward pressure on prices.
- The writer is an associate professor of Economics and Petroleum Market Research at the Petroleum Institute, Abu Dhabi
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