Business | Oil & Gas

Diminishing demand drives oil prices down

The Organisation of Petroleum Exporting Countries (Opec) met last week in an emergency meeting in Vienna in an attempt to halt crude oil's steep and sudden price decline, but without success.

  • By Dalton GarisSpecial to Gulf News
  • Published: 23:33 October 25, 2008
  • Gulf News

Abu Dhabi: The Organisation of Petroleum Exporting Countries (Opec) met last week in an emergency meeting in Vienna in an attempt to halt crude oil's steep and sudden price decline, but without success.

In fact, after the announcement of a 1.5 million barrel per day (bpd) production cut, prices actually fell another $3 on the New York Mercantile Exchange and the Brent benchmark fell on the Intercommodity Exchange.

The Dubai Mercantile Exchange's Oman futures contract broke through $60 per barrel on Friday, closing the day (OSP) at $59.90, and hit $56.40 in after hours trading.

The key to this dramatic price decline for Gulf crudes is the concern that China may have weaker macroeconomic projections than previously expected, with its economy possibly being hurt more by the international trade decline, than at first thought. This would pull demand down for Gulf crudes.

Opec is in a quandary: As they cut production, it just increases the amount in reserve. Already, North America and the US are showing a demand reduction of about two million bpd, leaving a sizeable production surplus ready to supply markets in case of emergencies. This has almost completely deflated the risk premium which has existed in oil trading since the daily oil balance of production surplus over demand fell to below two million bpd about three years ago.

Now, with demand quantity cuts in North America and Europe, and now in East Asia, the daily oil balance is likely above four million bpd, which is seen by traders as more than adequate to meet any perceived supply emergency. Opec reducing production only adds to this reality and actually reduces crude prices in the short run.

The North American crude benchmark, West Texas Intermediate, traded on the New York Mercantile Exchange, is now at $64.15 for December delivery, down from $71.85 last week for the then-active October contract.

The Chicago Board Options Exchange volatility index for crude oil, the OVX, is an option contract on crude oil price volatility. When volatility is at a normal, historical rate, the index is in the 30s to 40s range. The OVX closed last week at 81.88, one of the highest scores on record. It indicates that the direction of crude oil prices is extremely volatile and unknown.

The writer is an associate professor of Economics and Petroleum Market Research at the Petroleum Institute, Abu Dhabi.

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