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Oil markets well placed or on a knife-edge?

Buoyancy of prices has depended on medium-term hopes of a global recovery now in doubt

Gulf News

On the face of it, nothing very much is happening in the oil market. Brent and related prices have stuck fairly closely to the $100 mark that represents a reasonably comfortable level for producers in the Gulf.

The gathering of the Organisation of Petroleum Exporting Countries (Opec) in Vienna a few weeks ago quietly rolled over the existing production quota, conscious that the world economy has probably needed the gentle softening in the cost of crude that has occurred in recent months. Saudi Arabia has been reported as even raising monthly output in anticipation of summer requirements.

Moreover, in recent weeks it has also become apparent that the heavier, sour crude emanating from the Gulf and Russia has been in greater demand in Asia, a trend not reflected in the benchmark price series of both Brent and WTI.

Apart from the fact that some non-GCC exporters are more concerned about the implications of the US’s unfolding energy revolution, there’s a certain tension between the time horizons represented in the current trading range.

It may reasonably be expected in the short term that seasonal pick-up will be repeated, referring to the so-called driving season in the US, and the Gulf’s need of its own resources as the regional climate imposes its stifling burden.

Equally, for the medium term the unconvincing nature of the global rebound from financial crisis says something quite different about the likely strength of demand relative to supply, i.e. the fundamental balance of the market over time.

Naturally enough, any given price prevailing is accounted for by offsetting factors. But in the present circumstances there may be a sense of a narrowing of that bridge, to perhaps tightrope proportions, if in fact the prospect in the months ahead is tougher than lulled perceptions might have imagined.

To the extent that oil has not shared so much in the general weakening of commodities thus far in 2013, it might be taken as a bullish sign of conditions, or alternatively an indication of a disconnect between the physical market and the positioning of traders taking a bet on an economic recovery that may not materialize.

The International Energy Agency’s (IEA) recent medium-term analysis was described as bearish in its slant, recognizing the supply shock that North America has imparted, while Opec’s latest monthly report spoke of the “uncertainties” and “challenges” ahead in the second half of this year, for which bank research arms are said to be forecasting moderate price declines.

Certainly, the international financial markets have signalled in the past week their fragility in the potential absence of the life support of liquidity offered by the US Federal Reserve and the systemic difficulties holding back the Chinese economy. There is a disturbing story still waiting to be played out, one could say.

Given the growing nervousness over the scale and sustainability of real economic growth to be derived from the massive monetary injection attempted by leading governments, it makes you wonder how much oil prices actually respond to the respective, headline economic variables.

Furthermore, might speculative movements again overshadow trading (although the fact that seasonality can be a recurring factor in such a developed market at least suggests that ongoing conditions do account substantially for realized price trends).

In a recently-released explanatory paper, the US’s Energy Information Administration (EIA) noted that such financial positioning has actually reached record levels in 2013, in terms of the number of contracts struck in oil futures, owing to the influx of participants into the market.

While the relevance of oil to indicators of the world economy is obviously circular (i.e. cause and effect), both academic studies and official observations as to the two-directional causality of oil prices with inflation and growth are inconclusive, seeming to depend on modelling techniques.

So the element of guesswork would appear to rank especially highly in predicting oil (considering that economic forecasting per se is very hit-and-miss, arguably unscientific, in nature), except insofar as Opec is able promptly to regulate adjustments as they arise.

The IMF’s latest regional outlook concurred with the essentially untroubled tone for the moment. The oil-exporting GCC countries “generally face a benign outlook”, it said. The caveat was familiar though slightly ominous: “If the global outlook worsens, [they] would also face serious pressures. A prolonged decline in oil prices, rooted in persistently low global economic activity, could run down reserve buffers and result in fiscal deficits.”

With GDP growth predicted sideways at an agreeable 4 per cent for the GCC this year and next, the accompanying chart shows that the comfort zone afforded by positive financial balances is contracting, viewing the pending slippage in current account and fiscal surpluses.

Is it only paranoia to suppose that one day these concerns may truly register? Is the hush surrounding oil a genuine calm? Or does the anticipated jitteriness of stock and bond markets carry a note of broader foreboding for oil as well?


GCC financial balances