Strong reasons to sell keep oil prices down

Abu Dhabi: Despite gains in Asian and European bourses, and an impressive 500 point rally in the Dow Jones Industrial Average on Friday, the New York Mercantile Exchange's West Texas Intermediate closed at $49.93 a barrel (Dh183.40).

Light sweet crude hasn't been this cheap since May 2005. All the back months are topping out no higher than $84.00. Brent closed at $49.25. The local Dubai Mercantile's Oman heavy sour nearby future closed the week at $43.50, gaining back $1 per barrel on the final day of trading.

Why the dramatic selloff?

Two main reasons: (1) Leveraged positions are still being unwound to increase cash balances and reduce losing positions. This is adding supply to a market already in surplus. And, (2) in the presence of continually falling prices traders and crude inventory owners are acting as they did when prices were steadily rising - only in reverse. Sellers are in a panic to sell before prices fall further but buyers are in no hurry to buy, creating price gaps and steep declines in a relatively short time period.

The Chicago Board Options Exchange's $30.00 puts, or options to sell oil at $30.00, are selling briskly. Local crudes will likely be selling in the $30.00 range before rising back to higher price ranges perhaps later in 2009.

Traders on the fundamentals of supply and demand are taking losses as prices fall below their long run valuations; while technical chart traders have no tools to analyse recent and current price moves, since none of the patterns or usual relationships are providing any useful guidance.

Adnoc's Murban is still selling at a premium to the DME Oman; but downward adjustments are inevitable as new information seems to indicate that its Far East customers may be in serious stress and could cut back purchases in future. Japan, for instance, now has a trade deficit.

And the US dollar's strength is only a relative value, appearing strong in relation to the far weaker European and British currencies. Therefore, oil's price decline cannot be blamed on dollar strengthening but on demand weakening.

Natural gas

The Chicago Board of Options Exchange's OVX volatility index for crude oil closed on Friday at 79.70, down from last week's close of 82.27. This index is a gauge of price volatility; the lower the number the less the volatility and the greater the certainty around current price levels on the part of traders. Last week's slight decline indicates the possible building of a consensus that current low prices are likely to be around for a while.

Natural gas in New York traded slightly higher, reflecting colder weather and seasonal demand increase for space heating and energy generation. The Nymex natural gas contract closed the week at $6.48 per million Btu, up slightly from the previous week's $6.31. All the back contracts remain higher

- Dalton Garis is Associate Professor of Economics and petroleum market behaviour at the Petroleum Institute, in Abu Dhabi