Monday, August 31, 2009

Oil: The commodity that's largely ignored the U.S./global recession

By Money Matters Editors

What’s the most perplexing market in the world? Well, a strong case can be made that it’s the oil market.

The oil market’s fundamentals – primarily high inventories - argue that the price should be considerably lower, perhaps as low as $40-45 per barrel, and yet, oil’s price hangs in the $70-range. What’s going on here?

Some assert that market speculation - institutional investors who establish positions in oil not for industrial reasons, but simply as an investment - are keeping oil’s price artificially high, or above where it would be based on supply/demand fundamentals. Net long positions did increase in the past week to more than 16,800 contracts - a period when oil briefly neared $75 per barrel - according to the Commodity Futures Trading Commission, marketwatch.com reported Monday.

Can oil bulls keep crude’s price high?

Still, it remains to be seen whether the oil bulls, including speculative longs, can keep oil near $70 amid plentiful supplies and slack demand. On the former, oil storage facilities on land have started to run out of room, so oil holders are storing oil in super tankers at sea. On the latter, slack demand in the U.S., due to more than 6.8 million job lay-offs since the recession started, and modest demand increases in emerging markets, have been unable to prevent supplies from building.

This fall, the U.S. Congress is expected to again take up the issue of the role speculation plays in the price of oil futures, including considering proposals to limit speculative positions by increasing margin requirements, or by capping the number of positions an institution/trader can hold, and certainly if oil remains at its current lofty price, there will likely be increased pressure to investigate market participants who trade the world’s most important commodity.

On the other hand, if oil’s price corrects back to $40-50 per barrel, the pressure on Congress to investigate may lessen. Where’s oil headed from here? If emerging market GDP growth in Q3 meets/exceeds expectations, that will keep oil at/near its current price, about $65-70.

However, if any signs of lower-than-expected Q3 GDP growth in Asia, especially China, appear, that will bring the oil bears out in force, and oil will likely drift back toward the $50-range heading into the end of the year.

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