A moderate rebound in crude oil looks to be in the offing after Opec announced its largest output cut
Crude oil futures touched US$ 35.13 per barrel on 24 December 2008 — their four-year low before witnessing a rebound to US$ 40 plus level. The worst-ever global recession is far from being over and the demand destruction across the globe is hurting oil demand. However, a moderate rebound looks to be in the offing in the commodity after the Organisation of Petroleum Exporting Countries (Opec) announced its largest output cut.
The output cut of two million barrels will be imposed from 1 January 2008. The winter season in the US and Europe has started. This, in many ways, is a ray of hope for increasing demand for heating oil in the days to come. All in all, oil is turning out to be a suitable asset to play on the bounce and investors can buy the commodity with a target of US$ 50-US 55 a barrel.
Worries of inflation
The first half of 2008 brought worries on account of inflation. This was the period when crude prices on the New York Mercantile Exchange (Nymex) were spiraling at US$ 147 per barrel. The scenario was transformed quickly in the second half (July onwards) with the sub-prime crisis spreading to the financial and then the auto sectors in the US. As the demand slackened, crude oil prices tested new lows of US$ 35 per barrel in December 2008.
Following the global economic slowdown, crude prices tapered 53% in 2008. Billions of dollars of bailout packages and large reduction in interest rates have been provided so far to recoup the economies. The US Federal Reserve’s lending rates are now at 0-0.25%, and this has helped the other major currencies to rise against the dollar. Yen touched a 13-year high of 87.11 against the greenback on 17 December 2008, while the euro was at two-month high of 1.4718 on 18 December 2008. A falling dollar brings with it a rise in demand for dollar-driven commodities such as crude.
After being bogged down to low levels, crude oil can see swing northward. The recent report from the Energy Information Administration (EIA) highlights the fact that the lack of investment and demand will cause a supply crunch in 2009. The EIA projects crude oil will trade at an average of US$ 51 a barrel in 2009.
Worried by the falling prices, Opec announced in December 2008 that it would cut production by 2.2 million barrels from 1 January 2008 on top of the two million barrels reduced in September 2008. Thus, the total cut is 4.2 million barrels. This is the largest reduction in its history. The supply cut also brought the cartel’s daily supply target quota down to 24.85 million barrels a day. Opec officials have also decided to meet before the scheduled March 2009 conference if prices continue to fall. The affects of supply cuts are yet to be seen on the prices as the 2.2 million barrels cut imposed by Opec was scheduled from 1 January 2008.
Geopolitical tensions have always played a vital role in reviving crude-oil prices. The recent tensions between Israel and Hamas in the Gaza strip supported prices from falling further in the international markets as there were concerns of supply disruptions. The Nymex light sweet crude oil futures ended the year at US$ 42.42 per barrel. With a fall of 53%, the price is at a four-year low.
Comparing the last six years’ price data, an interesting picture emerges. Crude-oil prices have a tendency to move higher in the first quarter of the fiscal (Januray-March). This is due to the fact that the winter season in the US and Europe starts prevails at that time and it increases the heating-oil demand in the western world. This increases consumption, boosting crude-oil prices. Although the recession this time is the worst in several years, expectations are that demand will recoup in the coming months.
Crude-oil supplies declined 3.1 million barrels to 318.2 million barrels in the US on 19 December 2008 as per the recent estimates by the EIA. The agency expects non-Organisation For Economic Cooperation and Development (OECD) countries to drive demand for crude oil, and recession in OECD countries will remain in focus. Technically, the charts for crude oil are at breakouts. From here, a move towards US$ 50-US$ 55 per barrel on Nymex and Rs 2400 per barrel on the Multi Commodity Exchange, respectively, seems likely.
The US dollar is also expected to provide support for crude prices. The recent interest-rate cut by the Federal Reserve to 0-0.25% has made the greenback vulnerable against the euro, pound and yen. Therfore, dollar losses will ensure that crude oil maintains a slow but steady path north.