Oil's Outlook Is Hard to Refine
Just over a month ago,
dominated the economic conversation in a way it hadn't since before the financial crisis kicked into high gear in September 2008. Prices had more than doubled, to over $70 per barrel, and talk of a new oil spike made the rounds on Wall Street.
But things move quickly in the financial world these days, including oil boomlets. On July 8 The Wall Street Journal published an op-ed written by French President Nicolas Sarkozy and British Prime Minister Gordon Brown that blamed commodity traders for adding volatility to the market. Meanwhile, the Commodities Futures Trading Commission, spurred on by Congress, threatened to take action against speculators in the market.
As summer began, crude prices fell back to $60, and Wall Street's attention turned elsewhere: Second-quarter earnings season loomed, ( (CIT)) teetered on the edge of bankruptcy.
All Over the MapAmid the near-term uncertainty, energy traders continue to position themselves for the future. But what does the future hold?
Predictions are all over the map. Estimates range from a low of $40 to a high of $80. With a range that wide, one would expect oil bulls and bears to have widely divergent views on the fundamentals.
Surprisingly, that doesn't seem to be the case. Both sides see similar market dynamics at play. Ultimately, the differences may come down to belief—belief in the economy's strength, belief in OPEC members' ability to toe the production line, belief that supply and demand will eventually find balance.
Bulls and bears agree that 2008's economic collapse devastated the market. Demand plummeted, and attempts to reduce supply by OPEC and other producers could not keep up. Inventories worldwide increased rapidly to about 600 million barrels more than was needed to meet demand, according to a report from the Benchmark Company, an independent brokerage.
Bulls and bears both agree that the situation has begun to correct itself, with the current global imbalance cut in half to around 300 million barrels.
Toeing the Line on QuotasIt's what happens next where they diverge. Start on the supply side. OPEC, not normally known for its discipline, has been remarkably good at meeting its production quotas. This has played a big role in reducing some of the supply overhang. For oil to go higher, OPEC will have to stick to its production targets.
But the cartel's discipline is often tested when members get a whiff of higher prices. Oil bears find it hard to believe member states will toe the quota line, especially now that crude has rebounded from its lows. "OPEC should have some slippage as people want to produce to have some more money," says Ben Halliburton, chief investment officer of Tradition Capital Management in Summit, N.J.
Much too, will depend on the economy. Across most U.S. industries, inventories fell further and faster than consumer demand as the downturn progressed. Oil has been one of the few examples to the contrary. Now, economists expect companies to start building up inventories once again, spurring growth in the economy. That, in turn, could help goose demand for petroleum.
Bulls and bears agree that economic growth won't eliminate the imbalance between supply and demand, but it will help reduce it. That should be enough to keep prices above $75 says Barclays Capital ( (BCS)) oil analyst Costanza Jacazio. "If the market continues to rebalance, then [$75 oil is] achievable," she says.
Following the MarketOr maybe, just maybe, the price of oil will have nothing to do with fundamentals at all. In a recent report, Nomura Securities predicts that oil will stay around the mid-60s for the rest of the year. But they give two alternative predictions, both based on investor appetite.
Scenario One: If stock markets trend higher, the dollar falls and investors start putting their dollars to work, the price can climb above $75. But if the markets start to fall, and investors get fearful, then oil will fall with it.
"Oil is looking ahead. It always is," says T. Rowe Price ( (TROW)) analyst Tim Parker. "But there's nothing to say that it can't stay at these prices."