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Are Oil Prices Poised To Spike Again?

Oil prices soared to an all-time peak of $147 a barrel in July, before slumping to below $33 in December as the global economic crisis bit.
Oil prices soared to an all-time peak of $147 a barrel in July, before slumping to below $33 in December as the global economic crisis bit.
Oil prices have more than doubled since the start of the year.

That might be surprising. The world economy is, after all, in the midst of a severe recession brought on by the financial crisis. Global oil demand is still expected to be lower than it was last year

Analysts say one big factor behind the rise is optimism. The dark mood as economies descended into recession is being replaced by hope that the worst might now be behind us.

“There is growing optimism that we are starting to see the bottom of this economic crisis very soon, at least during this summer," says Thina Saltvedt, an oil analyst with Nordea Bank in Oslo. "And what the market is expecting is that as soon as we see the world economy start to gradually pick up again, hopefully some time this autumn or winter, the need for oil and energy will start picking up again as well.”

So it's about expectations that the pace of contraction is slowing, rather than any hard evidence major economies are actually on the mend.

Money Into Commodities

Other factors are helping push prices up.

There’s all that massive spending by governments trying to help pull their economies out of recession.

When you take these two facts together, you have to consider that this level of prices isn’t going to be tenable for long.
If it works, the worry is it could stoke inflation. And so investors typically want to put more of their money into commodities as a “hedge” against inflation, which eats into the value of other investments.

Then there are those production cuts announced last year by OPEC – 4.2 million barrels a day – as it tried to stem the fall in prices.

And though world stockpiles of oil are still high, reports this week showed them falling in the United States, the world biggest energy user.

Then there’s the dollar, which has weakened in recent weeks.

"We see in the last few weeks that there’s a higher correlation between the weakening of the dollar and the oil prices," Saltvedt says. "What we did see in the second half of 2007 and the first half of 2008 was a strong correlation between the oil price and the dollar weakness. So when the dollar starts to weaken and since the oil price is set in dollars, many use oil as a hedge against the weakening of the dollar, so money was moved from the money market, the dollar market, to the oil market.”

So are we in for another spike in oil prices?

Some say that’s likely, but only down the road because the oil price crash led to the shelving of many oil drilling projects, particularly those that are more expensive to develop.

And while that doesn’t affect oil production right now, it will in a few years’ time.

The boss of Shell, Jeroen Van der Veer, this week told an oil conference that the next price spike “may already be in the making.”

“If you cut investments now, that will not influence the production of oil before 2012," Saltvedt says. "And in 2012 we expect the world economy to be back to more normal levels. And when we see more normal growth in the economy, we need more oil and energy.

"So if we see a squeeze in production in 2012, as well as an increase in the demand for oil, we might see a squeeze in the total balance and this will push up prices, maybe to a high level as we saw in July 2008.”

Prices Untenable

In the near-term, though, experts say there’s a risk that oil prices are rising too quickly, too soon.

There could be a correction in store, the argument goes -- especially if those optimistic expectations about the world economy turn out to be unfounded,

“You have to consider that back in 2007, when we crossed over $60 [per barrel], the world economy was growing at a real rate of 5 percent," says Harry Tchilinguirian, a senior oil market analyst at BNP Paribas in London. "Most projections, including BNP’s, are looking at the world economy contracting between 1.5 to 2 percent [this year].

"When you take these two facts together, you have to consider that this level of prices isn’t going to be tenable for long. Eventually what’s going to happen is that some of that oil that’s been stored away will come onto the market. Given what we said about a very weak level of econ activity you could see a very strong correction in the price of oil,” Tchilinguirian added.

Tchilinguirian says he expects prices to drop to the “low $50s” in the next couple of months, before rising again to $65 to $70 a barrel toward the end of the year as the U.S. economy picks up.

But for those optimists seizing on any glimmer of hope, there was another small signal that the global recession might be bottoming out.

On June 11, the International Energy Agency said it expects the fall in global oil demand to be slightly less steep this year – an annual 2.9 percent – than it previously thought.

Still a decline, but a smaller decline.

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