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Tuesday, June 23, 2009

OPEC's Report: Oil Market Have Entered A New Environment

Tuesday, 23 June 2009

As oil prices seem to have stabiles at levels over $70 per barrel optimism has returned to the market. At the same time the need of pumping more oil from OPEC members emerged again as the fear that economic crisis is not yet history still exists. At its last Monthly Oil Market Report, covering the month of May, OPEC underlines that the worst has passed for the world economy, but at the same time, it marks key uncertainty facing the market is the sustainability of the more optimistic sentiment currently in the market.  “A key uncertainty is the sustainability of the more optimistic sentiment currently in the market, which will largely depend on improvements in the real economy and in financial markets. While the acute tightness in credit markets has begun to ease and equity markets have staged a steady recovery – although from a low base – economic prospects for the coming quarters remain uncertain. Despite spreading optimism that the deep economic downturn may reach bottom in the coming quarters, the world economy is still facing considerable challenges. In the
OECD region, unemployment is still rising; bank balance sheets remain shaky; and private consumption, investment and exports are expected to remain subdued. These concerns could dampen or delay a global recovery. Moreover, markets are beginning to worry about the consequences of the huge public deficits”.
OPEC’s report acknowledged that the oil market appears to have entered a new environment. At the beginning of the year, most institutions were expecting that a continued deterioration in fundamentals would naturally exert downward pressure on prices, particularly over the seasonally lower-demand second quarter. However, despite continuous downward revisions to economic growth and demand expectations along with a growing supply overhang, such pressures never materialized. Instead, prices have not only remained steady but have even moved higher. Between February and May 2009, inventories and prices switched from the traditional inverse relationship to move in parallel, with higher inventories coinciding with higher prices.
Financial market developments have been an important factor behind this recent divergence between oil market fundamentals and prices. Crude oil prices have shown a strong correlation with developments in the equity markets as well as fluctuations in the US dollar. The rise in equities generally reflects an improving sentiment about the
outlook for the world economy and hence oil demand growth. As a result, crude futures and equities have risen in tandem, on the general perception in the market that the worst is over for the world economy.
The growing imbalance has resulted in a contango market structure which has provided an incentive to build inventories both onshore and in floating storage. This has helped to push OECD commercial crude oil inventories toward maximum operational capacity, last experienced at the time of the Asian crisis in 1998. However, looking at the difference with the five-year average, inventories appear to have peaked. This turnaround is in large part due to OPEC efforts to stabilize the market by reigning in excess supply and is the result of strong compliance of
the OPEC Member Countries with production adjustments. Moreover, seasonal demand changes and the narrowing contango should also support a decline in the overhang in OECD crude stocks and floating storage, although from very high levels of 70 mb and 100 mb respectively.
As for the oil market, demand for gasoline typically surges during the summer driving season and refiners try to increase their throughputs. Over the last few weeks, some positive developments have been seen in the gasoline market.
However, under the current economic situation, gasoline demand is not expected to increase significantly in the coming months and hence would provide only limited support for the oil market. Additionally, ample spare refinery capacity in the Atlantic Basin should ease any risk of gasoline supply shortages during the current driving season.
In light of the considerable challenges the world economy and commodity markets, particularly the oil market, have undergone, the worst appears to be behind us. Providing this more optimistic sentiment holds, ongoing efforts to reduce the excess supply is the key factor in supporting market stability and should help to gradually bring commercial inventories back to more healthy seasonal levels by the end of the year. In line with these efforts, OPEC Member Countries at the recent Meeting of the Conference have reiterated their firm commitment to agreed production levels, as well as their readiness to respond swiftly to any developments which might place oil market stability at risk.