When 2010 began, the world was different. More positive sentiment was around. With evidence mounting that the global economy was on the mend, with the euro zone, Japan and the US emerging from a deep recession, oil markets were trading at around the $80 mark — rising almost eighty percent from a year ago.
In sharp contrast, here we are, in end 2010, barely out of the Great Recession, with the jobless rate hovering around 10 percent — twice the levels in 2007 — 08 and the housing sector in the US continuing to languish in the intensive care with existing home sales down 27.9% year-over-year in November. The perspective is not that bright.
And this brings us to the question — how could crude be at this price level, given ample supplies, considerable spare capacity and a lack luster macroeconomic indicators?
Indeed severe winter and snowstorms have hit parts of Europe buoying the expectations that fuel demand will increase. Crude markets have definitely responded to the galloping winter demand and temperature factors. Energy demand in China continued growing despite projections of a slowing dragon, adding to the global demand picture. The Chinese economy is expected to expand by 9.1% in 2010, with its oil demand expected to grow 10.4 percent this year. So there are anticipations of a increasing consumption momentum.
Yet in the immediate sense, the biggest mover for energy markets appeared financial investors,” said Juerg Kiener, chief investment officer at fund manager Swiss Asia Capital Ltd. in Singapore.
“The additional liquidity pumped into the markets by the Fed’s Treasury purchases should also reach commodity markets and is thus leading to increasing oil prices,” analysts at the Frankfurt-based Commerzbank AG said. “What is more, the higher price level reflects the weaker US dollar which is a direct consequence of the ultra-expansive US monetary policy.”
When oil reached its record high in 2008, it was largely because speculators had piled into crude — and a host of other commodities — to hedge against the beleaguered greenback. Similar behavior appears in play once again.
Oil markets are peculiar — they transcend the simple supply and demand equation. Other factors, including investor sentiment and the value of the US dollar, are always at play.
Because oil is priced in dollars, it is vulnerable to changes in the greenback’s value relative to other currencies. A stronger dollar makes oil more expensive.
Currently, the US Federal Reserve’s commitment to a loose monetary policy has undermined the value of the dollar. Furthermore, the Fed has effectively flooded the system with cheap money, meaning there are more investment dollars available for commodities such as oil.
The price of oil has climbed up by more than seven percent since the Fed on Nov. 3 announced it would buy an additional $600 billion of US Treasuries through June, and it’s surged some 17% since mid-August, when the Fed first indicated it would consider a second round of quantitative easing.
Expectation of inflation, improving global growth, and increasing risk appetite because of the US Federal Reserve’s QE pumping up the economy, have understandably driven investors to plow money into the commodities and stocks at a record pace. This massive Quantitative Easing (QE) liquidity is a major factor in the current strong correlation between WTI crude and S&P 500 — another reversal of historical pattern. The broader equity and commodity markets, including crude oil, are artificially supported by the US Federal Reserve, and largely detached from the market demand and supply factors.
This is happening despite indications that the Chinese dragon is slowing. Beijing has just slapped a 4 percent hike on domestic gasoline and diesel prices effective Dec. 22. This and other tightening measures to fight inflation, is to crimp growth as well as oil demand in China, the major growth engine of the world.
Oil producers too realize that high oil prices could trigger a global recessionary cycle. Bank of America Merrill Lynch estimates that a $15 rise in the price of oil could shave about half a percentage point from US economic growth in 2011, enough to wipe out the Fed’s QE2 effect. The deepening European debt crisis may also have lasting impact on the state of the global economy.
The issue of US sovereign debt and/or municipal debt crisis is also looming large on the horizon and the escalating geopolitical tensions in N. Korea, the Middle East, could also impact the global demand scenario.
Right now, speculative longs are dominating the crude market with hedge-funds and other large speculators long positions outnumbered short positions by 205,890 contracts in the week to Dec. 14, according to the Commodity Futures Trading Commission (CFTC).
And it was perhaps in that perspective that Shukri Ghanem, chairman of Libya’s National Oil Corp., said in Cairo as Arab oil ministers and officials gathered for a meeting on Saturday, ‘Oil prices will climb to $100 a barrel.’
Strategists at Goldman Sachs Group Inc., Morgan Stanley, JPMorgan Chase & Co. and Bank of America Merrill Lynch also underpin that prices will return to $100 for the first time in two years during 2011.
Global Insight, in conjunction with affiliate IHS Cambridge Energy Research Associates, sees oil averaging $88 a barrel next year, $95 in 2012 and topping $100 by the end of 2013.
Others peg oil even higher. Hussein Allidina, head of commodity research at Morgan Stanley, estimates crude will average $100 a barrel in 2011 and $105 a barrel in 2012. Goldman Sachs sees oil at more than $100 a barrel in 2011. Financial markets are playing a lead role in this transformation.
Non-fundamentals are driving the market. Trading legend Jesse Livermoore, once said, ‘remember, the market is designed to fool most of the people, most of the time.’ And the oil markets continue to do so, baffling even the pundits.
