Oil prices are back at record levels. The benchmark West Texas Intermediate contract hit $101.32 a barrel on Wednesday after staging a dramatic recovery from a low of $86.24 only two weeks ago. The rally has caught many investors by surprise, given a clear deterioration in the global economic outlook.
Oil first reached $100 on January 2 but WTI was unable to hold that elevated level amid rising fears of the US economy sinking into recession.
These concerns were amplified by downward revisions to projections for world demand growth in 2008 with the International Energy Agency cutting its demand forecast by 500,000 barrels a day.
The darkening outlook encouraged hedge funds to open short positions – bets on prices falling – in an attempt to profit from negative macroeconomic views. But efforts to drive prices below $87 were met by substantial consumer buying.
“Shorting oil on account of a negative view on the US economy is always very dangerous and likely to backfire, because global oil demand growth is centered on emerging markets,” says Paul Horsnell of Barclays Capital. “We are now seeing those who made such a macro call exit those positions.”
Mr Horsnell says oil prices are set to consolidate in the high $90s, but they could also see increasingly frequent moves above $100.
The entire WTI futures curve is currently trading above $90, suggesting the market believes high prices are sustainable.
Harry Tchilinguirian, senior oil market analyst at BNP Paribas, highlights developments in the options market. “Open interest on call options (the right to buy) is creeping higher on the April futures for strikes from $105 to $120 alongside the symbolic $100 levels,” he says .
He maintains an economic slowdown in OECD countries is likely to have only a moderate impact on energy-intensive emerging markets.
The perception that strong demand in emerging economies is tightening the global energy market is supported by historically low levels of crude stocks in OECD countries. Supply disruptions in Nigeria and the North Sea are also helping prices recover.
But Opec has helped alter the market’s mood. Investors realised Opec is prepared to defend oil prices at higher levels after the cartel decided to keep its production quotas unchanged at its January meeting, rebuffing calls to increase supplies, most notably by president George W. Bush.
Since then speculation has mounted that the cartel’s next move will be a supply cut. Earlier this week, Chakib Khelil, Opec president, indicated production would either be cut or left unchanged at the cartel’s March meeting.
Rising volatility in credit and equity markets has also fuelled a significant increase in investor inflows into commodities this year.
“The oil complex is benefiting from fundamentals and money flows,” says Adam Sieminski, chief energy economist at Deutsche Bank: “Investors are looking for a place to put their funds where they don’t have to worry about subprime. The move above $100 is likely to reverse but selling oil keeps proving to be bad advice.”
