Global Insight Perspective | |
Significance | The US$100/b price point has been passed before, but this was the first time that oil prices closed above this symbolic level. |
Implications | The price surge followed rumours that OPEC was planning to cut output at its 5 March meeting, coupled with a refinery explosion in the United States and heightened security concerns in Nigeria. |
Outlook | Oil prices are a key factor in global economic prospects for the coming year, and although Global Insight still expects them to fall back as supply/demand fundamentals reassert themselves, yesterday's record close was nonetheless a heavy blow for fragile investor sentiment. |
Record-Breaker
Not one, but two records were broken yesterday on the New York Mercantile Exchange (NYMEX) for March-delivery crude oil futures. Not only did prices hit a new record of US$100.10/b, but they also closed at a new all-time high of US$100.01/b—up US$4.51 on the day. Meanwhile in the United Kingdom, on the London markets, Brent crude futures for delivery in April closed up US$3.65 to US$98.56/b. The previous NYMEX peak was set in early January when crude oil prices reached US$100.09/b. The cause of that particular jump was said to have been one trader wishing to make a mark for himself, but the successive records have nonetheless highlighted what appears to be a disconnect between the actual price level and where prices should be given supply/demand fundamentals.
Yesterday's peak came upon expiry of the March futures contract, so it is likely that trader position covering was a contributory factor in the rise. Other prime suspects have included initial rumours circulating that OPEC was planning to lower oil output at its 5 March meeting. These rumours have since been displaced by an expectation that current production rates will remain untouched. The cartel, which is responsible for nearly a third of global oil output, continues to maintain that the world remains well supplied, although the future oil demand outlook remains uncertain. It has come under heavy pressure from many quarters to open up the taps, but it has firmly resisted of late.
Two other news items may have also played a role in prompting fresh oil price records: an explosion at a U.S. refinery and suggestions that a prominent member of a Nigerian militant group had been killed. As far as the former is concerned, a blast at Alon’s 67,000-b/d Big Springs refinery in Texas this week put the facility out of commission, with suggestions that it could be offline for as long as six months. This estimate has since been toned down to two months. In Nigeria, there has been speculation that Henry Okah, the financier and gunrunner of the notorious Movement for the Emancipation of the Niger Delta (MEND) militant group, had been killed while in government custody. MEND has itself waged war on the country’s oil output for years, and rumours of Okah's death have prompted concern that fresh attacks might be on the way. The Nigerian government has insisted that he is alive.
Market Reaction
Equity markets have taken another battering on the oil price news. Stocks fell yesterday in the United States, and have led Asia and Europe lower today. The prime concern is that high oil prices will dampen consumer spending, and hence economic growth and business profits. Inflationary pressure also restricts policy options on the part of monetary authorities. Other factors in the mix include the ongoing heavy writedowns by banks hit by the sub-prime/credit crunch crisis. At the time of writing the Morgan Stanley Capital International (MSCI) World Index had lost 0.9% over the day, the biggest drop in two weeks. The index has now lost 9.4% in total this year. Most of the key European indices were down at the time of writing to the tune of between 1.1% and 1.3%. Asian stocks shed around 2% over the day.
Outlook and Implications
Oil is now some 67% dearer than it was a year ago when prices were around the US$60/b level. Since then, the rise in prices has demonstrated an almost unbroken positive trendline slope upwards. This has exacerbated concerns over the health of the U.S. economy, a key driver of the global economy. Global Insight has previously warned that a spike in near-term oil prices above US$90/b coupled with an even deeper housing recession could thrust the economy into the dreaded "double-dip" recession scenario, similar in depth and duration to the 1991 recession. The prospect of recession, whether brief or "double-dip", in the United States should in theory help dampen oil prices, but demand around the world has remained strong and a stream of geopolitical concerns has rattled the markets. Tighter refining margins in the world’s largest economy have managed to an extent to mitigate the full extent of price rises in gasoline (petrol) for U.S. consumers. The Energy Information Administration (EIA) is expecting gasoline to finally breach the psychologically important US$3/gallon level this year, as the U.S. summer driving season arrives.
As ever, non-fundamentals seem to be driving large capital inflows into crude oil and commodities markets, in turn weighing in on crude oil prices, pushing them to ever higher levels. Global Insight, however, believes there to be little reason, barring unforeseen supply shocks, why prices should not retreat over the coming days and weeks, once markets begin to digest recent events and their consequences more fully. After closing at yesterday’s new high, prices have since settled somewhat, and were down over 1% to US$98.99/b at the time of writing. If prices do ease off the "double-dip" recession scenario can retreat once more.