Future Direction – What is the Next Direction of Oil?

Going into the fourth quarter of 2012, any substantial decrease in the temperature could increase demand for oil during the colder seasonal changes, increasing the price of oil. The current oversupply of 0.5–0.8 mbpd may be offset by an increase in the last quarter demand, potentially in the regain of 1.1 mbpd on average, which would lead to an overall increase in price.

Due to geopolitical risks and the increased sanctions on Iran’s oil, along with the increase in the money supply through quantitative easing, Mario Draghi, president of the European Central Bank, stated that, in the third quarter of 2012, traders pushed prices up on their perceptions of the pricing-in of quantitative easing expectations.

The sanctions on Iran are having a pronounced mark on oil production with approximately 1mbpd being cut from the Iranian oil production, reflecting in a $7 billion reduction in the balance of payments. This is having a material effect on Iranian oil production.

This scenario is expected to push oil prices even higher, and the price of oil would again be relative to the increase in worldwide equity prices this year. These are reflected in country specific funds that have underlined the weakness in the price of oil.

Due to the increased production from Saudi Arabia of approximately 500,000 bpd more than a year ago as well as increased production from the USA, this additional flow has allowed the price of oil to look relatively cheap compared to the increase in economic activity.

Oil demand has been hampered by the depths of the recession in Europe and the United States along with their stubborn levels of high unemployment. Although there is still uncertainty about whether Spain will follow Greece with requirements for a bailout, Greece is requiring subsequent tranches for its sovereign debt. Now the eurozone is expecting economic activity
to lightly contract, although the U.K. and the United States are starting to show some green shoots of recovery.

This has had consequences in China regarding whether to increase the production of goods, and in Australia where they are supplying the commodities to produce the goods and subsequent energy demands for China. China’s manufacturing output increased for the first time in a quarter with improving returns in growth-linked assets. China’s manufacturing purchasing managers’ index increased significantly from 49.8 in September to a high of 50.2 in October. China, the second-largest consumer of oil behind the U.S., shows manufacturing and oil consumption on the rise.

The graphical information for both the oil chart and the S&P correlate as closely as any two separate markets can. The decision-making process in oil companies and the price of oil are largely shaped by the increase in equity prices worldwide and the demand for oil by industrial output.

Looking at the charts before the 2008 banking crisis (in the United States and Europe with its subsequent downturn) and then post 2009 upturn have shown that a 2012 barrel of oil looks underpriced comparatively to the new resilience in the equity markets, which would suggest an oversupply.

With the S&P and the Dow Jones Industrials advancing on their respective 2008 highs and nearing a four-year economic cycle, it is increasingly becoming possible that there could be profit taking leading to a correction in the share price within the next year, which will have a significant effect on the price of a barrel of oil. In the short term, however, there may be an increase in both equities and the price of oil due to the factors above.

The most significant immediate political factor was the too-close-to-call presidential race in the USA with both candidates according to the polls running neck and neck. The bounce in share prices, if Mitt Romney had been voted in with his substantial financial background, did not occur.

CNN reported “President Obama, meanwhile, had unveiled a new plan in April 2012 to limit oil market speculation as a way to address high gas prices angering Americans as the campaign for the November election heats up.”

And a once in a decade change in the Communist Party’s leadership could lead to uncertainty in the political direction of China. From the projected release of economic data in the United States when this article was written, the U.S. manufacturing activity was due to be published by the Institute of Supply Management. The U.S. was also going to release the initial jobless claims and state the ADP report for nonfarm payrolls.

OPEC quoted the following projections:

“The OPEC forecasts that world demand is projected to grow by 900,000 b/d. In 2013, growth is expected to be 800,000 b/d. Non-OPEC supply is expected to increase by 700,000 b/d this year and 900,000 b/d next year. And demand for OPEC crude in 2012 is projected to average 29.9 mb/d and 29.5 mb/d in 2013. In addition, OPEC spare capacity remains at relatively comfortable levels and total commercial stock levels are healthy.”

With oil hitting the critical $85 a barrel, which OPEC likes to maintain as a significant support level, there may be a reduction in supply. With oil currently at $86.30 as of November 1, 2012, we have initial support levels at $84.33 followed by $80.49 with resistance levels at $89.13 and $92.40 and then $96.32.

As seen in the graph below, the oil market has not spiked again like its pre-2008 level; the market appears to be relatively linear, trading within two preserved channels. However, if there is to be any significant effect in the supply or demand for oil, you could see speculators entering the market, causing a significant increase or decrease in the cost per barrel.

The question is not “if” but “when” there is a correction in the equities markets, the price of oil will be reduced by free market forces. On the other hand, President Obama wants to create this reduction through legislation, by limiting the number of oil speculators in the market. Just like King Canute, you only find your feet wet when the sea comes in, and this type of legislated restriction on a free market would do nothing to reduce the price of oil but only reduce the liquidity of the market.