x Abu Dhabi, UAEMonday 24 July 2017

Oil less tied to fundamentals

Fears of long-term disruptions to the world oil supply emerge as crude prices decouple from fundamentals.

VIENNA // Fears of long-term disruptions to the world oil supply are emerging as crude prices become increasingly decoupled from fundamentals. Instead of responding to signals about oil supply and demand, crude-price fluctuations now mainly reflected massive flows of capital between securities, foreign exchange and commodities markets as fund managers seek safe havens from financial turmoil, analysts said following an emergency Opec meeting on Friday.

The result has been unprecedented volatility that is leaving oil producers with little guidance on how and when to invest in big projects to supply future oil needs, while robbing them of capital resources for such development. "The signal is being swamped by the noise," said Addison Armstrong, the director of market research at Tradition Energy, a Washington DC brokerage firm catering to institutional clients.

In the latest sign of such decoupling, international oil markets on Friday brushed aside Opec's promise to cut crude output by nearly five per cent, or 1.5 million barrels per day (bpd), as of Nov 1. Instead of rallying on the decision - as they would have in normal times - oil prices fell more than US$3 to a 16-month low of $62.65 a barrel on Friday as stock markets plunged and the US dollar gained strength.

Opec's inability to arrest the steep slide that has cut more than $40 from the price of a barrel of crude in the past month will exacerbate the group's worries about future oil supplies. "Oil prices have witnessed a dramatic collapse - unprecedented in speed and magnitude - falling to levels which may put in jeopardy many existing oil projects," Opec said in an official communique issued after its Friday meeting.

Another symptom of abnormal market behaviour is the unusually strong inverse correlation that has emerged between the US dollar and international oil prices. As the subprime lending fiasco unfolded in the US, sending the value of the currency sharply downwards relative to other major currencies, oil started to soar. Crude's subsequent 58 per cent plunge from its July 11 peak of $147.27 a barrel has accompanied a strong dollar rebound as European and Asian currencies weakened on deepening fears of a global recession.

"This is a new phenomenon," said Ehsan ul Haq, the head of research for JBC Energy, a Vienna-based consulting firm. "The correlation emerged late in 2007." The decoupling of crude prices from fundamentals is something Opec has also noted, with growing alarm. It means trouble for the group as it attempts to bring some stability to oil markets so that sufficient long-term oil supply can be assured.

Earlier this year, the key Opec oil producer Saudi Arabia increased production twice as crude prices soared, with no apparent impact on the market. "The oil price was high not because of supply/demand issues. Some of our members actually increased supply in that period. It did not have any effect on oil prices," Chakib Khelil, the Opec president, said on Friday. "We had lots of speculation driving the oil prices. We are going to see the same effect on other things."

Because of the deepening uncertainty about how and when oil prices might respond to supply cuts, Opec is not attempting to defend a specific price band for crude - its strategy during previous periods of falling oil prices. "The price will be decided by the market," Mr Khelil said. The difficulty of predicting an oil price response is also driving deep divisions within Opec, making it harder for analysts and investors to read the group's strategy and predict its likely future actions. That could exacerbate oil price volatility, offsetting the hoped-for calming effect of the organisation's move on Friday towards greater transparency by publishing the individual production cuts it expects from its members.

In the aftermath of Friday's decision on quotas, the Venezuelan president Hugo Chavez, who had been calling for a two million bpd production cut, undermined Mr Khelil's position on pricing by saying Opec should defend a price band of $70 to $90 for crude. Venezuela, a founding member of Opec, is the group's biggest western hemisphere oil producer. While the Opec president said on Friday that the group would review the effect of its quota reductions, either at its next scheduled meeting in December or at another interim emergency meeting, with a view to possibly making a second production cut, Saudi Arabia predicted that would be unnecessary.

"As we stand now, we see no reason to take another cut," the Saudi oil minister Ali Naimi said after Friday's meeting. "Let us see what this cut does before we talk about a second cut." Mr Khelil and Mr Naimi did agree on one point. Both blamed recent oil price volatility on "mismanagement" of the world financial situation. After the meeting, Opec said the global financial crisis was having a "noticeable" impact on the world economy and was "dampening the demand for energy in general and oil in particular".

"Forecasts indicate that the fall in demand will deepen, despite the approach of winter in the northern hemisphere," it added. tcarlisle@thenational.ae