Oil prices bounce back from low $30's but struggle to stay above $40

China (Platts) -- Dec 24 - 30, 2008

By reporters at Platts, the energy information division of the McGraw-Hill Companies. For more information about Platts' information products in China, contact Platts at china@platts.com, or call its representative office in Guangzhou at (+86) 20 2881 6588.

After setting a new low of $33.87/barrel on December 19, benchmark oil prices have since recovered slightly to $40.21/barrel when the Asian markets opened on Tuesday, December 30.

In recent days, prices have firmed up during light trading, partly due to a surge in violence between Israel and Palestine in the Gaza strip-but mostly because of cuts in OPEC production and apparent compliance by OPEC members with the new production targets that era set for January.

The December 19 bottom was last seen almost five years ago in January 2004.

For now, prices seem to be bobbing either side of the $40 mark-some 73% off from the all-time peak of about $145 set in July this year.

Liquidity on the NYMEX has been below average in recent days due to two back-to-back holiday-shortened weeks and a move by market participants to square away their positions before the end of the year, which has left the market susceptible to price spikes, up or down.

The front-month crude contract price spiked to $42.20/b during London hours after Israel bombed Palestinian positions, and India moved troops from its border from Afghanistan to its border in Pakistan.

On a technical note, prices appear to be struggling each time the market trades above $40/barrel.

Crude futures pared gains made during London trading at the start of open outcry in New York as the US Dollar Index on ICE strengthened throughout the session, rallying off an intra-session of 79.631, and shortly moving into positive territory before the close of NYMEX floor trading.

At NYMEX close, the dollar was down 16 points at 80.729.

Looking beyond geopolitics

Beyond the immediate geopolitical factors surrounding the Israeli-Palestinian conflict, market players were looking at supply-demand fundamentals to gauge the longer term outlook.

On the supply side, OPEC's President Chakib Khelil said over the weekend that the group's recent decision to cut crude oil output by 2.2 million b/d from January would likely result in decline in oil stocks held in storage by consuming countries to just 52 days of forward cover by the end of 2009. This compares with the current estimate of 56-57 days of forward cover.

He also expects oil prices to stabilize in January or February. "Several members of OPEC have already applied the decision to cut production," Khelil said.

Meanwhile, the UAE's ADNOC has announced cuts in crude oil allocations to its customers of 3-15% for January and February 2009 liftings, in line with OPEC's decision to slash output.

On the demand side, some discouraging news made its way to the market that Chinese oil demand sunk to a 20-month low of 27.93 million mt in November, according to the latest government figures.

The November figure represented a decline of 7.8% from October and was also down nearly 2% year on year, according to Platts estimates.

China last posted a year-on-year drop in petroleum demand in March 2007.

China's export-oriented economy is seeing a sharp downturn that has prompted the country's oil companies to curtail imports and cut production to clear stocks, industry sources said.

China published a series of economic data for November over the past week that showed the world's fourth largest economy and second largest oil consumer was feeling the impact of the global financial crisis much more than initially expected.

Among the chief concerns was that exports posted their first fall in more than seven years, dropping 2.2% in November after growing 19.2% in October.

Inflation also dropped abruptly to a 22-month low of 2.4% in November from 4% in October, reversing worries of soaring prices seen early this year and raising the specter of deflation.

Industrial output growth eased dramatically last month to 5.4%, compared with this year's peak of 17.8% in March, as manufacturers cut production and laid off staff to cope with a sharp decline in consumption in the US, Europe and Japan.

"The weakness in oil demand is likely to persist until the end of next year's first quarter as it takes time for the inventories to run down, and the quarter is also traditionally a low season," a Hong Kong-based analyst said. "Whether or not oil demand will pick up would depend on how effective the Chinese government's economic stimulus measures are on invigorating domestic consumption."

In an effort to wean itself from over dependence on exports as the main driver of economic growth, Chinese authorities have announced plans to bolster the country's GDP growth through public works spending and by stimulating domestic demand.

However, the task of boosting domestic consumption may be easier said than done, as China has one of the world's highest savings rates-about 46%, compared to 26% for Japan and just over 1% for the US.

The reason for the inordinately high savings rate is simple: an inadequate public health care and pension system which compels the average wage earner to set aside their own money for medical care and retirement.

Chinese state planners are keenly aware of the problem and are taking long-term measures to address the imbalances.

For now, fiscal and monetary tools appear to be the most affective means of returning to higher growth rates.

Updated: January 02, 2009

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