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CALGARY — Oil could fall to $40 (U.S.) a barrel or even as low as $30 as speculative investors sell their positions and spare production capacity increases, according to a research report published Monday by Sanford C. Bernstein & Co., an independent analysis firm.
The price of crude spiked higher in 2004 as demand from China surged at the same time the key cushion of spare capacity evaporated. As the commodity jumped, billions of dollars from speculative investors piled in, buying futures contracts on the New York Mercantile Exchange, helping push oil to almost $80 a barrel last year.
“We believe such speculative activity created perhaps the biggest artificial distortion of a market since the technology bubble of the late 1990s,” analyst Ben Dell of New York-based Sanford said in a 67-page report entitled: “Energy investing: Beware the Ides of March.”
“Timing when the good times will be over is difficult but we fear that the collapse could be dramatic.”
Sanford C. Bernstein—which in 2000 predicted the coming collapse in Nortel Networks Corp.—is almost alone in its bearish outlook for the world's most popular commodity, with the median analyst estimate suggesting that oil will average more than $60 a barrel and several observers predicting it will average more than $70.
FirstEnergy Capital Corp. of Calgary, for example, said last week that “a noose is slowly tightening” around the crude market due to rising demand and tighter supply, and it predicted prices will soon jump past $60 and average $68 for the year.
In January, oil fell to almost $50 as investors sold their holdings because of ample oil supply and middling growth in demand. It has since spiked back to about $60 but on Monday afternoon the benchmark contract in New York had fallen $2.17 to $57.72 after Saudi Arabia said it planned to ship more oil to Asian customers next month, increasing availability.
For Mr. Dell of Sanford, the key factor in the crude market is what's known as a contango, which means contracts for immediate delivery are currently trading at lower prices than those further into the future. Historically, near-month contracts are more expensive that longer-dated contracts, also called backwardation.
For example, the current benchmark at $57.72 is a contract for March delivery of oil, while contracts for July trade around $60, peaking at about $62 December contracts, according to the New York Mercantile Exchange's website.
This suggests investors believe the price of oil will rise, though the future curve of oil contracts has a poor predictive record. Mr. Dell said the situation means investors with money in oil futures are in a difficult, money-losing position, which he argued could eventually lead to a stampede out of the market.
Investors lose money in this situation because when a contract comes due to sell, they have to buy a more expensive futures contract to maintain their position. Mr. Dell noted that the Goldman Sachs Commodity Index, of which more than half is oil-based, fell 16 per cent in 2006. Money invested in the commodity index has jumped to $70-billion from $17-billion in the past five years.
At the same time as market speculation could ebb, fundamentals in the crude business suggest lower prices could occur as well.
“Growth in spare capacity should force prices to $40 a barrel — but if passive investors flee, oil could fall to $30,” Mr. Dell said, adding that such a decline would hurt stocks of companies in the energy business.
Spare production capacity among members in the Organization of Petroleum Exporting Countries is rising towards 4 million barrels this year and is expected to exceed that in 2008, returning to levels recorded in the mid-1990s when the price of oil was far lower.
And expensive oil has quelled growth in demand for oil. While demand is still rising in countries such as China, though at a lower rate than recent years, demand in developed countries is actually down. The International Energy Agency, whose members include countries such as the United States, Germany, Japan and Canada, said in January that oil consumption in the group fell 0.6 per cent in 2006, the first significant slip since the 1980s.
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