OPEC worries about weak oil market fundamentals

WTI, S&P May09.jpg

Back in April, the blog noted that stock markets had embarked on “their 7th bear market rally since October 2007″. So far, it has been the most impressive of them all, with the S&P 500 rising 40% between 6 March – 8 May, before falling 5% last week. And as the chart shows, crude oil has also rallied, with WTI rising 35% over the same period.

The result has been that the S&P’s price/earnings ratio, the most fundamental measure of stock market value, has risen to an astonishing 122 (based on reported earnings). Whilst oil inventories are probably at record levels, if floating storage and other tankage are included.

Financial investors are responsible for both of these rallies. They are convinced that economic recovery is just around the corner. And as MF Global brokerage told Bloomberg on Friday, “if we are seeing a recovery, things could tighten up very quickly on the energy front”.

The blog traded oil products early in its career, and certainly respects the power of sentiment to move market prices in the opposite direction to fundamentals. As Petromatrix note, investors are paying even higher prices for future delivery, with May 2010 priced 14% above today’s level.

But the longer the rally continues, the higher the risk that it will all end in tears, if recovery turns out to have been delayed. The blog is not alone in worrying about this, with OPEC noting in its latest monthly report that “oil market fundamentals have continued to weaken”.

Last July, when WTI was close to $150/bbl, the blog suggested chemical companies might be wise to hedge for a swift downside to $100/bbl, as well as for higher prices. Similar risks are on the horizon today.

A move towards $80/bbl is certainly possible by the summer, if investors remain confident. But if sentiment begins to change, $40/bbl could happen very quickly.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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