Analysis: Uptrend in Crude oil price may have little legs

The fundamentals namely, demand does not support the spike in prices, which are led by speculations of political unrest in Egypt disrupting supplies

The recent rise in crude oil price has surprised many. It comes at a time when the price of most other commodities has been relatively weak, including precious metals like gold and silver, as investors seek to invest in Dollar on the back of US economy gaining strength and the Fed talking of reducing liquidity.

WTI (West Texas Intermediate) crude oil, the US benchmark, has been fuelled by speculations that political upheaval in Egypt will lead to disruption of oil supplies through the Suez Canal. WTI surged above $100 a barrel in the last one week for the first time since April 2012 (currently $105), while Brent crude rose to $108. Egypt controls the Suez Canal and the Suez-Mediterranean pipeline, through which more than three million barrels of oil per day (mbpd) is shipped from the Red Sea to Europe and North America.

Nevertheless, even after the army intervention in Egypt, there are no signs of supply disruption. Oil revenues remain crucial and are mainstay for the Egyptian economy and in the backdrop it is most unlikely that the army will disrupt supplies, say experts. Economists at Canadian Imperial Bank of Commerce feel that in Egypt’s case, the temperature gauge may cool rather than heat up in the wake of the military’s move to oust President Morsi. They add, if anything, it could be the
first step towards more effective leadership and less political risk. If so, crude oil should give back some of its recent gains.

Besides, although Bernanke's comments saying the US needs highly accommodative monetary policy for the foreseeable future have raised sentiments, fundamentals also do not support this upside. Global supply of crude oil is constantly rising year after year. From around 84.34 mbpd in 2009, global oil supply is expected to average around 89.88 mbpd by end-2013. US production has been increasing sharply. It is up from five mbpd in 2008 to seven mbpd in 2012 to around 7.3 mbpd currently. The European demand remains subdued on the back of economic slowdown. The April-July period, which is peak demand period in US and Europe, has not seen any substantial upside this year, says Soumya Dixit research analyst, at Nirmal Bang.

Demand from China and Japan, too, remains soft. While Brent had seen highs of $119.34 a barrel in February this year in anticipation of strong demand from China and Japan, it later slipped to its 52-week low of $96.79 in April as demand was lower than expected.

Sugandha Sachdeva, AVP- Energy research at Religare Securities, says that it appears crude oil prices are running ahead of the fundamentals and are not taking into account the slew of weak data from China, the world's No. 2 oil consumer. She adds that the prices look all set to test $103.50 in the immediate short run. If it finds support, the counter is likely to make a switch towards $109 mark. But, in case the speculation dilutes, Dixit adds that current $3-4 premium can fade in just 1-2 days.