Why crude prices are not correcting

Prices continue to be sticky, as demand from Asia remains strong, while supply from Libya and Iran continues to fall.

After the world’s largest economy, the USA, lost its triple-A rating in August, the world went into a tailspin. The only good thing that seemed to have emerged in the ensuing days was the fall in crude prices. A month after, crude prices have recovered and remain firm above the $110/bbl mark.

According to Platts, an energy research agency, “Without the need for any headline records, 2011 remains on track, with the occasional wobble, to deliver the highest oil prices ever seen, in the course of a calendar year.” And, this is despite much talk of a double dip in the USA and crisis in the euro zone. Unlike what happened in 2008, this time around, the correlation between global growth and oil prices is being tested. According to Societe Generale Cross Asset Research, oil prices used to be very sensitive to US growth, but things are different this time. Emerging market demand outpaced that of the US, maintaining global oil demand at high levels.

A big reason for sticky oil prices, is the shifting demand pattern. While demand for oil is expected to shrink in Organisation for Economic Co-operation and Development (OECD) countries, robust demand from Asian economies is expected to support oil prices. Platts expects Asian demand to grow, far outstripping OECD contraction: “Even if OECD does experience a double-dip recession, the Asian juggernaut looks likely to continue on the same trajectory, albeit at a slower pace, just as it survived the financial crisis and subsequent recession.”

In addition, other supply-side issues also continue to impact oil. Despite the triumph of rebels in Libya, oil production may take at least a year to return to 1.6 million barrels per day. According to analysts, crude oil exports from Libya are not likely this year, as political risks continue. Additionally, on an average, output is falling anywhere between 300-330,000 barrels per day a year, according to National Iranian South Oil Company in its estimate to the Organization of the Petroleum Exporting Countries (OPEC). The Platts OPEC survey for July production estimates Iran’s output at 3.61 million barrels per day, down from 3.67 million barrels per day in June. While global growth may play a role in determining future movement of oil, the other supply and demand-side factors may prevent a substantial correction.