Oil Prices Expected to Fall Further As Demand Eases

The recent decline in oil prices is expected to continue amid fresh signs that the rapid run-up in crude prices is curbing demand, particularly in the US, analysts say.

“It just really feels like a market that wants to head south for several more dollars probably down to $117 during the next one or two weeks,” said Jim Ritterbusch, president of his own oil trading advisory service based in Galena, Illinois.

Oil rallied briefly on Monday, with prices up about $2, after  new rebel attacks on Shell Oil’s facilities in Nigeria and new concerns about Iran’s nuclear program.

But these geopolitical factors, which Ritterbusch said in earlier months would have triggered a buying frenzy, were undercut by reports of significant decline in demand.

A report released Monday by the US Department of Transportation showed that Americans in May drove 3.7 percent less—some 9.6 billion miles less—than they did a year ago May, the third-largest monthly drop in the 66 years such data have been recorded.

Three of the largest single-month declines - each topping 9 billion miles - have occurred since December.

The Energy Information Agency also reported that the US was using 900,000 barrels of oil a day less than a year ago.

“That’s huge,” said Ritterbusch, who added that if the demand decline trend continues there was a “strong possibility” of prices slipping under $100 looking out three months.

But with so many parameters at work affecting prices John Blass, a trader at Capitol Oil Brokers was more cautious predicting prices.

”I think it is going to play between the $110-135 market on crude—it is just a gut read on what we are seeing on demand and other factors affecting this market,” said Blass.

But high oil prices are also suppressing demand in Europe where a recessionary pressures are just beginning to bite, according to Christopher Bellew, a trader with Bache Commodities.

“It looks very much as if a lot of the steam that has pushed prices up to $147 has gone out of the market now,” he said. “I would think over the course of the next several months we could easily go below $100 again.”

Soft demand is the biggest factor, he said, but so was lack of “the lack of bullish news” on the geopolitical front or significant new supply disruptions. Periodic attacks in Nigeria were largely discounted by the market as business as usual in that troubled African country, he said.

News from Iran over the weekend that the country has more than 5,000 active centrifuges for enriching uranium, suggesting a rapid expansion of their nuclear program, also stoked oil market concerns, but these worries eased with subsequent conciliatory comments from President Mahmoud Ahmadinejad.

Ahmadinejad himself told NBC in an exclusive interview that oil prices were overvalued and "not realistic" because of market manipulation.

John Kilduff, of MF Global told CNBC that reduced concern about Iran could trim $12 from the price of crude but he still expected short-term pressure to bump prices up to $130 range.

Institutional Players Unwind

Another important factor in the softness of oil prices is the gradual unwinding of long positions by institutional players in oil markets, said Ritterbusch.

“The institutions that worked the long-side of this market the first half of this year appear to be in sell type mode at the present time,” he said.

“They are looking to liquidate positions rather accumulate long positions and that’s why we were unable to hold this rally of about two dollars.”

This seemed to be confirmed by a report released Friday by the Commodity Futures Trading Commission which showed that speculative funds were shifting to a net short position for the first time in 17 months.

If crude prices do drop by $20-25 – leading to pump prices of $3.25-$3.50 – it could undercut current conservation measures by stimulating demand and pushing prices up once again, analysts cautioned.

Moving into the fourth quarter weather in the northern hemisphere will be a major factor determining prices.

© 2009 CNBC.com