You know the oil markets are in touble when even a hurricane can't stop prices from falling.
Hurricane Ike is threatening the main oil facilities of the Gulf of Mexico, but oil plunged again Thursday, settling at $100.87 a barrel after dipping to $100.10, the lowest level since early April.
For that reason, many expect crude oil prices to hit $100 as soon as Friday—and keep falling.
“There is just a lot animal sentiment in this market that wants oil to cross the $100 mark again, going in the other direction," says Bryon King, an oil industry geologist and editor of Outstanding Investments newsletter. "I can just feel it, I can see it in the trading patterns.”
If oil hits $100, King says prices could drop another $15 to $20 in the short-term before OPEC would step in again to reduce supply to keep prices at least above $90.
“Going below $100 would be psychologically significant for the world economy, for inflation, but it becomes a threat to the oil producers who have been banking on higher oil revenues,” said Joe Stanislaw, an oil industry expert now acting as an independent senior adviser for Deloitte. “Most countries have budgets that require $80-90 a barrel, if not a little bit higher.”
Why are oil prices falling, even when a hurricane threatens? Traders are focused on other factors, particularly the slowing worldwide economy, which is cutting into oil demand.
“You have tremendous negativity across every asset class right now…the perception is quickly shifting towards a global recession in which oil prices should be lower because demand is going to be destroyed,” said Roger Diwan, a partner at PFC Energy consultancy.
Watch discussion of oil prices on video at left
For that reason OPEC announced earlier this week a production cutback to tighten global supply in the face of significantly weakened demand, in order to prevent a price collapse.
The fact that the cutback was modest—to formal quota levels—suggests the balancing act OPEC is trying to manage, including not wanting to aggravate economic weakness – particularly during a US election.
But right now, added Stanislaw “there is a lot of oil floating around looking for a home, the demand curve is weakening significantly…..there is a risk of the price collapsing.”
Prices collapsed in 1997-1998 when, in the face of an economic slowdown, OPEC did not pro-actively cutback production.
“Serious cutbacks take time - the markets move quicker than their ability to cutback,” noted Stanislsaw, co-founder of Cambridge Energy Research Associates (CERA).
Most analysts interpreted OPEC’s move as signaling that the cartel is comfortable with crude prices around the $100, or even a bit lower.
That perception was strengthened with private assurances from Saudi Arabia, following the formal meeting, that they would make sure oil markets are well-supplied, regardless of the cartel’s decision.
But Diwan insisted that markets are less focused on OPEC than the broader economic outlook.
“The markets are very bearish right now and as long as we don’t have a sense that the credit crunch and the Lehman mess is not cleaned up, I think everything will keep going down,” he said.
But when the global economy rebounds, so will demand.
When that happens expect significant upside to oil prices, these analysts said, especially because new non-OPEC supply is failing to meet earlier expectations, which saw an additional one million barrels per day coming on-line in the next year.
More recently that supply is being forecasted at 270,000 barrels per day, said Stanislaw.
“OPEC is not increasing capacity significantly and the market looks out two-three years and that’s what it sees.”