Oil Set to Continue Sell-Off; All Eyes on FOMC, Greek Debt Woes

Sri Jegarajah|Reporter, CNBC Asia Pacific

Benchmark crude oil futures will likely extend last week's sell-off as the Federal Reserve may cut its U.S. growth forecast for 2011at its two-day policy meeting this week. Meanwhile, optimism about a second bailout package for debt-laden Greece may prove supportive though many continue to fear Athens may still default.

Crude oil futures dropped more than 6 percent last week, the biggest weekly loss since early May, reflecting risk-off selling momentum across global financial markets as investors worried about the contagion risks from a Greek default. A continued soft patch of U.S. Economic data deepened the negative tone across commodity markets.

NYMEX crude settled at $93.01 a barrel on Friday, dropping $6.28, or 6.3 percent, for the week. That marks the biggest weekly percentage loss since prices fell a record $16.75, or 14.7 percent in the week to May 6. Meanwhile, front-month Brent settled Friday at $113.21 a barrel, falling $5.57, or 4.69 percent, over the week - the biggest weekly loss since the week to May 6, when prices tumbled $16.76 or 13.3 percent.

Selling is set to continue this week, according to CNBC's weekly poll of oil analysts, traders and strategists. Out of ten respondents, six are calling for prices to fall, three say prices will rise while one expects little change.

"The Greek debt crisis will remain the driving force and a default could have very serious implications for several members of the euro zone," said Linda Rafield, Senior Oil Analyst at Platts. "A test of $90/barrel is imminent. If $90.09 front-month NYMEX crude can't hold, then the market will probe even lower levels - there is a gap down to $87.88/b that was formed back in February by the beginning of the uprising across MENA."

For Brent, Rafield said a break of $111.21 will signal a move down to $106.00. "Neither market has breached major support lines - not yet," she added.

Dovish Tone From Fed?

Currency markets, and how they react to what may be the endgame - or the latest act - in the Greek tragedy and perhaps more importantly, the tone struck by Fed Chairman Ben Bernanke at the press conference following the FOMC will have a decisive influence on oil and commodity markets this week.

Todd Elmer, Currency Strategist at Citi said Bernanke would strike a doveish tone. Still, the U.S. dollar could continue to draw safe-haven demand should Greek debt woes continue to weigh on sentiment, and any resurgence in the Greenback could add to the pressure on oil.

As a result of the anemic recovery, Fed policymakers will likely be in little hurry to exit QE2. Negative for oil would be any downgrade of the full-year growth forecast. How the Fed deals with the bout of what some are calling 'mini-stagflation' will also be closely watched. Assuming that the current soft patch of U.S. economic data "will be temporary (i.e. no double dip) and that China is not facing a hard landing, we would be buying dips in the Brent crude oil price at between $100 and $110 per barrel," wrote Societe Generale commodity analysts led by Michael Wittner.

The Bank advised: "It is critical to buy only on dips as, in the absence of further export disruptions from the Middle East or Africa, the fundamental outlook for the next few quarters is only moderately bullish. Preliminary U.S. oil consumption data suggest that this year's sharp price rally is starting to have a negative impact on demand."

Libya's Return

Although global macro events and policy risks predominate, strategists are also highlighting the importance of supply flows from OPEC, which suffered an embarrassing lack of consensus at its last meeting, and the producers hit by the Jasmine Revolution, ostensibly Libya.

"While oil markets fret over the impact on global growth from turbulence in the euro zone sovereign debt markets, timing of Libya's return to the world oil export markets is arguably a more significant variable," wrote Lawrence Eagles at JPMorgan.

Recent comments from the head of the Transitional National Council's (TNC) National Oil Company highlight the length of the rehabilitation process ahead, Eagles added. "His comments suggest that infrastructure damage has been significant, both at a field level as well as export infrastructure. Furthermore, security on the ground for oil workers-both domestic and expatriate-will be a pre-requisite for any increase."

Overall, with the bias to the downside, forecasters are calling for a lower floor for oil prices. Platts' Rafield earlier talked about an imminent test of $90. Phil Flynn at PFG Best is predicting a an even lower floor at $85.