Oil to Fall on Resurgent Dollar, China Slowdown: Survey

Sri Jegarajah|Reporter, CNBC Asia Pacific

Oil prices are set to extend declines as uncertainty persists over the euro zone's future, growth slows in China and the dollar rises. But international talks in Baghdad scheduled on Wednesday around Iran's nuclear program may contain losses if the country's leadership resists pressure to curb uranium enrichment, CNBC's weekly survey showed.

A Petroleos Mexicanos (PEMEX) oil rig near the shores of the state of Campeche, Mexico.
Eunice Adorno | AFP | Getty Images

Five of the week's sample group of nine respondents said prices would fall this week while one said they would rise. Three respondents in the survey expected prices would remain unchanged.

The resurgent U.S. dollar - the de facto "safe-harbor" for investors - will continue to keep commodity prices in check, said Dhiren Sarin, Chief Technical Strategist for Asia-Pacific at Barclays Capital in Singapore.

"It has been a remarkable bullish streak for the U.S. dollar -- 14 higher closes above the previous session close in a row. We haven't seen such a move in our entire U.S. dollar index chart history and this is dominating market sentiment," Sarin said. "Commodities are likely to remain under pressure catalyzed by a paring back of global growth expectations."

For oil, Sarin expects a move lower for Brent crude towards the 100-week average near $104.40 a barrel and for U.S. crude futures "into a target zone between $89.20 and $90.40 before we get a bounce."

Oil markets, like most cyclical commodity sectors, were swept along in the downdraft of broad risk aversion besetting global financial markets because of fears of aGreek exitfrom the euro zone and concerns about outflows from .

Cross-asset liquidation, where large investors sold out of their holdings of commodities or other sectors to cover losses in other markets, will continue to be a negative risk this week.

"We believe crude oil is vulnerable to a liquidation in investor length," Deutsche Bank analysts led by Michael Lewis said in a report on May 18. The process has been underway across the industrial metals and precious metal sectors for several months now, they said. "Our break-even analysis suggests that pressure on a majority of OPEC producers will only start to escalate when Brent falls below $90 a barrel."

Concerns about the growth outlook in China, the world's second-largest economy, have compounded the gloomy global picture. China's premier called for additional efforts to support growth on Sunday, signaling Beijing's willingness to take action after a recent series of economic indicators suggested that the economy will slow further in the second quarter.

"We should continue to implement a proactive fiscal policy and a prudent monetary policy while giving more priority to maintaining growth," Premier Wen Jiabao said in comments reported by state news agency Xinhua.

"Lower deposits at the four largest banks, lower bank lending in May, and falling home prices in a record number of cities all point to growing risk of a hard landing" in China, said Kirk Howell, Chief Operating Officer of SunGard's Kiodex.

"The trend remains down and over the next few weeks I would expect oil to continue to test lower levels," Howell said, adding that "the extreme long speculative position from early March has now been greatly reduced" and "some consolidation" around current levels is likely.

Geopolitical Risk

Geopolitical risk may return to the oil markets this week with negotiations scheduled Wednesday in Baghdad between Iran and the U.S. and its allies over Tehran's nuclear program.

Yukiya Amano, director general of the International Atomic Energy Agency arrived in Tehran early on Monday voicing optimism he could reach a deal to investigate suspected atom bomb research - a possible breakthrough that Iran may hope could help ease Western sanctions pressure and deflect threats of war.

However, Russia's Deputy Foreign Minister said on Sunday that military action against Iran over its nuclear program was being considered in some Western countries.

Deputy Foreign Minister Sergei Ryabkov was speaking to reporters on a plane on his way back from the G8 summit in Camp David, where the G8 leaders signaled their readiness to tap into emergency oil stockpiles quickly this summer if tougher new sanctions on Iran threatened to strain supplies.

"Globally the oil market is over supplied, which makes you wonder why the White House is pushing the G8 for a strategic oil reserve release," said Phil Flynn at PFGBest. "It would seem that all that would accomplish is to irritate OPEC and other countries that have taken steps to replace Iranian oil." Admittedly, though Iran has been "talking tough"  and the market has already gone a long way to prepare for a cut off of Iranian supply, Flynn said.

U.S. crude futures fell nearly 5 percent last week, down for the third week in a row. On the New York Mercantile Exchange, crude for June delivery, which expires on Tuesday, settled at $91.48 a barrel on Friday, falling $1.08, or 1.17 percent.

In three weeks, front-month U.S. crude has slumped $13.45, or 12.82 percent, the biggest three-week loss since the week to August 14, 2011, when prices dropped 14.54 percent, Reuters reported.

Brent crude , meanwhile, closed below $108 a barrel on Friday, extending losses to a third straight week. In three weeks, front-month Brent has fallen $12.69, or 10.59 percent, its biggest three-week drop since the week to May 20, 2011, when prices ended 10.72 percent lower.

By CNBC's Sri Jegarajah