A new oil market downturn?

Is the oil market heading toward another cycle of uncertainty, but on the downturn side this time? The initial signals point to that direction.

Four months ago, the price of a barrel of oil hovered around $126 and the talk at the time was it would be heading towards $160. Last Thursday and as a reaction to US stocks reports, July prices dropped $1.74 a barrel to close at $82.29 and the feeling now is that the prices are heading to go below $80 in two weeks' time.

So in four months' time, oil prices lost one-third of their value. Again it is an issue of supply and demand. The US oil stocks report showed an increase of 2.86 million to 387.3 million, the highest level seen in 22 years. That was compounded by the increase in domestic US oil production of 117,000 barrels per day (bpd) to top 6.35 million bpd, also the highest in 13 years. These are indicators of the general increase in oil production and supplies worldwide. They now stand at 91.1 million bpd and of that OPEC is pumping 31.5 million, which puts the organization's market share below the conventional 40 percent and that is despite the fact that it is exceeding its self-imposed production ceiling by more than three million bpd. In addition to the increase in supplies, another important factor playing a significant role is the growing sense of a looming world economic slowdown, if not outright recession. That is adding to the new mood governing the market now and probably signaling to emerging belief that the long growth in oil demand and strengthening of prices for more than a decade is finally coming to a halt.

The first decade of this century was characterized by strong demand mainly pushed by China, which was and still is to a great extent clouded in mystery. Unlike the United States where available data in terms of historic record and future forecast give some clues enabling analysis, China is a big mystery. And that is why the world market was taken by surprise by a strong Chinese oil demand and growth in imports.

One of the first results of that demand drive, it saved OPEC then the effort of applying its newly created price band that was introduced back in March 2000 to allow the organization the flexibility to deal with price changes immediately and without waiting for formal meetings. The idea was simple: If prices were to fall below $ 22 a barrel, an automatic drawdown of half a million barrels a day is ensued; equally if prices were to exceed $ 28 a barrel, the same half a million barrels would be added to supplies.

OPEC never resorted to this mechanism. Thanks to strong demand, mainly from China. Moreover, prices went on their ascending trend up to reach their historic level of $ 147 a barrel back in the summer of 2008 before starting to drop. At one point this year they stood at $ 128 a barrel.

And to a large extent part of the price rise was to do with perception and the geopolitics in the region. The Iranian row with the Western countries regarding its nuclear program has played a significant role in that. The potential clash carried with it a potential threat that Tehran may resort to the oil weapon shutting up its own and threatening to close the Straits of Hormuz to stop 17 million barrels a day from passing through to the oil market.

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