Oil Prices Down on Global Demand Worries


NEW YORK (TheStreet) -- Texas light sweet crude oil prices continued falling Monday on concerns about slowing global demand and the impact of Saudi Arabia's oil output hike.

Trading was also influenced by the looming end of the U.S. government's bond buying program later this month and the effect of China's inflation problems on the dollar.

West Texas Intermediate light sweet crude oil for July delivery was falling $2.61 to $96.68 and the Brent Crude contract, earlier trading in positive territory, was down 98 cents to $117.80. The WTI is utilized in the U.S., while Brent crude, sourced in Europe, is bound for destinations all over the world.

Currently, U.S. oil storage levels are full, with supplies at record highs, at the main delivery point in Cushing, Okla. This, as U.S. oil demand continues to be softer than that of emerging economies such as China, which has become the world's number one energy consumer.

Brent crude prices was up earlier in the day on the buildup of risk premiums, given the greater ties of Brent oil to the overall macroeconomic risk picture -- such as those relating to tensions in the Middle East and North Africa. The turnaround later in the day could explained by a bout of risk aversion after Standard & Poor's slashed Greece's credit rating by three notches.

Still, the greater picture continues to point to a widening spread between Brent and WTI.

"WTI is again the odd one out today, with the spread between WTI and Brent widening to another record -- now over $20 -- but this would seem more to do with weak market conditions in the U.S. than anything," Summit Energy analyst Matt Smith had said. "Any weakness from economic data in the next few days could push prices down to the previous lows around $95, but we have seen a good deal of support enter the market at these levels."

Chinese lending fell more than expected in May, while Japan, still suffering from the impact of the earthquake, saw machinery orders fall 3.3% in April from March. A slew of critical Chinese data is to be released this week, including the Chinese Consumer Price Index measuring inflation.

"Some the data seems to suggest that their economy is slowing a little bit, but their inflation is not," says PFG Best Senior Energy Analyst Phil Flynn. "Call it stagflation, call it whatever you want, that doesn't bode very well for the price of oil."

"Any signs of weakness in China may give our dollar a little bit of a boost, psychologically." With oil being a dollar-denominated commodity, a stronger dollar against other currencies would make oil more expensive for those countries to purchase, hurting demand.

Also putting a damper on WTI oil was the widespread expectation that the Federal Reserve's $600 billion bond purchase program, or QE2, will give the dollar a boost when it concludes at the end of June.

"That's QE2 been a major crutch for the oil bulls," said Flynn. "That's something that we will want to keep an eye on. I think we're in a choppy downtrend on oil right now."

Flynn thinks that oil may dip below $90 by mid-July, possibly visiting the mid-80s, based on current trends. His view right now is that the Brent-WTI spread supports being long Brent and short WTI, and that this is a trend that will likely hold until the situation in the Middle East stabilizes; though dips could happen along the way.

A simpler approach suggested by Flynn however, would be to "pick a horse" and either go short the WTI or long Brent -- which could drive up investors with less chance of a pullback. If there is a correction in the markets, Brent may be more susceptible to a substantial pullback, given that the WTO is already weak, though that, says Flynn, would likely be a stretch.

Other major oil developments included news that Saudi Arabia is reportedly raising its crude oil output to 10 million barrels a day in July in order to meet Asian refinery demand. The decision brushes aside the first deadlock among Organization of the Petroleum Exporting Countries members in at least 20 years over discussions about raising oil output quotas that occurred last week.

"Since the newspaper that reported it is more or less state controlled and the information has not been denied from official sources, it should be taken seriously," says Filip Petersson, a commodity strategist at SEB Commodity Research.

The JBC Energy Research Center estimates that this increase would imply producing an additional 1 million barrels a day from May levels, putting the country's total output at the highest level in at least 32 years.

JBC Energy Research Center now expects the OPEC giant to produce 9.4 million barrels a day in June.

Phil Silverman of Kingsview Capital believes that oil is unlikely to go down, post QE2, with the view that the U.S. dollar will remain weak.

"It doesn't look like in any way that the U.S. is going to tighten their policy," said Silverman. However, he also factors in the view that oil could go down if China's fight against inflation by hiking interest rates has a slowing effect on the country's growth.

Furthermore, Silverman is watching to see whether longer-term investors will pull their money out of commodity ETFs if general market conditions deteriorate.

Silverman has been collecting money by selling WTI options "closer to the money" and buying options farther away from the money. "So, oil's trading at $98. Let's say I sell an option at about $90 -- what that means is that if the market goes below $90, I am required to buy it at $90. And I get paid to take that. In a sense I'm insuring someone else's downside."

SEB's Petersson advises against trading WTI-Brent spreads unless the investor has a very good understanding of U.S. oil infrastructure dynamics. "I would rather trade on global fundamentals and therefore use Brent as the vehicle."

Oil stocks were trading lower. Chevron ( CVX) was falling 1.1% to $98.62, Exxon ( XOM) was losing 0.9% to $79.04, China Petroleum & Chemical ( SNP) was falling 0.5% to $95.38 and Petroleum Development Corporation ( PETD) was plummeting 11.7% to $28.93.

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-- Written by Andrea Tse in New York.

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