Oil Prices Finish Off Lows, but Traders Bracing for Decline

NEW YORK ( TheStreet) -- Although oil prices came off lows Thursday on market relief over news that the European Union summit will proceed at pace, the enormous task entrusted to leaders to come up with a comprehensive plan to save the region is still hovering ominously over markets.

West Texas Intermediate (WTI) light sweet crude oil for December delivery fell 22 cents to settle at $86.07 a barrel Thursday, as the December Brent crude contract rebounded, rising $1.18 to $109.57.

With the big focus Thursday being on Europe, news that former Libyan leader Muammar Gaddafi was killed in Libya did little to move oil prices, except to highlight that there are still multiple obstacles to bringing Libyan oil back to full production.

"Libya is still about chaos with Gaddafi out of the picture," says WeatherBELL's energy markets analyst Alan Lammey. "New governments take time -- renegotiating contracts; new leadership for energy assets; new investment, etc -- plus there's always the possibility that new tensions could break out."

"It will be at least a couple of years before there's any sort of normalcy," he added, meanwhile pointing to escalating tensions between the top oil-exporting regions of Iran and Saudi Arabia.

Despite a brief respite for markets late Thursday on relief news that Sunday's European summit will proceed at pace, participants still felt they were walking on pins and needles ahead of the event. "The big event," said Channing Smith, co-manager at the five-star Capital Advisors Growth Fund, "is this weekend."

"Is Europe going to get their act together or not? What's the plan for saving the banking system or shoring up systematically important banks? What's the plan for debt auctions and the Eurozone going forward? There needs to be coordinated efforts between the International Monetary Fund, central banks, potential sovereign wealth funds and the nations themselves."

And, adds Smith, "it has to be a comprehensive plan. If it's not, we expect the market to go back down because they'll expect there will be a crisis in Europe and the euro falls into a recession," Smith said. "It's a tall order."

This week, Moody's slashed Spain's credit rating, and warned France its own rating could soon be lowered. Meanwhile, the president of the European Commission, Jose Manuel Barroso, cautioned that even if EU leaders could agree on an answer to the growing economic or financial debacle in the region, it will take a significant amount of time to execute it -- and they don't have much time left.

"This situation is already in the 11th hour because the danger of sovereign defaults and extensive banking breakdowns looms closer," said WeatherBELL's Lammey.

On Wednesday, multitudes of Greek workers -- numbering in the thousands -- walked off their jobs, instigating a general strike to protest new reductions in government-funded programs. Businesses ranging from factories to stores to shops had to close up for the day. The majority of public transportation was canceled, including trains, ferries, buses and flights.

"This situation is blowing up!," said Lammey, referring to the unrest in Europe.

But no matter how bad things get for the global economy this year, Smith of Capital Advisors expects it's unlikely oil prices will fall as far as they did in 2008, when the WTI quote plunged to the $30 a barrel range from around $146; given that most economic evidence is pointing to a continued sluggish recovery, rather than recession, a scenario that would have a milder impact on global consumption this time around.

"We're not going to see a big drop," Smith said, pointing to that lack of excess that was seen in the housing and auto markets prior to 2008. "We've seen Japan, we've seen Europe, we've seen the U.S. slow quite considerably, but we're still not falling off a cliff."

That said -- there is an exception to this notion for Smith, who warns of an exacerbated decline if the "thug-ocracies" -- a term he uses for the Organization of the Petroleum Exporting Countries that control two-thirds of the world oil supply -- decide to "say one thing and do another."

"What people don't understand about oil prices ... everyone is looking at supply and demand, but unfortunately, two-thirds of the supply of world oil comes from what we would classify as thug-ocracies," he said. "And so, what happens if you really break this down ... a lot of countries where there's oil, Venezuela would be an example; Iran, Nigeria ... the regimes that run those countries and therefore determine oil output, need oil revenue. They're not focused on earnings per se. They need revenue to keep the people happy and to stay in power."

"What happens when you have a downdraft ... OPEC would say we're all going to cut production," Smith continued. "Unfortunately there's cheating and lying by a lot of these dictators because they need revenue; and so they're supposed to cut their production back and they don't."

This "accelerates the move lower in oil prices."

In separate news, the Commodity Futures Trading Commission (CFTC) this week, in a 3-2 vote, approved a rule to limit bets on oil, gold, sugar and other commodities. The decision -- part of the Dodd-Frank act mandating that the CFTC write rules to regulate the swaps, or over-the-counter market, in addition to their oversight of the futures market -- is still hotly debated among oil analysts.

Smith approves of the decision. "When traders apply leverage to these markets, I think it accelerates the impact on pricing, and you get a situation where pricing isn't maybe driven by supply and demand, but more by what's happening in the financial world," the Capitol Advisors' analyst said. "To me that's not healthy."

WeatherBELL's Lammey agrees that the decision helps rein in "abusive and manipulative trading practices."

But "ultimately, it could cost the consumer more. If these rules prove to be too cumbersome and restrictive, then I would imagine that some of the bigger players in the market will simply pick up and move to foreign markets that don't mandate such overly restrictive rules," Lammey said.

"When you have less players, you have less liquidity, which opens the door to those with the deepest pockets being able to ultimately better control price direction ... If they want to take the prices higher, consumers ultimately pay the price."

PFGBest's senior energy analyst, Phil Flynn, is "extremely disappointed by the decision and says it will lead to volatile oil prices. "I think we do risk losing traders and seeing less transparency, not more," he said.

"If a lot of speculative liquidity dries up, the market could potentially become even more volatile, and the idea could backfire," says Kingsview Financial trader Matthew Zeman.

"I think it is still too early to assess if the limits will interfere with hedging liquidity or if large speculative accounts trading activity is really curtailed," says OptionsXpress analyst Michael Zarembski.

BGC financial director Roger Volz says the CFTC decision won't worry him until some kind of geopolitical, weather-related supply crisis occurs. "Then institutions may get caught racing for the limit."

Energy shares settled mixed. Suncor Energy ( SU) ended up 0.2% to $29.51; Continental Resources ( CLR) fell 0.3% to $58.22; Chevron ( CVX) rose 1.1% to $103.39; Apache ( APA) gained 1.3% to $91.29; Anadarko Petroleum ( APC) lost 1% to $76.95; Kinder Morgan Energy Partners ( KMP) added 0.5% to $76.54; and BP ( BP) advanced 1.3% to $41.32.

--Written by Andrea Tse in New York.

>To contact the writer of this article, click here: Andrea Tse.
Copyright 2011 TheStreet.com Inc. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

If you liked this article you might like

Energize Your Portfolio With 12 Stock Picks in Oil, Gas and Drilling Services

Energize Your Portfolio With 12 Stock Picks in Oil, Gas and Drilling Services

4 Oil Stocks Goldman Sachs Loves for 2018

4 Oil Stocks Goldman Sachs Loves for 2018

5 Stocks to Buy With Oil Prices Hitting Highs Again

5 Stocks to Buy With Oil Prices Hitting Highs Again

Keystone Pipeline Critics Appealing to GOP's Favorite Issues in Nebraska Battle

Keystone Pipeline Critics Appealing to GOP's Favorite Issues in Nebraska Battle

Why Barron's Has It Wrong on Oil

Why Barron's Has It Wrong on Oil