Alliance Trust: Oil price trends

Commenting on oil price trends, Angus McPhail, Global Oil and Natural Resources Analyst at Alliance Trust said: Oil prices are currently being driven by only one side of the supply-demand equation, by the outlook for demand. Over the longer term, once the market returns to a more complete assessment of industry fundamentals, the effect of restricted supply will support rising prices.

Over the last weeks we have seen a significant drop in oil prices - to a level which is clearly unsustainable in the long term. Oil is now trading below the marginal cost of production of around US$60/bbl.

"Demand obsession" is the current predominant feature in the oil market. Prices are tracking the changing perception of demand with the outlook for supply taking a back seat for the moment. OPEC is watching global oil levels closely and can agree and implement significant cuts to production. It is positive to see that members of the oil suppliers' group are, unlike previously, adhering to their own supply limits.

OPEC is due to meet this week in Algeria to discuss another possible cut to production. OPEC as a group has changed significantly over the last four to five years as its members have now realised there are limited options to increase its capacity significantly from where it is now.

The picture being painted by economists regarding macroeconomic conditions affecting oil remains grim. China's growth forecast is gradually being reined back in, which is having an extremely bearish effect on oil prices. This is because China has the largest incremental global demand for oil compared to meet the rapid industrialisation or as some would coin ‘The Third Industrial Revolution'.

At the demand side of the market, stabilisation remains a long way off, and this is dependent on macroeconomic circumstances and not OPEC's willingness to act.

The supply end remains very weak and non-OPEC producers are all struggling to obtain meaningful growth in the replacement of existing reserves. Russia, and in particular Mexico both have large production declines. The only real growth opportunities are currently in Brazil and the Caspian.

The ground is now being laid for even more supply problems in the next decade, although this is an issue which is unlikely to affect oil prices in the short term.