FUNDAMENTAL AND MARKET ANALYSIS OF CRUDE OIL

Fundamental and Market Analysis of Crude oil

Contents
1. 2. 3. 4. 5. 6. OVERVIEW ....................................................................................................................................... 2 PRODUCTION & SUPPLY SITUATION ............................................................................................... 3 DEMAND & CONSUMPTION PATTERN............................................................................................ 4 Peak Oil Mega-trend ....................................................................................................................... 6 IMPORTERS & EXPORTERS .............................................................................................................. 7 EFFECT OF FUNDAMENTAL FACTORS ON CRUDE OIL ..................................................................... 8 6.1. 6.2. 6.3. 6.4. 7. OPEC cartel.............................................................................................................................. 8 Geopolitical Factors ................................................................................................................ 9 Weather Conditions .............................................................................................................. 10 World demand supply situation............................................................................................ 11

VARIOUS MARKET FACTORS AND CRUDE OIL ............................................................................... 11 7.1 Inflation Factors .......................................................................................................................... 12 7.2 Exchange Rates and currency pressure ...................................................................................... 13 7.3 Interest Rates .............................................................................................................................. 15 7.4 Oil Price Impact on the Stock Market ......................................................................................... 16 7.5 Gold and Silver prices.................................................................................................................. 17 7.6 Crude oil prices and the S&P500 index ....................................................................................... 18

FUTURE TRENDS.................................................................................................................................... 18 Berclay's Analysis 0f crude oil in 2008 vis a vis 2011 ............................................................................ 19

List of Figures and Tables Fig 1 : Crude oil production in world Fig 2: Region-wise share in production of oil Fig 3: OPEC Oil Production 1973-2009 Fig 4: World GDP and oil production
Fig 5 : World crude oil production and consumption

Fig 6: World oil consumtion viz-a-viz Non-OPEC production growth Fig 7: Forecast projection for global Peak Oil Fig 8: Correlation between crude oil prices and major currencies Fig 9: Correlations: Oil vs CAD/USD Fig 10 : Correlations: Oil vs CAD/USD Fig 11 : Price trend for gold, silver and oil Fig 12: Correlations Of Gold and silver prices with crude oil Fig 13: Correlations Of Gold and silver prices with crude oil Fig 14: Oil production world summary
Table 1: Top 14 exporters and their net oil exports Table 2: World Crude Oil Production and Consumption (2000-2009), Million Barrels Per Day Table 3: Monthly Change in the Price of Crude Oil MBA-AB 2010 Page 1

Fundamental and Market Analysis of Crude oil

1. OVERVIEW
Crude oil is the most important energy source in a global perspective. About 35 percent of the worlds primary energy consumption is supplied by oil, followed by coal with 25 percent and natural gas with 21 percent. Transport relies to well over 90 percent on oil, be it transport on roads, by ships or by aircrafts. Total world production of crude oil is around 85 million barrels per day. The crude oil feeds a network of refineries at key locations located close to consuming centers or next to pipelines or shipping facilities. The crude oil is processed at the refineries and transformed into finished oil products. Therefore, the economy and the lifestyle of industrialised societies relies heavily on the sufficient supply of oil, moreover, probably also on the supply of cheap oil. Economic growth in the past was accompanied by a growing oil consumption. But in recent years the growth of the supply of oil has been slowing and production has now practically reached a plateau. This is happening despite historically high oil prices. It is very likely that the world has now practically reached peak oil production and that world oil production will soon start to decline at initially probably increasing rates. Because of the importance of oil as an energy source, and because of the difficulties of substituting oil by other fossil or renewable energy sources, peak oil will be a singular turning point. This will have consequences and repercussions for virtually every aspect of life in industrialised societies. Because the changes will be so fundamental, the whole topic is not popular. The oil industry is now admitting to the fact that the era of easy oil has ended. And the International Energy Agency, in stark contrast to past messages, is now warning of an imminent oil crunch in a few year time. The oil is primarily secured via term contracts as refiners are typically loath to rely too heavily on spot supplies as these may be unreliable and exhibit high price volatility. End users (airlines, manufacturers, etc.) operate similarly. The mechanisms for pricing crude and products vary by market sector and geographical region. Only 5-10%, is sold on the spot market. A spot deal is usually defined as a one-off deal between willing counterparties for a physical commodity. Because the deals are on a one-off basis, the spot market is representative of the marginal barrel in terms of supply and demand. Typically, spot sales are surpluses or amounts that a producer has not committed to sell on a term basis or amounts that do not fit scheduled sales. Thus main facts pertaining to crude oil are: 1. It accounts for 40% of worlds energy demand. 2. US hold 1.6% of world reserves but represent 23% of demand and imports 2/3rd of its oil requirement. 3. OPEC controls 80% of the world oil reserves. 4. Crude oil is characterised by high price volatility.

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Fundamental and Market Analysis of Crude oil

2. PRODUCTION & SUPPLY SITUATION

Saudi Arabia is the largest country in the Middle East and 14th largest country in the world and the number one producer of crude oil with average daily production of around 10.8 million barrels perday. Russia is the largest country in the world by area by a large margin and the second largest producer of crude oil in the world at 9.8 million barrels per day. Then comes United States, Iran and China. China is actively increasing its oil production to meet its own increasing demand from its rapidly growing economy which just overtook Japan as the 2nd largest economy in the world after the United States. The oil production trend for the world is shown below: Fig 1 : Crude oil production in world

crude oil production

74,000.00 72,000.00 70,000.00 68,000.00 66,000.00 64,000.00 62,000.00 60,000.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 production

Region-wise share in the production is as below: Fig 2: Region-wise share in production of oil

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Fundamental and Market Analysis of Crude oil

If we look for the production estimates by OPEC over the years we can have the below graph:

Fig 3: OPEC Oil Production 1973-2009

In addition to the pace of world economic activity, oil demand has been further supported by the composition of growth across countries. China, India, and the Middle East use substantially more oil to produce a dollars worth of real output than the United States. These economies are among the fastest growing in the world; together they have accounted for nearly two-thirds of the rise in world oil consumption since 2004. Moreover, these economies still consume relatively little oil on a per capita basis. Over the longer term, as these economies continue to develop and incomes rise, per capita energy use is likely to increase further. While global demand has remained strong, overall non-OPEC production growth has slowed. In the past three years, non-OPEC production growth has been well below rates seen earlier this decade. World oil consumption growth has simply outpaced non-OPEC production growth every year since 2003. This imbalance increases reliance upon OPEC production and/or inventories to fill the gap. However, since 2003, OPEC oil production has grown by only 2.4 million barrels per day while the call on OPEC (defined as the difference between world consumption and non-OPEC production) increased by 4.4 million barrels per day. As a result, the world oil market balance has tightened significantly.

3. DEMAND & CONSUMPTION PATTERN

The key driver of oil demand has been robust global economic growth, particularly in emerging market economies. As shown in Figure 1, world gross domestic product (GDP) growth (with countries weighted by oil consumption shares) has averaged close to 5 percent per year since 2004, marking the strongest performance in two decades. Fig 4: World GDP and oil production

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Fundamental and Market Analysis of Crude oil

Major demand centers are USA, EU, China, Japan and India. But the consumption was always more than production. The consumption pattern vis--vis production can be seen from the graph below: Fig 5 : World crude oil production and consumption

100,000.00 90,000.00 80,000.00 70,000.00 60,000.00 50,000.00 40,000.00 30,000.00 20,000.00 10,000.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 production consumtion

The rise in global economic activity has been accompanied by corresponding growth in world oil consumption. As depicted by table since 2003, world oil consumption growth has averaged 1.8 percent per year, representing an estimated 1 million barrels per day in 2008. Non-member countries of the OECD, especially China, India, and the Middle East, represent the largest part of this growth. Despite higher prices, growth in world oil consumption remains strong. But the reliance is majorly on OPEC countries only(refer below graph).

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Fundamental and Market Analysis of Crude oil Fig 6: World oil consumtion viz-a-viz Non-OPEC production growth

4. Peak Oil Mega-trend

Firstly, Peak Oil does not mean that the world is running out of oil any time soon, peak oil means that the world is about to pass the point of maximum rate of production after which production is expected to decline as it becomes ever more costly to find and extract new oil fields thus resulting in diminishing supply. The theory of Peak Oil is based on the principle originally developed by M King Hubbard in the 1950's, who observed the rate of production and depletion of oil output from the United States oil fields over time which culminated in a bell shaped curve. M King Hubbard went on to use his findings to accurate predict that U.S. oil production would peak by 1970 and decline rapidly. The below updated graph illustrates the most recent forecast projection for global Peak Oil which implies that the supply output peak is imminent, where the test will come when supply fails to respond to rising demand as the worlds economies return to trend growth.

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Fundamental and Market Analysis of Crude oil Fig 7: Forecast projection for global Peak Oil

Peak Oil is a reality, the major cheap oil fields across the big producing nations have already passed their peak outputs and are declining fast in output and where discoveries of new economically recoverable reserves are not keeping pace with. We got a taste of the consequences of peak oil during 2008 when Crude oil soared to $147, where a small shift in the supply demand balance can cause extreme shifts in price as MARKET SENTIMENT (speculators) drives prices into ever increasingly volatile price trends.

5. IMPORTERS & EXPORTERS

Huge revenue is earned from crude oil exports and this has played a key role in making the gulf countries global leaders. The rate at which crude oil is being consumed is increasing due to technology improvements, demands of the individuals and industries. At present, United States of America is the largest consumer of crude oil. The major crude oil exporting countries are Saudi Arabia, Iran, Venezuela, Kuwait, Nigeria, Iraq, Libya, Qatar and many more. The major crude oil importers are United States, India, Germany, France, Italy, Spain, China and Japan. There are lots of factors that influence the need for crude oil imports. The top five exporting countries accounted for 71 percent of United States crude oil imports in December while the top ten sources accounted for approximately 87 percent of all U.S. crude oil imports. The top five sources of US crude oil imports for December were Canada (2.051 million barrels per day), Mexico (1.063 million barrels per day), Nigeria (1.020 million barrels per day), Saudi Arabia (0.886 million barrels per day), and Venezuela (0.772 million
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Fundamental and Market Analysis of Crude oil barrels per day). The rest of the top ten sources, in order, were Algeria (0.336 million barrels per day), Iraq (0.325) million barrels per day), Angola (0.266 million barrels per day), Brazil (0.181 million barrels per day), and Colombia (0.179 million barrels per day). Total crude oil imports averaged 8.133 million barrels per day in December, which is a decrease of 0.576 million barrels per day from November 2009. Major exporters for crude oil are listed below:
Table 1: Top 14 exporters and their net oil exports Net oil (million of barrel /day) Exporters2
1. Saudi Arabia 2. Russia 3. Norway 4. Iran 5. United Arab Emirates 6. Venezuela 7. Kuwait 8. Nigeria 9. Algeria 10. Mexico 11. Libya 12. Iraq 13. Angola 14. Kazakhstan

exports (2009-2010)
8.65 6.57 2.54 2.52 2.52 2.2 2.15 2.15 1.85 1.68 1.52 1.43 1.36 1.11

6. EFFECT OF FUNDAMENTAL FACTORS ON CRUDE OIL 6.1. OPEC cartel

The Organization of Petroleum Exporting Countries (OPEC) accounts for around 40% of current world supply. This gives OPEC a pivotal influence in shaping the direction of oil prices but only when the cartel acts together to control production and balance supply and demand in the international market. Non-OPEC countries account for the largest portion of total supply. Oil is produced in nearly every corner of the world, and nearly every region has been expanding oil production in the last decade. This includes Europe, where Norwegian oil companies are achieving a rapid increase in oil extraction and also Russia now one of the worlds largest oil suppliers. OPEC sets quotas for how much crude oil they want to produce with the aim of stabilising the price at a target level. There are always major doubts about OPECs ability to keep to
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Fundamental and Market Analysis of Crude oil output limits. Basically, OPEC acts as the swing producer in the world oil market. It controls that part of the world supply curve which is easiest to change and if it wants to keep oil prices high, then it can keep tight control on short run production so that supply does not run too far ahead of demand. OPEC has to tread a fine line, because if prices remain too high for a long period, then oil consumers have a clear incentive to look for alternative sources of energy or other non-oil substitutes in production.

6.2. Geopolitical Factors

Just as the lack of surplus capacity is related to the growth in global demand, the impact on prices due to geopolitical risks is related to the lack of surplus capacity. If surplus capacity was sufficient to make up for any reasonable likelihood of a loss in supply, then the risks would not have as great an impact on price. However, because there is very limited surplus capacity, concerns about potential or existing supply problems in Nigeria, Iran, Iraq, Venezuela, and elsewhere, have exacerbated price increases related to the supply-anddemand factor above The risks brought by geopolitical factors include instabilities of a nation's government and/or domestic economy, such nations do not necessarily to be an major crude oil exporter. For example, Singapore has strategic geographical location on the strait of Malacca, a main ocean waterway where 11.7 million barrels of crude oil passing by daily (2004 data). As a result, failure to crack pirate activities in the strait of Malacca by Singapore and other neighboring nations' law-enforcement departments will sometimes bring a up curve in the crude oil futures price. In Venezuela, a disastrous two-month national oil strike, from December 2002 to February 2003, temporarily halted the whole nation's economic activity. Because Venezuela continues to be an important source of crude oil for the U.S. market. Both the instant effect of oil output volume collapse and aftermath effects as inflation and unemployment became fundamental drivers for a price hike of WTI future contact during the period, November 2002 to March 2003. Venezuela's national strike ended in February 2003, the following U.S. invasion to Iraq, started on March 20, 2003, kept the crude oil futures price at its local peak for another week. During the period of 2003-2006, the forces exercised by geopolitical factors to global crude oil market are clearly pull-up ones. Besides the situation of Venezuela as described above, the U.S. invasion to Iraq successfully toppled the regime of Saddam Hussein in a short time frame, however the following insurgent activities in the war-torn country have been put the Middle East in long-time instability. During the same period, the conflicts between U.S. and Iran, the world's fourth largest oil exporter in 2004, have never really come to a rest. In year 2003-2004, some analysts even believed that a U.S. invasion to Iran had been planned and military actions of none-regular attacks, such as missile assaults might be taken. In Nigeria, it is not uncommon for oil producing and transporting facilities to be vandalized and result in sharp drop in oil output. In May 2005, Gasoline gushing from a
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Fundamental and Market Analysis of Crude oil ruptured pipeline exploded as villagers scavenged for fuel in Nigeria, killed up to 200 and caused a 50% drop in the nation's oil output for a week. Also the world's biggest oil exporter is Saudi Arabia and thus it can highly affect the prices. On February 24, 2006, Islamic extremists took a bold daytime attack on the world's largest oil-processing facility, called Abqaiq close to Saudi Arabia's main export terminals on the Gulf coast. Although the attack was defeated at the security roadlock and did not affect the oil-processing facility's daily production at all, future contract 1 of WTI (to be delivered in March 2006) had a 3.4% price increase the next day. This is a terrific example of the magnitude of Saudi oil's influencing power to the global market.

6.3.

Weather Conditions

In terms of demand, the impact of weather is felt mainly for particular crude oils that enjoy especially wide cuts of the middle distillates that are needed for making heating fuels.In general, there is a swing between winter and summer oil demand of about 6 million barrels per day, or roughly 8.5% of average annual demand. This seasonal demand is driven primarily by winter fuel requirements across the developed countries of the Northern Hemisphere. Other seasonal patterns such as the peak in summer gasoline demand in the US and Europe or the winter fuel requirements of the Southern Hemisphere provide only a slight offset. The main fuels that drive this seasonal pattern are heating oil or gas oil in North America and Europe and kerosene in Asia. Also for example, For certain fields, such as those in Alaska and the North Sea, production peaks in the winter. In Alaska this is because of the greater efficiency of gas injection and in the North Sea it is because field maintenance is concentrated in a few summer months. Nigerian Forcados crude in the Atlantic Basin or Malaysian Tapis Blend in Asia. When demand for winter fuels is strong, refiners seek out these grades and pay premiums for them that reflect their richer yields. The heating oil markets of the US and Northwest Europe follow similar seasonal patterns and cope with the vagaries of the weather in fairly similar ways. The markets are also intertwined through arbitrage and cargoes will move east or west across the Atlantic according to relative price signals. In a peak week, arbitrage volumes can exceed 1 million barrels per day or more. The impact of weather is not all on the demand side. In periods of extreme cold, refinery operations are sometimes disrupted and the market looses extremely important sources of supply. This obviously exacerbates any tightness that the market is feeling from increased, weather-driven demand. These kind of incidents are rare but both the US Gulf Coast and the Mediterranean, which are both important export centers for heating oil and other products, have lost considerable refinery capacity for periods of days and weeks as a result of unexpected hard freezes that have disrupted operations. In Northeast Asia, the main winter heating fuel is kerosene, which is used in individual heaters rather than furnaces. Seasonality is most pronounced in Japan and
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Fundamental and Market Analysis of Crude oil Korea, and as with the heating oil markets of the US and Europe, refiners manage these requirements through a combination of inventories and processing flexibility. Consumer stocks are quite small relative to seasonal requirements, but the distribution systems have multiple layers of inventories.

6.4. World demand supply situation

There is a strong link between the demand for oil and the rate of global economic growth because oil is an essential input into many industries when the economy is expanding, the demand for oil rises. The best recent example of this is the growth of the Chinese economy. Fast growth of national output in energy-intensive sectors has led to a surge in demand for crude oil into the Chinese economy. Also demand for crude oil affected by the relative prices of oil substitutes (e.g. the market price of gas). If, in the longer term, reliable and relatively cheaper substitutes for oil can be developed, then we might expect to see a shift in demand away from crude oil towards the emerging substitutes. The high price of oil during 20042006 seems to have led to a rise in research and development into non-oil substitutes. These can take several years to come through to affect the market for energy. Also, it is often said that if the winter in North America is fierce, then the price of crude rises as the USA and Canadian economies raise their demand for oil to fuel household heating systems and workplaces. The demand for oil is also price inelastic. This combination of an inelastic demand and supply helps to explain some of the volatility in world oil prices. When we consider the global supply of oil we need to make a distinction between short-term and longer-term supply to the international markets. The short run supply curve is normally drawn on the basis of a given state of production technology and fixed use of capital inputs (i.e. the oil industry is supplying from a known level of oil reserves and a given stock of capital machinery used to extract that oil). There is inevitably a short-run limit on daily oil supply and, as production gets close to capacity limits, so the short run supply of oil becomes more inelastic. In short, the short-run supply of crude oil is affected by a series of different factors like profir motive, share capacity, stocks, external shocks etc. Taking a longer-term perspective, the long run world oil supply is linked to reserves, exploration, technology etc. Supply demand situation for past few years is shown below:
Table 2: World Crude Oil Production and Consumption (2000-2009), Million Barrels Per Day

Year Total Production Total Consumption

2003 76.9 79.4

2004 80.4 82.3

2005 81.3 83.5

2006 81.6 84.4

2007 81.4 85.6

2008 82.0 85.2

2009 79.9 84.1

7. VARIOUS MARKET FACTORS AND CRUDE OIL

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7.1 Inflation Factors

The price of oil and inflation are often seen as being connected in a cause and effect relationship. As oil prices move up or down, inflation follows in the same direction. The reason why this happens is that oil is a major input in the economy - it is used in critical activities such as fueling transportation and heating homes - and if input costs rise, so should the cost of end products. Thus rising oil prices tend to affect the overall consumer price index (CPI) directly by raising its energy cost component, which includes the prices of energyrelated items, such as household fuels, motor fuels, gas, and electricity. Among these, gasoline and fuel oil are directly derived from crude oil, so their prices follow oil prices very closely. An increase in the price of oil may also affect energy costs through the prices of other items that are close substitutes; for example, households and businesses may switch from oil-related energy items to natural gas, thus leading to an increase in its price. The extent to which rising oil prices translate into higher overall inflation through higher energy costs depends on their persistence. If they continue to rise, they may lead to sustained increases in the overall price level, that is, to an increase in the overall inflation rate. Rising oil prices tend also to affect the core portion of the CPI indirectly, because energy prices represent a considerable portion of the production cost for many of the items in it, such as transportation services. In addition, if workers have to pay higher energy prices themselves, they may bargain for compensating wage increases, which also increases the production costs of items in the core CPI. The extent to which rising oil prices translate into higher core inflation through higher production costs depends, among other things, on how much they break into the overall inflation expectations of those who set prices and wages. In fact, if rising oil prices lead to higher inflation expectations over the longer term, rising energy and wage costs are more likely to be passed through in terms of rising consumer prices. In this case, rising oil prices may lead to sustained increases in the core portion of the CPI, that is, to an increase in core inflation. The direct relationship between oil and inflation was evident in the 1970s, when the cost of oil rose from a nominal price of $3 before the 1973 oil crisis to around $40 during the 1979 oil crisis. This helped cause the consumer price index (CPI), a key measure of inflation, to more than double from 41.20 in early 1972 to 86.30 by the end of 1980. Let's put this into perspective: while it had previously taken 24 years (1947-1971) for the CPI to double, during the 1970s it took about eight years. However, this relationship between oil and inflation started to deteriorate after the 1980s. During the 1990's Gulf War oil crisis, crude prices doubled in six months from around $20 to around $40, but CPI remained relatively stable, growing from 134.6 in January 1991 to 137.9 in December 1991. This detachment in the relationship was even more apparent during the oil price run-up from 1999 to 2005, in which the annual average nominal price of oil rose from $16.56 to $50.04. During this same period, the CPI rose from 164.30 in January 1999 to 196.80 in December 2005. Judging by this data, it appears that the strong correlation between oil prices and inflation that was seen in the 1970s has weakened significantly.

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Fundamental and Market Analysis of Crude oil

7.2 Exchange Rates and currency pressure

The relationship between exchange rates and oil prices is complex, and the causality can run both from exchange rates to oil prices and from oil prices to exchange rates. Typically, a depreciation of the dollar would be expected to lead to a rise in the dollar price of oil. As oil is priced in dollars, a lower exchange value of the dollar reduces the foreign-currency price and thus boosts demand. To clear the market, the dollar price of oil must then rise, assuming (reasonably) that supply is not perfectly elastic. Empirical studies do not reveal a clear, precisely estimated relationship between oil prices and the exchange value of the dollar. The available evidence suggests that oil prices respond approximately proportionately to changes in the dollar when all other economic factors are held constant. In other words, a 10% depreciation of the nominal, trade-weighted, multilateral exchange value of the dollar is associated with a 10 % rise in the dollar price of oil when other factors are held constant. That finding suggests that the depreciation of the dollar since 2002 has contributed to the rise of the dollar price of oil, but can explain only a portion of the overall run-up. Clearly, oil prices have risen sharply regardless of the currency of denomination. Moreover, from mid-March through June 2008, the dollar was stable, whereas oil prices increased appreciably. An additional linkage between exchange rates and oil prices may arise through the production decisions of key oil exporters. Oil exporters suffer a decline in the purchasing power of their revenues when the dollar depreciates. To defend their international purchasing power, these producers could, in principle, seek an offsetting increase in the dollar price of oil by curtailing supply. Shocks specific to the oil market can also feed back into exchange rates. As the United States is both a major producer and consumer of oil, increases in oil prices tend to lead to depreciations against the currencies of major oil exporters and appreciations against the currencies of major oil importers. Empirically, these bilateral exchange rate movements often tend to cancel out, resulting in little net change in the multilateral value of the dollar. During the past few years, however, the nominal value of U.S. oil imports has soared, resulting in a significantly wider trade deficit than would have otherwise occurred. This widening may have exacerbated concerns about the sustainability of the current account deficit, thereby putting downward pressure on the dollar. Lets look at the relationship between crude oil prices and major currencies: During June there were high correlations among daily percent changes in crude oil prices (WTI and Brent oil) and EUR/USD, AUD/USD,USD/CNY & USD/CAD i.e. there was a negative correlation between the (daily percent changes) US dollar and crude oil prices.

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Fundamental and Market Analysis of Crude oil Fig 8: Correlation between crude oil prices and major currencies

During the month, EUR/USD rose by 0.88%; AUD/USD inclined by 0.58%; and USD/CAD fell by 0.56%. These figures show that US dollar depreciated during the month compared to other currencies. That being said, the daily fluctuations (around the trend) and not the trend of these exchange rates were probably linked to the daily percent changes of crude oil prices. Next figure shows the clearly positive relationship between oil and the Canadian loonie. In fact, it should come as no surprise that the price of oil actually acts as a leading indicator for the price action of the CAD/USD. Since the traded instrument is the inverse, or USD/CAD, it's important to note that based on the historical relationship, when oil prices go up, USD/CAD falls and when oil prices go down, USD/CAD rises. Fig 9: Correlations: Oil vs CAD/USD

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Fundamental and Market Analysis of Crude oil Source: FXCM Also looking at this from a net oil exporter/importer perspective, the currency pair that tops the list of currencies to trade to express a view on oil prices is the Canadian dollar against the Japanese yen. Figure 2 illustrates the tight correlation between oil prices and CAD/JPY. More often than not, oil prices tend to be the leading indicator (as with USD/CAD) for CAD/JPY price action with a noticeable delay. As oil prices continued to fall during this period, CAD/JPY broke the 100 level to hit a low of 76. Fig 10 : Correlations: Oil vs CAD/USD

Source: FXCM

7.3 Interest Rates

The relation between interest rates and oil prices can vary, as it depends on the interactions of many economic variables. A decline in interest rates by itself might be expected to raise oil prices to some extent, suggesting a negative correlation between these two variables. But if the decline in interest rates is in reaction to a downturn in economic activity, oil prices may very well fall in response to that weaker demand, resulting in a positive correlation. One mechanism by which declines in interest rates could push up oil prices is through a reduction in the costs associated with storing oil and other commodities. An implication of this hypothesis is that inventories of oil should tend to rise when interest rates decline. Such increases, however, are not evident in the available data. Another channel through which lower U.S. interest rates could drive up oil prices is by leading to excessively expansionary policies and faster increases in oil demand in countries that peg their currencies to or manage their currencies against the dollar. In the current setting, the stance of monetary policy in the United States, which has come in response to concerns about the domestic economic outlook, may not be appropriate for many fast-growing, commodity-intensive economies. In practice, however, much uncertainty surrounds the extent to which foreign central banks have matched U.S. monetary policy moves, the effect of this on foreign economic growth, and its ultimate influence on commodity prices.

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Fundamental and Market Analysis of Crude oil

7.4 Oil Price Impact on the Stock Market

The consensus view as iterated on a near daily basis in the mainstream press and on the internet is that rising oil prices are generally bearish for the stock market, and falling oil prices are generally bullish. However, the below graph of the Dow and Crude Oil price illustrates that most of the time the oil price and the stock market (Dow Jones index) can be expected to trend in the same direction. This clearly implies that most of the time a rising oil price is associated with economic growth and thus rising future prospects for corporate earnings are discounted by rising stock prices. Whereas a falling oil price is associated with weaker future economic activity and thus implies lower future corporate earnings which is again discounted in the present.

As mentioned earlier, rising oil prices are part of an inflationary mega-trend, which means that as higher oil prices trend higher, the associated costs can be expected to be passed into consumers in an orderly manner, thus the peak oil mega-trend is bullish for nominal stock prices. The only fly in the ointment is that as illustrated by the oil price trend during the first half of 2008, when there was a serious divergence between the stock market and the oil price as mania gripped the market that sent inflation soaring, and thus as the oil price soared the stock market entered into a severe bear market. However this divergence did not persist as oil price bubble burst sending the oil price literally crashing lower, playing catch up to the stocks bear market into the March 2009 low.
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Fundamental and Market Analysis of Crude oil

7.5 Gold and Silver prices

The oil price has in the past few years been a major influence on the gold price and vice versa. Both represent an unalterable definer of power and value. But of late the gold price has lagged the oil price in its relationship with oil. Fig 11 : Price trend for gold, silver and oil

During June, daily percent changes of crude oil price (WTI) were strongly and positively correlated with gold and silver prices. The correlation was weaker than in May, but stronger than in February- April. Fig 12: Correlations Of Gold and silver prices with crude oil

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7.6 Crude oil prices and the S&P500 index

In the last three months there were strong positive linear correlations between S&P500 index and crude oil prices. Fig 13: Correlations Of Gold and silver prices with crude oil

The abovementioned findings suggest that crude oil was strongly linked with the US stock market and gold and silver.

FUTURE TRENDS
Fig 14: Oil production world summary

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Fundamental and Market Analysis of Crude oil

The oil production capacity of middle east, Africa, Latin America, South Asia, China and other oil producing countries after reaching a peak around 2008 dropped and are expected to drop even further by 2025. Bullish View for Crude Oil 1. 2. 3. 4. 5. More supply shocks Spare capacity cushion Refining bottleneck Robust demand for oil Rise in oil prices have not depressed oil demand.

Bearish View for Crude Oil 1. 2. 3. 4. 5. Resolution of any geopolitical factors Knockdown risk premium Chinese economic growth Non OPEC supply will respond to higher oil prices Global demand for oil would

Berclay's Analysis 0f crude oil in 2008 vis a vis 2011

NEW YORK (Commodity Online): Sovereign debt fears, US financial crisis and consequent recessionary trends have caused crude oil prices to crash in the past few weeks. WTI crude for September has fallen 9.2% on week to $86.88 while Brent Crude has fallen 6.2% to $109.37. This has created concerns about a repeat of 2008 when Oil prices crash from $147 levels to below $70 in a short span of time.
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Fundamental and Market Analysis of Crude oil Barclays Capital in an analysis points out five factors that could make a repeat of 2008 impossible in the present scenario. 1) Libyan supplies are unexpected to return to world market in 2011: Considering the civil war and political tensions which means that 1.5 mn barrels per day would be out of supply from the market for a longer time. As of today, the cumulative loss of Libyan output since the start of the civil war amounts to 233 mb, nearly four times the amount released by the IEA and almost a third of the total size of the US Strategic Petroleum Reserve. The absence of Libya has allowed Saudi Arabia to move its output above 9.5 mb/d and to eye 10 mb/d, without to date having to run any risk of oversupplying the market. 2) OPEC may not sell below breakeven: In 2008 when prices crashed to below $70 there was a strong compulsion on the part of OPEC to allow price to go below breakeven levels to kick start demand in consuming economies as they slid into recession. The present underlying issue for recessionary trends is caused by sovereign debt while Saudi Arabia and much of OPEC member nations. Barclays Capital said that it is very unlikely that Saudi Arabia will feel the need to sacrifice revenues to sell below breakeven levels. 3) No major demand crash expected: Barclays Capital points out there was a massive fall in US oil demand in 2008 September at 2.56 mn b/d on year-on-year basis and OECD oil demand fell 3.9 mn b/d in November 2008. In 2011 there are no projections or expectations of any falls in demand of that severity or anywhere close. Yes, US oil demand has weakened , but the damage has been contained to falls of 0.5 mb/d, not 2.5 mb/d. Considering demand for the main oil products. 4) Call on OPEC still rising: Even after a fairly sharp paring in estimates of oil demand growth, we are still forecasting a call on OPEC crude and inventories of 30.3 mb/d in Q3 and 30.5 mb/d in Q4). OPEC crude output in Q2 amounted to just 29.5 mb/d. In other words, we could cut our H2 demand estimates by a further 1 mb/d before OPEC even needed to cut anything if it wished to avoid an overall inventory build. To justify the scale of cut that OPEC made in 2008/9, H2 demand would have to be lower than the current forecast by 4 mb/d. The macroeconomic concern at the moment is of frustratingly low growth and more austerity, but not yet the sort of economic implosion that could produce a 4 mb/d fall in oil demand across all of H2. The call on OPEC in H2 that is larger than OPEC output in Q2. While another round of monthly reports due in the next week is likely to cut that gap, we doubt that it will remove it completely, particularly in the case of the IEA projections. We expect that the IEA will still think that OPEC should be adding oil the market, precisely at the time when OPEC thinks it should be taking oil away. That combination seems unlikely to be associated with any price collapse that could be sustained. In short, current fundamentals appear to be a far cry from those that drove the 2008/9 cycle, Barclays Capital said in the analysis. 5) The cycle repeats itself: During downswings below breakeven levels renewable economics and also oil sand economics began to break, and the whole supply-side reaction led much of the market to conclude that $100 per barrel for the back of the curve was now the new normal, and below that would represent low prices. The oil
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Fundamental and Market Analysis of Crude oil industrys ability to cope with lower prices without damaging future supply is limited On the demand side, lower prices fed into a sharp global demand upswing, leading to the fastest demand growth for 30 years, with demand growth in 2010 running at least twice as fast, and perhaps three times as fast, as the maximum the supply side could cope with into the medium term, Barclays Capital noted. Spare capacity of 6.5 mb/d quickly became spare capacity of just 2.5 mb/d. The lesson of the last cycle is that the further prices are forced below $90 and the longer they stay there, the faster the market tightens in the upswing. During that last downswing we wrote that we did not believe prices could be sustained into the medium term below $90. In the final analysis we believe that proved to be correct, prices could move below $90 but they could not be sustained below that level. Since then, cost inflation has returned and, as noted above, producer aspirations have moved upwards by some $20. We thus feel even more confident this time to reiterate that 2008 view that prices are not sustainable below $90 per barrel because of the associated damage to supply and the stoking up of demand that prices below that level represent. Indeed, in this particular aspect we suspect that $100 for Brent is probably the new $90 in terms of what is a sustainable price, Barclays Capital report said.

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