A new year has passed, and the global economies are still suffering the aftermath of the worst recession since the Great Depression, as the recession hit demand levels deeply and led oil prices to drop heavily from their record lows back in 2008, yet all expectations signal that 2010 is going to be much better, as signs of recovery from all around the globe started to emerge, yet still there are challenges ahead that could affect oil prices and accordingly the outlook for oil prices remains somehow unclear. We are detailing the major developments that occurred in 2009 that led oil prices to rise from as low as $34 a barrel to hover around $70 a barrel towards the end of the year, and we will also put some light over the outlook for oil over the course of 2010.

The year 2008 marked a dark year for many as major economies around the globe fell into the depth of recession and this indeed affected demand on oil deeply, amid the huge drop in production levels and this was directly reflected onto oil prices, as oil prices rose to a record high above $147 back in July 2008 but started to fall ever since then to reach their lowest level at $34 a barrel in 2009. 

Oil prices settled around $40 a barrel early in 2009 as oil prices dropped from the 2008 record highs to reach $34 a barrel in January 2009, amid the huge wave of pessimism that dominated investors early in 2009 as a result of the worst financial crisis since the Great Depression. 

Oil prices were affected by the political tension in the Gaza Strip, as Hamas and the Israeli Army started to lock horns, leading eventually to a war that raised concerns among investors over the stability of the Middle Ease Region, and since the ME has the world’s largest reserve of oil; prices started to rise to reach $54 a barrel, since this war was seen as a major threat for oil exports from the Middle Ease Region, and that helped oil prices in settling around the $50 a barrel levels. 

Optimism dominated financial markets after US President Obama announced his plan, which was aimed at reviving economic activity in the United States; the fiscal stimulus had a total bill of $787 billion through tax credits and governmental spending to support the US economy, in addition the Federal Reserve Bank announced it will buy more than $1 trillion in Treasury Securities and Mortgage-Backed Securities and other long term securities in the so called “quantitative easing policy”, which boosted demand for oil as an alternative investment. 

Confidence started to increase among consumers from that point on, as consumer spending started to recover slightly supported by the fiscal stimulus of course, and accordingly this was reflected on the performance of several sectors around the US economy, where this indeed supported oil prices and prevented them from dropping any further. 

The data released from the US housing sector also supported oil prices, as the US housing market started to show signs of stabilization during the second quarter of 2009 and continued to improve from that point, as activity in the housing market indeed started to increase towards the end of 2009. 

The Recession  

The recession indeed affected oil prices, as the US economy continued to contract during the first half of 2009, which meant that demand on oil remained weak in general, and this was clearly shown through the rising slack in spare capacity throughout the world and not just in the United States. 

Fears among investors about the recession might become prolonged, weighed down on demand levels as well, as consumer spending dropped and income growth also declined amid rising unemployment levels all around the globe, and this indeed affected production levels negatively and pressured oil prices to drop early in 2009. 

The weekly EIA report from the United States is considered one of the main indicators for demand on oil, as the US is indeed the world’s largest consumer for oil, as the EIA reports continued to show demand was declining, yet later on in 2009, the EIA report started to show that demand is somehow recovering and accordingly this helped in pushing oil prices higher. 

Central banks around the globe slashed their interest rates in order to help revive their economies; where the BOE, the ECB, and the FED were among the leaders as they reduced their short term borrowing costs to record lows. 

Open reduced its output levels to 4.2 million barrels per day, as OPEC was trying to trim the huge supply of oil to meet the sluggish demand levels and accordingly support oil prices, where OPEC signaled that the fair price of oil should be between $70 and $75 a barrel. 

As for Asia, the drop in Chinese imports signaled clearly that the Chinese economy, which is considered the second largest consumer of oil on a global scale is suffering as well, as demand on foreign goods including oil dropped heavily, as that pressured prices of oil to remain low amid weak demand levels; while Japanese exports also dropped signaling that demand for oil was also falling from Japan the world’s third largest consumer of oil. 

The Beginning of the Rally in Oil Prices 

The start of 2009 marked the bottom for oil prices, as oil prices started to rebound In the middle of 2009, as global economies started to show signs of improvement as a result of the fiscal stimulus plans that helped in increasing economic activity all around the globe, as this supported oil prices to increase towards the $81 a barrel levels. 

Oil prices however were affected by the H1N1 virus, which was later described as a pandemic, as investors were worried that the flu will further hurt demand levels from consumers and will affect commercial trades between countries, as that would have weighed further on global economy, and this prevented oil prices from continuing their rally though for a short period of time. 

After the feelings of optimism dominated markets; the outlook for global growth started to improve significantly, where data from major economies around the globe, including the  US, the UK, the Euro Zone, and Japan signaled that the pace of contraction is indeed easing, and that economies are on the right track to recovery. 

The inverse relationship between the US dollar and oil prices also contributed to the fluctuation in oil prices throughout 2009, as the dollar continued to weaken noticeably against major currencies since March 2009, which helped oil prices into extending their rally. 

The Euro and oil prices have a positive relationship, as both benefit from a weak US Dollar; however, this relationship is more accurate over the long term rather than over the short term, yet still both the Euro and oil moved in the same direction, as oil prices rose this year to set the highest level at $81.00 a barrel; while the Euro rose against the US dollar to reach its highest level at $1.5145 this year. 

The main driver for oil prices over the last few months of 2009 was the movement in commodities in general, as gold prices rose to a record high at $1226 an ounce in December, which also boosted the appeal for oil as an alternative investment. 

Investors’ expectations over the outlook for major economies and their hope that the recession is coming to an end, helped in increasing confidence levels in financial markets and that supported the positive relationship between oil prices and stock markets, as stock markets have been rising over the past few months drastically, where the Dow Jones Industrial Average rose to the highest level this year in December around 10500. 

Outlook for Oil Prices 

Given the current circumstances and the ongoing weakness in oil exporting countries, we should expect oil prices to settle around $70 a barrel, as this would fairly reflected all the fiscal stimulus plans by global governments and their effect on stabilizing economic activity all around the globe, as the recession is indeed fading and the recovery has already started which means that demand for oil will start to recover gradually as well. 

Most analysts in financial markets believe that oil prices will average around $72.25 a barrel in 2010, where median expectations ranged from as high as $80.00 a barrel and as low as $3.00 a barrel, although some analysts predict oil prices will reach $100 a barrel by the end of 2010; while Brent oil is expected to average around $75 a barrel in 2010. 

The IMF sees oil prices which average between $70-80 a barrel in 2010, which is also near the range set by OPEC, as OPEC predicts oil will fluctuate between $75 and $85 a barrel in the upcoming year. 

Expectations signal that oil prices will undertake an upside direction over the upcoming few years, as economies around the world started to show that the worst recession since the early 1930s is indeed coming to an end; however, most economies are still facing huge challenges ahead, while demand levels are still rather weak while supply levels of oil remain somehow elevated, and accordingly we can’t take expectations that oil prices will rise in 2010 for granted…

ecpulse.com