Some traders bet a recovery will strain supply by yearend

By Mark Shenk, Stanley Reed and Alaric Nightingale

Source:

April 29, 2010

• “Slower rates of…growth mean that OECD demand has peaked”

Riding on the blue-green waters off the tiny emirate of Fujairah is a growing fleet of Iranian supertankers. Some 15 of the monster ships, which hold 2 million barrels each, are loitering around the Gulf in hopes that now depressed demand for Iranian crude will pick up. Much the same is happening off the U.S. Gulf Coast, where nine tankers holding some 19 million barrels of oil, a day’s U.S. consumption, are idling. At the oil depot in Cushing, Okla., the largest in the U.S., storage tanks are filled to near-record levels.

Tankers on a trip to nowhere are symptomatic of today’s paradoxical oil market. Current demand looks weak, but prices remain firm, recently testing the highest levels since October 2008. Many traders argue the world economy will stage a strong recovery that strains supply by yearend. “We’re heading for $100,” says John Kilduff, a partner at Round Earth Capital, a New York hedge fund. “The industry is going to get caught flat-footed again.”

Take a hard look at the oil market and such fears seem unfounded. Some forecasters, including the International Energy Agency in Paris, believe this downward shift could be long-lasting. The big price surge of 2008 helped dampen demand while encouraging investment in new wells and increasing supply. Consumption in the industrial countries that belong to the Organization for Economic Cooperation & Development will average 45.4 million barrels per day this year, down a hefty 8.8% since 2005, when OECD oil consumption hit an all-time high. “Slower rates of economic growth mean that OECD demand has peaked,” says Rick Mueller, director of oil markets at Energy Security Analysis in Wakefield, Mass. Demand in China may be rising by a brisk 7%, but in the U.S., which consumes twice as much oil, inventories are well above the closely watched five-year average.

While demand in developed markets levels off, global oil output keeps rising. The Organization of Petroleum Exporting Countries, which helped put a floor under prices last year with sharp production cuts, is now opening the valves. Production has risen by 1.5 million barrels per day from the low in March 2009.

Producers outside of OPEC are getting in on the act. The U.S., long dismissed as an energy weakling, produced 5.5 million barrels in March, the highest since 2005, according to the American Petroleum Institute. The world also has a healthy margin of six million barrels per day of spare capacity, largely thanks to a huge Saudi investment program. “The current imbalance between supply and demand will likely lead to increasing storage levels and lower prices going into the summer,” says Goran P. Trapp, global head of oil trading at Morgan Stanley in London.

How low? BP () CEO Tony Hayward expects prices to stay in the $60 to $90 range for the medium term. A hard core of skeptical traders has a darker perspective on prices than Hayward’s more mainstream view. The New York Mercantile Exchange has 130,000 put options for June sales in the $50 to $60 per barrel range compared with just 51,000 calls to buy at $100 per barrel. Says Eugen Weinberg, senior analyst with Commerzbank in Frankfurt: “It’s a bubble, and it’s just a question of time” before it bursts.

The bottom line: The Saudis are the key to where prices will settle. They like $80 a barrel but could cut output fast if prices drop.

is a reporter for Bloomberg News. is London bureau chief for Bloomberg Businessweek. Alaric Nightingale is a reporter for Bloomberg News.