Supply glut will lower oil price

The oil price is creeping up again. But with the fudamentals not improving, and an ample supply, oil looks overpriced and due a correction.

Oil has bubbled up again over the past few days. US futures have broken out of their recent $70- to $80-a-barrel range, climbing to a three-month high around $82 this week.

The recent recovery in risk appetite, along with the decline in the dollar (which bolsters dollar-priced raw materials) has tempted more investors into the market. The number of speculators betting on further price rises is at its highest since May. Yet the fundamentals "have not improved", says Christophe Barret of Credit Agricole. Indeed, they suggest oil is overpriced and due a correction.

The oil market is amply supplied. American crude inventories recorded their biggest weekly increase in almost two years in the week to 23 July, as imports hit their highest level in four years. They're also at record highs on a seasonally adjusted basis, says Harry Colvin of Longview Economics. Opec's spare capacity has been back at 2002 levels of around six million barrels per day for over a year now. Countries' compliance with their agreed quotas has been slipping, says Dian Chu on Seekingalpha.com.

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In short, there is a global "supply glut", says Colvin, and it could well get bigger. Note that minor oil producers have been rapidly raising production; in Brazil and Angola, for instance, it is at record levels.

What's more, Iraq is "looking increasingly well placed to raise production capacity dramatically". The impact of political infighting has been "muted". A programme to auction off oil fields to international companies has accelerated in recent months. If the firms meet their own production targets, output could rise eightfold by 2017.

On the demand side, emerging economies don't dominate the oil market in the way that they do with other raw materials, adds Colvin. Sliding demand in Japan and Europe has offset almost 80% of the growth in demand from the Bric economies since 2005. The pattern has persisted even during the weak recovery.

So a lacklustre recovery, or a renewed slowdown in the West, would continue to hamper the world's appetite for oil. All this adds up to "a downward risk for prices", says Tim Evans of Citi Futures Perspective. Deutsche Bank reckons that, in the fourth quarter of this year, the oil price will average just $65 a barrel.