Oil is set to slide further

Oil producers have upped supply to multi-decade highs to compensate for the slowdown in global economic growth. And with the global downturn thoroughly entrenched, the slide in the oil price is set to continue.

The latest bout of risk aversion on global markets wiped about 12% off the oil price. Brent crude dropped to just above $100 a barrel last week before regaining the $110 mark. It is still up by about 15% this year. The fundamentals, however, point to further falls, says Commerzbank's Eugen Weinberg.

For starters, "sustained high oil prices and slowing economic growth have dramatically curbed global oil demand", according to the International Energy Agency (IEA). It expects worldwide demand to rise half as quickly as last year. In America, which remains the world's biggest oil consumer, year-on-year demand fell in April and May, the first two successive months of decline since late 2009. The IEA now thinks US demand will shrink by 1% in 2011. Europe and Japan won't compensate for this drop. Indeed, many countries "will be actively sapping demand through fiscal retrenchment" over the next few months, says Christopher Swann on Breakingviews.

China, where consumption has almost doubled in the last ten years, is the world's second-major demand driver. But it is also slowing, with annual demand dipping in June. With China's leading indicators turning down, and inflation not yet under control, expect its appetite for oil to keep falling, says Longview Economics. Growth in emerging market heavyweights India and Brazil is also ebbing as they battle inflation.

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Supply, meanwhile, is "surging", says Javier Blas in the FT. Saudi Arabia, the world's top exporter, has raised its output to a 30-year high. Oil cartel Opec has now fully compensated for the loss of Libyan output. While Opec may well attempt to cut output to shore up the oil price, there's no guarantee it will be able to, says Swann. A reduction in output during the financial crisis failed to stop the oil price slide, for instance.

So while oil seems unlikely to fall off a cliff as it did in 2008/2009 (when demand actually shrank) the darkening global outlook bodes ill for oil bulls. Ongoing nervousness in financial markets about the eurozone debt crisis will also temper risk appetite, as Capital Economics points out. Further quantitative easing, which has buoyed commodities in the past, remains some way off. Weinberg sees oil heading back towards $100. Meanwhile, Capital Economics is pencilling in a price of $85 as achievable by the end of the year.