A slippery time ahead for oil prices

CONTINUED geopolitical issues in Iran and its stand-off in the Strait of Hormuz has pushed up oil prices over fears of a threat to supply, but will global economic weakness be enough to take the edge off these rises in the long term?

“Crude traders were of course spooked by the escalating situation in the Strait of Hormuz and Iran, with WTI Crude leaping $4.50 in the first few trading sessions of 2012,” says Ian O’Sullivan, head of marketing of SpreadCo. Since this earlier jumpiness, tensions have eased somewhat, with crude working its way back to the $101 support level. According to O’Sullivan, although some are saying that, should the Strait of Hormuz close, crude could hit $200, we are likely to see crude trade sideways around $100 for now.

Though the Iranian issues have the potential to drive up crude prices, yesterday provided an indicator that European economic fears could trump worries over Iranian supply restrictions.

Chancellor Angela Merkel and President Nicolas Sarkozy met yesterday for yet another round of talks about how to deal with a problem like Greece, but rolled out their usual caveated statements about wanting to be proactive and effective in dealing with the crisis, just not yet. Merkel maintained her stance that a second bailout for Greece won’t come until there is an agreement on private bondholder haircuts. Should a decision not be arrived at on this issue, Greece would be at serious risk of default.

European demand is also at the mercy of the euro’s fortunes against the dollar. With euro-dollar sliding to the $1.2700 area, dollar-denominated crude is getting even more expensive for European consumers. The combination of the Iranian risk premium and the FX costs are set to cause real damage to European oil demand throughout the next quarter.

Though the Iranian problems and the European debt crisis both have the potential to cause big movements in crude prices, according to Mike Franklin, head of investment strategy at Beaufort Equity, these are almost certainly not the only areas of potential risk. As well as the potential for social and economic disruption caused by natural disasters, Franklin cites the continued Democrat-Republican standoffs in the US and the worries over Chinese growth as areas of concern: “Against this background, investors can be expected to contiunue with caution as this year unfolds,” says Franklin. “Consequently, the short-term trading mentality – and accompanying volatility – that characterised 2011 looks likely to continue into 2012.”