High Correlation Between Stock Markets and Oil Prices

Monday, 27 July 2009

Who really cares about oil market’s basic fundamentals like demand and supply at this moment? Probably no one as during last week the tone was given by the stock markets. The optimism sentiment that recession is closing to an end and world economy is heading to recovery were supported by the better than estimates corporate results for the second quarter of the year.

During last week Dow Jones Industrial Average earned about 3,72% closing over 9.000 points, the Standard & Poor’s 500 Index rose to the highest level since President Barack Obama was elected on Nov. 4, FTSE 100 Index gain 3,21% and Nikkei 5,84%. Crude oil increased 7.1 percent last week, the biggest gain since May and climbed to a three-week high of $68.05 a barrel in New York.

According to market analysts this optimism can sent stock markets and oil prices to even higher levels as there’s a belief that any signs of economic growth are good for both fuel demand and equities. That means that if economic recovery is a reality for the stock markets it must also be the same for oil markets. This correlation between oil and equities, which is not the norm historically works like a domino for the markets but this time has a positive direction.

Some financial experts, among them professor Nouriel Roubini, warn that this rally is not supported by the basic economic fundamentals as the recovery is still very vulnerable and not sustainable. They warn about a great storm in the near future as the unemployment rising and public deficits in the United States and Eurozone countries loom in very high levels. And the same time, consumer spendings are still very weak.

But all this can not destroy, for the moment, the party in equities markets and high correlation between stocks and oil prices seems to be the case for this year.But what will be happened when the announcements of corporation results will end? Nobody knows with accuracy the answer but the most likely is that stock markets wiil focus again to the basic indices of world economy, that means the would be time for correction.

Then oil market will focus again to the main bearish factors like weak demand and high stockpiles. Falling demand remain the main problem for sustainable prices near the $70-$75 per barrel as OPEC’s members wish. Major forecasters, including the Organisation of the Petroleum Exporting Countries, the International Energy Agency and the US government's Energy Information Administration, have all said demand this year will be lower than last year. They expect consumption to begin growing again next year, but demand for OPEC crude is expected to stay low.

In its medium term outlook published this month, the group said it did not expect demand for its crude to recover to approximately last year's levels until 2013.Inventories, especially in the U.S is another factor that can push oil prices to lower levels. Weak demand has generated huge stockpiles. Even well into the US summer driving season, inventories of motor fuel have been climbing.US distillate stocks, which include diesel, are at their highest levels for 25 years and gasoline stocks have risen to the top of their five-year range, according to US government data.

In addition to the large amounts of fuel storage on land, traders have built up fleets of floating of storage at sea. The latest estimates peg the amount of crude held on tankers at 57 million barrels, down from 82 million at the beginning of June, but the amount of refined products held on vessels at sea has risen.Shipbrokers last week estimated the amount of distillates held on tankers had climbed to 50 million barrels in early July from 34 million barrels at the start of June.

The oil has been stored on vessels rather than on land as traders have taken advantage of cheap freight rates and market structure.High volumes of crude at sea coincided with a deep contango on the crude futures market - meaning prompt contracts were cheaper than those for later delivery and traders could make a profit from buying oil now and selling it later.

The contango on the crude market has narrowed, but distillates are still in a deep contango. Decisions for oil producers nations will be critical in the coming months. OPEC members will be called for one time to consider their policy under unceetain circumstances. Faced with rising stocks and weak demand, OPEC agreed to reduce supply by 4.2 million barrels per day compared with last September's output.At its most disciplined earlier this year, OPEC compliance was around 80 percent. It has since slipped to nearer 70 percent, according to analyst estimates.

At its meeting in March, the group said it would limit its action to tighter compliance with existing curbs, rather than introducing new ones.To help heal the world economy, it said it was willing to accept a price lower than its preferred level of around $75 a barrel.At a follow-up meeting in May, it said the world could be ready for prices of around $75 later this year, but some analysts have said insipid US gasoline demand has shown how price sensitive consumers have become. They argue around $70 is too expensive for now.OPEC next meets in Vienna on Sept 9 to reconsider its output policy.

Makis Theodoratos, Hellenic Shipping News Worldwide