Crude oil prices have continued to plunge in recent weeks, down from the record highs seen in mid-July. Benchmark WTI crude has fallen by half to below $80/b earlier this week. With the recent sharp declines, crude oil prices now stand close to the levels seen in September of last year.
The ongoing downward trend in crude oil prices reflects the dramatically worsening conditions in global financial markets in recent weeks and their negative impact on the real economy, as well as the decline in the demand for oil. As attempts multiply to stabilize financial markets, coordinated efforts among central banks and governments are crucial. Even if governments are successful in calming equity markets and unfreezing credit markets in the near future, the fallout on the real economy from the financial market headwinds is expected to be considerable. This comes on top of the already visibly weakening of OECD economies and a deceleration of growth in emerging markets.
There is mounting evidence that the US economy might already be in the midst of a recession the depth and length of which remain to be seen. The same applies to the EU and Japan, which have already witnessed a contraction in GDP in the second quarter. Recent indicators point to further contraction ahead. Although emerging market economies have until lately appeared to be partly shielded from significant economic contagion, equity markets in these countries have suffered greater losses than in the advanced economies this year and their currency markets have recently been experiencing considerable volatility. However, it is expected that the damage to their economic growth can be contained if markets stabilize in the coming weeks. All these events are expected to impact different aspects of the oil market, including demand for crude and products, particularly in OECD countries and to a lesser extent in emerging market economies.
Slowing demand in OECD countries, especially in the US, had adversely affected refining margins and operations in the first seven months of this year. Moreover, the decline in demand forced American refiners to trim refining throughputs to 88% during the peak driving season in August — a time of year when refining throughputs typically surge to around 95%.
Supply concerns particularly for products rose again following hurricanes Gustav and Ike, which temporarily affected about 3.9 mb of refining capacity at the initial stage and disrupted both crude oil and gas installations in the US Gulf. This led to huge product stock-draws and boosted crack spreads — the difference between the crude and product price — and refining margins worldwide in September. However, over the last two weeks, product markets lost ground significantly as refineries returned to normal operations and crack spreads for light products, especially for regular gasoline, plummeted from about $40/b in the week ending 19 September to minus $4/b in the week ending 10 October.
Middle distillate crack spreads have weakened, but not as much as those for gasoline. The approaching winter season and the current tight supply of middle distillates in the US and Europe combined with a possibly cold winter may provide support for crude prices to some extent. However, due to the increasing risk of demand deterioration resulting from the widening financial turmoil and economic downturn, developments in the distillate market are not likely to be sufficient to significantly support crude prices in the coming months. Additionally, new refining capacity in Asia which will come onstream in the near future, along with refining operational flexibility in the Atlantic Basin, could ease the risk of a distillate supply shortage in the coming months.
In light of the weaker product outlook as well as the comfortable situation in OECD crude stocks, the fallout from the recent financial turmoil on the real economy could considerably affect the oil market as it moves beyond the industrialized nations, which would considerably reduce demand for crude oil. In light of these growing uncertainties and the pace of weakening fundamentals, OPEC will hold an Extraordinary Meeting of the Conference on 18 November to discuss the global financial crisis, the world economic situation and the impacts on the oil market, as part of its ongoing commitment to market stability.
