Oil falls to $64 on recession, oversupply concerns

For months, oil analysts have said oil's price has risen too much in relation to the commodity's fundamentals, and that some sort of correction would occur.

However, the market largely ignored that reality -- until recently. On Monday it appeared the correction (or something larger) was well underway, with oil dropping $2.71 to a four-week low of $64.02 per barrel, extending last week's decline.

This bearish sentiment is likely to prevail, especially given this recent data. First, the price of crude is falling despite the fact that militants in Nigeria, the Movement for Emancipation of the Niger Delta (MEND), said they blew up a pipeline operated by Chevron (CVX) Nigeria Ltd, Bloomberg News reported Monday. Attacks in the Niger River delta have reduced Nigeria's oil production by more than 20 percent since 2006.

Second, the political climate in Iran, which pumps about 3.75 million barrels per day (bpd), remains unsettled following the disputed presidential election, with opposition presidential candidate Mir Hussein Moussavi saying he will continue to push for an annulment of the vote and seek a new election, The New York Times reported Monday.

Typically, flares in two key oil production centers would send oil prices higher, but the market has digested the news, and oil's price is still falling -- an indication of pervasive bearish sentiment.

Oil bears gain upper hand

The oil bears argue that oil's fundamentals have called for a lower price for months, but here-to-date institutional investors and others have prevented fundamentals from ruling the day, by piling into oil as an alternative asset – as a hedge against both a weakening dollar and the risk of rising inflation.

Traders had also bid-up the price of the world's most important commodity in the winter/spring on the belief that both the U.S and global economies are recovering – trends that would lead to rising oil demand. However, the June U.S. jobs report, which indicated the U.S. economy shed another 467,000 jobs, renewed fears that the U.S. recovery will not begin in Q3 – a scenario that would weigh on oil demand, hurting oil prices.

To be sure, the oil bulls will point to OPEC's production cuts as a sign that excess oil supply is being removed from the market, and inventories are likely to begin to fall, supporting prices. However, the oil bears counter that absent a growing global economy, global oil demand will remain weak, serving to check oil price gains. The International Energy Agency said as much in its Medium-Term Oil Market Report 2009.

Oil Analysis: For months, oil bears said there was too much oil sloshing around in global markets relative to demand, accompanied by too much optimism about the U.S. and global economies. But, as noted, the oil market largely ignored oil inventory fundamentals. Now, it appears the fundamentals are coming back into focus, as the economic recovery forecast becomes less-certain. Further, if institutional investors exit oil as an asset play, oil's fall could be pronounced, and it could prove to be more than a 10-15 percent correction off the $72 per barrel highs registered last month.
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