ANALYSIS-Oil price plunge hands world economy early win

www.forbes.com Reuters, 03.21.03, 9:50 AM ET

LONDON, March 21 (Reuters) - Just a day into the U.S.-led war against Iraq, oil importers have been handed an early economic victory by an unexpectedly quick and sharp fall in the price of crude. But analysts caution against premature celebration. Speculative hedge funds have sold heavily short on crude futures on London and New York exchanges over the past two weeks, leaving prices vulnerable to a sudden leap on signs of a snag in the military campaign. U.S. and British troops secured some of Iraq's southern oilfields on Friday in an early success for the invasion, but some wells were set on fire and traders are on alert for any sign of long-term damage to Iraq's oil industry. "One should appreciate how easy it is for things to go wrong," said futures brokerage Fimat in a report. "Ignoring this would be terrifically imprudent." For weeks, analysts had expected oil prices to drop once the attack got under way as the "war premium" was eroded. But no one was prepared for a $10-a-barrel rout that began several days before the first shot was fired. On Friday, benchmark Brent crude for May was trading close to $25 a barrel, down from a peak of $34.55 nearly two weeks ago. U.S. crude has fallen even more heavily, having hit $39.99 at the end of February. The steady climb in Brent prices from a November low of $23 has been all but erased in the space of seven trading days. Barring uncertainties from Iraq, many oil traders say a Brent price of $25 is roughly in line with fundamentals but that balanced view may yet turn bearish if ultra-thin U.S. commercial stockpiles build quickly during the low-demand second quarter. "It is the weight of oil, rather than the force of bombs, which is pushing markets lower," said Leo Drollas of London's Centre for Global Energy Studies. "OPEC is now producing more oil than has been lost."

SWITCHING OUT OF OIL Battered equities markets have raced higher as investors and funds switched from oil and safe-haven bonds into the financial sectors depressed by months of war worries and economic gloom. Consumers and oil-importing governments grappling with the highest prices in a decade will have breathed a sigh of relief as prices deflated, easing fears of a fully-fledged price shock on economies struggling to escape recession. "Clearly it's a positive thing that the price has come down. It should relieve inflationary pressures and improve business and consumer sentiment. But the pace of the fall has been a surprise," said Royal Bank of Scotland economist Tony Wood. Even OPEC producers should be pleased by the fall back into the cartel's preferred $22-$28 price band because the high price was stalling demand from importers. The abrupt plunge was led by speculative hedge funds. As diplomacy failed and war became inevitable they took profits from long positions and then began selling heavily short as U.S. forces prepared for what many dealers believe will be a quick, overwhelming victory. But if the campaign drags on, oilfields are severely damaged or if further disruptions to world supply emerge, speculators desperate to cover exposed short positions could send prices bouncing sharply higher. "Instead of positive news flows, prices have been moved by a speculative bet of staggering proportions," JP Morgan oil analyst Paul Horsnell said. "In short, the market seems to have pushed far too far, far too fast and on the basis of far too little hard information." Prices reacted similarly during the first Gulf War, falling as U.S. troops moved into battle -- but then they were helped by the release of emergency inventories held by the International Energy Agency. This time around the Organisation of the Petroleum Exporting Countries (OPEC) pre-empted any release by pumping extra oil months in advance, with Saudi Arabia sending tens of millions of extra barrels toward the United States since January. These barrels coupled with recovering output from strike-hit Venezuela have helped offset the effective stoppage of Iraq's 1.7 million bpd of exports, which came to an end this week as international traders shied away.