Impact of the Euro-zone debt crisis on the oil market
In the fourth quarter 2011, crude oil prices remained volatile despite the partial return of supply from Libya and higher OPEC production, which should have reduced price volatility associated with the fear of a supply shortage. The OPEC Reference Basket remained volatile, fluctuating in a range between $98-114/b (see Graph 1).
This volatility was mainly due to the impact of Europe’s debt crisis on market sentiment and
worries that possible contagion effects could seriously undermine economic growth in Europe and the rest of the world. More recently, these bearish economic concerns have been offset by increased geopolitical uncertainties as well as civil unrest in some producing countries, boosting the risk premium in the market.
Undoubtedly, the Euro-zone debt crisis constituted a key challenge for the global economy in recent months and is expected to continue to do so for at least some time in 2012. While Euro-zone leaders have made a continuing effort to tackle the sovereign debt crisis at the beginning of the year, capital markets have not yet been convinced by the provided solutions to deal with the crisis. The euro fell to its lowest level versus the US dollar in 16 months and compared to the yen even reached an 11-year low. The Euro-zone debt crisis and its consequence have had a considerable effect on the global economy in the second half of last year through reduced international trade, implementation of austerity measures, and a growing credit crunch in the region with pass-through effects on the global banking system.
Graph 1: OPEC Reference Basket Graph 2: Euro-zone Manufacturing PMI
The long-standing inverse correlation between the US dollar/euro exchange rate and the price of oil has weakened recently. As a result, the strength in the US dollar has had little impact on crude oil prices. It is unclear whether this decoupling will persist. With the strengthening momentum in the US economy along with the weaker outlook for the Euro-zone, the euro is not likely to see a recovery against the dollar in the near term, unless there is a quick solution to the region’s debt crisis.
There is still some additional risk that the Euro-zone economy could even contract this year. This can be seen in the declining trend in Euro-zone PMI over the last six months to well below 50 (see Graph 2), the level separating contraction from expansion. Even Germany, the strongest economy in the Euro-zone, is showing a sign of weakness, with GDP estimated to decline by 0.25% in the last quarter of 2011 according to the government’s statistics office. Overall, this implies a reduction in regional and international trade and consequently would result in a further decrease in the demand for oil. Already, the most recent data shows that exports to the EU from China – a key trading partner with the region – have fallen since August.
Moreover, the need for large capital injections into Euro-zone banks could also reduce the amount of liquidity available for investment and trade, not only in Europe, but also on a global basis. This might lead to an additional slow-down in global trading and investment activity, and further entrench the negative growth trend.Here's the table of contents:
Although the Euro- zone crisis has been a key factor behind oil price volatility, so far it has had little impact on market fundamentals in other regions. However, if the situation were to worsen, the effect on the oil market could be seen not only through a further decline in oil demand in Europe but also with spillover effects on oil demand in the emerging economies, amid an adequately supplied market. Whether this materializes, the ongoing impact of the Euro-zone debt crisis on market sentiment is also likely to add to oil price volatility. Effective steps to meet these challenges should lead to an improvement in economic growth and increased oil market stability. At the same time, geopolitical uncertainties are likely to continue impacting crude oil prices going forward, either by increasing or reducing the risk premium in the market....
Oil market highlights69 page PDF
Crude oil price movements
World oil demand
World oil supply
Product markets and refinery operations
Balance of supply and demand