NEW YORK (Dow Jones)--Oil prices have bounced back from a four-year low, but analysts and traders aren't quite ready to call a bottom to the market.
Crude futures traded down to $40.50 a barrel earlier this month, marking a 70% plunge since July and the erasure of four years of gains in just five months. Since then, the looming production cut by the Organization of Petroleum Exporting Countries and a sharply weaker dollar have lifted oil. The market has gone seven straight sessions without hitting a new low, a feat achieved only once since August.
Oil futures settled 91 cents, or 2%, lower at $43.60 a barrel on the New York Mercantile Exchange. Futures briefly crossed above $50 on Monday.
Tight supply and a weak dollar had played leading roles in a confluence of factors that lifted oil to record highs during the first half of 2008. The mere hint of their return caused oil to shoot up nearly 20% less than a week after nearly falling to $40, and prices remain nearly 10% above the four-year low.
But with the all-time high of $145.29 a barrel an increasingly distant memory, some of the biggest champions of the bull market still believe that the worst is yet to come.
Declining petroleum demand could still overwhelm attempts by OPEC members and other producers to reduce output, or prevent oil from regaining its status as a safe haven from the weakening dollar. On Tuesday, oil prices fell even as the dollar weakened after the Federal Reserve cut interest rates to a historic low and as OPEC telegraphed its intentions for a large production cut.
"What is not yet clear is how long the bottoming phase will last," wrote Arjun Murti, an equities analyst with Goldman Sachs Group Inc. "Global economic conditions are the weakest the world has seen since at least the early 1980s and global oil demand is declining at an accelerating rate."
Analysts have called a bottom to oil's correction several times, and were proven wrong when the economy deteriorated - as evidenced by the steady stream of indicators - more quickly than expected. A consensus on a recovery of the broader economy would have to develop before oil prices have a chance at staging a comeback. This isn't seen in the near future, as recent U.S. government reports show the biggest declines in jobs, housing starts and consumer prices in decades.
Marriage Of Convenience
The recent uptick in oil prices came as the dollar lost significant ground to the euro, recalling the first half of 2008, when commodities and currency markets seemed bound together by the investor flows between them. Between January and July, the dollar sank to regular record lows against the euro, and oil shattered all-time highs almost daily. As oil fell, the dollar recovered, in October reaching its highest point since April 2006. The euro recently traded at $1.4150, its highest point since Oct. 1.
Oil and the dollar can act as convenient hedges against dramatic shifts in one market or the other. An investor can counter the effects of inflation by buying crude futures priced in weakening dollars. Oil also becomes cheaper for traders who book profits in other currencies when the dollar weakens.
"Oil was a safe-haven play," partially supplanting the role usually played by the dollar in troubled times, said Phil Flynn, an analyst with Alaron Trading Corp. in Chicago. "That all changed when we realized this was a global crisis."
The dollar strengthened as economies followed the U.S. into a downturn. Now, currency traders are betting on a change of direction in the dollar that has yet to be embraced by their counterparts in oil. The Federal Reserve on Tuesday sent interest rates to unprecedented lows, while government stimulus packages are putting more dollars into circulation. Both efforts will almost certainly weaken the dollar. But they also serve to combat an economic decline that the Department of Energy believes will cause a contraction in global oil demand of 450,000 barrels a day next year.
"There's various cross-currents at work here," said Jim Ritterbusch, president of Ritterbusch & Associates in Galena, Ill. "If the economy weakens further, it could possibly force a further weakening in the dollar. Oil may simply have to choose."
Perception Of Oversupply
With the oil market at a crossroads, OPEC is hoping to force traders' hands. The group meets Wednesday in Oran, Algeria, and will announce a cut of around 2 million barrels a day, Saudi Arabian Oil Minister Ali Naimi said Tuesday. Russia, the world's No. 2 oil exporter after Saudi Arabia but not an OPEC member, has also said it may join in cutting output, though the country's fields are already in natural decline.
Traders said Naimi's comments contributed to Tuesday's drop in oil prices, as they seemed to lessen the chance that OPEC's cut would exceed market expectations.
The combined cuts, along with reductions from other producers whose fields cost more to operate than the oil is worth, could total 2.5 million barrels a day, said Ehsan Ul-Haq, head of research with JBC Energy in Vienna.
World inventories will decline after a cut of that size, though it may be months before enough traders take notice to move oil prices higher.
"It takes time," Ul-Haq said. "The market is still seeing an oversupply, and this perception has to change."
The imminent drop in oil supplies indicates that crude is approaching its low point, but the market won't hit bottom until demand begins to level off, wrote Murti, the Goldman Sachs analyst.
While economic data continues to point to a worsening recession in the U.S. and other developed countries, lower energy prices may be helping to reduce the slide in demand. Refiners supplied 6.1% less in refined products in the week ended Dec. 10 than a year earlier, but that was the smallest year-on-year decline since September, according to the U.S. Energy Information Administration.
A large cut by OPEC and a little positive news on the economic front may be just enough to keep oil from setting fresh lows, traders said.
"I do think we could see $56 (a barrel) or close to it," said Dean Hazelcorn, a trader with Coquest Inc. in Dallas. "For $56, OPEC needs to cut big. A two-million (barrel) cut, and just a little momentum should get us there."
-By Brian Baskin, Dow Jones Newswires; 201-938-2062; brian.baskin@dowjones.com
(Spencer Swartz in Oran, Algeria, contributed to this article.)