Are the bears getting ready to pounce on oil?

By Chris Tedder, research analyst, Forex.com

Numerous countries have now outlined that they will limit the amount of oil that they purchase from Iran, amidst pressure from the US and UN to impose sanctions on Tehran due to their nuclear program. As a result, tension in the region sits on a knife edge; Iran is threatening to block the Strait of Hormuz and Washington has fired back by guaranteeing free passage through the straight. The threat by Iran's leaders is not realistic given the military strength of the US but any action in this direction could drive the price of oil to 200+ and this is last thing that Washington would want. We estimate that even a $10 increase in the price of US crude could negatively impact US GDP by around 0.2%.

Also on the supply side, a sell-off in oil was trigged by a surprise in US stockpiles, with government data showing that domestic crude stockpiles rose 2.2 million barrels during the last week of December 2011. This figure startled a market that was expecting oil refiners to have cut stockpiles for year-end tax reasons.

Elsewhere, Nigerian trade unions have threatened to strike which could theoretically shut down large parts of the country's oil industry, thereby hitting global oil output and putting upward pressure on its price. The unions are demanding that the government restore a scrapped fuel subsidy. However, oil company senior officials have been quoted saying that most processes are automated and don't require human involvement and that if union members strike then management will likely take over their roles in the short-term.

Despite these concerns, the biggest threat to oil prices in our opinion is the situation in Europe and the associated impact this will have on the demand for oil. Given the amount of issues facing the EU we cannot see a quick solution to the crisis; Greece is rushing to enact economic reforms so that they receive their next tranche of bailout funds, France is facing a credit rating downgrade, Spain needs to re-capitalise its banks sector, and the list goes on. As a result investor sentiment is likely to continue to suffer.

Our outlook for the US and China is somewhat brighter. Recent data from the US points towards an economy that is growing, albeit at a fairly sluggish pace. If the world's largest consumer of oil can avoid being dragged into a global recession, it should limit oil price declines. In China, recent growth figures have slid off 2010 levels, yet GDP growth is still above 9% and we are forecasting it to stay above 8% for 2012, bolstered an arsenal of stimulating measures at the governments disposal.

Overall, the negative sentiment surrounding Europe could overshadow any positive data out of the US and China, and as a result we think that US crude should end the year around $95, unless tension in the Middle East boils over and results in a significant hike in oil prices, but we think this is unlikely given the fact that it is in the best interests of the US to not let this happen.