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Saudi Arabia has threatened that oil prices may return to $150 or above in three years time. The global equity markets are rallying on hopes of economic recovery signified by consumer confidence data of USA.

Merill Lynch said that $70-80 per barrel for oil could pose serious threat to recovery in OECD countries while in emerging markets it could be $90-100/bbl. Geo-political tensions in Negeria and Peru have also contributed to recent bullishness in oil prices. Nigeria’s production is down to 1.2 mn barrels per day as against 1.8 mn barrels six months ago. Spare OPEC capacity stands at 6 bn b/day and this could rise if oil prices were to rise.

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What could pull down oil is the near term demand in USA and Europe while emerging markets a seeing some improvement.Analysts argue that rising oil prices could be a signal of economic recovery while dollar weakness is being cited as a major reason for bullishness in Gold and oil.

Of course, a stronger economy can also support higher oil prices, so the relationship between oil and the economy works both ways. More importantly, Merill Lynch analysis suggests that the link between oil demand and global GDP is not linear.
In fact, small improvements in GDP can result in significant improvements in oil demand, when GDP is either very low or very high relative to trend.

Consequently, an upturn in economic activity around the world, even if modest, could have a very significant impact on oil demand. In turn, given that oil supply is semi-fixed in the short-run, any improvement in demand conditions quickly
translates into higher prices.

If crude breaches the $80 mark excess capacity in OPEC can be utilized to meet the demand. On the other hand it is not clear how far increased liquidity as a result of stimulus packages will fuel a oil price hike. In an oil constrained world where the ability of OECD consumers to take additional leverage is limited,monetary policy can have some dangerous side-effects. History suggests that extremely loose monetary policy can create asset bubbles, Merrill Lynch observed.

Oil demand in OECD is expected to improve in Q4 2009 which is also true for emerging markets. Car sales are already up in emerging markets signifying growth in oil demand. For instance, China saw an increase in car sales of 7.5% YoY in 1Q09, while India experienced a 38% reduction in vehicle purchases in 1Q09. Similarly, Electricity generation data across a numberof EMs is still very weak , with China posting –3.6% YoY, Brazil showing a –3.7% YoY figure, and India experiencing a 6% expansion in April.

Merrill Lynch observed that a sequential improvement in global oil demand on the back of expansive fiscal and monetary policies, coupled with continued restrictions on OPEC output and an outright decline in non-OPEC supply could ultimately put further upward pressure on oil prices. How far will oil prices go before OPEC members start to increase supply again? Any large reversal in OPEC policy or a change in the evolving demand trend is unlikely before WTI or Brent Crude Oil prices hit $80/bbl.

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