Oil prices down but not out

By Jane Merriman and Barbara Lewis - Analysis

LONDON (Reuters) - The old saying what goes up must come down seemed true of oil markets this week as falling demand helped to wipe more than $10 off the price, but long-term supply constraints could keep investors keen.

Bullish forecasters say the record rally that took prices to more than $147 a barrel last week has a long way to run and that it will take years to make up for a chronic lack of investment in bringing on new supplies.

Others say prices, which were below $134 a barrel early on Thursday, have hit the kind of levels that have a significant impact on demand.

"We believe the 100 percent rise in the oil price over the last year is not sustainable going forwards," said Richard Batty of Standard Life Investments.

"While cheap oil may be a thing of the past, oil prices could be much more volatile, falling and rising with the business cycle in the years ahead."

Oil contracts for delivery as far into the future as December 2016 have traded above $140 and are still above $130, implying strength in the market will be maintained.

Goldman Sachs, one of the most active investment banks in the commodities markets, has predicted prices could reach $200 and oil tycoon T. Boone Pickens said this month prices would not ever fall below $100.

But $100-plus oil and fall-out from the credit market crisis is spilling over into the wider economy.

"Soaring energy prices have eroded households' purchasing power and pushed up producers' cost curves, squeezing both revenue flows and profit margins," said Ruth Stroppiana, economist at Moody's, the credit rating agency.

"Concerns about the health of the United States and major European economies are expected to remove some of the speculative froth currently built into most commodity prices, particularly oil."

LONG-TERM VIEW

Investors, such as pension funds and insurers, who tend to buy for the long term are unlikely to flee en masse.

Their stake in indexes made up of baskets of commodities, notably oil, has grown to an estimated $270 billion.

For them, commodities are still tempting as a means of balancing their portfolios in the face of a weak U.S. dollar, rising inflation and weak equities.

The S&P 500 index became a bear market last Wednesday, when it fell more than 20 percent below its record high close in October last year.  Continued...