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Oil prices stabilize as traders discount Iran doomsday scenario

The fever that gripped oil markets in recent weeks has begun to subside as traders discount the likelihood of a doomsday scenario in Iran, yet many remain cautious due to a variety to geopolitical risks.

Crude oil prices have slumped to their lowest levels of the year after spiking at $69.20 per barrel in New York on January 23, near the all-time highs of $70.85 in August 2005 after Hurricane Katrina.

New York's main contract, light sweet crude for delivery in March, lost $0.78 to close Friday at $61.84. The possibility of international sanctions on Tehran and a cutoff of Iranian oil has been plaguing the market amid growing concerns about Iran's nuclear energy program.

Iran is the fourth-largest oil producer, pumping some 3.9 million barrels a day, according to U.S. Energy Department data for January. Of that, some 2.7 million barrels per day are exported.

"The worst-case scenario assumes that a military strike against Iran would occur late in the year," said Diane Swonk, economist at Chicago-based Mesirow Financial. But Swonk and others argue that Iran needs oil revenues as much as the world needs Iranian oil.

"Iran counts on oil revenues to fund 90 percent of their government spending and, therefore, cannot afford to give up those revenues for any length of time," Swonk said.

For BMO Nesbitt Burns analyst Bart Melek, the downward price trend came "as the market started to feel increasingly comfortable that there are sufficient inventories to compensate for any potential production losses from Iran."

Even if the United Nations imposes sanctions, Melek said he expected that any such move "would no doubt keep oil from Iran flowing in order to get China (who holds a veto and imports 10 percent of its oil from Iran) to agree."

Yet prices remain at historically high levels, and many market participants are not willing to throw out the "risk premium" due to concerns about Iran and elsewhere.

"Considering the heights from which the market has fallen, recent declines are quite small when viewed proportionally," said Mike Fitzpatrick at Fimat USA.

"The political realities have not changed all that much. Iran has gotten a month's reprieve. Iran has already suffered through economic sanctions, imposed by the U.S. since the late 1970s."

Fitzpatrick noted that Iran has threatened "consequences" if sanctions are imposed, "even though they keep denying that oil will be withheld from the market."

As a result, the analyst said he believes "that the recent fall in prices is only a correction, and the 3-year-old rally should continue shortly."

Stephen Auth at Federated Investments said it was not just Iran, but that "geopolitical tensions are running unusually high around the world, particularly in oil-producing regions."

Auth said oil supplies could be affected by strife or political change in Sudan, Russia, Nigeria and Latin America - not to mention the Palestinian situation that may affect some Middle East oil producers.

"The higher level of geopolitical risk is likely to be transmitted to financial markets via energy prices," Auth said.

"In fact, much of the recent strength in oil prices seems to trace to nations attempting to build up oil reserves to offset the risk of a sudden supply disruption." While the situation is hard to predict, Auth said he did not expect a new oil shock.

"That's not what we expect. But in such a case, it wouldn't surprise us to see oil spike into the $90 range," he said. "We think the more likely outcome is for oil to remain in the $55-$65 range."

Nariman Behravesh, chief economist at research firm Global Insight, said "the tripling of oil prices since early 2002 is almost entirely due to fundamental market forces, including the near-elimination of spare capacity in OPEC. Basically, the demand for energy has been growing faster than the supply."

He said the risk premium is about $5 to $10 per barrel, but that a crisis could "potentially push prices as high as $100 a barrel for a few months."

But Behravesh said historical trends suggest oil prices will eventually retreat, possibly quicker than many expect.

"Global Insight expects that it could take 10 years or longer. But history shows that market forces always have a powerful effect on commodities - often with a lag, and sometimes with a vengeance," he said.

Beirut,02 13 2006
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