Oil price tipped to take a tumble

OIL will drop more than 30 per cent to $US40 a barrel in March and may drop to $US30 as rising prices for storing crude lead to a "breaking point" that forces speculators to sell, according to investment bank Sanford C. Bernstein & Co.

"As storage fills up, storage costs rise and the contango widens," the analysts said in a February report. "At some point, investors will reallocate money away from the commodity funds, causing futures prices to fall."

Last month, New York-traded crude fell to $US49.90 a barrel, as warmer than expected weather spread across the US and fuel inventories surged. Crude has since risen on a second production cut by the Organisation of Petroleum Exporting Countries and a cold snap in the US, the world's largest energy consumer.

The "breaking point" could come in March if Saudi Arabia, OPEC's largest producer, failed to cut production below 8 million barrels a day, the level needed to keep the market balanced, the Bernstein analysts said.

Spare capacity would rise, widening the contango and driving investors out.

"The funds flow into commodities in recent years is staggering," Mr McMahon and colleagues said.

Net assets invested in the Goldman Sachs Commodity Index rose to almost $US70 billion in 2006 from $US15 billion in 2003, they said. "The bubble is bound to burst."

Mr McMahon, 36, joined Bernstein from McKinsey & Co, in 2003. He previously spent three years in geology at BP and BG Group.

"You've got a lot of money coming into commodities from people who want to diversify from bonds and equities," Bernstein analyst Ben Dell said. "To some extent the bubble has burst. Making money on commodities is not as easy as it was."

Bernstein has been looking at the problem of passive investment since June 2006, after the market curve changed into contango in October 2005, according to Mr Dell.

"After four years of fund flow into commodity futures, investors in oil are now struggling with how to generate a return with the curve in contango and a negative roll yield," he said. Investors can lose money even as oil rises when funds sell expiring contracts and then pay more for future contracts.

Bernstein said last October that oil would probably fall to an average of $US50 a barrel in 2007, as inventories remained high and non-OPEC production rose. Crude has averaged $US55.76 so far this year.

Among analysts predicting an increase in oil prices, Goldman Sachs said New York futures might rise to $US71.50 a barrel this year because producer investment was significantly short of requirements.

Goldman said in December 2005 that oil prices might go as high as $US105 a barrel in a "super spike" period that might last until 2009, as production lagged growing world demand.

Bloomberg