IEEJ: January 2011

Special Bulletin
July 1, 2010
A Japanese Perspective on the International Energy Landscape (1)A Review of Crude Oil Price Trend in 1st Half of 2010
Ken Koyama, PhD
Director
Strategy and Industry Research Unit
Institute of Energy Economics, Japan

The WTI crude oil futures price (the daily closing price of the front-month contract)
averaged $78.5/barrel between the beginning of 2010 and the end of June. During those six months,
the WTI price peaked at $86.8/barrel on April 6 and bottomed at $68.0/barrel on May 20. On June
30 at the end of the period, it closed at $75.6/barrel, down $0.3 from the previous day.

The crude oil price trend features various key points, which can be narrowed down to two.
First, the price remained range-bound in the period after the wild fluctuations over the previous twoto three years. Second, the price fluctuation within the range reflected macroeconomic and financialsituations.

The first point becomes clearer when the trend during the six months is compared with thatin the same periods of the previous two years. In the first half of 2009, the WTI futures priceaveraged $51.8/barrel, peaked at $72.7/barrel and bottomed at $34.0/barrel. In the first half of 2008,
it averaged $111.1/barrel, peaked at $140.2/barrel and bottomed at $87.0/barrel. The average in thefirst half of 2010 stood in the middle between the averages for the same periods of the previous twoyears. The fluctuation range (the gap between the peak and bottom) narrowed relatively.

What are factors behind the narrowed fluctuation? One factor is that market participants
after the past excessive fluctuations perceive excessively high and low prices as unsustainable.
Another factor is that market participants’ perception now plays a key role in forming futures marketprices.

As indicated by the famed “beauty contest” theory as discussed by John Maynard Keynes
in his “General Theory”, market participants’ perception, or “average option of average option”can1

IEEJ: January 2011

impact actual trading behaviors and plays a key role in forming prices. This is a key point of thecrude oil price formation in the present futures market. In this sense, successive remarks by many
leaders of oil consuming and producing countries on problems with excessively high and low prices
and desirable price levels (albeit the absence of any complete agreement on a specific level) after
crude oil price plunges following the Lehman Shock might have helped form the present market
perception. Among these leaders, King Abdullah of Saudi Arabia’s statement that $75/barrel would
be a fair price attracted market participants’ attention.

The second point is that crude oil prices, while remaining in a $65-85/barrel range, haverepeated hikes and drops linked closely to developments in the global economic and financialsituations. This means that these developments are the key to future prospect for crude oil prices.

Of course, it may be needless to say that supply/demand fundamentals in the internationaloil market are important as the basic factor for price formation. In the price formation process whereperception plays a key role as discussed in respect to the first point, speculations and predictions
about future supply/demand conditions, rather than current actual conditions, have great influences.
Then, world economic and financial situations attract attention as the largest factor for influencing
future supply/demand conditions (particularly demand). In fact, stock prices, which mirror a world
economic recovery and its expectations, have indicated a strong correlation with crude oil prices
since the first half of 2009.

The trend continued in the first half of 2010. When the WTI futures price was rising to thepeak of $86/barrel, IMF and other world economic growth forecasts were being revised upward,
with stock prices continuing a strong upsurge. In and after April, however, stock and crude oil prices
turned down on the unfolding Greek budget crisis and the fears of spreading sovereign risks in a
run-up to the May bottom for the WTI futures. The crude oil price drop at the end of June also kept
step with stock price falls as market tones were affected by worries about the future course ofEuropean and U.S. economies, or more directly by reports on a downgrade of the Spanish sovereign
rating. In looking at crude oil prices and the international oil situation, we may thus have to fully
understand oil supply/demand fundamentals as the basic pricing factor and widely andcomprehensively analyze or consider complicated and diversified problems regarding world
economic and international finance situations, international politics and geopolitical situations.

What are the questions to be asked after discussions on the two key points? They may
include whether the perception characterizing the present market could change, what the conditions
for such change would be, and what would happen to the international oil market and crude oil2

IEEJ: January 2011

prices as a result of such change. In considering these questions, we may have to analyze not only
European and U.S. economic and financial situations but also the future course and potential
downside risks for the Chinese economy that now drives world economic growth. We may also haveto take full consideration on how the Gulf of Mexico oil spill accident attracting global attention
would affect the entire oil market. The task is not easy at a time when future developments ofvarious factors are very uncertain. Nevertheless, I would like to analyze the entire international oilsituation including the above discussed points at the IEEJ’s 404th forum on research works planned
for July 14.

Contact: report@tky.ieej.or.jp

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