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Oil prices down but not out

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.

A motorist checks the gasoline price board as he stop to refills his gas tank at a gas station in Manila July 12, 2008. REUTERS/Cheryl Ravelo

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.

By contrast, in the first half of this year, the S&P GSCI commodity index, which is heavily weighted to oil, produced a 41.4 percent gain. At the same time, the S&P 500 stock index was down more than 12 percent, according to Reuters data.

“I think the weak equity markets have attracted trend followers into the oil futures market,” said Evan Smith of U.S. Global Investors.

The shorter term speculators, however, could leave and some say losses could be steep.

“The sellers will become more aggressive as soon as they look down,” said Tim Evans, analyst at Citi Futures Perspective.

“It is tough to judge whether we can inch a little higher up the cliff before the market plummets...or whether it has already gone as far as it can go.”

What is bearish for equities -- economic slowdown and weak corporate profit growth -- can also ultimately be bearish for oil, as consumers and companies feel squeezed and cut demand.

“Oil is not a one way bet. It is volatile and subject to investor perceptions and sentiment,” said Michael Laznicka, chief executive of asset manager Gardner Finance.

“The higher it goes, the more risk there is to investors.”

Even the demand from emerging economies led by China and India that has spurred the record oil rally might not be immune to the economic slowdown taking root in the United States.

“Weakness in the U.S. is now feeding through to Europe, Japan and parts of the emerging world with considerable implications for demand,” said Batty.

Following the oil crisis of the 1970s Japan switched from being one of the most oil intensive economies to being one of the most fuel efficient in the world.

“The pressures are growing on the Chinese authorities to follow the path of Japan when it was industrializing rapidly,” he said.

“If trends like this were repeated across the developing world, the demand-supply balance could alter radically in the years ahead.”

additional reporting Richard Valdmanis in New York

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