The Outlook for Oil Prices in 2012

2011 was a relatively stable year for oil prices. Brent crude oil traded in a narrow band all year between $100 and $120 a barrel. But 2012 may be a very different year with traders bracing themselves for a much rougher ride.

The base case scenario is for oil to remain at about $100 a barrel in 2012. This is founded on relatively healthy oil demand growth of about 1 million to 1.2 million barrels a day in 2012. This outlook also is based on OPEC maintaining its output at the current 3-year high of around 30 million barrels a day and the end of supply disruptions that troubled the oil market in places like Libya.

And indeed, at its recent meeting, OPEC did set a target for output at 30 million barrels a day.

However, despite the apparent calmness in the oil market, there is currently an extreme difference of opinions between the bulls and the bears on oil prices in 2012.

There are traders on opposite sides of the market who are buying large amounts of out-of-the-money oil futures option contracts that would profit from both a collapse in oil prices and a super-spike. These traders are betting on low probability events – either a rise to $150 a barrel for oil caused by Middle East unrest or a drop to $50 a barrel brought about by a eurozone collapse.

The key benchmark Brent crude oil contract is now trading for approximately $108 a barrel.

Although there are bets occurring on both sides, recent options buying on the New York Mercantile Exchange has been skewed toward an upward spike for oil based on risks coming from a possible European Union embargo on Iranian oil.

Since October, many trading firms have noticed persistent interest in call options for prices ranging from $120 to $180 a barrel. The number of options contracts purchased betting on a move for oil to $130-$155 a barrel by the end of 2012 has risen more than 25% over the past six months to more than 93,500 contracts.

These buyers perceive greater geopolitical risk than just the situation with Iran and its nuclear program. There is also the threat of regional war if Syria were to collapse or even a turn for the worse politically in Egypt or Libya.

Finally, there is even the risk that political turmoil in Russia surrounding the presidential election in March may disrupt output from the world's second-biggest oil producer.

But the bears have their reasons too. They say a eurozone collapse will trigger a worldwide recession that cuts oil demand sharply. The global financial crisis of 2008-09 did see two consecutive years of falling consumption for the first time since the 1980s. This did drive oil prices briefly below $40 a barrel, forcing OPEC to cut production.

Bears also point to a hoped for increase in Iraqi oil production of at least 500,000 barrels by the middle of 2012 as well increased U.S. shale oil production from North Dakota and Texas.

Both bulls and bears could be right depending on if one of these 'low probability' events comes to pass. Either way, 2012 looks to be a far more interesting year for the oil market than 2011 was.

Individual investors can join in with professionals on trading the perceived upcoming volatility in oil prices through the use of exchange traded funds.

Some of ETFs available for purchase include: United States Oil Fund (NYSE: USO), United States Brent Oil Fund (NYSE: BNO) and United States Short Oil Fund (NYSE: DNO).

Article originally written for the Motley Fool Blog Network. Check out my articles there at: http://blogs.fool.com/tralmoe/