When oil prices first hit the $100 per barrel mark during the first week of January, most oil analysts said the three digit level was unsustainable. Prices promptly corrected to less than $90, as the US economic outlook worsened. Global growth was also seen as clearly decelerating, with forecasts for both China and India being lowered.

But, oil is back above $100 and managed to settle above that level for the first time early this week. In less than a fortnight, oil prices gained nearly 15%. What changed?

Global economic outlook has actually worsened. The US Fed has further lowered its GDP growth forecasts, but expects inflation to remain a problem. Outlook for Europe has also weakened. The only surprise was Japan, where the last quarter growth was way above expectations.

There were a few stray incidents which caused some supply concerns in the markets, but were not significant enough to support such a strong recovery in prices. The US refinery that was shut down this week after an explosion is too small to disrupt supplies. The rumoured death of a Nigerian rebel leader has not yet caused any widespread violence as feared.

The reasons behind the oil rally are more complicated. Oil cartel OPEC said recently that it expects oil demand to decline, because of the economic slowdown. If demand weakens, prices should slip. Not so when a cartel controls a major portion of supplies. Markets now expect OPEC to cut production in March and defend prices. This has attracted more speculators into oil. Add to that the increasing attractiveness of commodities to large investors, who are scared to venture into equities and bonds.

Another possibility is that many hedge funds were trapped with their short positions and were forced to unwind. The weak economy prompted many hedge funds to short oil in January, as the forecasts were that prices will slip below $80 per barrel by mid-year. Those predictions have now being proven wrong and the funds were forced to close their positions, fuelling the rally.