Will Surging Oil Derail a US Recovery? 27 comments
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Back on December 10th, when many momentum chasing oil analysts were forecasting $25 crude, I wrote here on Seeking Alpha that:
'While demand destruction will cap upside to maybe $80 through 2009, the collapse in desperately needed investment spending, as production in key exporters like Mexico collapses, is setting us up for an inflationary surge in energy prices when the world economy inevitably recovers post 2010. Long term production exposure via oil majors and second-tier exploration plays with proven reserves is now very attractively priced (although oil service stocks will be impacted by slumping E&P spend).'
That proved a prescient call, and the oil price is now back at levels above $65 seen in late 2006/early 2007 amid a global economic boom, and just before the explosive speculative surge that peaked in Summer 2008. At the time, I identified the move above $100 as fueled by a Nasdaq-style bubble driven by huge inflows into a very poorly regulated market, and one that would precipitate a global recession. The impact of soaring gas prices on already overleveraged US consumers is generally underestimated, and proved a critical tipping point that accelerated housing foreclosures and a retail spending slump, as discretionary income was squeezed.
In the last month, average US gas prices have jumped over 20% and are now approaching $2.50, despite ongoing demand destruction and ample global stocks of crude and products. Why? At $40 and below, crude was a steal, as that was barely above marginal cash production costs (and marginal costs of new offshore production are about $70). The steep contango structure in the market encouraged not only OPEC quota compliance but also speculative arbitrage between spot and futures by storing oil in offshore tankers.
As a result, about 100m barrels is now floating in tankers awaiting a home (at a storage cost of $1/barrel per month), while onshore storage tanks are also full to capacity (including both the Chinese and US strategic reserves). While the 2007/8 bull run was driven fundamentally by a narrowing cushion of daily supply over demand, there is no such constraint for the next couple of years. Essentially, the tidal wave of liquidity unleashed by Fed monetary policy is now washing through the commodity markets directly in driving speculation and rising inflation expectations and indirectly by undermining the dollar.
As I forecast early this year, inflation expectations as reflected in the 10 year Treasury/TIPS spread are already back at 'normal' levels of near 2%, after the deflation panic earlier this year. It is quite possible we will see $75-80 oil by year end, on real evidence of a global economic recovery in 2010. Near term, the speculators who bought oil around $40 are looking at a 50% return in a few months after storage costs, and the temptation will be to bank it as the price curve has flattened considerably. That would blunt the pace of the current move. Otherwise, a move above $70 on pure technical momentum at this fragile point for the US economy would prove a major setback to recovery hopes, particularly in conjunction with mortgage rates heading above 5% again and mortgage refi activity reversing. While equity markets are being boosted overall by the oil surge thus far, that may soon change if it begins to kill some of those tender green shoots.
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This article has 27 comments:
'Travel' season will hide the building glut, and it will 'suddenly' appear in fall.
Oil, however, is also a political barometer of global geo-strategic risk and a proto or nascent currency.
As an economic good, oil sees weak consumption and high storage but also production interruptions(Nigeria) and declines(Mexico, Venezuela) and tepid investments in production capacity. On the net, the resolution of these forces is in favor of lower prices.
Oil, as a political barometer, however, reflects proliferating and rising geo-strategic risk in many parts of the world(the positives in Iraq are more than offset by negatives in Asia, Latin America and Africa and the growing business and investment risk from bad public policies in the US and EU , where being anti-oil is now a political fad) . As the barometer rises, the price of oil is pushed up.
Oil as a nascent or proto currency is both interesting and very difficult to analyze. Clearly, in this role, oil/dollar exchange reflects the slowly unfolding but, because of the benighted policies of both Washington Dc and Wall Street, now inexorable devaluation of the fiat dollar. As a proto -currency oil prices are rising briskly in dollar terms(but necessarily in terms of gold or copper or some other hard assets). Some oil in storage may be a " substitute savings acct" rather than merely excess supply.
Given the triune nature of oil, at least ,in my opinion, the price of oil is facing downward pressure as an econmic good and upward pressure as a political barometer and proto-currency. In the nxt few months Bad Government rather than weak consumtion may have a greater influence on oil prices. A scenario of languishing use and rising prices would have seemed improbable 5 or even 2 years ago......it is less fantastic today.
I agree with two of your points and disagree with one other.
The proto-currency insight is absolutely right and one should cast one's mind back to the 1970's when the price of oil quadrupled shortly after Nixon abandoned the gold standard. Most traditional economists see these as unrelated events and the oil shock was considered, as most things that economists can't explain with traditional macro-economics, as an exogenous factor.
I disagree with your second sentence that oil is priced to reflect the "fundamentals of production, production capacity, storage and use."
Oil has never been truly priced by the markets - notwithstanding the gyrations in the NYMEX pits every day. It is oligopolistic pricing dictated by OPEC, the major oil companies and government taxes.
I suspect that if properly priced in a relatively free market the fact that supply and demand for oil based products are inelastic would also help to contribute (apart from the proto-currency issue) to the conclusion you reach of languishing use and higher prices
in 1967 there was a middle east war & the arabs cut off europe. the texas railroad commission opened the valves wide & supplied europe from our excess capacity & broke the cartel.
in 1973 there was a middle east war & the arabs cut off everybody including the u.s. there was no spare production capacity in TX,
you say that oli price rise was due to nixon dropping the gold standard, i simply can't agree with that.
> jack
I didn't actually say that there was a causal relationship but rather that they were "related" events. Middle eastern conflict was clearly also another factor as you say
If crude is going to take off like a rocket every time there's the least hint of demand recovery, then I don't see how we avoid getting stuck in a perpetual stagflation scenario.
As shown clearly by zero hedge they finished this off with manipulated run down in the markets from Jan to march this year, and then drove it up again with a speed that has happened only once in history.
When one looks at the entire crisis I am afraid this is the only conclusion that easily fits all known facts, explains all events, and leads to the results which have ended up happening. There is certainly enough evidence to engage in a major congressional investigation of this company, it's ties, it's connections, and the roll it played in the crisis using a special prosecutor.
Please don't tell me they don't manipulate markets. the roll they played in the run down Jan to march and the speed of the current rally is overwhelming. Everyone knows the role they played in raising oil prices. Everyone knows of their connections with regulators, sec, washington, NYSE, commodites futures exchange, and NY fed, Aig, Treasury.
It is all there for everyone and anyone to see if they just decide they want to connect the dots. When you actually put it all together it becomes so simple you realize there really isn't any other way this happened.
On May 30 08:41 AM conceptwizard wrote:
> The Oil prices are, have been, and will always be manipulated by
> the Goldman trading floor. With so much inventory on tap and demand
> so low this is likely the case again. The Plunge Protection Team
> are swimming in every pond including commodities.
This is the future Bernake and his misguided wall street advisors have doomed us to. All to avoid nationalization, making banks down their balance sheets, and keep the slush money flowing. The idea that you could trust the advice of someone who is willing to ruin their own company making themselves rich defies logic.
In fact it is exactly the ability to ruin something while making yourself rich that show you deserve being admitted to the old boys network
I am also sick of people who run around giving thumbs down to every comment they don't like. the issue is does one add to the topic, do they understand the concept. It doesn't matter bull or bear, but the quality of the analysis.
On May 30 08:17 AM Freya wrote:
> Dave: I want you to think about where the USD denominated Oil prices
> could go in light of what you just said.
>
> Last year was a Manipulated Spike. This year the USA has Trillions
> in added debt and a USD which is still 10% higher than it was last
> year, 79 vs 71.
>
> And we are quite early in the stronger demand season. Even with Demand
> destruction, Seasonalities do not change. The USD goes back to a
> Minimum of 71, whither oil?
On May 30 08:03 AM User 353732 wrote:
> Oil is acquiring a unique status amongst commodities. It is, of course,
> an economic asset or good and as such its price reflects the fundamentals
> of production, production capacity, storage and use.
> Oil, however, is also a political barometer of global geo-strategic
> risk and a proto or nascent currency.
> As an economic good, oil sees weak consumption and high storage but
> also production interruptions(Nigeria) and declines(Mexico, Venezuela)
> and tepid investments in production capacity. On the net, the resolution
> of these forces is in favor of lower prices.
>
> Oil, as a political barometer, however, reflects proliferating
> and rising geo-strategic risk in many parts of the world(the positives
> in Iraq are more than offset by negatives in Asia, Latin America
> and Africa and the growing business and investment risk from bad
> public policies in the US and EU , where being anti-oil is now a
> political fad) . As the barometer rises, the price of oil is pushed
> up.
>
> Oil as a nascent or proto currency is both interesting and very difficult
> to analyze. Clearly, in this role, oil/dollar exchange reflects the
> slowly unfolding but, because of the benighted policies of both Washington
> Dc and Wall Street, now inexorable devaluation of the fiat dollar.
> As a proto -currency oil prices are rising briskly in dollar terms(but
> necessarily in terms of gold or copper or some other hard assets).
> Some oil in storage may be a " substitute savings acct" rather than
> merely excess supply.
> Given the triune nature of oil, at least ,in my opinion, the price
> of oil is facing downward pressure as an econmic good and upward
> pressure as a political barometer and proto-currency. In the nxt
> few months Bad Government rather than weak consumtion may have a
> greater influence on oil prices. A scenario of languishing use and
> rising prices would have seemed improbable 5 or even 2 years ago......it
> is less fantastic today.
The importance of the Dollar comes from two things; firstly, it is the currency of the world's largest economy, and secondly, it is the denominated currency for oil trading. The creation of trillions, via the expansion of the Fed's balance sheet and the willingness to exchange dollars for toxic assets has caused astonishment and consternation among the oil powers. Any willingness to keep oil prices down to aid global recovery has been removed by the decision to debase the dollar to prop-up a reckless banking industry which pretended to be creating wealth but was exposed and went running to the government for help.
Currently, the dollar is being used to support the long bond market in a desperate hope of stabilising the housing market.
So now we will have oil permanently above $75 a barrel, but how much this means for other nations depends how far the dollar falls.
There is a joke told in various countries about how Americans think all the world's oil belongs to them, but sometimes it seems they really do believe it....
And Goldman Sachs may be powerful, but please, they aren't that powerful.
On May 30 12:45 PM Freya wrote:
> dcb: thanks for the help, but its not a problem really.
>
> Its probably just a plain old never ending grudge for crititizing
> or debunking some author or other.
>
> Each Author has a "following", some followers are more "Rabid" than
> most.
>
> Just replying to the question of another commentator gets me a thumbs
> down. a couple of few comments ago, I typed out a Line from an article
> and told the Author that he was about to get ambushed for even saying
> something like that and I was going to get reamed for quoting him.
>
>
> Sure enough, 8 maybe 9 thumbs down now, Just for that alone.
>
> You can either be an adult and listen to both sides or you can maintain
> that everyone else is insane and your views are the only ones that
> matter.
>
> Watch.
$100 by end of year?
nixon terminated the bretton woods fixed-value system in august 1971 (8/15).
arabs attacked israel in october 1973 (10/6). more than 2 years separate these events, they are hardly related.
> jack
And I dare you to say anything against John Peterson's fixation on lead batteries.
CNG and Lead Batteries. thats who I'd vote for.
arabianmoney.net/2009/.../
This recession is far from over, it has hardly started.
On May 30 12:45 PM Freya wrote:
> dcb: thanks for the help, but its not a problem really.
>
> Its probably just a plain old never ending grudge for crititizing
> or debunking some author or other.
>
> Each Author has a "following", some followers are more "Rabid" than
> most.
>
> Just replying to the question of another commentator gets me a thumbs
> down. a couple of few comments ago, I typed out a Line from an article
> and told the Author that he was about to get ambushed for even saying
> something like that and I was going to get reamed for quoting him.
>
>
> Sure enough, 8 maybe 9 thumbs down now, Just for that alone.
>
> You can either be an adult and listen to both sides or you can maintain
> that everyone else is insane and your views are the only ones that
> matter.
>
> Watch.
I can then dismiss the Chaff and concentrate on the Wheat. I want Ideas, I DO NOT WANT the rest of the associated Garbage.
I have aligned myself with Freya, Optionsgirl, Yellowhoard and Sniper so far because I get more upside, timing and market psychology out of their combined comments than I do from the mostly incomprehensible Articles I read.
I want what "works", not what someone who doesn't understand why what he/she is saying isn't working but can't change to accomodate the new trends.
But the correct phrase should be:
"The Dow is in a trading range between 7,900 and 8,650." Go short when it approaches the upper level or some inanity like that.