Oil: Up to $200 or Down to $25?

It is worrying for oil producers when the Russian President Dimitri Medvedev talks of $150 oil because it is so reminiscent of the $250 a barrel forecast last summer. A little hubris often comes before a fall.

Oil got down to $33 a barrel last December. Could another fall be on the cards this autumn?

Two things drive the oil market: speculation and fundamentals. It has been the speculators who have taken over the market since December and ramped oil prices back up despite the fundamentals of the worse recession since the Second World War.

Inflation

It is almost as though government bailout and stimulus money has been redirected back into the oil markets to cause this primary inflation. Well, it certainly could be that cheap money from the Fed has been put to good use gambling on rising oil prices.

The problem surely is that this surge in oil prices is self-defeating. Let us not forget that it was the spike in oil prices to $147 last July that preceded the collapse in financial markets last autumn. Oil prices and recessions have long been close associates.

As oil prices rise that places an additional cost burden on industry, transportation and consumers. And the impact is huge. The recent oil price rises could well have entirely offset all the global bailouts and stimulus packages since last autumn.

Indeed, surely here we can see the cause of the next down leg in this Great Recession. Oil prices are a tax on the global economy that it can not afford to bare, and demand will tumble as a result.

Horrific impact

British Airways has warned of a ‘fight for survival’ because of higher fuel prices on top of a global slump, energy prices will also go up for consumers already saving more and so they will spend even less and industry will struggle to pass on the additional cost, hitting profits.

Are higher oil prices therefore unsustainable in the short term? Will speculators then rush for the exit and drive prices down even below levels seen last December?

It certainly seems possible, even likely. For oil producers then only compensation is that this false recovery shows just how well prices are going to perform one day when a real recovery arrives as it must in due course.

Comments

[Advill:]

Inflation will be a sustantial part of the governments way of getting back the tons of millions they injected in the world economy, it is why your idea of oil prices could have ground, however, you are ignoring the huge effort big oil consumers are doing for avoid just that scenario, DOE official report of energy in 30 years keeps the amount of energy in US economy coming from oil IN THE SAME LEVEL that it is today.

That means that all future increases of comsumption will come from other sources, sun, nuclear, wind etc. and that is for a retrograde country in energy matters, Europe is well ahead and the prediction is for a net reduction in the absolute level of energy comming from oil, that leaves developing countries with the burden of absorbing future oil prices.
Huge new fields are now in the pipeline, from Brazil (next oil power) to Russia (not to say that Saudis has been without exploration for decades), other fields in Falkland and South Atlantic also looks promising.

A 80-120 dollars in real terms for the next 20 years seems a realistic approach, this oil speculation using TARP funds will explode soon and a new scandal in relation with lack or low level regulation will arise....we ll see.

Regards.

Jun 07 04:54 AM

[Tom Armistead:]

Bill Clinton tapped the Strategic Petroleum Reserve during his presidency with oil around 30 per barrel. He released 30 billion barrels, with the recipients obigated to return it when prices became more favorable. The market retreated.

If Obama becomes concerned speculators are driving oil prices above what supply and demand considerations support, he could repeat Clinton's maneuver, enough to drive prices down to levels consistent with sustained economic recovery.

Free market capitalism relies on market participants to allocate resources in the best interests of the economy. Unfortunately speculators manipulate markets, creating economic inefficiencies. Government intervention is one possible way to deal with this problem.

Jun 07 06:54 AM

[JET1C:]

"It has been the speculators who have taken over the market since December and ramped oil prices back up..."

BS, this is mostly just the usual price manipulation.

Jun 07 10:14 AM

[Ferdinand E...:]

The author was right about the relationship between high oil prices and
recessions. This needs to be recognized.

As for the oil price going down into the bargain basement range, forget about it - unless of course those good OPEC people spend so much time in my favorite 'gin-joint' in Vienna that they forget about how much power they have.

Jun 07 10:17 AM

[Gravity404:]

Tom - "Bill Clinton tapped the Strategic Petroleum Reserve...He released 30 billion barrels, with the recipients obigated to return it when prices became more favorable. The market retreated."

First, the SPR only holds approximately 700 million barrels. Second, Clinton may have released 30 million barrels.

A little over two day supply.

That's not even a blip on the radar screen.

Jun 07 12:06 PM

[Tony Daltorio:]

"It has been the speculators who have taken over the market since December and ramped the oil prices up despite the fundamentals."

What absolute rubbish - the author has completely ignored the supply side of the equation. Because of the financial crisis current, and even more so, future production of energy has been drastically affected to the downside.

Wall Street speculators were in control of the market prior to December and drove prices to an unsustainably low levels. Late in 2008, there was ample talk around the globe about how the NYMEX contract was being manipulated lower to help the US economy. At the time, major global players were looking for a better alternative to NYMEX contracts which "no longer reflected fundamentals."

Jun 07 01:53 PM

[Dennis U. A...:]

About the drivers of oil market, the author was quite right:speculation and fundamentals. But for the past year and half, it has been mainly speculation.

During the oil price shock of 2008, oil prices were spiralling higher while the market was well-supplied. More recently, despite the massive global supply overhang, weak demand and evidence of deepening recession in Europe especially in the OECD countries, oil prices were surging higher, challenging the US$70 per barrel mark.

As l held in my recent post there may well be an oil price shock when the global economy rebounds from the current recession, but save for extenuating circumstances (war or equivalent, outages etc), such shock is unlikely to hold any fundamental support.

Jun 07 05:26 PM

[Jasper M:]

Avill,
The 30 year prediction might Very well be true, because of something that seems to have slipped by the mainstream media: Amidst all the furious funding in the Stimulus Bill (Which I do NOT support), EMCC's "Whiffleball" got funded.
This the immediate descendent of the late Dr. R. W. Bussard's concept of a compact, relatively cheap fusion energy plant. Web search "pollywell" for a general theoretical overview.

I find the physics of this model compelling, and I suspect we we may be getting an economically significant percentage of power from the descendants of this program within 20 years (it would be sooner, but government entanglements do tend to draw things out).

Jun 07 05:46 PM

[utilitus:]

On Jun 07 06:54 AM Tom Armistead wrote:

> Bill Clinton ... released 30 billion barrels...

Right, but that wasn't oil....

Jun 07 08:24 PM

[john boy:]

i think you had a typo or something as we only have capicity for up to one billion barrels in our strategic oil reserve.
j.b.


On Jun 07 06:54 AM Tom Armistead wrote:

> Bill Clinton tapped the Strategic Petroleum Reserve during his presidency
> with oil around 30 per barrel. He released 30 billion barrels, with
> the recipients obigated to return it when prices became more favorable.
> The market retreated.
>
> If Obama becomes concerned speculators are driving oil prices above
> what supply and demand considerations support, he could repeat Clinton's
> maneuver, enough to drive prices down to levels consistent with sustained
> economic recovery.
>
> Free market capitalism relies on market participants to allocate
> resources in the best interests of the economy. Unfortunately speculators
> manipulate markets, creating economic inefficiencies. Government
> intervention is one possible way to deal with this problem.

Jun 07 08:39 PM

[Dean M:]

Unfortunately I think we are headed for a major leg down in oil prices in the near term. Why: the ridiculous GS price target for $85 bbl oil in 2009. Last time Goldman made a pie in the sky estimate for $200 last was just before it began to slide - you can easily imagine another pump and dump scenario by the oil traders. I say unfortunately because I would rather endure the high prices if it could be a catalyst for ending our oil addiction for good - it still makes me sick to my stomack to be sending billions to Iran, Russia, Saudi Arabia and Venezuela.

Jun 08 12:04 AM

[Fred Linn:]

There is an alternative to oil. Biodiesel oil can be made from algae. It is being done right now. PetroSun has an operation eventually slated to produce 4.4 million gallons of algae oil per year on 1200 acres of ponds in Rio Hondo TX. up and running now. Algae oil requires no refining---it is put through a process called transesterification to be made into diesel replacement fuel. This is similar to soap making. Components such as glycerin which have a higher value and are not needed in the fuel mix are removed. Algae is so efficient compared to petroleum, that one gallon of biodiesel made from algae replaces the need to import 2.3 gallons of crude oil. Any conventional diesel engine can run on biodiesel with no modification. Biodiesel can be mixed with petroleum diesel in any proportion from 2% to 100% with no loss in performance. Biodiesel runs much cleaner than petroleum--so clean in fact, when made from salvaged oils, the engine exhaust will have the smell of the previous use of the oil---if it was used to make french fries, it will smell like french fries.

Over the road trucks have been using biodiesel fuel mixes for years. Biodiesel has approximately the same BTU content as petroleum and runs and burns much cleaner. Less maintenance and less pollution.

Railroad locomotives can run on biodiesel mixes, and they have been successfully tested on jet aircraft by several airlines and the USAF, and tested in large marine engines successfully.

I think we need to get algae derived biodiesel in the market and end our dependence on oil. I think it is one thing we can do that would make more difference in the economy than any other single thing.

Jun 08 01:41 AM

[Tom Armistead:]

Right, it was 30 million. The last year or so it is hard to remember whether you're talking millions or billions, TARP and so on.

Probably the effect was more psychological than real. There was a huge debate about Bush continuing to fill the SPR while the 2008 energy bubble was inflating. The amounts involved were trivial, but the message was, we aren't going to stop this thing.

On Jun 07 12:06 PM Gravity404 wrote:

> Tom - "Bill Clinton tapped the Strategic Petroleum Reserve...He released
> 30 billion barrels, with the recipients obigated to return it when
> prices became more favorable. The market retreated."
>
> First, the SPR only holds approximately 700 million barrels. Second,
> Clinton may have released 30 million barrels.
>
> A little over two day supply.
>
> That's not even a blip on the radar screen.

Jun 08 07:26 AM

[Living4Divi...:]

I like your article - thanks for posting it. I wrote an article about this titled: How High Will the Price of Oil Go? seekingalpha.com/artic...

Jun 08 12:52 PM

[Gravity404:]

Cheers, Tom.

There was a big push to double the size of the SPR when prices were above $120. This would have been huge for EPC companies like KBR, HAL, JEC, etc, but I have not heard about it for a while.

Oil will always be cyclical. So, to me, it makes sense to build the infastructure and fill that baby up when oil's below $50, not when we hit $140 again - which we will at some point.

It all sounds good when the talking heads are up for re-election.

Jun 08 01:45 PM

[toobad41:]

My thinking on oil as a commodity is that it is subject to what the producer wants to get for it and what the consumer has to pay for it. In other words, the producer will not sell his oil for less than it costs to get it out of the ground. This is the same all over the world. The consumer will not like it but that is reality. Which brings me as a domestic oil producer I break even at $65 a barrel, after taxes, after leasehold expenses, operating expenses, after drilling costs, transportation fees, workover costs, tubing repairs, employees salary, etc. What is my fair profit? Perhaps 6% profit which brings the cost of a barrel of oil to $69. Anything less is giving away money. Thus I keep the oil in the ground. I don't have any control on the cost of oil that is imported and that is a problem I sometimes cannot deal with. To get oil from overseas cheaper than I can produce it domestically means I shut down operations. I will not sell my oil without making a profit. End of story.

Jun 08 09:22 PM

[Peter Cooper:]

The high oil price could also be the emergence of cost-push inflation with speculation as the medium through which this is transmitted into the marketplace. In that case much higher oil prices are to come with the creation of money by the Fed.

Jun 26 01:02 AM