Will Oil Continue Its Rise? 12 comments
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As numerous observers have said of late, the causes of oil’s substantial climb from about $40 to $70 were primarily the weakening dollar and purchases by investors and speculators (if there is a difference) to hedge their inflation fears. I’ve noted these causes ever since oil broke $50.
More recently I offered the view that some fundamental supply and demand pressures may be building on U.S. oil inventory levels due to the combined difficulties of four of America’s five largest suppliers, Mexico, Venezuela, Nigeria, and Canada, to maintain, much less increase, their supplies, perhaps accounting for recent inventory declines. Nonetheless, inventories are above the seasonal average and I am not suggesting there is anything like a supply squeeze developing; there are ample global reserve levels, including about 4 mb/d of spare OPEC capacity.
So the real question is: if the global economy shows further signs of starting to expand, will further speculative buying keep driving the oil price higher? My guess is that there is limited further upside from speculation because the higher the oil price goes, the more supply is likely to be increased. New supply will come from one or both of OPEC or greater production efforts and willingness to sell among non-OPEC operators. Given that there will be plenty of spare oil capacity in the world for the next couple of years as least, my expectation is that increasing supply due to higher oil prices limit those price from rising much further.
If, on the other hand, the world fails to pull out of the recession it’s possible that oil will retrace some of its recent gains. On the other hand, failure to pull out implies that the U.S. economy continues down. In that case the U.S. budget deficit will be further exacerbated and it will seem increasingly likely that the dollar will fall more rapidly, which will support the oil price. Therefore, I don’t expect oil to fall back much below $60.
Naturally, all bets are off if an unexpected political upheaval somewhere were to suddenly disrupt supplies or if fears of such disruption were to increase rapidly. Such could be the case if Iranian domestic political stress continues to increase or if toward year end the Israelis decide to attack Iran’s nuclear sites. Other potential disruption candidates are Nigeria and Iraq - a less likely candidate. Venezuela is more likely to see a steady deterioration of exports than a sudden rapid decline.
But absent a globally significant political card being played, I expect oil to trade more or less in line with the dollar over the next 18 months plus or minus. I think speculative buying is more likely to come out of oil in that time frame than to become more intense.
On the other hand, my analysis of fundamental supply and demand factors which I published in March indicates that supply shortness will become a factor within the next five years and possibly as soon as three years from now, due mostly to high and increasing rates of depletion. So at some time between 2012 and 2014 I expect to see record breaking oil prices.
Will much higher oil prices bring down the OECD economies and thus cut oil consumption rapidly as has happened after the 2007 - 2008 rise from $50 to $147? My guess is that OECD oil consumption will not have increased so much over the next 2 - 4 years that another economic downturn would be able to reduce it as dramatically. Also, a countervailing force will be the huge budget surpluses that higher oil prices will provide the exporting countries, which now account for 40% of global oil use. These countries have rapidly growing populations, rapidly growing needs for new infrastructure and industrial investments and with their greater wealth they will rapidly expand their internal use of oil, thus offsetting much if not all reduction in OECD oil demand from an echo recession.
The above projection, if accurate, suggests to me that if oil goes to $250 some time in the 2012 - 2014 time frame, the pullback will be limited to, say, $150, not to the $40 level reached recently. The next wave after that one would take it to, say, $400 with a pullback to $250 - perhaps in the 2014 - 2018 time frame.
This vision of permanently expensive and scarce oil calls for a very different world from the one we are accustomed to living in. I recently read Jeff Rubin’s new book, Why Your World is About to Get a Whole Lot Smaller. He doesn’t make specific price projections but he does flesh out the fundamental supply and demand vectors that will result in the sorts of price predictions I just made. He then suggests a number of ways that life will change because of the new reality of expensive oil. I found it compelling reading because it added a lot of factual information and a number of conceptual nuances to my understanding of our likely future of oil scarcity.
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This article has 12 comments:
We desperately need GLOBAL energy reform....now....if we are to avoid the above scenario. Time is, indeed, running out. All the low hanging fruit has been picked. Going forward, oil will be increasingly harder and more expensive to obtain.
The coming energy crisis will make this recession look like a walk in the park....
From here, the depression will kill commercial demand, which is a Huge chunk of total petro consumption.
The downside is far, far lower than most people realize. Remember '79? I do.
On Jun 16 02:11 PM Mad Hedge Fund Trader wrote:
> If it does, it is without me. Get me out of oil! ... Better to bail now at $70 and buy it back at $50 once reality sets in. And for Heaven sakes, don’t try to get too clever by shorting the stuff!
I guess, it's as you imply from your article that it isn't demand but rather some other thing that will move oil: it must be the hurricane season or the "summer" driving season, or political instability or what ever chaos theory suits/rules the day.
I do have one question: what is up with the SOR? Is is a reserve or a drain. I cannot believe they are still putting oil in that thing. They wouldn't be buying oil, using the reserve, to create political stability for Russia and Saudi would they?
The worst thing is the trade of last sumer becoming this summer's crushing blow tot he recovery: bid the dollar down, bid commodities up (this in turn will raise input costs to companies and squeeze the consumer) then short stocks because the raising input costs will not be offset by increase consumer demand.
It's a terrific world the hedge funds, totally unregulated, have created for themselves- being a pariah on the consumer. I'm so glad they are unregulated! I'm also glad they aren't speculators but, instead, greedy disgusting little pin heads who create and no value-add at all. At least they will be able to afford their rentals in South Hampton, Nantucket and Newport this summer.
It seems that the natural gas trade is also a little crowded as well, with many betting the oil gas ratio to close to more normal levels.
Speculators are human beings too, and on the average - as a group - they know more about the great world of oil than any other group, even if they don't know as much as Jim and myself. They not only have made some heavy bets on oil before, but on one occasion managed to double the price (100%) in a very short time, and on another occasion push it it up over 300% in a very short time. . BUT THESE WERE SPIKES, ánd these spikes were not sustainable because given the amount of oil in the crust of the earth, and how much they were finding, it didn't pay speculators or anyone else to keep betting that the oil price would stay up. Some did make that kind of bet, and they were hardly able to afford bus fare home.
Things were different in 2008. When the speculators looked at the fundamentals, they saw oil demand outrunning oil supply. They started betting and kept betting until the macro-financial market meltdown changed most minds. Then they headed for the exit in a hurry. BUT NOTE, THE SPECULATORS ALSO EXAMINED THE FUNDAMENTALS, so I think that a little formal logic will show that the fundamentals rather than the speculators were the root cause of that escalation. Of course, some speculators got their ideas from comic books and late night entertainment channels, but as a group those people working for Gordon Gekko can read the signs even better than a lot of employees of big oil. If you don't believe anything else I say, please believe that.
So how about something original lets regulate the futures energy commodities market? Or better yet, free us from the use of oil altogether? The oil industry as a whole made around $476 Billion in net profit over the last 6 years, the pulse of the worlds economy is under the thumb of 13 OPEC nations and 5 major oil companies. Is this the legacy we want to leave our children and grand children?
So, while there is is plenty of oil in shale, it is expensive and very difficult to extract. With this problem oil has continued to deplete at about the same rate as in recent years. As the world economy recovers, the demand for oil is starting to increase.
Betting that oil will stay below $75 next year is betting against recovery. Prices will rocketship, when the recovery starts in earnest.