Oil: Bernanke's Fatal Flaw

Apr.29.11 | About: iPath S&P (OIL)

As I sat at CNBC HQ and watched Chairman Bernanke skillfully answer the press corps’ questions I was struck by how confident he was that oil prices would decline. In my 17 year career, rarely have I seen such conviction by a government official (especially from a central banker) concerning the price of a finite and declining resource. The only explanation for his hubris was demand destruction. With the memory of the 2008 oil spike fresh in his mind, the Chairman is surely counting on the wonders of a free floating price to rebalance demand as supply remains constrained. But is he right?

The following chart depicts the price of oil (continuous Brent contract) and imports of crude oil by China.

(Click chart to enlarge)

Notice that during the 2008 oil price spike imports of crude into China declined with the rising price, however, currently this is NOT occurring. As China continues to grow, its appetite for oil is becoming insatiable and Chinese price sensitivity is changing.

It is this paradigm shift that is Chairman Bernanke’s fatal flaw. His assumption that rising prices will result in demand destruction is being proved incorrect and is likely to remain that way. The Chairman is an educated man and surely can construct a similar chart to depict this paradigm shift. Therefore, he is either ignoring the evidence or understands that yelling fire in a crowded theater is not a career enhancing activity.

The bottom line is higher oil prices are here to stay with or without unrest in the Middle East. Currently our long positions in the energy space include CNQ, UPL and oil futures.

Disclosure: Accounts managed by Brian Kelly Capital are long CNQ, UPL and oil futures.