When Will Oil Stop Its Rapid Ascent?

Until last week, there have been two stories running in parallel. The first story is of rampant inflation fueled by the price of oil making record new highs every week. The subtext to this story is the dawn of a difficult decade. The second story is of a stock market that believed inflation would be contained and that the worst of the credit crunch is behind us. Last week these two stories collided with the end result being a sudden realization that we're not quite out of the woods just yet.

According to Michael Cartine of Thomson/Reuters:

The danger from inflation comes in from its inherent volatility; when prices rise 3% the first year, 5% the next, 10% after that, but then stagnate or even drop for a year before trending higher again. This type of environment becomes increasingly difficult to make economic decisions in. Market participants around the world will certainly attest that the last year or so has been a particularly volatile time.

The FTSE sold off hard, falling further than most other global stock indices on the week. UK top tier stocks, led by banks and real estate shares, fell on fears of negative equity in the UK housing market leading to trouble for banks and consumers. Retailers including Marks and Spencer were being punished as UK shoppers face the prospect of not being able to bank on further house price rises to fuel further spending. The bricks and mortar ATM is no longer paying out.

The plight of UK equities was not helped by that fact that even with oil hitting $135; UK oil stocks were strangely subdued towards the end of the week. Oil & gas stocks make up nearly 20% of the FTSE by market capitalization. The question remains whether this relative weakness is the start of a rotation out of this sector, or whether it is just a couple of days profit taking. Markets gave us a significant 'tell' on Thursday as equities spiked following a natural gas inventory report which indicated increased levels of storage. Oil fell back and stocks surged in the opposite direction. Unfortunately, the rally didn't last as crude reaches back to previous highs. However, the way that markets reacted was certainly telling and could be an indication of how things will play out when oil finally stops going up.

Crude oil has now accelerated by 30% in under two months and 80% in a year. It is little wonder that the MPC voted 8-1 to keep rates on hold with inflation running so high. However, there are some potential weaknesses in crude which are worth pointing out. According to Mike Rothman of ISI, global demand growth for oil is now well below last year's increase. In addition there are reports of the Gulf being crammed with oil tankers chartered by oil producing nations to hold oil they cannot sell. This suggests there are no buyers at this price and when this happens, the laws of supply and demand come into effect. Goldman's Analyst Arjun N. Murti recently predicted that oil could hit $150-$200 in the few years. While this prediction may still come through, there are increasing signs of this oil bubble over stretching.

With bank holidays in both the UK and US, it was a quiet start to the week on Monday. The most notable release on Tuesday is the US new home sales data which is expected to show indicated further pain for US home builders. The only question is the degree of acceleration in this decline, as is expected to be the case with the UK's Nationwide House Price index released some time on Wednesday morning. The week's top announcement though is likely to be the US GDP figures on Thursday as the US economy weighs up the benefits of the Bush tax rebate against the rising cost of oil.

After experiencing a much needed sell off, there is the potential for the FTSE to stabilize over the next week, especially if (big if) oil manages to go a week without making a new record high.

Comments

[Brian Pursley:]

As long as there are Democrats in Congress preventing any supply increase, the commodity will continue to rise.

2008 May 27 11:15 AM

[AlexS:]

I agree with Brian. The last time oil prices had a sustained downward push was when Reagan decontrolled prices, letting supply loose. Congress doesn't have price controls on crude, but their holding up on exploration in the U.S. has the same effect. As long as the Dems are in charge, the price will remain high and will probably go up. If Obama gets it, look for a sustained rise from here, unless of course he plunges the world into another depression, which is very possible.

2008 May 27 11:27 AM

[barnburner:]

I'm just a little ole bleeding heart liberal so why don't you Reaganomics experts tell me how much extra oil those pinko democrats are holding up? Think it would get gas down to $2 a gallon, and if so for how long? Of course we know from past experience that a Republican Congress, if they had a chance like they did during the last eight years, would just jump right in there and get us off the foreign oil addiction with more alternative energy and energy conservation-right? I mean, didn't the do that before or was those pesky democrats standing in their way?

2008 May 27 06:24 PM

[Brian Pursley:]

barnburner - The United States has 12,383 miles of coastline. You do the math. ANWR has between 4 and 16 billion barrels we really have no idea until we drill. And the last time I checked it's a bipartisan Congress which means even if Republicans want to drill the Democrats won't let them.

2008 May 27 06:37 PM

[hubert boateng:]

The only thing we can pray for right now, isthat, the Dems stay in Congress and McCain stays in the WH and we all stay happy.

2008 May 27 09:59 PM

[Louis Paquette:]

Why focus exclusively on the supply side. Do that - but tend to the demand side too.

Large communtes to monster homes driving moster vehicles might be a good place to start. The current model is obsolete and on its way out. The only question is how painful the transition will be.

2008 May 27 11:59 PM

[Louis Paquette:]

that was "commutes"

2008 May 28 12:00 AM

[ArtfulDodger:]

Both the author of the article and Brain have made some excellent points.

Because the Dumborats in Congress want to control everything we do and also think they're smarter than every other living being and know what's best for all of us, they'll do all they can to keep energy prices high, because they hate anything that comes from the earth, except of course corn and grains, which should be used for food; but those brilliant beings want us to use them for fuel.

The Controlcrats also hate with a passion that so many Americans have become so affluent over the last eight years that, even after the Y-2-K Con, the Dotbomb exlposion, 9-11, and Katrina, our resilient, hard-working people can still afford large homes and SUVs. They want to be the only ones who can ride in limos, have a home in their district (or state), one in Washington, and a million dollar vacation get away.

To the Controlcrats this is too much affluency and far too much freedom. Thus behind-the-scenes, no matter what they say in public, they are cheering high energy prices, and they'll do all they can to keep them high.

But that doesn't mean that the recent 50% spurt of the last few months will last. Prices will crash from where they are, and the media will begin telling us how flush oil supplies are, and that will cause them to go down further.

But I doubt whether we'll ever see them back to the levels we have over the past fifteen years when reasonably priced energy has helped the nation more than double its gross production rates.

I don't like the politicians who're purposely atempting to put the squeeze
on oil supplies so that prices will spurt upward and they can brainwash the people into accepting their eco-maniac agendas. These same cynical type of people have been predicting the earth's demise for the last sixty years. They simply have to change every decade or so in they manner they tell us it's going to day; today it's going to heat up to a boiling point and explode, killing every living thing. Another hoax!

Me, I like seeing people prosper. I like their being free to choose the homes and cars they like and can afford.

But, of course, I'm not a Controlcrat.

Rebeldog

2008 May 28 09:44 AM