5 Reasons Why the $700B Bailout Could Translate to $250 Oil 59 comments
Keith Fitz-Gerald
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I’ve been predicting record oil prices for a number of years now, so when crude oil prices recently plunged from their record highs, I warned investors and consumers that the decline was nothing more than a temporary respite.
But now it’s clear that the fallout from the $700 billion banking bailout pact will virtually guarantee that my prediction will come true.
As the curtain closed on the third quarter yesterday (Tuesday) - leaving many investors worried that the long-feared "Super Crash" was imminent - crude-oil futures were staring at their first decline in seven quarters and their biggest quarterly decline in 17 years, thanks to worries that a slowing economy would curtail global demand. As of early afternoon yesterday, crude oil for November delivery had dropped $39.36 a barrel - or 28% - during the third quarter to close at $100.64 yesterday afternoon.
It’s been a volatile market, too. Oil traded within a $56 range in the quarter, reaching a record $147.27 a barrel on July 11 and retreating to as low as $90.51 a barrel on Sept. 16, Bloomberg News reported. Oil futures moved 5% or more during one quarter of the trading days.
Analysts said this decline was merely the beginning, and that with a global economy that had been severely singed by the U.S. credit crisis, oil prices had nowhere to go but down.
But I continued to make the opposite argument. And a week ago, the markets made my point for me. On Sept. 22, crude oil futures for October delivery soared $16.37 a barrel, or 15.7%, to close at $120.92, after trading as high as $130 a barrel - thanks to a steep decline in the U.S. dollar and to speculation that the Bush administration’s plan to bail out the financial sector might actually jump-start the U.S. economy, fueling inflation in the process. The gain surpassed the previous record single-day-price gain of $10.75 a barrel, a move that occurred on June 6. [The biggest-ever percentage gain in a single day - 20.9% - was recorded on Jan. 3, 1994, according to FactSet Research Systems Inc.]
This record one-day surge caught many by surprise and jump-started speculation about whether oil prices will rise or fall from here.
For you disciples of doubting Thomas out there, you only have to look at the reaction to the different phases of the bailout negotiations this week to see that the market has spoken again. Crude oil for November delivery dropped $10.52 a barrel, or 9.8%, to close at $96.37 on Monday after the House of Representatives rejected a Bush administration bailout plan. But that was a knee-jerk reaction to a worry that the lack of a bailout pact might spawn a recession.
Yesterday, however, crude oil futures rebounded $4.27 a barrel, or 4.4%, after analysts realized, upon reflection, that the U.S. economy - together with the global demand for oil - wasn’t about to just disappear. And that was without the benefit of even a bailout proposal. When a pact is signed - as most analysts figure it will be - crude prices will likely rebound even more.
The Outlook for "Black Gold"
In the extreme short term, oil’s probably going to bounce around the psychologically important $100-a-barrel mark, - if not a little higher - as the U.S. government works to sort out the financial crisis.
The reason is that any "recovery," or bailout, is intended to strengthen the flagging U.S. dollar. And a rising dollar tends to push crude prices lower because crude is traded mostly in U.S. dollars around the world.
So, as much as most of the world looks to Organization of the Petroleum Exporting Countries (OPEC) to determine the price of oil, the more important influencers in the near term actually are U.S. Federal Reserve Chairman Ben S. Bernanke and U.S. Treasury Secretary Henry M. "Hank" Paulson Jr. - the Batman and Boy Wonder of Washington’s bailout set.
The $700 billion banking bailout package proposed by this "Dynamic Duo" directly impacts the flagging U.S. dollar. And the dollar, for reasons we’ve just explained, helps determine oil prices.
There are exceptions, of course, but the relationship between currencies and oil prices generally suggests that 90% or more of the decline in price that crude oil has experienced since mid-summer can be accounted for simply by how much the dollar has risen since July.
But here’s the trick - the reverse is also true.
We mentioned inflationary pressures before. Well, if Congress actually passes the bailout plan, another $700 billion would be pumped into the world financial system. And that would mean far higher prices are ahead. We’re talking Econ 101 here: Every one of the bailout bucks dilutes the buying power of every other dollar already in circulation. That erosion in buying power is the textbook definition of inflation.
In fact, that’s just how it played out this week. When the bailout plan was rejected Monday, meaning those bailout bucks wouldn’t be joining the financial system, oil prices fell precipitously, since there would be no additional inflationary pressures. But when investors started to rethink that thesis Tuesday - meaning they believed some sort of new bargain would be reached - oil prices reversed course and rose in anticipation of that money possibly being pumped into the financial system.
While a bailout could jump-start the financial markets for a while, history suggests that over time the "cost" of the liquidity Bernanke and Paulson have cobbled together may manifest itself in the form of far higher oil prices. Other commodities would rise significantly, too. Investors have only started to see this outcome.
So, what happened back on that Monday, Sept. 22, when oil prices made that record one-day run?
My experience as a professional trader makes me think that somebody simply got trapped on the wrong side of the markets and was trying to cover a humongous position at any cost.
And what I saw on my screens seems to confirm that. It was a late-session spike at a time when traders either had to get in line for delivery or unwind their positions before the October crude futures contracts expired. With a mere 30 minutes remaining, there were no sellers to balance prices, while the market makers who normally would provide a modicum of orderly behavior were nowhere to be found amidst the chaos.
Five Points to Bank On
What’s likely to happen longer term? Simple. In fact, here are five points you can take to the bank.
- First, global oil demand is still accelerating and, according to the United States Energy Information Administration [EIA], will reach more than 115 million barrels per day by 2030 - even with conservation efforts and high prices stunting demand.
- Second, daily production has probably peaked right now at nearly 90 million barrels a day, or will peak in a few years at the very latest. While experts once debated the reality of the "Peak Oil" concept, they now accept it and only question when it will take hold.
- Third, the world’s fastest growing economies, China and India, are still increasing consumption at double-digit rates, and that more than offsets any conservation efforts that are under way elsewhere around the world. And their governments want to buy oil at any cost - even if that means there’s none left for us.
- Fourth, the world will learn one day - probably sooner rather than later - that Saudi Arabia’s vaunted reserves are nowhere near what it claims them to be, and those reserves are certainly not at the levels long held as "gospel" in the oil business. Matthew Simmons, chairman of the Houston-based investment bank Simmons & Co. International and author of the seminal 2005 book, "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy," has been most vocal about this alleged shortfall, and I respect his work, especially since I’ve spoken behind closed doors with several OPEC figures who privately acknowledged that this may be their worst nightmare. Simmons recently predicted that oil prices would rally to $500 a barrel.
- Fifth, Bailout Ben has dropped trillions into the system to stabilize the Wall Street while Paulson has broken out his bazooka which suggests that as much of 95% or more of oil’s price drop can be attributed to nothing more than the dollar’s rise since July. Nothing else has changed.
Should traders see through the smoke and mirrors or simply decide to run for the exits, we can expect to see the dollar shrink to new lows and oil to rise to new highs in a perverse flight to quality.
Only this time, this "quality" is literally quite crude …
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This article has 59 comments:
On the subject of the bailout, watch this video:
market-ticker.denninge...
Once again I do not see the correlation between a gov't plan to clean up bank balance sheets and an increase in oil demand. Consumers worldwide are in bad shape and this will not be solved overnight by a 700bn investment in MBS.
Not so!
Fiction doesn't cut the Dijon Mustard!
Soon competitive solutions will be displacing the status quo paradigms!
Enough said!
It's good to take walk in the fresh air every-now-and-then instead of suffocating in the flatulence enriched polluted indoor gaseous vapors!
Smile! and have a gatorade!
Best regards,
Mr. SunErgy*USA.
this subject is better over drinks. the biggest bullshitter wins.
The Chinese market, whose economy you laud as unstoppable, is off 66% from it's highs. That does not support your weak dollar theory as they certainly need them badly and if China starts pumping money into their markets and dropping export prices, the dollar gets stronger too.
$250 oil may happen on day but that would translate to $10 per gallon gas and if you don't think there will be demand destruction at $200 per tank, then go ahead and place that bet.
If the bail out only works partially and we get a world wide recession like Japan experienced in the 90's then, demand destruction would continue and could compensate for the predicted Peak Oil declines of 2% a year after peak and stay around $100.
I suspect the dollars days as reserve currency of choice are numbered anyway and will continue to weaken as Sterling did after world war 2, so you could see some raise on the back of a weak dollar.
On the bull side www.upstreamonline.com...
Canadian Oil need $100 dollar oil to be viable and the new discoveries in Brazil are estimate to cost up to $240bn develop. That leads to another problem, if the credit crunch continues then there just not going to be enough capital around to develop future oil supplies, so the supply crunch get worse even with the demand destruction.
This already appears to be happening to Sevan Marine (rig builder) has seen its share price drop on concerns it cannot finance its capex. Its similar story with the alternative fuels, nuclear requires massive capex for up to 10-15 years before it starts producing electricity. That is a risky investment to make currently and if the price of Oil does fall below $100 in the short term it will delay further these vital investments. The situation is similar for Wind and Solar, i.e. high up front capex, this could see a dangerous increased reliance on Natural Gas.
So overall I don't see how the Oil price can fall much in the coming years. If it does it will make the Oil supply crunch worse by depressing investment in both Oil and alternatives. Ideally we get inflation (not nice, but better than deflation) and we muddle through. But if the bail out does not work, we get continued deleveraging, reducing investment and future growth. It does not matter much if you believe in Peak Oil or not, what is certain is we need massive investment to develop new oil or its alternatives and upgrade the ageing energy infrastructure. The credit crunch could not of come at a worse time.
Only if the value of the dollar went to @ 15 cents from over printing could this even happen and that would assume that americans salaries kept up with this rate of printing.
Get the scotch out of your coffee man before you write something like this.
"The Hand" guessed it right. You wrote this artical over drinks.
> jack
People just can't afford the fuel prices that would come with $250 a barrel, no one could live with the cost so it will never happen. Maybe for a few days due to some b*llshit panic/speculation but that is it. Maybe in 30 years when inflation make that $250 what $150 is today.Why they publish this rubbish is beyond me.
www.senate.gov/general...
www.senate.gov/general...
Two things to ponder:
1) If oil "stabilizes" @ around $100/barrel, you will find big oil and their cronies won't be shouting "drill, drill, drill". Not enough profit margin for them to put large amounts of capital at risk. ANWR will stay untouched, and only the juicy offshore sites will be explored.
2) There may be temptation by the Russians, Iran, or perhaps our good friends the Saudis to prop up oil prices. They have adjusted their spending habits upwards, and need the income to support their lifestyles. An "accident" in the Persian Gulf, geopolitical change in Ukraine/Georgia, perhaps a terrorist attack or tanker hijacking would send prices up.
$70/barrel is nothing but a wet dream.
The OP's whole premise relies on a huge spike in the October contract, saying it was huge demand when it was nothing more than a short squeeze.
We can't handle a price like the one you mention, Keith, and the oil exporters know it, and so they probably won't let it happen. Why should they? Never in their (or my) wildest dreams did they believe that the dollars would be rolling in the way that they are now.
As one who follows commodities, it was very easy to see what was going on. Volume was light in Oct contracts, but much heavier in Nov. and Dec. The very next day, people probably thought oil fell $14 when it closed at 106 or so, but that was because the quoted front month changed.
I have seen far too many use that anomalous trading day in one contract to draw conclusions about so many things. It had nothing to do with the economy, the dollar was down, but not nearly enough to account for that, nor did it have anything to do with any bailout, etc.
Unfortunately, common practice is to assign a cause for every single market issue, but the problem is, most of the time the causes claimed, are not the real reasons. There is an unwinding of many things going on right now causing more volatility, but there is no denying that commodities entered a bear market in July, and this is bear market behavior.
But I would contend that any destruction here will be easily picked up by China, India, and other industrializing countries.
It is as simple as....
We are broke. They are not.
he oil income trusts specialize in buying oil fields, and replacing the ones that start to run dry with new fields. On top of any capital gain, they pay great dividends. One I have, PGH, is paying $255/1,000 shares for October. That is a rate of 20.55%/year at the current share price of $14.89.
Canadian oil sands stocks would be a good choice since most of them are valued according to oil they have in place, ready to be produced when the spot price of oil is right. My favorite is Oilsands Quest (BQI).
www.mantleplumes.org/
P.S. There are some great "geology" websites that prove that the earth is only 6,000 years old, do you dig those? Real geology comprises many debates and open-ended questions; science is not characterized by certainty, but you turn that idea on its head by advocating crackpot nonsense. How lucky have the oil exploration scientists been so far in finding so much oil using their meager, goofy, obviously bone-headed conceptual frameworks? Hmmm, pretty lucky. Real geology is conceptually dynamic and exciting, come on in the water is fine.
In reality, demand destruction outside of the U.S. are right now mostly based upon speculation and this speculation has given cover to hedge funds and other large institutional investors who were forced to de-leverage to justify the unwinding of their energy and commodity investments. If the credit markets improve, many institutional investors will re-establish many of these positions.
The Ponzi I-banks and various speculative commodity hedge funds are no longer propping up the price of oil anymore.
While I do believe that peak oil is coming very soon - within the next 5 years, I've also noticed lately that all the SUVs are disappearing at my condo complex and are being replaced with tiny fuel sipping cars.
Your premise that a $700 billion bailout is going to cause massive inflation is weak IMO. ALL the countries around the world are slowing down and will inevitably lower their interest rates, thus most of them will be matching our inflation/deflation in certain assets and commodities $s.
I've started to follow HEAT RATE of coal, natural gas, oil, and alternate energy.
I've learned that one kilowatt hour of electricty requires about, more or less, 10,000 BTUs INPUT.
home.comcast.net/~bpayne37/pnmelectric...
I am also STARTING to think about heat transfer of wind energy along with solar technologies.
Hey, even wind and solar must obey the first law of thermodyamics.
Any ideas?
Have some fun too.
Enjoy Iran Maiden.
www.prosefights.org/th...
Just think of the expense of the display.
Only in New Mexico.
Will I see $250 bbl in my lifetime? Absolutely. $500? Probably. But that is a long term trend. In 1981, there were a lot of books and articles coming out correctly predicting $100 bbl oil within our lifetimes. Yet if one had applied that reasoning to investing, one would have probably sold sometime during the next two decades after losing one's shirt. Simultaneously, one would have missed one of the greatest periods to own stocks in history and retired in poverty - this despite being absolutely right about the eventual direction of this commodity!
The threat of inflation, the ballooning national debt, trouble in the middle east - that was 1981 AND 2008. Predicting what lies next will require more than a rear-view mirror.
Peak Oil is a scam.
Demand destruction is permanent.
21st Century energy technology is COMING!
China and India demand is a complete distortion.
To base a thesis on ill founded trading theory and outlier trading days signifies someone not steeped in the market being commented on.
Really terrible... $250 ppbl... c'mon...
Yes, absolutely.
When?
Second, handing money to banks right now isn't going to make them hand it to anyone else. Banks aren't going to lend freely until we are out of this situation and that may be a long time. I think deflation is the more obvious and persistent threat with the massive credit destruction prevailing. The only way they can stop it is with a real and massive printing. No piddling $700 billion. They'd need more like $2.5 trillion and they'd have to make sure they were simply handing it over to the banks instead of trading it for stuff already listed on the banks' balance sheets for similar values.
People are desperate for cash to pay bills. Increasingly over the next six to twelve months people are going to be concerned to raise cash and sell assets. There's no way for the Fed to get money to ordinary people without bypassing the uber rich banking establishment and the Fed would never do that. So the best they can do is hand money to banks and watch them sit on it.
Would you loan an indebted, profligate American consumer money at this uncertain time?
With those safeguards in place, I would gladly lend 5 ounces of gold for 1 year at 36% interest to any employed adult who is not a resident of Texas and has a credit score of at least 700 (these last three requirements actually encompass more than half of American adults). I guarantee you I would clean up lending on such terms - I would have no interest rate risk or inflation risk, and my ultra-senior claims would be certain to be paid by anyone who remains employed. About the only debtor I could lose on is the one who gambles the money away and then loses his job - and that would have to happen to 1/3 of them before I'd be in any danger of losing money.
You see, it's all about the terms. There will be plenty of lending when the terms compensate lenders for the risks they are taking. Today's "consumer" is not prepared to offer such terms, so he does not receive credit. Seems simple enough, no?
LIBOR 30 days ago around 2.8.
LIBOR now about 4.3 and rising. It is the equivalent of a rise in the discount rate from 2.00 to 3.50 as it relates to consumer debt.
Congress would dismantle the Fed if it tried to do it. But by keeping rates at present levels, it is exacerbating the Economic Crisis.
Deflation is already in place, the dollar's strength exacerbates an already existent condition. Wealth destruction first in Housing and now an acceleration in the stock market's downturn with more than 50% of the population watching their 401K's deteriorate again. This is a Deflationary double whammy.
A move toward inflation is needed and needed Now.
Otherwise as our unemployment rate doubles, you can say "But we have a stronger Dollar". Our economy can't compete with a stronger dollar, hasn't been able to this century.
www.rseg.com/sample/MP...