Crude oil prices started their astonishing price rise in January of 2007 right on cue for a normal seasonal rise into the summer. By August, prices were accelerating and continued higher going into the end of 2007. The usual seasonal year-end decline was hardly noticeable.
As 2008 began, crude prices seemed to be a one-direction trade as prices accelerated even faster. Something unusual was taking place in this market. OPEC and the Saudis claimed there was plenty of supply on the market but prices were being bid up regardless. Many analysts revived earlier predictions about peak oil and the impending decline in production as the justification for higher prices in anticipation of supply shortages in the future. Then in the middle of the summer the selling began. Was peak oil just a multi-billion dollar hoax?
In Volatility Trading Digest™ Volume 8, Issue 25, Saudi Oil Summit, dated June 23, 2008 we wrote:
A number of recent events suggest that there may be a coordinated effort underway to lower crude oil prices and the Saudi Summit may mark the beginning of more coordinated actions designed to curb prices.
After the meeting, we were surprised by the lack of coverage by the financial press. There were hardly any mentions of the event and no details were provided about any agreements that were made.
Crude Oil basis December 2008 (NYMEX) (CLZ8) 72.13.
Shortly after the Saudi Oil Summit crude oil peaked on July 11, 2008 at 148.60 per barrel. No doubt there are many factors contributing to the subsequent decline including the claim made by OPEC and the Saudis of excessive speculation in the futures market. If excessive speculation played a part in the price rise we would expect to see declining open interest in the futures market as long positions are liquidated. In November of last year, open interest was 1.6 million contracts, by the middle of May when crude prices were still rising it had declined to 1.5 million. At the price peak on July 11, 2008 the reading was 1.4 million and by this week they have declined to 1.1 million. So in the last 11 months open interest has declined about 31% with half of the decline in open interest occurring in the last 3 months since the peak in prices. We are seeing long liquidation in the futures market and with hedge funds under redemption pressure we think there could be more to come.
We are not claiming the entire price increase that began on January 15, 2007 at 57 and accelerated in August of ’07 from 67 was futures related. Nevertheless it must now be obvious to most everybody that it accounted for a substantial portion just as OPEC and the Saudis claimed throughout the entire episode.
Here is what Abdallah S. Jum’ah, Saudi Aramco’s president and CEO, during his address at the 11th Congress of the World’s Energy Council in Rome last November, as the price of oil was accelerating:
We have grossly underestimated mankind’s ability to find new reserves of petroleum, as well as our capacity to raise recovery rates and tap fields once thought inaccessible or impossible to produce....we still have almost a century’s worth of oil under the conservative scenario…and nearly 200 years’ worth under the target scenario. As a result I do not believe the world has to worry about ‘peak oil’ for a very long time.
Apparently nobody was listening to the Saudis, as everybody was focused on making the case for peak oil production as a justification for higher prices.
While we do not have the analytical resources of the Wall Street investment bank that first produced the $150 per barrel price forecast and then the $200 per barrel forecast, we do think OPEC has regained credibility for knowing something about their market. Perhaps in the future we should be paying more attention to OPEC and less to Wall Street analysts. If so, then here is the current OPEC outlook:
Even if governments are successful in calming equity markets and unfreezing credit markets in the near future, the fallout on the real economy from financial market headwinds is expected to be considerable.
The rapid crude oil price rise was like an alarm bell ringing and it was heard. In a democracy is seems we are only capable of focusing on the crisis of the moment. There is no doubt the credit market crisis needs attention, but hopefully the US will not allow this opportunity for greater energy independence to be lost even if crude oil prices continue to decline in the near term.
Disclosure: No positions in the sector