Economy at Risk if Oil Breaches $89/barrel
April 6 2011 delayed FreeVenue public release of Dec 1st guidance @ our MemberVenue ~ The USA Contract Crude Price averaged $80 in November, up $4 over thirty days. The increase was mostly attributable to speculation activity with new records set for "long", "total" & "net" contracts! The cost of imported oil ranges from $61/barrel for Canada Heavy to $89 for Malaysia Tapis Light. Including spikes, crude oil should settle into a general trading range of $72 - $98/barrel thru the balance of Q4 & Q1.
Whereas the 2008 price spike was based on a perfect storm of factors assaulting fundamentals, the present price run is very much a classic commodity bubble. As seen in the chart above, Crude Price historically runs at 1.44 x's the value inferred by its fundamentals (see yellow & dashed yellow lines). Price started to break away from this "fair value" metric in June 2009.
By November 2009, it had drifted to a factor of 1.77 - a premium not seen since late 2004. The subsequent hover at these levels was the foundation for the obscene IOC record profits we predicted for 2010Q1 & Q2.The fundamentals-based Crude Price (yellow line) was $51/barrel in November. The monthly avg for the USA import-weighted contract price exceeded fundamentals by 57%. The low point for "fair value" factor last decade was 6% at the Dec/2008 correction trough. Surprisingly, it was 43% at the July 2008 Peak ... hence our position that the historic spike was not a bubble.
In the short term outlook, it appears Crude Price will be perilously close to the New Car sales Collapse Threshold. Along with the break from "fair value", Crude Price is being pushed upward by continuing USDollar Debasement. A $14 price component today, we project it to rise to $33/barrel as we approach the USA's 2012 Presidential Election.
This resumption of the US$'s secular decline (since 2002) is attributable to the failure of Congress to address its structural deficits as shown once again by the apparent decision to extend all of the Bush tax cuts. The pace of the Debasement may increase significantly if today's "Moment of Truth Report" recommendations by the National Commission on Fiscal Responsibility and Reform are shunned.
The New Car sales Collapse Threshold (brown line) is a demarcation by Trendlines Research of the same gasoline cost/GDP ratio that brought the manufacturing & sales of Light Vehicles to its knees in 1980, 1990 & 2007. As illustrated in our Gas Pump chart, this last occurred when gasoline hit $3.19/gallon ($86/barrel crude). Price may be straddling the ratio for several quarters and will breach same when the import-weighted monthly average of USA Contract Crude Price passes thru the $89/barrel ($3.30/gal gasoline) level.
Another critical juncture occurs if Price rises past $106/barrel: several G-20 nations (incl USA) may find themselves relapsing into Recession. Should Price continue its upward spike even further, we have high confidence it would eventually be blocked by the same Demand Destruction Barrier (DDB) that firmly arrested the 2008 price run @ $131/barrel. The negative effects of rising energy costs on the disposable income of consumers and the profits and viability of businesses and institutions eventually takes a toll against the economy.
The Demand Destruction Barrier represents a definitive Crude Price/GDP ratio ($135/barrel today) whereby recessionary feedbacks come to fruition that can enhance economic contractions. As happened in the Summer of 2008, Demand will back off as alternative energies and substitutes are pursued.
Looking down the road, we expect Crude Price to enter a period of softness when the USDollar recovers ... dipping to as low as $65 in 2015. Ever rising Extraction Costs and the exhausting of Surplus Capacity will together drive a two decade secular uptrend. Probable business cycle Recessions in 2017, 2026 & 2034 may give short respites. Price will again exceeds the New Car Sales Collapse Threshold in 2028, but this time there will be no salvation via correction. Any demand destruction will be mopped up by eager markets. It is at this juncture that policy makers must aim all their efforts to have infrastructure in place for the transition away from the gasoline/diesel fleets. The model predicts Crude Price will hit an all-time high in 2033 ($356/barrel) before settling to $333 - our 2035 target.
In comparison to our outlook, the similar WTI Futures Contracts for the 1-yr & 5-yr targets are $91 (up $3 from 30 days ago) & $92 (up $1) respectively today. Look for the futures prices to drop $7 on the short term & fall $20/barrel for 2015, as they catch up with current realities. Our comparative figure for the final futures date of Dec 2018 is $86/barrel, much less than the $95 (same) for today's contract.