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Barrel Meter: $92/barrel Oil ($3.42/gal pump) in January Could Decimate USA New Car Sales

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The USA Contract Crude Price averaged $70 in June, down $2 over thirty days, but still near double the $37/barrel four year low of December 2008. The decline was mainly attributable to a toning down of media hysterics & reduced speculation/hedging activity. The cost of imported oil ranged from $65/barrel for Mexico Maya Heavy to $79 for Indonesia Minas Light.

Including spikes, crude oil should settle into a general trading range of $74 to $92/barrel thru the balance of Q3/Q4. The present spiking activity is completely detached from fundamentals. As seen in the chart, Prices during the last three seasons was closer to 1.9 x's fundamentals rather than the 1.4 "fair value" norm (dashed yellow line). The obscene record profits for IOCs we predicted for Q1 have been confirmed, and shortly to be announced quarterly earnings should reveal this disturbing trend continued in Q2.

The fundamentals-based Crude Price (yellow line) was $41/barrel in June.  The monthly avg for the USA import-weighted contract price exceeded fundamentals by 70% .... an unduly inflated price considering this premium averaged 43% over the last five years.  The recent high for this metric was 143% in y2K, yet it was only 37% during the July 2008 price spike.  The low point for the factor was 6% (over fundamentals) upon the price collapse at year end (Dec/2008).  The current level of bullishness reflected by this metric has not been seen since late 2002.

One factor for the relatively higher Price is renewed speculation/hedging activity.  A record of 307 thousand long futures contracts was set in early April, compared to 259k volume in March 2008.  A record non-commercial (long/short) contracts volume of 493k was set as well (in early June), much above the 453k level of May 2008.  The net volume (longs minus shorts) set a new record of 135k in January, substantially more than 2008's high mark of 100k.

On the medium term, we expect Crude Prices will escalate to new record highs ... then promptly plunge.  Geopolitical events could spike Price over the $100 threshold as early as 2011Q1, and the monthly Avg will almost certainly cross over in 2011Q1.  Two major forcings are behind this general upward price movement:  (a) a return to secular uptrend of USDollar debasement;  and (b)  ever-rising Extraction Costs.  TrendLiners will recall that this has been our position since late 2008.

The first significant impact of higher prices will be a serious re-collapse of USA New Car & Light Truck Sales.  As illustrated in our Gas Pump chart, this occurred in 1980, 1990 & most recently in 2007Q4, upon attainment of certain Gasoline/GDP ratios - signalled when Crude hit $3.19/gallon gasoline ($86/barrel.  This same threshold will have been breached when the import-weighted monthly average of USA Contract Crude Price passes thru the $92/barrel ($3.42/gal) level ... likely in 2011Q1.  The weak state of the Recovery raises question as to whether the USA economy can absorb such a shock to the auto sector.  Even more doubtful is ability of the rest of the world to take this in stride.  Several G-20 nations may find themselves relapsing into Recession, about the time Price goes thru the $107/barrel level (2011Q1).

The present record for the monthly Avg ($131/barrel) was set in July 2008.  Unsustainable spikes & the Monthly Avg could breach that figure in 2011Q4, but only for several weeks.  Hopefully, sticker shock during this crisis will coax the American Congress & President to address their fiscal mismanagement at that point.  Due to political realities surrounding the timing (Nov 2012 Elections), the Republican Party is poised for good fortunes with respect to potentially slashing the Democratic Majority ... and possibly dethroning Obama himself.

The Barrel Meter model assumes the USD:EUR exchange rate will recover post-crisis to a 0.77 exchange rate (EUR:USD = 1.30).  Political platforms by both Parties will be required to address the Deficits & National Debt during the Election Campaign.  Whatever the outcome of the Race to the Whitehouse, the USDollar debasement should be halted by hard decisions in Washington, to the glee of the investment community, and despite the USDollar's diminishing status as the global reserve currency.

The present price run of Crude's contract price will finally be impeded in 2011Q4.  At that juncture, Price will be blocked by the same Demand Destruction Barrier (DDB) that firmly arrested the 2008 price run.  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 an Crude Price/GDP ratio whereby recessionary feedbacks come to fruition that can enhance economic contractions.  To that end, this $140 peaking of Price could quite likely precipitate an economic contraction should the neither the Fed not mitigate with appropriate Monetary Policy, nor Congress with appropriate Fiscal measures.  As happened in the Summer of 2008, Demand will back off as alternative energies and substitutes are pursued.  With the marginal All Liquids being less required, Avg Price should collapse (as much as 69%/$97) to $43/barrel as international Inventories burgeon ... but alas the secular uptrend will not be thwarted for long.

Rising Extraction costs and diminishing Surplus Capacity will entrench a rising trend thru the remainder of the decade.  Based on an 8.5 year business cycle in play, the USA is likely to see an economic cycle high in 2013Q2 and another contraction in 2017Q3.  The extent of this being a hard or soft landing is dependent on Federal Reserve action.  A 2017 Recession will contribute to temporary softness in Extraction Costs & Crude Price.

In comparison, the similar WTI Futures Contracts for these same 1-yr & 5-yr targets are $80 (down $2 from 30 days ago) & $85 (down $3) respectively today.  Look for the futures prices to rise $40 on the short term & fall $16/barrel for 2015, as they catch up with current realities.  Our comparative figure for the final futures date of Dec 2018 is $74/barrel, much less than the $91 (down $3 from 30 days ago) for today's contract.

Over the long term, rising Extraction Costs is a major forcing.  There will be softness is Crude Price as a result of a probable 2026 Recession.  Most volatility will surround the evaporation of Surplus Capacity.  From its peak of 7.5-mbd in 2011Q1, spare production capacity completely dwindles away by 2023, only rebounding during economic events.  An encounter with $358/barrel is projected in 2033, but a probable 2034 Recession will truncate that spike as well.  Technical obsolescence inspired Demand Destruction should bring about some degree of price stabilization deep into the future.

Disclosure: no positions