Why oil prices won't collapse further
Posted
Oct 09 2008, 04:57 PM
by
Anthony Mirhaydari
Rating:
Crude oil prices have crumbled since July: From nearly $148 a barrel, it now trades under $85. Here's why the crash will be short-lived.
How we got here:
After stabilizing around $120 a barrel in May, hot money flowed into the sector and eventually pushed it to its peak. It's now clear that the leveraged long-energy / short-financials trade was a key element in the rapid ascent. The crash is due to Paulson and Bernanke's cagey over-the-weekend announcement in July that the Feds would back Fannie Mae and Freddie Mac, plus the SEC's ban on short selling.
But this alone wasn't responsible for the descent in oil. As it became increasingly clear that Europe, Japan, and the once-invincible emerging markets would follow the U.S. into an epic consumer-led recession, global investors sought the safety of our government's debt, boosting the dollar.
Finally, Americans made drastic cuts to their energy consumption, causing inventories to build. According to Merrill Lynch commodities analyst Francisco Blanch, U.S. oil demand fell nearly 9% over the first three weeks of September. Crude oil inventories began to build, rising more than eight million barrels last week -- up from a four million barrel increase the previous week -- to more than 300 million barrels.
Where we're going:
UBS economist Jan Stuart notes that much depends on the size of the consumption decline next year in the U.S. So far, the drop in crude demand has been due to behavior; in other words, it's much too early for systematic fuel efficiency gains in automobiles, for instance. So it's quite possible that lower prices at the pump could reignite, if you will, America's innate need to roam the road. Continued economic pressure could quell this, however, especially if unemployment continues to rise.
The other big piece of the puzzle is China. While many forecast growth in the mid single digits next year as fuel subsidies are lifted, China's oil demand could surprise to the upside as the Chinese government becomes increasingly accommodative in its fiscal and monetary policies.
It's worth remembering that, while the developed world will only see economic growth of around 0.6% in 2009 (the weakest since 1982) the emerging market economies are expected to grow 6.1%, according to Merrill Lynch estimates. At 5.5%, this spread is four-times the average from the 1990s.
Given that trying to forecast energy prices in the best of times is only slightly more accurate than reading tea leaves, the current turmoil complicates matters greatly. A consensus is emerging that prices will remain around $100 over the near-term. Citigroup cut its 2009 oil price forecast to $90 a barrel (down from $122) while UBS cuts its forecast to $105 (down from $120).
Over the long-term, supply constraints will return as the dominant issue. In fact, Jan notes that "even low case oil demand trajectories leave no spare capacity at all by 2015, in our relatively optimistic view of supply developments. The takeaway: Enjoy that SUV while you can.
(Disclosure: I don’t control a position in any of the companies mentioned)
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Did the government force down oil prices?
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