Update: Oil smashes $86 for the first time
This week’s inventory report will be very interesting. If there is a significant build, the price could unravel quickly. If there is another surprise on the downside, we may crack $90 by the end of the week. But as long as oil prices stay at these levels, Saudi is going to be under pressure to increase production by more than the already announced 500,000 bbl/day. If they truly have spare capacity, they have been playing Russian roulette with the economy. They may have let it go a little too far.
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The price of oil continues to climb:
Oil tops $85 for the first time
SINGAPORE (AP) — Oil prices kept rising Monday after closing at a new record in the previous session on worries that supplies are insufficient to meet coming winter demand and concerns over the conflict between Turkey and Kurds in northern Iraq.
Recent reports have indicated that crude inventories are falling. Last week, the U.S. Energy Department reported that U.S. oil supplies declined in the week ended Oct. 5, while the International Energy Agency said that oil inventories held by the world’s largest industrialized countries have fallen below a five-year average.
Some analysts think the supply shortfall in last week’s U.S. Energy Department inventory report is an anomaly. They doubt demand is as strong as recent forecasts by the department and the IEA suggest. These analysts expect oil prices will soon begin a seasonal decline to $70 a barrel, or lower.
Count me among those in the anomaly camp. No way would I be a buyer at these prices; I think your downside risk is great, and your upside potential is small. Longer term I think oil prices are going to stay high, and I won’t be surprised to see it crack $100 next year, but I think prices have gotten a bit ahead of themselves at the moment.
I was doing some research over the weekend on predictions that have been made by oil industry analysts. I thought this one was interesting. From September 2006:
$1.15 a Gallon? Leading Oil Industry Analyst Says Prices Could Plummet
A leading oil industry analyst, Philip Verleger, believes we are going to see continued reductions in the price of oil and at the pump, perhaps to as low as $1.15 per gallon for regular gasoline.
Philip Verleger was one of the few oil industry analysts to predict dramatic price increases in the cost of oil a few years ago, but his estimates proved accurate as the price per barrel soared to nearly $80 this year. With the increase came significant upward pressure on transportation costs, heavy fuel surcharges by carriers, rising costs for petroleum-based raw materials.
But Verleger is now predicting the current reduction in oil prices is no temporary aberration. According to a story in The Seattle Times, Verleger believes a combination of financial market twists and fundamental supply and demand forces will keep driving oil lower – much lower. Verleger said it’s not unthinkable that oil prices could return to $15 or less a barrel, at least temporarily. That could mean gasoline prices as low as $1.15 per gallon.
Oops. A year later oil prices are over 400% higher than his prediction.
One of my favorite catches was this one, made on July 28th, 2005:
[…] Sherrie Childers Arb, director of environment and energy communications for GM, said it’s wrong to assume higher oil prices.
“Our indicators show that oil will go down, not up,” she said, pointing to information she gets from the federal Energy Information Agency, which is part of the Department of Energy.
By 2010, the agency expects a barrel of oil to fall to $26, she said.
(The link into the Dallas Fort Worth Star-Telegram is now dead.)
My take-away, especially over time, was that GM was not wrong for relying on a bad prediction, but for relying on a single prediction.
They, like all of us, should have plans that are good for ranges of outcomes. In the case of GM specifically, that might have meant keeping Saturn as a small and efficient make, even while positioning other name-plates to benefit from low gas prices.
Longer term I think oil prices are going to stay high, and I won’t be surprised to see it crack $100 next year, but I think prices have gotten a bit ahead of themselves at the moment.
Re-read that statement and think about it from the perspective of a commodity futures buyer. From $85 to $100 in a year is a return of 17.5%. And a futures buyer only has to put down a fraction of the contract size, the rest can earn interest in t-bills during the life of the contract. This is a very attractive return, and suggests that if the $100 price target is probable, prices are not out of line.
Re the observation that Saudi might be playing Russian roulette with the economy: It wasn’t too long ago that OPEC was saying that around $60/b is an appropriate price level for crude. If so, then why let it get this high? Either oil producers are playing a dangerous game, or they really don’t have much spare production capacity.
I sense oil will be strong a while longer. Why?
I think I (and maybe others) have undeerestimated the sheer incompetence/corruption/laziness of thug oil states.
Most of the world’s oil is conrolled by tinpot regimes largely unconcerned with the welfare of the citizenry at large. Iran, Iraq, Libya, Mexico. Venezuela, Russia, former SU states, Nigeria – The Oil Gods love cretins and thugs. Even KSA cut production. Nice guys.
How much production is effectively shut in? Maybe 10 mbd. Enough to cause a full-on glut.
It ain’t Peak Oil. It is obviously Thug Oil.
The bad news is that the thugs are not going away. The OECD nations are seemingly incapable of doing anything to encourage production in thug states. The thug regimes are wealkthy and strong. They have oil money, and even with reduced production, they are making more than ever. What an effing mess. The Bush Administration has probably made matters worse, but trying to cut off investment in Iran, and bungling it in Iraq, two countries with huge reserves. Libya is actually showing signs of hope.
This looks like years in the fixing, if ever. I hope someday we have democracy, and free market economies all over the world (with whatever degree of socialism local people choose). But we can’t seem to do it by reason or force.
So, maybe oil goes to $90.
The other reality is that it is hedge funds setting prices on the NYMEX now. So should oil trade at $60, $70, or $90? No one can say. It is a betting game.
In the long run, I see oil dropping, and no disasters (other than the horrible ongoing disaster it is everyday to be a woman, or religious minority, or intellectual in a thug state).
The PHEVs could emerge as the dues ex machina. Or maybe people will drive much smaller cars and trucks.
If they truly have spare capacity, they have been playing Russian roulette with the economy. They may have let it go a little too far.
What makes you think they have gone too far? Record oil prices? I doubt that’s a relevant metric.
Such weakness as there is in the economy seems to stem primarily from the real estate sector and from some of the policies of the White House. I don’t see any weakness that can be connected to high oil prices.
Don’t get me wrong. There is plenty of sentiment and hysteria about the record oil prices. But if I was OPEC right now, I’d be thinking: You know, I bet they can handle $100/bbl…
Great! The MSM agrees with my assessment, for what that may be worth: From a low of just over $50 a barrel in January, oil prices on the futures market have surged nearly 75 percent. Yet the economy remains relatively healthy, corporate profits are holding up well.
And as for the role of real estate: “Let me be clear, despite strong economic fundamentals, the housing decline is still unfolding and I view it as the most significant current risk to our economy,” Paulson said in a speech delivered at Georgetown University’s law school. “The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth.”