Oil prices witnessed a dramatic increase. To be fair, it also saw a free fall from $150 levels. Remember those $150 days?! Remember when Goldman and other oil experts were speculating oil prices will hit $200 and $250?! One analyst even expected a $500 figure! NONE of them was right because oil prices plunged all the way down to $30 and are now hovering near the $70 mark. Today, Goldman announced that they expect oil prices to reach $85 by year end. Why should we believe them now?!
So, WHAT drove oil prices from $30 to $68? I think this question deems to be answered in 2 parts. The first part is that it became obvious this wasn’t Armageddon. Consequently, oil prices stabilized and rose marginally. The second part is what caused the ≈50% rise in oil prices from $46 to $68. I believe the second part was predominately caused by the plunging US dollar (USD). Please refer to the two graphs below.
In reference to the graphs above, it is evident that the USD weakness caused the 2nd wave of increase in oil prices. The reasons behind the negative correlation between the USD and oil prices are the subject of debate among analysts. Nevertheless, most agree that it exists because oil is USD denominated and as an inflation hedge.
Fundamentally speaking, oil outlook is still bleak. A US Energy Department report for the week ended May 29th revealed that fuel consumption fell to levels not seen since May 1999! This is particularly worrying since we are in the beginning of the driving season.
Another reason to worry is inventory levels. Yesterday, US stockpiles of crude oil unexpectedly increased. Many analysts think inventory levels are real reasons to worry. “Inventories remain extremely high, including barrels held offshore on tankers. Oil in storage, as well as an uneven economic recovery, could still send prices plunging back into the $40s,” wrote Harry Tchilinguirian, an analyst with BNP Paribas in London. Tchilinguirian revised his 2009 average price forecast to $54 a barrel, from $45 a barrel in March. (Source: WSJ)
The chart above further illustrates the decrease in demand for oil. (Source: ISI Report)
Oil prices rose too fast too soon. Let’s not forget that we are still at high and increasing unemployment levels. Further, I believe the excessive increase is based on USD weakness rather than solid fundamentals and economic expansion potential. It will be rather funny hearing analysts soon talk about how high oil prices will hinder growth prospects (if there are any indeed!).
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Loading ...Tags: Contango, Goldman Sachs, Oil, Oil prices fall, Oil prices rally, US Dollar
Interesting, only thing is that when will the dollar strengthen?? the economy is no where close to a fast recovery!
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http://gregor.us
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Specifically, this post
http://gregor.us/oil/price-pop/
We happen to be very bearish oil, but who knows where price is headed. The Dollar Index outlook is still leaning towards bearish…
Apparently, production cuts are actually trumping the fall in demand. Maybe there is a real case for an average price of 50 USD a bbl
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Dxb kola,
I kind of agree in that there is a reasonable case for $50 oil and that was reflected when I stated that I fundamentally agree with the first rally that took us to $46. On the other hand, I disagree with analyst suggestions that oil will fly back to near $100 levels. The dollar remains a mystery. On friday, it technically defended its lows and went up.
As for production cuts, its hard to see sustainability on that front! Managing supply can have effects in the short-run, but the long-run is more determined by demand. Also, OPEC is a cartel and cartels never work perfectly because of the presence of a prisoner’s dilemma situation. Most OPEC members are involved in projects that will increase their oil productions levels overtime. Moreover, Non-OPEC countries such as Brazil are relentlessly searching for more oil and finding it. The only advantage for most OPEC countries (think GCC) is the relatively low production costs. With more cost-efficient equipment, Non-OPEC members such as Brazil can have easily make up any cuts in OPEC production. On the other end of the spectrum, oil usage is becoming more efficient (think green cars).
Another significant issue is the effects the contango could have on oil prices. As you may know, spot oil prices were extremely cheaper than future prices for the past 3-4 months. This contango created a prolific trade: Buy spot oil, store it, and sell it in the future. Many got involved in this trade. Many bought oil at an average of $40 levels while futures traded at $70, filled up their storages, and even rented ships to store it (remember that ship rental was down the drain in the past 3-4 months). As shipping rates increase (they are increasing dramatically), many will close this trade and this could result in a supply shock.
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