Is The Oil Price Falling Off A Cliff - Like In September 2008?

9th Aug '11 by Andrew Butter

2 comments 3347 reads

I suspect that even the most sophisticated student of Econ-101 would concede that the trajectory of the price of oil in 2008 was a bubble and that 2009 was a bust? Not that anyone has come up with a convincing theory for what it was that pumped up the bubble or what finally popped it, outside of the old favorites such as…the insanity of crowds, terrorist plots, and Goldman Sachs. The dynamics of the price in 2011 are eerily similar to what happened then.

I have argued previously (a) the “correct” price for oil at this juncture is about $90 (b) that according to Farrell’s 2^nd Law the bust will be a mirror of the over-pricing at the top of the bubble…127/90 = 1.41…so the bottom of the bust will be…90/1.41 = $64…(c) the main cause of the blowing of the bubble in 2011 was the conflict in Libya (d) the “pop” was going to happen on 30th April 2011.

Let’s see what happens next.

Reflecting on the cause of what appears, at least from the current perspective, to have been a bubble and a nascent bust, was probably a combination of the “normal” trigger of too much easy money floating around, combined with the start of the Libyan crisis, exacerbated by the practice of pricing oil on indexes.

That there was easy money, there is no question, although cause and effect was not established in 2008 and not in 2011 either. My guess for the dynamics of how Libya affected the market is as follows:

1: The start of the conflict took out a (relatively small) component of supply, but it was a special sort of ultra-light oil used mainly by European refiners.

2: Refiners can’t easily change the grade of their feedstock, so those who were set up to process Libyan oil were obliged to go to the spot market to buy, and since they were European, and Brent is light oil, that’s where they went.

3: So…supply and demand, Brent went up.

What happened next is an example of how indexes can mislead the market; three things; the first is that Brent accounts for less than 1% of all the oil pumped in the world; second, although everyone says they follow their own index (WTI, Argus etc), the reality is that everyone looks over the other guy’s shoulder.

Third, most oil (and many gas) contracts are…

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emptyend

8th Nov '11

I think we can now safely say "no" in answer to the question in the thread title. I was away at the time this thread first emerged.....but can therefore recall that it coincided with the day of greatest panic in the August sell-off when many seem to have leapt on the false idea that the markets were going through a re-run of 2008 (and therefore stupidly tried to put on all the 2008 trades that worked then!).

Markets don't do re-runs.

The long-term supply/demand picture for oil prices remains pretty much as it has been for the best part of a decade. There have been a few discoveries that are encouragingly large (Brazil and Norway leap to mind for oil....and gas in Mozambique/Tanzania, where the estimates on two Mozambique blocks alone now top 30 TCF)....but the fact remains that depletion continues every day and global production capacity remains under pressure, despite the shale plays that are now driving US production up (and depressing the local price at Cushing for WTI).

Meanwhile Brent is back up at $115.50 this morning....which is a level not seen since the first few days of August. ....and WTI may still be lagging some $19 behind Brent - but even that oversupplied market is closing in again on $100.....

....and, so far, E&P equities are lagging the recovery in the oil price, having only recovered less than half the fall that started in early August when oil last went down through $115: (graphic from the FT link)

.....IMO there is plenty of recovery to come there, once the markets start to look through the euro-armageddon.

9th Nov '11

A bit more on this topic from the IEA...who it seems are more bullish than OPEC (Guardian report):

Oil price may hit $150, warns International Energy Agency

IEA's gloomy outlook rejected by Opec, which says there are downward pressures on the cost of crude oil

.....if investment in the Mena region runs one-third lower than the $100bn a year required between 2011-2015, consumers could face a near-term rise in the oil price to $150 a barrel.

Of course the current market turmoil and lack of confidence isn't going to lead to the investment demands being exceeded. Oil (and gas) remain core products that consumers need - whether or not they consume extra at the margin for their discretionary spending on vacations.

Is the Oil Price Falling Off A Cliff - like in September 2008?

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Andrew Butter

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Oil price may hit $150, warns International Energy Agency

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