oil barrel 88.
(photo credit: )
After three years of unremitting bullishness on the subject of oil prices, the time has come to consider a change of tune. After all, all trends change direction at some point and the seemingly relentless rise in the price of oil is no exception. At some point it will reverse and fall, probably sharply; about that there can be no doubt - the only question is when.
The rationale that underlay the bullish argument repeatedly advanced here was that oil was being driven by a factor much more powerful than "mere" supply and demand, namely geopolitical considerations. To mainstream economists - and to almost all analysts covering energy and energy stocks in 2003 - geopolitics was not a relevant issue. They couldn't measure it and they couldn't build it into their computer models, so they decided it didn't exist. Unfortunately for them, they were wrong, because "geopolitical considerations" is just a fancy name for fear - and fear, together with greed, are the primary movers of all markets, everywhere.
As the price of oil and other forms of energy - and, later, all commodities - rose to and through levels that the analysts had declared ridiculous and unjustifiable, the professional community was obliged to adjust to new realities. First, it blamed the Chinese for ratcheting up demand.
Although the Chinese were indeed increasing their consumption at a tremendous pace, they were not the ultimate cause, as became clear in 2005, when the increase in Chinese demand leveled off (for intra-Chinese reasons), but the price kept rising.
Last summer, the weather became the fashionable excuse, but eventually the analysts were forced to come to terms with the issue they had previously shunned: geopolitical risk. It was that nice Mr. Ahmedinejad from Tehran who persuaded them that there was a valid reason to be concerned about a major supply disruption.
Thanks to Ahmedinejad, Chavez in Venezuela, the rebels in Nigeria and other assorted problems in oil-producing countries, it finally became politically correct to link the rise in the price of oil to the fear that, in a world of rising demand for oil and very strained production capacity, there could be a serious disruption of supply. Were that to happen, the price would simply soar into triple digits and no one would be able to do anything about it.
Recently, this line of thinking has advanced to the point that it is even possible to mention, in mainstream media such as CNN and in professional analysis for large investment banks, that the continued absence of millions of barrels a day of Iraqi oil (relative to potential production) has been and remains a major contributory factor to the lofty price level - another theme pursued in this column since 2003.
However, the bald fact is that the price of oil is today below the $71/barrel level hit when Hurricane Katrina tore through the Gulf of Mexico in late August. True, it managed in the interim to climb to the mid-$70s, but it has spent most of the past six months around $70. The upward momentum has been lost and with it the sense that oil is going higher no matter what.
This is not to say that there is no chance of $100 oil.
The Iranian crisis alone could achieve that result, if it became acute. But that's just the point: the markets are increasingly tending to the belief that the Iranians will cut a deal with the West and a showdown will be avoided; that the rebels in Nigeria will not run amok; that Chavez has shot his bolt - in short, that there will be no major supply disruption in the next six-to-12 months.
Meanwhile, as geopolitics fade, economics is making a comeback via the supply-demand equation.
On the one hand, demand is set to fall because the US economy is slowing and, eventually, China's efforts to slow its runaway lending and investment boom will tame the Chinese economy and its thirst for fuel. On the other hand, supply is set to rise as increased drilling and new pipelines bring more oil to the market.
We can therefore entertain the idea that, unless there is a major crisis soon that involves a serious and sustained disruption in supply, the chances are that the great surge in oil and energy prices is pretty much over. Even more entertaining, it is no longer inconceivable that prices next summer will be significantly lower than they are now.