"Countdown to $100 Oil?!?" is my contrarian series on the direction of Oil prices. The premise of this series is that, even if we have arrived at the plateau of "Peak Oil", there will still be wild swings in its price (in fact, there already have been) and that demand destruction is taking place sufficiently such that oil will recross the $100 boundary before it ever reaches $200.
In the first installment, I argued that unsustainable heavy subsidies to the consumption of Oil in Asian economies, together with some evidence of hoarding of supply, and already apparent demand destruction in the US, meant that Oil was ready to decline below $100 sometime soon. Just a few days later, a number of Asian countries cut their subsidies, giving rise to my second installment.
Then Oil went on a sudden tear to $147+, before breaking down and by yesterday trading at $119.50, and at $118 this morning.
Since my first set of diaries, demand destruction in the US has continued, and now there is some evidence of demand destruction in China as well. In July the worm may finally have begun to turn. The price of a barrel of oil broke trend and went down from $147 at its high point to $119.50 yesterdy, a new short term low -- the first time that has happened in 6 months.
Even if you believe that long-term the price of oil must continue to rise due to the constraints of "Peak OIl", the record shows that there have been significant and sharp pullbacks in price a number of times in the last 5 years -- interestingly, with both of the biggest declines, at 26% and 34%, occurring during the autumns of Congressional elections in 2004 and 2006:
An equivalent decline now would take us back to $100/barrel Oil.
There has been a lot of speculation about whether speculation (ha!) or supply and demand was causing the surge in the price of oil. In the last two months we may have gotten a good answer. First, on June 6, as related by Bloomberg
Crude oil surged more than $10 a barrel to a record as the dollar weakened after the U.S. unemployment rate grew the most in two decades and Morgan Stanley said prices may reach $150 within a month.
Having briefly already reached $135 a barrel, as noted on the subsequent cover of the "Economist" newsmagazine, after a brief decline to $121, in the following 2 days including the date of the Morgan Stanley call, oil surged in price from $121 to $139 a barrel, prompting cover stories in "Newsweek" and "US News and World Report" as well:
Although "Time" magazine has not completed the set, according to the magazine cover indicator, Oil's appearance on the cover of these magazines means that it was ready to reverse.
Not to be outdone by Morgan Stanley, on June 16,
Gazprom Chief Executive Officer Alexei Miller made [a] forecast ... that ... Oil will reach $250 a barrel ``in the foreseeable future,'' about 85 percent more than the current price
Interestingly, that very same day,
SemCrude Pipeline was removed [ ] as project manager on the planned 524-mile pipeline project - connecting Platteville, Co. to the SemCrude storage terminals in Cushing - after it defaulted on the terms of the loan, lawyers for General Electric Capital Corp. wrote in a filing late Wednesday evening.
SemGroup’s collapse later became evident on June 17 after shares of its publicly traded subsidiary, SemGroup Energy Partners, dropped by 50 percent in one day.
The details of SemGroup's bankruptcy were detailed in its July 22 filing:
Oil traders said SemGroup could have exacerbated the spike in oil prices this month, when the market experienced unprecedented swings of more than $10 a barrel, as the company was buying back some previous bets on lower prices.
SemGroup bet in the futures market that oil prices would fall as a way to hedge its positions in the physical market. But as prices jumped this month to a record of $147.27 a barrel from less than $100 a barrel at the beginning of the year, the mounting losses triggered large margin calls from banks – a request to put up more collateral – draining the company’s cash reserves.
I have no evidence whatsoever of any wrongdoing on the part of either Morgan Stanley or its analyst who called for $150 oil by July 4, but it is interesting that it may have coincided with a "short squeeze" of SemGroup.
It has been speculated that
SemGroup's forced cover is the catalyst for one of the biggest recent corrections in crude oil.... But the fact that this correction started literally hours after SemGroup were forced to cover (July 16/17) seems to be more than mere coincidence.
The news of SemGroup's collapse came on a day that oil prices plunged to their lowest levels since early June, falling to an intraday low of $125.63 a barrel, down $5 on the day. After rebounding late last week, yesterday at one point Oil declined $5 to $119.50, with rumors of another hedge fund's forced liquidation front and center.
If demand destruction continues in the US and Europe, if China's bubble is bursting, and if speculators are caught wrong-footed on the "long side," the rout of Oil to less than $100 seems likely to occur.