Tuesday, September 11, 2012

"The Repricing of Oil"

From Gregor McDonald:
Now that oil’s price revolution – a process that took ten years to complete – is self-evident, it is possible once again to start anew and ask: When will the next re-pricing phase begin?
Most of the structural changes that carried oil from the old equilibrium price of $25 to the new equilibrium price of $100 (average of Brent and WTIC) unfolded in the 2002-2008 period. During that time, both the difficult realities of geology and a paradigm shift in awareness worked their way into the market, as a new tranche of oil resources, entirely different in cost and structure than the old oil resources, came online. The mismatch between the old price and the emergent price was resolved incrementally at first, and finally by a super-spike in 2008.

However, once the dust settled on the ensuing global recession and financial crisis, oil then found its way to its new range between $90 and $110. Here, supply from a new set of resources and the continuance of less-elastic demand from the developing world have created moderate price stability. Prices above $90 are enough to bring on new supply, thus keeping production levels slightly flat. And yet those same prices roughly balance the continued decline of oil consumption in the OECD, which offsets the continued advance of consumption in the non-OECD.

If oil prices can’t fall that much because of the cost of marginal supply and overall flat global production, and if oil prices can’t rise that much because of restrained Western economies, what set of factors will take the oil price outside of its current envelope? 

Those who still don’t understand the past ten years cling to the antiquated view that prices will eventually return sustainably to levels of 2002 in due course. They believe that a great volume of new global oil production will start to appear and prices will be driven back to the cheap levels of last decade. Many who take this view also believe that market manipulation and inflation largely account for the high price of oil and that once reflationary programs like quantitative easing (QE) come to end, the price of oil will lose its speculative bid.

To be sure, the prospect for significantly higher prices in the near term remains dim. The automobile-highway complex is in full retreat in the West, and the developing world is largely funding its next leg of growth not through oil but via natural gas and coal. Short of war, an oil spike of the kind seen in 2007-2008 will not occur until global growth resumes.

That said, the factors contributing to oil’s present stability are worth considering as the foundation for any crash lower – or spike higher – in the year ahead.

Oil’s Current Price Envelope
Autumn is typically a time for financial market crashes. Should the Federal Reserve or the European Central Bank (ECB) waver from their implied promise of more QE, there is not enough organic demand in the global economy to maintain even the current stall speed of international trade and industrial growth. Any return to austerity or move away from reflationary policy would quickly sink asset prices. And that would quickly flow through to demand for oil....MUCH MORE
The rest of the piece is pretty well researched although that last bit, "Autumn is typically a time for financial market crashes" isn't true. Crashes are decidedly atypical. What is true is that some of the more memorable equity collapses came in the fall, including the largest one-day decline on record, Black Monday 1987 (22.6%).
The Rich Man's panic began in October 1907.
The Great Crash began with a September 1929 top-tick.

On the other hand 1837, 1873 and 1901 were all May babies.
The Dotcom bubble popped on March 10, 2000 with the Naz dropping 78% before recovery began.
Except for the 89% DJIA decline from '29-'32 that is the largest U.S. debacle that I'm aware of.