05 June 2009

What drives current oil prices?

Some people will tell you that resurging growth in the Chinese economy is pushing oil prices up and will sustain high oil prices into the future.

That’s an interesting notion given the demand statistics.  take a look at daily consumption figures from nationmaster.com.  The figures here jive with a commentary by CBC Radio’s business consultant during an interview with On the Go’s ted Blade’s Thursday afternoon.

Now admittedly they are from 2007 but they show that American daily oil consumption is about thee times that of China.  Those figures have changed relatively over the past couple of years since both the American and the Chinese economies have taken a hit and the hits are connected.

There’s still an oil glut on the world markets, by the way, despite cuts in production at OPEC.

So why are oil prices high?

It seems that prices are relatively high for the same reason that helped drive oil to historic highs last year.  A weak American dollar coupled with questions about the American economic recovery are pushing speculators into the oil markets again. 

At some point, though, the markets will correct, just as they did last year. High oil prices will delay the American recovery and likely exacerbate the demand versus supply imbalance. In a world of tight money, the world can only sustain that situation for so long. 

At that point, just as in the mid-1980s, expect a second downward drop in oil prices after the initial steep slide.

Closer to home, that likely means any hopes of oil powering the provincial budget out of deficit might be a bit premature at best.  At worst, a dramatic drop in oil prices – like say to about half where it is now – or a delayed American recovery will only increase the deficit problem in the years ahead. 

-srbp-

11 comments:

Anonymous said...

Ed you may be right on this. However, another alternative is building on your case of a weak American dollar is the fact that it will probably continue to remain weak for the forseeable future. The astronomical US debt issue along with the TARP fundings and bailouts will continue to affect the American dollar for years to come. The real threat in the next couple of years is going to be inflationary concerns due to historic low interest rates and the amount of money that has been printed. Commodity prices are heading higher or will at the very least be supported at todays levels for these reasons, along with geo political reasons and increasing Chinese demand. If you look at Chinese demand versus USA you are correct today But the spread has decreased dramatically versus even 5-6 years ago. Chinese demand for oil over the last 10 years has increased exponentially. There may be a "glut" now but markets always look on a forward basis and try to price in the risk which probably explains much of the price action during the last 3 months. They feel this glut is a temporary concern.

With respect to the Nfld budget issue you ma be right on this one. However, some people (Jim Rogers) have suggested that this is a secular bull market that should last at least until 2015 or at the latest 2020. Which could suggest the province staying out of defict for many years( providing expenses do not go crazier than they already are). My concern is that this secular bull market in oil may actually end during the Hebron development.

Edward G. Hollett said...

Let's see if i can make this all pretty tidy, compared to my usual rambling:

1. China is NOT driving oil prices today. period. What happens 20 years from now is anothe rmatter, but today, right now, this minute - not having the effect people are claiming.

2. Prices are not based on some genius analysis of what will happen 10 years out. Markets work on psychology and sometimes hysteria, not some detailed "forward' analysis.

3. Projections of unending growth and ever increasing returns on the stock market (out to 2020 would make almost 40 years in total) that defy historic trends should be treated as the codswollop they are.

4. In that same vein, bear in mind there are a bunch of people who never saw the last crash coming at all, who have a vested interest of their own in unending high oil and spectacular growth who keep pushing the same analysis they pushed last year. They just haven't updated.

They just say this crash thing is no big thing and everything will be fine next week.

They are wrong now just like they were spectacularly wrong last year.
Not a single one of these gurus preaching higher and higher oil because of China saw the crash.

Anonymous said...

Ed:
1. China is NOT driving oil prices today. period. What happens 20 years from now is anothe rmatter, but today, right now, this minute - not having the effect people are claiming.
ANS:China has driven prices for the last 5 years. The amount of oil used by the USA peaked years ago and the spread between China use versus USA usage has narrowed considerably. Therefore they have affected oil prices

2. Prices are not based on some genius analysis of what will happen 10 years out. Markets work on psychology and sometimes hysteria, not some detailed "forward' analysis.
ANS: Yes markets do work on psychology, hysteria and a detailed forward analysis. How do explain price earnings multiples. Prices are based on what you said but to suggest that they are not based on price expectation in the future illustrates a fundamental misunderstanding how markets work.

3. Projections of unending growth and ever increasing returns on the stock market (out to 2020 would make almost 40 years in total) that defy historic trends should be treated as the codswollop they are.
ANS: Rogers predicted secular bull run from 1999 to 2015/2020. So yes it as an unusual long prediction based on historical oil bull markets but it is not 40 years as you have suggested. I count 16-21 years.

4. In that same vein, bear in mind there are a bunch of people who never saw the last crash coming at all, who have a vested interest of their own in unending high oil and spectacular growth who keep pushing the same analysis they pushed last year. They just haven't updated.

They just say this crash thing is no big thing and everything will be fine next week.

They are wrong now just like they were spectacularly wrong last year.
Not a single one of these gurus preaching higher and higher oil because of China saw the crash.


ANS: Rogers in his book "Hot Commodities (2004)" talked about big corrections during this bull markets in oil. He just saw it as an opportunity to buy. He interestingly talked about his experience getting out of tech stocks in 1998 when cab drivers were giving out stock tips and predicted that this mtge issue was going to be an issue. Anyway, it is a interesting read on someone who has bet a lot of money that he is dead on with his assertion on a sustained commodity bull market. Anyway, I appreciate your comments on this matter. Always good to see the other side of the arguement.

06 June, 2009 08:56

Edward G. Hollett said...

1. If China is driving oil prices, as you say, then we have a bizarre situation in which the big market and big demand does not have an influence over price.

Essentially your position is that even though the US has - in this 10 year period - consumed more oil than the other top three consumers combined and even then by an order of magnitude beyond that again, one of those smaller actors alone is behind the price hikes.

The gap may have narrowed but you seem to be using narrow in a highly supect way.

2. Future price expectations are themsevles based on a number of factors.

In the case of oil right now, anyone buying oil now based on the hope that Chinese damdn is going send oil soaring has to be wilfully ignoring the current and foreseeable glut.

The current situation is likely going to be shortlived. We will see another correction as the reality sets in versus the hype and artifical demand.

Rather than reset at the old or higher levels, when things do sort out, I think it would be much more sensible to expect the floor to be considerably closer to $35 a barrel, for example, than the 70 to 100 currently being hyped.

3. 40 years is my hyperbole and bad math early in the morning. Even a sustained run as long as 20 years would be highly unusual to my mind.

4. You seem to have a strong attachment to a single forecaster. If that works for you, then fine.

in my experience they are a bit like the guys who write books about making money from blogs. The way to make money is to write a book telling people how to make money.

There's one born every minute ready to buy it.

Anonymous said...

Ed:

Jim Rogers has a proven financial track record with The Quantum Fund with George Soros in the 70's. His fund was up over a 1000% in the 70s when the Dow was up slightly. He does not need to write a book to substantiate his income. He has the bank account, assets, and track record to prove it. No offence Ed but I would follow his advice/insight before I would follow a fellow Nflder who blogs on politics and whose only probable trading experience is trading mutual funds or ETF's in his RRSP.

I agree there are lots of fellows touting half assed theories in financial crutch books. This guy is not one of them.

Recent stats coming out of Canada and the USA seem to pointing to things starting to bottom out and there are glimmers of recovery. The banking situation seems to be be ironed out with banks starting to repay the TARP monies. Job losses were less in the US than expected. And some recent reports out of Canada have been not too bad. So hopefully things are looking up. The stock market is a leading indicator and it has been heading up since March along with oil prices.

Back to our discussion on China for a sec and its relation to oil prices. The US demand is built into the oil price. Therefore increasing demand from China along with the other host of factors that I mentioned before like geo political risk, high American debt levels, decreasing dollar drove oil prices to the levels last year.

With regard to yor assertion about the glut now. Again, markets are by their very nature forward looking. Companies are priced by what they can deliver to investors in the future. Many times the stock may be in a situation where the economic situation is horrible. Example, take Royal Bank in March of this year, It was trading at 9 times Price earnings (PE)ratio (27 bucks a share at the time I believe). Near a historic PE low for this stock. Most bank stocks in Canada normally trade at 13-15 times PE multiple. Traders bought this stock because it was cheap and with the expectation that earnings would get back to its traditional PE multiple level. They bought the stock on expectation of future earnings even though the economy sucked and there were going to be loan losses for a couple of quarters. Oil prices could be looked at in the same lens. Yes there is a glut now. But investors expectations may be that this will be shortlived and demand is recovering thus prices are going up again or will be sustained at this level. Then again I could be wrong and we could be headed to 35 bucks again as you have suggested. My truck hopes so, but as a prov taxpayer I hope not.

Edward G. Hollett said...

Like I said, man, follow whatever guru turns your crank.

I am not asking anyone to follow me, just to question the wisdom of the people out there who, among other things, claim that:

1. Chinese oil demand now and a decade from now is driving current high oil prices.

(The belief that it is might be having an impact in the short run but the reality of its demand isn't.)

2. The recovery is already under way. It is hard to imagine the western economy taking the shit-knocking it has and then just shaking it off in a matter of a few weeks.

But hey. It might be true.

Just like it was true last June when some of these same gurus that say the worst is over and sunny days will be here tomorrow told us that the credit issue was no issue at all and that oil would be no less than US$100 by December and then climbing rapidly to 200. or - my personal favourite - that an economy that is built pretty much on exports to the US would manage to keep surging despite the collapse of its major voerseas market.

Anonymous said...

Hi Ed:

this link seems to encapsulate some of the issues that we have been discussing on both sides of the equation. Interesting.

http://www.calgaryherald.com/Business/bounces+back+employment+data+price+forecast/1662198/story.html

Edward G. Hollett said...

GS is one of the band who missed the collapse and forecast oil at 100 by December '08 and on upward from there.

Needless to say they had to back-track a bit.

Anonymous said...

Interesting article written in Jan 2008 on Rogers and his outlook in the markets at that time. As well, his analysis on gold price action in the 70's is a possible parallel to what is happening today with oil.

Anonymous said...

Sorry here is the link

http://money.cnn.com/2008/01/30/news/international/okeefe_rogers.fortune/index.htm

Anonymous said...

Somehow having a problem with the link

http://money.cnn.com/2008/01/30/news/international/okeefe_rogers.fortune/index.htm