So much for $200 oil?
Dan Fisher at Forbes News wondered aloud when oil prices fell below $120 a barrel a day earlier, touching levels unthinkable just a few weeks back when rising oil prices seemed unstoppable.
Less than a month ago, we suggested that we are entering bubble territory, when the price dropped by $9 a barrel from $145. But as soon as the piece was posted, prices snapped back to record levels. Since then, prices have eased gradually to current levels.
The price charts (see Oil Price Watch sidebar) show a double top, with the second peak barely reaching the first level, but couldn't sustain that level. Trends in moving averages have completely reversed, and technical analysts definitely view this as bear territory. Are we now into a real bear market after the "bubble" was pricked?
Veteran oil price watcher and academic Ferdinand Banks in his incisive article "Speculation and the price of oil" which appeared on the July 9 issue of EnergyPulse castigated the idea of pure speculation as the main driving force of oil prices. A bubble, he pointed out, has no underlying fundamentals at all, giving the Dutch tulip mania in the 1600s, the South Sea expeditions (there is gold in thar seas!) and the 1929 stock market crash as classic examples. One could add the dot com bubble early this century.
Banks asserted that the rising oil price that we have witnessed of late is basically explained by the relation between ‘flow’ supply and ‘flow’ demand, and with or without speculation the result would be almost the same. This is somewhat different from the normal supply and demand relationship taught in Economics 101. The difference is the "flow" concept, which is taken to mean the movement of oil volume per unit of time, say from the ground to the oil tankers, or from the production platforms to the government inventories. The actual supply and demand could dictate a steady price, but an actual or even perceived disruption in the "flow" supply could alter the price equation.
In that sense we tend to agree with Banks that excessive speculation is not due to market manipulators at the Texas bars or at the New York Mercantile Exchange (NYMEX) but rather on the perceived disruptions on flow supply due to, among others, political posturings of the major powers, propaganda of depleted supplies by OPEC countries, attempts to use oil as a bargaining chip in economic negotiations, etc. Some observers are in fact suggesting that major oil producers are deliberately understating supplies and production levels to keep prices artificially high.
Data from the ground suggests that dwindling oil supplies are highly overstated.
Fisher noted that the pullback is vindication for analysts who for months have been saying that oil prices had entered bubble territory on a mix of financial speculation, worries about a military attack on Iran and rapidly increasing Asian demand. With hefty new supplies hitting the global market from Saudi Arabia, Libya and even Iraq, those analysts say, oil is likely to fall below $100 soon. Iraq in particular has been hitting record production levels since the U.S. toppled Saddam Hussein.
"This fall is a reaction to overshooting over the past couple of months," said Daniel Ahn of Lehman Brothers, which has issued several reports suggesting oil prices were unjustifiably high. "The fundamentals of new supplies suggest prices will be in double digits."
Saudi Arabia apparently hit its target of 9.7 million barrels a day in July, effectively muzzling its detractors who are harping on its supposedly depleted oil fields.
At the other side of the globe, oil production at the Gulf of Mexico is steadily recovering from the havoc wrought by hurricane Katrina.
The turnabout in oil prices has been excruciating to investors who flocked to oil and energy stocks at near the peak price. The Standard & Poor's Global Energy Sector Index Fund (IXC) is down 22% from its high of $54 in early June, and the Rydex Energy Services fund (RYVAX) is down 14%.
There could be more declines ahead, Fisher warns. Implied price volatility spiked to a high of 52% at the height of Iran-Israel tensions over suspected nuclear weapons facilities, but has settled to about 45 %. This is considered to be pretty high, as any number above 30 % is unusual.
Which means there is still too much froth left on oil prices.
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