Monday, July 6, 2009

A gentle cough toward the New York TImes

The NYT sees the current movements in oil prices as being extremely volatile, with “no signs of slowing down.” This implies that the world can expect that not only will prices rise above current levels, but that they can equally well drop to levels down around $30 a barrel.

In my own mind, accepting there is some transience in price, given not only the variations we are now seeing in demand because of the global slowdown in the economy, but also because of the time factor in moving supplies, the market has much less volatility and much greater rationality in performance than it is being given credit for.

Starting with the collapse of the oil price last year, and with demand dropping due to the recession the world was, transiently, in a period where there were was a significant surplus of production. But as that became evident, so OPEC moved to cut back production, so that the dramatic drop in price that signified over production was only transient in nature. At the time OPEC commented that an oil price in the $65 - $75 range would be a fair one, and one that they could live with. It would appear that they now have sufficient control of the market that they can achieve, and hold that price. However that only holds true for the short term.

It is being increasingly accepted that non-OPEC producers cannot, overall, further increase their production, and that, instead, from this point forward, non-OPEC supplies will decline, albeit in the short term only slowly.
Thus control of the supply moves to OPEC, and by cutting back on supply, to match demand, they were able to stabilize, and then gradually force an increase in the price, to a level that they remain comfortable with. I expect that, over the next year, they will be able, by adjustments in supply, be able to sustain the balance and thereby stabilize the price of crude at levels they are comfortable with. As I noted recently there are some indications that the drop in demand for transportation fuel has reached bottom, and is picking up, not only in the United States, but with the increases in vehicle numbers in China and India, also globally.

Unfortunately, the ability of OPEC to further increase supply, bringing their production back to the highest levels of 2008, will not potentially, be able to overcome the decline in non-OPEC production for long – even though we are talking about differences of only on the order of 1 mbd. Because as soon as that inequality re-establishes then I fear we will be back to the rising prices of oil that take it beyond OPEC control since they will be unable to pump the additional oil needed to hold the supply adequate to demand.

When will that occur, at present the leaves are too difficult for me to read, but I strongly suspect that it will be before the next Presidential election. Within that time frame I suspect we also will not see the volatility that the Times anticipates, but rather (with relatively minor perturbations) a slow but inexorable rise in price

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