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Have Oil prices bottomed out?

by Luis de Sousa Tue Mar 10th, 2009 at 05:13:26 AM EST

This post is a translation to English of an article penned by Jorge Nascimento Rodrigues and published in the 28th of February in the Economy section of the journal Expresso, the largest weekly publication in Portugal. It is built on the insight kindly provided by TheOilDrum contributor ace.

Jorge Nascimento Rodrigues is a free-lance journalist and author, editor of JanelaWeb.com and GurusOnline.tv

Crude Oil
February closing with the barrel close to 45 dollars

Crude oil prices might be back to a mid term bull dynamics, says Australian analyst. February behaved on significant oscillations from one day to the other and the American variety [WTI] climbed 10%, going from 40,78 dollars to 44,76 per barrel.

An audio version of this post can be downloaded here.

The minima for the price of a barrel of crude oil, since the peak in July of 2008, might have happened before the Christmas of 2008, advances the analyst from TheOilDrum, Anthony Eriksen, a Canadian mathematician seeded in Sydney, Australia, where he specialized in energy and mining investments.

The conclusion that can be made is that the price of a barrel might be back to a mid term bull trend, after the fall from 145 dollars to less than 50 in the span of only six months last year.

Eriksen reminds that prices of the American crude (WTI) and of the European (Brent) touched then the minima of 31,41 dollars per barrel in 22/12/2008 and 34,04 dollars on Christmas Eve, respectively. This year, the lowest prices occurred last week, on the 18th of February, with values of 34,62 for the WTI and 39,10 for Brent.

The International Energy Agency (IEA) points to a variation interval between 40-45 dollars per barrel, which would still be below the wishes of many producing countries that point to a minimum of 50 dollars for many of the projects they have in scope to be viable, both economically as technologically, underlines the analyst.

The price of a barrel of the American WTI variety reached on the 26th of February a figure slightly above 45 dollars and closed at 44,76 dollars. The Brent vareity closed the month with a price (44,72 dollars) practically identical to the opening figure (44,46).

Daily Brent Blend prices since last September. Source: UpstreamOnline.com; image not in original article.

Wild Oscillations

Notwithstanding, the fundamental behaviour of prices during this year has been what some analysts ironically dub "wild oscillations".

The months of January and February have been fertile with that kind of very close extreme variations; at least 11 cases were observed for the WTI variety solely in February: on 10/2 declined 5% and climbed 10% on 13/2; on 17/2 declined 7% and climbed 14% on 19/2; on 23/2 declined 3,6% and climbed 4,2% on 24/2, 6,6% on 25/02 and 8,5% on 26/2, to go down again on the last trading day of the month. This reveals the high volatility of the agents' behaviour in this market.

To where can these extreme oscillations go and in what measure can the barrel price climb again above 50 dollars or fall below 30 dollars, derives, according to Eriksen, from the "fight" between two heavy weights.

On the one hand the impact of the crisis on the demand of this commodity, continuing to reduce it below 85 million barrels daily (mbd) - the last estimate by the IEA points to 84,8 mbd. This daily figure was still inferior to supply in January of 2009, that was around 85,2 mbd, resulting in a difference of 400 thousand barrels daily.

On the other hand there are several political and physical factors that can influence supply, producing scarcity in the market. Something that didn't happen yet, in spite of the cuts programmed by OPEC, that "should already be enforced in 89% relatively to the commulative cuts announced since September that mount to 4,2 mbd, according to Bloomberg", says Eriksen.

Black Swans

The analyst underlines that, in the political plane, sudden geoplitics changes in productive regions (namely in the Middle East that continues to be potentially flammable with issues like Israel/Palestine and Iran) or a collapse of the dollar due to the dragging financial crisis or to the political behaviour of the main American currency supporters, can make the crude oil price shot up without previous warning. It would be the surging of inesperate "black swans" to the international scene.

Physical constraints can also have a negative influence on supply. Eriksen refers that the group of oil producing countries outside OPEC seem to have already reached, together, a production peak.

In spite of good perspectives in cases like Brasil (that, nonetheless, can reach "a production plateau around 2011", according to the studies of this analyst) and Canada for a few more years, global supply from this group is diminishing, with high decline rates in extreme cases like the Gulf of Mexico (around 20%). In 2009 production should decline in Russia, Mexico, Norway and the United Kingdom.

Concerning OPEC a continuation of the programmed cuts policy is to be expected, with a renewal already in the 15th of March, when the cartel meets again. A pressure group formed by Algeria, Iran, Iraq and Venezuela is playing to that tune, according to quotes issued during the last week and a half.

ace adds this final comment:

There remains great uncertainty about key OPEC producer Saudi Arabia's true oil reserves as they are kept as a national secret. The last time that Saudi had a production peak was in 2005 at 9.6 mbd.  There is a risk that Saudi Arabia's true crude oil reserves could be much smaller than official estimates implying that future production will stay below the 2005 peak.

Where are oil prices headed in the next few months?
. Below 40$ per barrel 7%
. Above 50$ per barrel 28%
. Will remain in the 40-50$ band 64%

Votes: 14
Results | Other Polls
I still think somebody has to write the story of how the rise up to $140 a barrel in the first half of 2008 occured. Right now it seems that there isn't the confidence within the market to sustain higher prices as they will further depress economic activity and drive down demand. We seem to be in a fragile balance at the moment where any changes in base conditions could have a magnified effect.

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Wed Mar 11th, 2009 at 04:19:00 PM EST
I still think somebody has to write the story of how the rise up to $140 a barrel in the first half of 2008 occured.

I thought there was half a hundredweight on ET about that at the time? And a right old ding dong some of it was, as well...

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Mar 11th, 2009 at 06:11:43 PM EST
[ Parent ]
But that's the point; no concensus was achieved. We talked a lot but really people just had their postions and stuck with them.

I still do not believe there is any view as to the extent of the roles of competing pressures such as speculation, resource depletion, panic demand, sheer exuberance etc etc.

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Thu Mar 12th, 2009 at 09:19:36 AM EST
[ Parent ]
There's no real data to base an argument on, as far as I can see, so it's all opinion and anecdotes.
by Colman (colman at eurotrib.com) on Thu Mar 12th, 2009 at 09:20:46 AM EST
[ Parent ]
There's data, but data won't help separate the two competing theories.  Theory one is is that expected growth in oil production could not keep up with expected growth in demand, therefore the price when through the roof.  In addition to Jerome, economists ranging from Marten Feldstein on the right to Krugman on the left bought this argument.  Theory two is that excess credit availability led to increased speculation that drove up the prices of all almost all real assets, not just oil.  This is the main argument of Jeffrey Frankel and Guillermo Calvo.  

However, since the credit crisis and recession have become evident that allows us to make some judgements about the assumptions underlying each of the two theories.  For theory one to right -- for oil to have been priced according to true expectations of supply and demand when it was $140 -- it means that markets for credit and commodities must have been working correctly and the underlying assumptions of perfect information (honesty) must have been more or less true. However, since the credit crisis became evident, we know now that the assumption of honesty in markets was NOT true, and for that reason we have no reason to believe that prices in markets dependent upon access to credit markets, which includes oil, have anything to do with real supply and demand for commodities.  More likely the prices had to do with dishonesty about true capabilities and intentions to honor credit, and the consequent oversupply of money.  This means that theory 1 probably isn't true, leaving us with theory 2 and the conclusion that the price of oil isn't going back up anytime soon.

by santiago on Thu Mar 12th, 2009 at 11:26:24 AM EST
[ Parent ]
I wrote about a third theory here.

The assumption that resources constraints would lead to monotonically increasing prices is flawed, both theory and practice show otherwise.

As for the speculation theories ... well, I'm still waiting to see the resulting commercial stock increase. Stocks only started filling up after September, when the contango exploded - a clear sign that demand wasn't supporting supply any more.

Your final assertion assumes that money supply (and velocity) will remain stable, which as I pointed before is not the case.


by Luis de Sousa (luis[dot]de[dot]sousa[at]protonmail[dot]ch) on Fri Mar 13th, 2009 at 04:25:05 AM EST
[ Parent ]
Luis, I like your theory a lot. Sorry I missed it the first time.  I'm not sure yet, though, whether it is an explanation of how the supply-demand theory (theory one in my comment) is consistent with current events rather than a distinct theory, but I'll think on it.  

In the monetery/speculation theory, which is based on the Dornbusch overshooting model from international finance, commercial stocks need not increase because they were never the variable factor causing price movements -- the change in monetary supply was. Although you argue that the Fed and other monetary authorities raised rates to cut supply growth in response to the oil price rise, this chart of M3, which the US Fed stopped tracking in 2006, shows why such rate hikes might not have cut monetary supply at all because at the time private banks had enough confidence in each other to create all the money they needed without central bank help.

by santiago on Fri Mar 13th, 2009 at 10:54:32 AM EST
[ Parent ]

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