December 05, 2008

Oil : How low do we go...

This is one of the best pieces written on the oil market and the current position. The reality is that speculation was driving up prices (we talked about this) in concert with the weak dollar. I wrote that piece in May assuming that the world wouldn't fall apart and that demand wouldn't deteriorate as fast it did.

Let me be frank... anyone who claims the drop in oil prices happened exactly as they predicted is lying to you. NO ONE anticipated demand destruction on the level we've seen this year with year over year declines of 5-10% in aggregate demand. That is a huge number. And while that depressed prices and deflated the bubble, the rest of the decline is purely related to the rise in the dollar. In my piece from May I thought that would only happen with restored fiscal policy. Turns out, all we needed was a collapse in the financial sector and a flight into dollars and dollar denominated assets to bring the dollar back up and drop the hell out of oil prices.

Now, with supply high and demand unlikely to rise up to meet it as people continue to transition to cars and trucks that require less oil, the likelihood of a quick rise (despite the prognostications of commodities permabull Jim Rogers) is non-existent save speculation or a dramatic deterioration of the dollar. Even those may not be enough to return prices to the 90's/bbl. The reality is that the runup in prices was more about our dependence on oil than our demand for oil coupled with a speculative frenzy. The frenzy drove prices up and our dependence kept us buying because we couldn't reduce demand fast enough to compensate. The problem with demand destruction is that it takes longer to play out than a price spike... which means the demand fundamentals are going to continue to drop.

At least we were right about one thing... once speculation was broken, the price did collapse. That being said, even we are stunned by this decline.

Posted by mcblogger at December 5, 2008 12:38 PM

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