There has never been any fundamental basis for the rise in oil prices over the past 3 years:
• At no time has there been any actual shortage of product
• In fact, inventories have always been at comfortable levels
They rose only for two reasons:
• The investment banks found they could make a lot of money by persuading the pension funds that oil had become a separate asset class, and was not simply a part of the real economy
• Regulators allowed high-frequency trading to dominate energy markets, thus removing the impact of fundamentals in price discovery
Equally, there have been plenty of people lining up to claim 'this time was different'. Even last month, a new IMF paper claimed that high oil prices no longer mattered due to "fundamental changes in the workings of the global economy" and the ability of brilliant central bankers to "use macroeconomic policy to mitigate the effects of rises".
As we discussed in chapter 3 of Boom, Gloom and the New Normal, this combination can be very powerful. It has taken prices higher and for much longer than any reasonable person might have expected:
• If pension funds start to put 5% of their assets into oil futures, they dwarf fundamental market movements
• And then the high-frequency computers add their central bank-funded leverage to take prices even higher
This is why the blog has used the 'triangle formation' in the chart above to try and highlight when these forces might finally play out. As it noted last month, the banks and the computers had a last effort to try and push prices higher, towards their ultimate $200/bbl target.
And in failing, they provided an excellent opportunity for those chemical companies who agreed with the blog's analysis to hedge their positions against any future price collapses. Hopefully, many did.
Of course, the banks and the computer traders will not give up easily. They have made a lot of money over the past 3 years, and they don't care about, or even understand, the damage they have caused to the global economy.
But as the chart shows, a clear breakout has now occurred on the downside. This provides at least the potential for prices to start reconnecting with fundamentals. $60-80/bbl seems a sensible target Base Case for this first phase.
After all, on the fundamental side, US oil inventories are now at a 22-year high, OPEC production is at a 23-year high, whilst demand growth in Asia, Latin America, Europe and N America continues to slow.
As Shell CEO Peter Voser told Reuters yesterday:
"Global demand is softening, we have got recessionary elements in Europe, a small slowdown in Asia Pacific. At the same time, some of the geopolitical elements of price volatility over the past few months have kind of receded, and therefore we see a softening of prices which I expect to go well into the second half of this year."