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Oil Prices: A Turkey Becomes Airborne, Danger Ahead

Business, China, Company Strategy, Economics, Oil & Gas, US

By John Richardson

OIL prices rose yesterday, despite the latest Energy Administration Information (EIA) report for the week ending 28 August revealing that:Flyingturkeys

  • Total US commercial stocks grew by 5.7 million barrels a day – and at 1.29 billion barrels are the highest level ever reached. (Number crunching, courtesy of David Hutton of the PVM oil report)
  • They are 15% above last year’s levels and 13% above the five-year average.
  • The US is now holding just under 2 billion barrels of oil in storage, including 695 million barrels as strategic reserve. This provides the country with close to 110 days of demand cover. That’s a lot of money tied-up speculation.
  • Crude stocks are 27% above last year’s levels, distillates 22% higher and gasoline 2% higher.

So go figure, why did oil prices rise?

“This is the latest cycle of ‘bad news is good news,’ with investors more pleased with the idea of ongoing stimulus than they are worried about poor demand,” said Tim Evans at Citi Futures.

“Prices may be able to stage short-term rallies – if the wind blows hard enough even turkeys can fly – but we continue to see the market as physically oversupplied,” he added.

(Note, Tim was obviously referring to farm-bred turkeys as, apparently, wild turkeys can fly).

But seriously, and this is a deadly serious time, as this latest “bad news is good news” approach of financial markets once again illustrates that for far too long now, the fundamentals of real supply and demand have not driven the price of oil.

The latest bad news – which again shows that quantitative easing anywhere is not working and simply cannot work, ever – is that the European Central Bank (ECB) looks as if it is going to miss its inflation targets.

So Mario Draghi, president of the ECB, seems to have hinted in his latest comments that more stimulus might be on the way.

Oil thus rose as the speculators became excited about more free chips to gamble in the casino – i.e. a further extension of very cheap interest rates.

But the trouble is  is that this would delay the day of reckoning –  as I discussed on Wednesday when I raised the possibility of a fourth Fed quantitative easing programme (QE4) backed up the ECB and the Bank of Japan. The longer the delay the harder it will be to pay down debt and drag the world out of its current deflation crisis.

What this means for the chemicals industry is that it has to cope with much greater short term volatility in oil prices as the “Will they, won’t they?” debate about more Western central bank stimulus plays out.

And this debate will continue even if the Fed decides to raise interest rates in September, as:

  • The interest rate rise will at least maintain, or perhaps further increase, the strength of the US dollar and thus undermine US exports.
  • And with an as strong or stronger dollar will come more capital inflows to the US and so further problems for emerging market currencies and economies – especially those that have also gambled in the casino: Borrowing heavily in US dollars to finance consumption-led growth.
  • Then the issue will become political in the run-up to next year’s Presidential elections, as US jobs will be under threat from both the stronger dollar and the further slowdown in emerging markets. So QE4 may become a reality.

But as this “Will they, won’t they?” debate continues, one debate is definitely over, which is over whether or not China will return to its old type of stimulus-led growth. We now all know that this will not and simply cannot happen – and that the end of old-style stimulus signals the end of the commodities bubble, and so largely explains why we face so much debt and deflation.

What does this also mean for forecasting oil prices over the long term? Here are some possibilities:

  1. No more major Western central bank stimulus and you are looking at prices returning to their long term average of around $30 a barrel.
  2. More major Fed etc. stimulus and we could be back to $100 a barrel.
  3. Or around $50 a barrel in a world of perhaps some stimulus, but still weak underlying demand.

More details on this soon when we announce an important new Study into a scenarios for oil prices, which will be published by ICIS Consulting and the UK-based chemicals consultancy, International e-Chem.