Oil markets have been driven by speculative excess since 2009. None of the factors that were supposed to create supply shortages have ever occurred. Markets have never even been close to scrambling for product. And the rallies are getting shorter and shorter, as this simple fact is finally being better understood.
Thus traders’ most recent efforts to create volatility over supposed Iraq interruptions have already fallen flat. The rally that began on 12 June has not only collapsed, but prices have actually gone lower again.
This raises the question of what might happen now we are in the seasonally weaker Q3 period, with the prospect of refinery maintenance looming in September, to further reduce oil demand?
The blog plans to look at this super-critical issue in more detail over the next few days.
WHERE ARE WE TODAY?
Key to this question is understanding where we are today.
As the chart based on data from the latest BP Energy reports shows, oil prices are now at levels which have always led to recessions in the past. The reason is simple, namely that today’s cost of oil is close to being 5% of global GDP – around twice historical levels:
- Consumers have little choice over their energy spending if they have to drive to get to work, or heat their homes when it gets cold. In hot countries, they also want air-conditioning during summer months
- But every extra dollar they spend on energy means a dollar less to spend on the discretionary items to drive the rest of the economy.
Of course, ‘this time has been different’ so far, in that central banks and governments have developed multi-trillion dollar stimulus packages and printed trillions of dollars of low-cost cash. This easy money has mitigated the impact of higher oil prices – but only at the cost of building up more debt for the future.
THE PENSION FUND VIEWPOINT
Critically, more and more pension funds are now realising that they were effectively ‘suckered into’ the oil price rally from 2009 onwards.
They had thought they needed to find a ‘store of value’, to overcome the downsides of the ‘easy money’ policies being pursued by the central banks. Oil seemed the perfect hedge, as it is essential to the modern economy, and is priced in dollars – thus combating the US Federal Reserve’s aim to drive down the dollar’s value.
But it really hasn’t been a very successful investment. Much of the profit was taken by traders and the investment banks. Most of the rest was taken by hedge funds. Being faster-moving, they could jump into the market ahead of the pension funds and build positions early.
Equally important today is that a number of senior pension fund investors now recognise that higher commodity prices actually reduce the long-term spending power of their members. They worry that their funds’ short-term gain on higher oil prices then forces their pensioners to pay higher prices for the essentials of life.
Thus there is a growing body of opinion in the commodity markets that prices have been too high, for too long, as the blog will discuss in more detail tomorrow.