The world of $100/bbl oil is unlikely to return

Oil markets

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GU 31Jan15Chemical markets are continuing to signal that the world faces major economic challenges in 2015.  The chart above highlights developments since August, when I first forecast that oil prices would see major falls, and that the value of US$ would see “a strong move upwards“:

  • Benzene, always my favourite indicator for industrial output, has suffered worst, down 56% (green)
  • Brent oil is down 53%, despite major buying by financial and physical players trying to ‘catch a falling knife’ (blue)
  • Naphtha, the major raw material for gasoline and petrochemical production is also weak, down 50% (black)
  • PTA. the raw material for polyester, confirms the weakness of China’s economy, and is down 44% (red)
  • Next we see the recent rapid collapse of US export prices for polyethylene, now down 26% (orange)
  • Then there is the weakness of the Japanese yen versus the US$, down 15% (brown)
  • And finally, there is the US S&P 500 Index, which has managed a 2% gain over the period (purple)

It is not hard to develop a narrative to explain these extraordinary movements.  Oil prices had been kept artificially high by the US Federal Reserve’s money-printing, which drove financial investors to buy oil futures as a ‘store of value’.

This effort had been supported by China’s vast stimulus, which created the illusion that the country had suddenly become middle class by Western standards overnight.  But since the summer, the growing impact of President Xi’s ‘New Normal’ has exposed this myth.

Yet even today, the vast majority of commentators are still arguing that oil prices – for some yet to be discovered reason – will soon return to the $100/bbl level.  This is very dangerous thinking, as it is delaying the necessary process of adapting to the real world of the New Normal.

The insights of double Nobel Prizewinner, Prof Daniel Kahneman can, however, explain what is happening:

  • The first issue is the one of anchoring, where the human brain relates to a number – and then judges subsequent developments in relation to this.  Kahneman has authored a fascinating YouTube video to demonstrate this process in action – it lasts just 1 minute 50 seconds, and is well worth the time spent
  • The second is our natural desire to make snap judgements.  Our ancestors had no time, if suddenly finding themselves alone in a cave with an angry bear, to sit and analyse the situation.  Today’s Twitter phenomenon, and the widespread use of sound-bites, continues this tradition

So everything combines to create the illusion that $100/bbl is normal and natural, as it has been the price since 2011.

Oil price Feb15Yet if we move from fast and intuitive thinking (Kahneman’s “System 1”) to a slower and more analytical mode (his “System 2′), we would immediately realise as the above chart shows, that high oil prices are exceptional, not normal.

 

WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:

Benzene Europe, down 58%. “sentiment in the European market remained sluggish amid ample availability”
Brent crude oil, down 53%
Naphtha Europe, down 50%. “market is tighter on certain grades following a pick-up in transatlantic and Asian demand, and good petrochemical utilisation in Europe”
PTA China, down 44%. ”operating rates were slowly lowered with the approach of the Lunar New Year holiday.”
¥:$, down 15%
HDPE US export, down 26%. “Domestic export prices kept falling during the week, in sync with dropping ethylene and energy market values.”
S&P 500 stock market index, up 2%

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