Comments: The more oil rises, the bigger the fall

Yes you could say that. However have not previous shocks been supply side in nature. Once the supply restored oil have fallen. This time shock is demand in nature. Different.

P.S. Could not say that the same for the housing market. Previous big rise followed by a big fall??

Posted by Hugo at April 23, 2006 09:05 PM

Fair points. I'd argue that we've already seen a demand response from high prices - and we'll see more - growth in global oil demand being weaker than one would have expected relative to GDP growth. I'd also suggest there are supply factors at work here - Iraq, Nigeria, the threat from Iran - and so on. But you're right to point out that OPEC could not click its fingers and bring the price down; they don't have enough spare capacity.

There is a parallel between oil and housing, though not in my view in the way you suggest. On oil, I think enough has changed to produce a rise in the long-run fundamental price, from the low $20s to the high $30s. I also think enough has changed to produce a revaluation of housing.

Posted by David Smith at April 24, 2006 09:01 AM


As always a great analysis. I have one problem. On the world/UK Economy you are the uber bull (and you've been right to be). You argue that oil will fall to $40 as demand falls away. Surley demand will only fall if there is bust to the current boom in the world/UK economy. Otherwise, even with supply increases surley demand is high enough to maintain prices >$40 (even parts of Africa is enjoying 5% growth).

Does this mean David Smith has become a bear now?

Posted by ash at April 24, 2006 02:51 PM

I'd question uber bull, but let that pass. The world economy is currently enjoying an exceptional period of growth, exceptional being the operative word. This is the fourth year of 4%-plus global growth and the third in which it will have been close to 5%. Sooner or later we will slow, perhaps to something closer to 3%. When this happens the growth in oil demand should slow sharply, perhaps even fall. How so? Last year we had global GDP growth of nearly 5%, but only a 1.3% increase in oil demand.

Posted by David Smith at April 24, 2006 05:09 PM

I would just like to challenge one point David - airlines in general are not big hedgers. They do not have big enough credit lines open to them to cover the margin calls. And to hedge jet fuel through crude futures would involve a huge amount of basis risk.

To hedge jet fuel requires buying gasoil futures and an OTC swap for the differential between gasoil futures and jet prices published by price reporting agencies, which carries additional costs. So most do not bother, they just buy on term contracts against published prices (which oil companies are able to exert a heavy influence on through spot market manouevres). In fact the person buying the fuel is often the same person buying the paper clips.

But the general point you are making here about demand is correct in my view. Although I think you should also have highlighted how stretched the ability of the US to meet its peak gasoline demand is. This, in my opinion, is as big a factor in current prices as the geopolitical situation.

Posted by El_Pirata at April 24, 2006 06:02 PM

Various points:
The price of oil is currently high, but demand is STILL rising, in contravention of basic economic theory.
I think it is important to reiterate it is not just supply capacity but refining capacity that is important. American refining capacity is expected to be shut down for longer maintenance than normal this year. Further, some oils are easier to refine into petrol than others (light, sweet as opposed to sour).
We do not know what impact the American reserves reporting standard will have on the oil market when it comes into force in July this year.
When oil is over $50 barrel various marginal supplies become economically viable (Canadian & Venezuelan oil sands), but that won't happen if oil falls to $40. Venezuela believes it has more oil than Saudi Arabia, so this point is important.
What would be the demand for oil if it fell anywhere near $40? Large, fast growing, but currently poor countries like Indonesia would be able to afford more and raise demand.
Not much good cheering about low oil prices if the World economy has gone belly-up and you're fearing for your job!

Posted by David Goldfinch at April 24, 2006 08:29 PM

One other point I'd like to throw into the mix

If a market is tight, you would expect it to be in backwardation ie oil for prompt delivery is more expensive than oil for delivery further out.

Yet this market is and has long been in contango (except briefly during the hurricanes) ie prompt oil is cheaper than oil for delivery further out, indicating ample supply

what does this tell us about the market? I don't have the answer but would be interest to know what others think.

Posted by El_Pirata at April 24, 2006 11:04 PM

You're stretching my technical knowledge, but here's an explanation from Mike Wittner, global head of energy market research at Calyon. It is taken from his weekly report last Friday:

"As we have stated before, prices can be the most current indicator of the physical fundamentals. Preliminary data on supply, demand, and stocks suffers from time lags and is subject to large revisions, so the shape of the forward curves (in the front months) can either confirm, or raise questions about, what we think we know.

"Currently, the forward curves for crude and products make sense. Brent crude has moved into shallow backwardation (dated to ICE front month), indicating tight fundamentals, which is consistent with the Nigerian outage. Tapis, the Asian light sweet marker, is also in backwardation, also due to Nigeria, recent Tapis maintenance, and Australian light sweet outages caused by a series of cyclones. In contrast, WTI is in steep contango, weighed down by stratospheric US crude stocks.

"Tight US gasoline is in backwardation, but this is the only key product in the Atlantic Basin that is not in contango; everything else is well supplied. In Singapore, naphtha and gasoil are in backwardation, due to several recent unplanned outages of Japanese refineries, heavy planned maintenance for Asian refineries, and recent strong demand from China."

Posted by David Smith at April 25, 2006 10:37 AM

What about OPEC? Are they not now looking to defend a $60 barrel? Any significant fall in oil price will be followed by a reduction in output and moderation of any price falls. In a world where oil isn't going to last for ever it would make sense to flog it for all it's worth.

OPEC obviously doesn't have complete control of falling oil prices, but for the foreseeable future defending a $60 barrel doesn't seem too difficult.

As previously stated this shock has a significant demand bias. The western powers have to contend with a rapid increase in the eastern use of the oil resource. Growth continues and so does oil consumption. Greater consumption results in a higher price.

P.S. The hurricane season isn't too far away. Hold onto your hats and cats...

Posted by Werewolves at April 25, 2006 04:13 PM


You say: "I also think enough has changed to produce a revaluation of housing." Releive me of the faint hope I have that you DONT mean house prices are fundamentally over valued? (sigh)

Posted by Ash at April 27, 2006 04:50 PM


How much research have you done on peak oil? With the North Sea, Burgan oil field in Kuwait and the giant Cantarell field all peaking do you not think that we may never see $40 again. Have you read Twilight In The Desert by Matt Simmons? What's your opinion on this.

The other point I might make is with the Fed printing so many dollars (and stopping the publication of M3 so you don't know how many dollars have been printed) - maybe you are suffering from money illusion

Posted by Alex A at May 3, 2006 11:13 AM

I'm very familiar with the peak oil argument, in fact I've a copy of M. King Hubbert's original article on my desk. I just don't think we're there, or even very close, yet.

The M3 point is a bit of a red herring, though it is the case that if the dollar were to fall very sharply, oil producers would seek to protect a higher dollar price.

Posted by David Smith at May 3, 2006 09:28 PM


A month from publication and oil is still above $70. Have you got any date by which you think we will reach this $40 a barrel figure? Predictions are not really that much use without a timescale?

Thanks Alex

Posted by Alex A at May 28, 2006 06:42 PM

The longest modern-day spike in oil prices we had was in the early 1980s, which lasted 5-6 years. Usually they are a bit shorter than that. As I said in the piece, the short-term risk is of yet higher prices from hurricanes and so on. Add to that the fact that there is a lot of speculative interest in maintaining a high price and I think it could take 2-3 years to get back to a sustainable (lower) price, though I would hope it will be somewhat sooner.

Posted by David Smith at May 28, 2006 08:09 PM

The guys at the oil drum (an obsessives* site on peak oil) have graphed the average of the EIA and IEA output. Given the current high prices you would have thought output would be higher? Cantarell in Mexico seems to be on course for a decline of 8% a year. Saudi Arabia production doesn't seem to be rising further. I note today Oil prices have stubbornly remained above $75 a barrel even after hurricane Chris has become a damp squib.

Do you not agree this is looking horribly like a plateau?

The only way I can see $40 a barell is a global depression - is that your prognosis?

* obsessives on the internet are very useful as the tend to be right.

Posted by Alex A at August 3, 2006 09:55 PM

the price of crude is finally creeping up again. the devastation the gulf with the BP oil spill plus the hurricane season I guess is contributing to that.

Do you think the price will go as high as above $100's?

Posted by Crude Oil futures trading guy at July 25, 2010 06:21 PM