Lower Demand Increases Chance of a Pullback in Crude Oil Prices

If interest rates go even lower—and the wave of re-setting subprimes ensures the Fed will have plenty to worry about—how much higher might the oil price go? And will it prompt OPEC to begin pricing oil in a currency that’s not falling apart faster than a leper in a dodgem car?

There are probably more questions than answers today, especially about oil. The cost of production for a barrel of Saudi crude is around US$7, if we recall correctly. For lower grade Russian crude buried under Siberian perma-frost, it’s closer to US$12. Either number is a long way from US$81. Is oil part of the melt-up bubble too? Hmmn.

Mike Rothman, the former Chief Energy strategist at Merrill Lynch, told US financial weekly Barron’s over the weekend that he reckoned oil is headed to US$45. He says new supply is coming along, demand growth has slowed, and high prices have prompted two predictable marketplace reactions, substitution and conservation.

“I don’t think people are aware that demand has really fallen off so much,” Rothman told Barron’s. “The rate of global oil-demand growth has really slowed pretty dramatically since ’04. I’ve had to make a large downward revision for the second quarter, and it looks like I am going to have to make another one for the third quarter. A chart of the OECD [Organization for Economic Cooperation and Development] countries shows demand growth has been negative, with the exception of a small gain in the second quarter; that’s the first time since 2005 that there’s been some growth in demand, and it was modest. That’s the worst showing since the ’80-’82 recession.”

Did he mention recession? With Japan headed toward recession and America already in one, you’d expect both to be bearish for oil demand. And then there’s that bit about high prices being the cure for high prices. If US$80 oil doesn’t take the edge off demand, what will it take? US$100 oil?

Leaving aside the declining dollar’s influence on oil prices, it’s probably a good time for energy bulls to seriously consider the chances of a pullback in oil prices—even if oil and energy stocks are still in a long-term bull market. For the Aussie energy sector, Woodside’s (ASX:WPL) US$55 billion deal with China is about as good a news item as you can get.

Woodside is trading just below its 52-week high of US$47.89. It wouldn’t surprise us to see Woodside make a new high 52-week high today on the back of the rate cut and the move in oil. And after that…a correction.

In making these predictions, we’re trying to figure out the current inter-market relationships between asset classes like cash, gold, stocks, bonds, and oil.

Those relationships are never cut and dried. But they used to be much clearer than they are today. US stocks, for example, absolutely love the rate cuts. But if you’re investing in US stocks from abroad, the dollar’s morose reaction means what you’d gain from the rise of the Dow, you’d give back with the decline of the dollar.

Again, it’s not as cut and dried as we describe. But what we’re getting at is that with so many variables affecting your total return as an investor, it’s best to break Occam’s razor and keep it simple. That means seriously considering gold’s role in a fiat currency world gone mad.

Dan Denning
Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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An institution might well reduce oil holdings at these levels,though there is a significant difference between an organisation and the small investor.One doesn’t drive a car,the other does.Like insurance,you hope you’ll never need it.What do you guys call it?-Yes a hedge.

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