Falling Oil Prices: Party like it's 1999?

Will oil prices even further? That’s what some speculators are betting. The New York Mercantile Exchange, or NYMEX, reports that traders are buying up large numbers of $25 “put options” for February oil futures contracts. A put option gives a trader the right to sell oil at a future date for a given price—generally the price the trader thinks oil will fall below. As analyst James Cordier told Bloomsbury this week, the large volume of $25 options represents “somebody making a bet that crude oil is going to crash in the next six weeks.”

            But is it a reasonable bet? Maybe. As bad economic news continues to mount, it’s more and more probable that economic growth—and thus, demand for oil—will stay stagnant or even fall for the next year. Merrill Lynch, for example, just cut its 2009 oil price forecast from $90 a barrel to just $50. If oil does indeed collapse to $25 (a price we haven't seen for 7 years or so), that could pull gasoline prices down to around $1.60 a gallon—and give recession weary consumers a much-needed break.

            But low energy prices aren’t welcomed by all. Thus summer, many New Englanders signed contracts to buy heating oil this winter for $4 a gallon. That made sense when high prices seemed the new norm (in August, Goldman Sachs predicted $145-a-barrel oil by November 15)—but now seems foolish, given that heating oil is selling for around $2.75.

            OPEC, too, doesn’t like bargain barrels. The cartel is considering cutting its production by as much as 1 million barrels a day to keep prices from falling below the level many cartel members need to balance their budgets.

            But don’t get too used to cheap gasoline. The main driver for lower prices is the recession. When the economy eventually recovers, energy-hungry developing countries like China and India, responsible for more than half of recent growth in oil demand, will resume their high consumption. And as demand returns, so will higher oil prices. The Paris-based International Energy Agency predicts oil prices will average $110 in current dollars by 2030.

            In fact, today’s low oil prices will likely bring back those higher prices even sooner. As oil gets cheaper and cheaper, oil companies can no longer afford as many new oil projects, especially in hard to reach fields, which means they won’t be bringing as much new oil to market over the next few years. Likewise, cheap oil removes the incentive to produce oil alternatives, like biofuels.

            All of this retrenchment means total fuel supplies and production capacities will be falling just as the recession begins to lift and demand returns—a recipe for yet another spike.

            So maybe you'd better take that Hummer back off the Christmas list.

Comments

[Paul Letendre]

Hey Paul,

My Technology & Society class at school has been using 'the End of Oil' paperback as reading this semester. First, let me say how great I think your work is, and thank you for putting out something that's loaded with facts, gives an accurate picture, and isn't too depressing like some authors. My question for you is this...I see some discussion on 'assett inertia' in Chapter 11, but nothing on 'energy inertia'. My professor wants us to compose an essay on Ch. 11 regarding energy inertia but I can't find anything in the reading about it. Any help would be greatly appreciated!

[tyronen]

I have just finished your book.

I am puzzled at just how fast oil prices have moved during 2008. I could believe that the general rise of the past few years was due to demand outpacing supply. That, however, pointed to a gradual increase, not the meteoric rises of the spring.

Similarly, although there is a global recession, it hardly seems deep enough for oil prices to drop by nearly two-thirds.

One explanation I have heard is that oil futures speculation is amplifying price swings. Do you think there is any truth to this?

[Patti Absher]

Hi Paul,

I'm in Cancun for two weeks and have been reading your book by the pool. For a tome so packed with facts and figures, it keeps you turning the pages like a who-done-it. If only!

What do you think of Obama's appointments so far in terms of leading this country to the fundamental changes in our energy system you call for? It's seems like such a great opportunity to turn things around but I'm afraid it will be business as usual in Washington.

[Online Commodity Trading]

Well after a big old rise in oil prices recently, I re-read this with interest. However I think oil prices are now going to drop hard and fast again with this swine flu outbreak hitting the demand for air fuel.

[Anna Coulling]

Moves by the CFTC to try and regulate the oil trading market and prevent the kind of speculation which has seen crude oil prices rise from $30 per barrel back towards $70+ this year took an interesting twist yesterday when it was announced that the weekly COT data would now include new details on the aggregate holdings of the big Wall Street dealers, hedge funds and other financial participants. COT data is a useful market sentiment tool but as many of the market participants both hedge and speculate it has become increasingly difficult to analyse. According to the CFTC the new format will be making its debut next Friday.