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Crude Oil Fundamentals And Overpriced Oil

Commodities / Crude Oil Oct 05, 2012 - 12:20 PM GMT

By: Andrew_McKillop

Commodities

Best Financial Markets Analysis ArticleFUNDAMENTALS?
After another "severe correction" on 3 October, another magnificent dead tiger bounce in oil prices as traders decided the correction had been "overdone". The Syrian crisis is looking to spill over the Middle East, Iran bombing is back on the menu, US gasoline supplies are down a little due to a refinery fire - but above all the oil trading and financial community, and Big Energy need overpriced oil.


The oil trading community can be depended on for "transparent pricing" which makes a point of avoiding real fundamentals. In four words these are oil supply, stocks, demand and the energy-economics of oil in a fast changing global economy. All of these fundamentals are bad for overpriced oil, as if that concerned the oil trading community with its heavy and ever-rising dominance of the financial-only players in the oil pricing game.

Times have changed a lot, even since 2008, and have been transformed relative to the epic era of oil paranoia in the Oil Shock 1970s and very early 1980s, but the oil trading community and Big Government minders prefer not to know that. Equipped with the frail props of QE-something in the US and Europe, Chinese recovery spending, industrial output data, jobs data, PMI and CPI data, the US dollar's supposedly controlled slide, the supposedly rational rise of the euro money's value against the dollar, the global macro music used to talk up oil prices can always be reworked when needed. When the global macroeconomic munitions are low, the oil trader community turns to generous lashings of hopes and fears of Iran bombing, Syrian civil war, African coups and other geopolitical risk premium newsbytes to jack up prices - before talking them down again.

This circus act has its own rules: oil prices are always pushed higher towards "unknown highs", when they are not slashed, burnt and dumped. The relation to all and any other energy, and its price, is given short shrift: what are fundamentals?

NEW LIMITS IN VIEW
The big news is the circus act for keeping oil prices high and volatile has reached its likely terminal extremes since 2008. Through 2008-2009 the oil trading community excelled itself: it was able to talk prices up beyond $145 a barrel, then crash them to slightly below $40 a barrel. Since 2009, it has excelled itself again by preparing the exact same thing. Oil Crisis-2.

As we said, fundamentals do not concern the oil trading community - its attention span to these things is measured in minutes rather than days but this is too bad for them: at the end of the day, and increasingly at the start of an average trading day, they count.

As we also said, all the energy-economic fundamentals are bad for overpriced oil. To be sure, we can fantasize along with the traders, their favourite analysts and data-spin doctors, ably backed by the OECD's IEA and the US EIA for a variety of reasons, mostly political. Oil producers especially in the Opec group plus Russia, meaning Saudi Arabia and Russia, could or might simply cut back on production and starve the world of oil. Who knows what they might do? Helping out the oil trading community and along with Saudi minister al-Naimi we can even put a price number to that: $75 a barrel for Brent, not WTI. The reasons why this "rational price level" for world oil will be a disaster for Big Energy has almost nothing to do with those exciting Indiana Jones oil geopolitics myths, legends and fantasies, and a lot to do with (you guessed it) those tiring fundamentals.

One reason is kept carefully out of public view, simply because it is so powerful. The oil producer and Big Oil fraternity, which in "the free world" means the historic oil majors once known as the Seven Sisters, but woefully downsized since that time badly needs oil prices which do not fall below about $75 a barrel. When rather tan if prices fall below that new floor price, their E&P will take a major hit, due to reasons including their dangerously overproductive natural gas resource search and development strategy leading to the one-way trip for natural prices: down. Ask Gazprom, or Shell, or Total or Exxon, or BP and Chevron about the role of "oil indexed" natural gas prices

At the producer level, whether Opec, Nopec, the NOCs of emerging and developing countries, the historic majors and growing minors, the risks and dangers of overpriced oil are certainly well known - but are also carefully ignored in their corporate communications for public consumption. Any talk from producers about accepting reliable and remunerative, sustainable and reasonable oil prices well below the "magic 100-dollar level" is a cue for a massive sell out of oil futures. And nothing else.

HIGH, VOLATILE OIL PRICES WORKING THEIR POISON
This is too bad for the oil trading community, and oil producers, and anybody who (still) uses oil. High and volatile priced oil is worse than plain old style overpriced oil, of the 1970s vintage. Any serious and totally rational slide in oil prices to $75 a barrel will be curtains for oil E&P, which stays high priced, and gets higher priced, with plenty of help from overpriced oil. Another fall in global oil E&P of the 2008-2009 sort or type can easily create a "self fulfilling prophecy" of the IEA and EIA sort: that is oil shortage when or if (a big if) the global economy comes right and grows at anywhere near its supposed and claimed potential - let us say 4.5% per year after inflation, in real terms.

Anybody honest will state they do not know if the global economy can (ever) come right. Since 2008 the global economy is a different thing. Subsidiary and related changes certainly include the role of oil in the economy, and for oil prices this is the killer - one of them, that is.The global economy does not need overpriced oil, and too bad for Goldman Sachs and the trading community.

We can backtrack to 2005-2006 and check out the US Gas Cliff. Google search with that term will deliver a rich selection of now wildly outdated myths. At the time, US gas prices hit as much as $16 per million BTU. Just recently they have "recovered" from around $2.50 to a little over $3 per million BTU. Now ask any hands-on trader in the energy patch if he or she thinks US gas prices are set to recoup much of the lost ground since 2006. Even if you bought them a tasty cappuchino with all the trimmings its unlikely they would have the time to say anything except "Impossible".

That 16-dollar price for US natural gas in 2006 made its barrel equivalent price about $92.50. Oil at a year average of $58.30 per barrel according to WTRG wasn't too expensive in the US, in 2006, even if natural gas was. Times have changed but the oil trading circus act has not.

The huge number of subsidiary, related and add-on rationales for "why oil prices stay high" are available at the push of a button from any full-time memer of the oil trading community. But this in no way prevents overpriced oil from working its dark magic in the energy-economy. As we said above, on of the direct, not collateral victims of this circus act are the Big Energy corporations, struggling to stay alive with declining sales volumes of oil, higher labor and equipment prices, rock-bottom priced gas, in the US but soon also outside the US, the onrush of the renewables - and rising numbers of new producers.

How long the circus act stays in place is the open question. Oil is overpriced and needs at least another 15% cut in WTI prices and 25% off Brent. Knowing the oil trading community and its circus act, it will soon find the "killer numbers" enabling it to further talk down prices without losing face and having to be bashful. Opec and Nopec may help, or may not, that is their problem in a global economic context where overpriced oil is a real luxury we do not need.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2012 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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