What goes Up …sometimes takes a different path coming Down
Jon, regarding the question you posed in your post “What Goes UP…” http://www.pumptalk.ca/2008/11/what-goes-up.html#comments
In order to understand where oil (gasoline) prices are going, one needs to take into consideration why/how oil prices ramped up in the first place.
A simple regression analysis by agorafinancial.com
showed an 87% correlation between the M3 money supply and the price of crude, and yes that doesn’t mean there’s an underlying causal link, but….
Add to this, another report by the Washington Post (A few speculators dominate vast market for oil trading) that indicated, “reports that financial firms speculating for their clients or for themselves account for about 81 percent of the oil contracts on NYMEX,” effectively crowding out the user market. That finding was shared by Roger Lowenstein writing for the NYTimes ( What’s really wrong with the price of oil) .
These two factors seem to indicate that (past) pricing was impacted not only by consumption requirements – but by an influx of money seeking to earn a return on their investment. The problem isn’t the investment per se – but where it is being invested. If for example the investors/speculators traded in the stocks of the oil companies like PetroCan or Exxon the resulting stock price gyrations would have negligible impact on the price of crude – which is established in a different market…
However when participants in the crude market speculate on a relatively constrained supply commodity that has inelastic (short/medium term) demand – it simply ratchets up the cost of the crude for all users ultimately trickling down across all sectors of the economy throughout the world. And since we don’t have reasonable energy alternatives, everyone is forced to pay the new-found intermediaries….who by insinuation became a defacto financial OPEC.
It seems the tipping point was reached when US retail gasoline prices hit $4/gallon in June 2008. Consumers finally pushed back, businesses cocked their eyebrows, politicians proclaimed from the stump – all of which set into motion new impetuses for alternative energy initiatives.
Today, in our post financial-bubble world speculators are no longer flush with cash and global economies are tanking – including China and India that were pointed to as a contributing ’causes’ for the ramp up in demand. And so the rubber band has snapped and powerful forces are now constraining demand for the black gold in addition to a reinstatement of normal pricing mechanisms.
So to offer an answer to your question, in the short term – I suspect we will tend to see the current prevailing prices until such time that:
1.the balance between the reduced demand and reduced supply that OPEC (and others) are able to achieve via production cut-backs
2. oil stockpile inventories dry up, and
3.that we don’t have distribution choke points develop somewhere or some significant political instability.
It will be interesting to follow whether the government enacts a floor price tax to encourage the innovation and infrastructure push for the establishment of a new energy matrix, and whether oil companies elect to push forward their invests in the development of new energy reserves or whether they distribute more of their windfall profits to shareholders etc…
Where should the price of oil/gasoline be?
This chart plots weekly retail gasoline prices in Toronto (cents/litre) versus the spot price of a barrel of West Texas Intermediate crude (US$/barrel) from 1987 through to May 2009. We see that at any given price of crude (horizontal axis) there is quite a large range of retail prices. For example at $60/barrel – retail prices over the years have ranged from $0.80/l and $1.02/l
Some may think with crude topping $61/brl today (March 20,2009) and Toronto retail at $0.97/l – that in the midst of the weakest economy since the Depression, retail prices that push the top boundary seem excessive.
Or maybe ask these folks:
(sources courtesy of Econbrowser : How big a contribution could oil speculation be making?)
Akira Yanagisawa, Senior Economist at Japan’s Energy Data and Modeling Center: “In the most recent terms (the third and fourth quarter in 2007), the fundamental prices [of oil] are estimated around 50 to 60 dollars. On the other hand, it is estimated the premium has risen up to around 40 dollars at maximum.” [Institute of Energy Economics, 3/08, p. 13]
Larry Chorn, Chief Economist of Platts: “says the actual costs incurred in producing the most expensive oil is only around $70 or $80 a barrel, meaning that about $50 of the current price represents ‘the market’s risk premium plus speculation.'” [ BusinessWeek, 5/13/08]
J. Stephen Simon, Executive Vice President, Exxon-Mobil: “the price of oil should be $50 to $55 per barrel based on supply and demand fundamentals.” [House Testimony, 4/1/08]
John Hofmeister, President, Shell Oil Co: The proper range of crude oil is “somewhere between $35 and $65 a barrel.” [Financial Post, 5/22/08]
At least we have all learned some valuable albeit expensive and painful lessons that will guide our energy policies going forward. The US-led public shift in recognizing the strategic security issues surrounding the massive transfer of economic wealth from oil consuming to oil producing countries, the long-term economic importance of an expanded menu of energy alternatives, global warming, rising and more aggressive mandated fuel efficiency standards and changed consumption habits have created a dramatic new landscape that is just beginning to unfold – witness the changes in the auto sector.
It doesn’t take a rocket scientist to see that demand has and will be changing …..permanently.