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Thursday, June 12, 2008

The rise and fall of sweet crude, fact or fiction?

"One hell of a roller coaster ride," that's exactly the phrase to describe the recent rise and fall of the sweet crude. From the steepest ascend to the most unrecoverable downturn, the fluctuation in crude has profited all international oil firms but left the consumers in awe, startled and shaken. For the SUV owners, a trip to the bump not only puts a dent on the wallet, it is also a stark reminder that an end will soon come to the gas-guzzling monsters popularized in the nineties. For a consumer like you and me, our driving habits are no longer shaped by the destinations, but by an abstract price the world has come to respect. Some brave souls even switched how they commute, from the once paddle-happy, guilt-free accelerator to the now burden-laden, human-power form of transportation. Although they argued it's a healthy alternative which would strengthen the body, mind and pollute less, deep down inside they cursed on being self-reliant and whined at the first sign of exhaustion.

What is more nerve-racking is the ongoing inflation of everything, coupled together with a fixed income, further exasperate the situation to ten-fold, especially for the lower demography. So, are the consumers doomed to comply with the path of no return, paved in secret by the alliance between OPEC and major oil conglomerates, or is there a leeway which would otherwise alleviate the ongoing high cost of filling a tank? Below is an extensive commentary from a dear friend of mine who has been closely tracking the cause and effect of crude prices. Enjoy!
My 2 cents on recent fluctuations of LSC (light sweet crude) and price at the pump.

It's been very interesting few months watching the market closely. This is what happened to oil price in previous months. The prices are 'future contract' prices. Major highlights of LSC price in past few months are as follows:

1. broke $100 in January.
2. broke $120 in March.
3. broke $130 in May and climbed up to $135 during the week of May 22.
4. retreat to low $120's early last week (closed at $122 on June 4th).
5. sky rocket $5 on June 5th and $11 on June 6th. This is the largest jump of LSC future contract price in the history of NYEX.

For each of the above, the main cause, as far as I can tell (gathering news from Bloomberg and Globe and Mail, plus other investment firm's announcements) is listed as follows:

1. The steady rise of crude price since last year is due to the weakening US dollar since sub-prime mortgage bubble burst in August '07. On January 21st '08, US Feds cut rate by 0.75%, largest cut in 5 years since 9-11. This impacts the dollar and weakens it on the global market.

2. March 16th is the day when US Feds announced that it will help JP Morgan to take out Bear Sterns Co., 5th largest investment firm in US. It's the first time the US Feds directly intervene with the market since the 1930's. In doing so send shock waves through the entire world. DJIA dropped 5~10% across the board and commodity prices kept on rocketing upwards.

3. In May, the OPEC rejected Bush's request for increase production and limits the demand for this year, therefore, price goes up further and pushes through $130.

4. In mid-May, the price at the pump broke $4/gallon for the first time in history. The CPI (monthly Consumer Price Index data) and other data showed weakening of gasoline consumption by as much as 8% the moment the price went over $4/gallon (i.e. the demand of oil finally reduced for the first time) and the price started to decline. Also, US Fed, as well as Bush, started to signal the end of rate cut, as well as strengthening of the US dollar. This will eventually reduced the price of crude because crude is priced in US dollar.

5. This is an interesting one. Because there has been no major announcements before June 4 in regards to crude prices. The sudden jump of the price on June 5th is the work of 'insiders' who know about the JP Morgan's announcement on Friday (June 6th). On Friday, JP Morgan's energy specialist announced their projection for crude future is $150/br by JULY 2008 due to increasing demand from China and India.

Currently (June 10th) the crude is trading at mid 130's and the projections are everywhere: Lehman Brother (another large US investment bank)'s projection is $80/br by the end of this year or early next year while JP Morgan's project is $150/br by this year. CIBC's projection is $150 by 2009 and $200 by 2012. In all cases, the main factors that will be driving the crude price are:

1. supply: The "peak oil" is now the consensus of the industry. Global production peaked in December 2005 (this is verifiable data and published). Although there are reserves in the Alaska region, as well as BC/NS offshore and couple of possible deep-water wells. THEY HAVE NOT BEEN DRILLED and therefore it will take 3~5 years before they start to produce oil (if they even have oil to start with). Bio-fuel's production is now under a lot of criticisms because it only supply ~1% of the demand while jacking up food prices by 300~500%.

2. Demand: Emerging market (China and India) is increasing their demand. However, we do started seeing demand reduce in north America and Europe when the price is high. This is a good thing. Toyota, for the first time, out-sold their small cars to GM's SUV's and trucks. GM is now closing 5 major truck/SUV plants and is considering selling the HUMMER brand (for nothing? because no one wants to buy a Hummer when it cost ~$200 to fill up). All of this signals the consumer realization of 'the end of cheap oil' and will likely continue as price rise. China is now subsidizing 75% of their gasoline and this will not continue (not at $130/br) and eventually will drive the demand down.

3. Political stability of middle-East and other oil-producing regions: Israel recently intensified their threat to attack Iran while Obama made speeches to support Israel's sovereignty. The supply from Iraq is also not stable. Yesterday Nigeria's energy minister made a speech that OPEC is no longer be able to handle the price of crude.

4. Strength of the dollar: Since the sub-prime bubble burst last August, US dollar has been spiral downward. Since crude is trade in US dollar, weakening US dollar means price increase. As of now the home-foreclosure situation HAS NOT HIT THE BOTTOM AND WILL GET WORSE FOR AT LEAST 9 MORE MONTHS. The banks, on the other hand, has dealt with the liquidity problem and should start coming back sooner than that. At the same time, US Fed has announced the end of the rate cut, which will strengthen the US dollar against other currencies. Bank of Canada also followed suit just today (June 10th) with decision NOT to cut rate.

5. Other speculations: This is actually not that important in the long run (3~5 year+) but fairly critical in the short run. Speculators drive up the price. But at the same time, the demand drops when the price rise too sharply. I haven't give this one a detailed break down yet and will not comment further.

Gathering above factors. The impact of #1 and #5 is almost real-time and they almost for sure pushes the price up. While #2~#4 works against the price increase. However #2~#4 will not come into full effect for at least another 10 months (as for #3, I don't think I'll see it happening in my life time).

So long story short, the price of crude will likely swing between $140 and $120 this year. If world peace and all the best case scenarios played out (not likely), we may see it go back down to $80 (not likely) within a year. But the price of crude will go up for sure.

What does it mean for gasoline price at the pump? It will stay at 1.30 ~ 1.45 for rest of the summer, if not going up more.

What should we do? I wouldn't buy a car this year nor next year. In 2~3 years you will see amazingly fuel-efficient cars coming on-line and another year or two to drive the price down. Then buy the car of your choice. In the mean time, I would rent cars for trips / weekend outings and use buses or walk. Glad that I stayed in Halifax because I can walk everywhere.
Well, all these analysis is giving me a headache? Don't you agree? Although informative as it may sound, glancing through this in-depth analysis can easily overwhelm all sensory inputs and put the reader in a self-induced migraine. I guess that's why there's a profession for everything at a premium, such that the end-user would never, ever have to think except how to pay, how much to pay, and sign that damn underline authorizing payment.

Regarding the "oil" problem, my take is, with the limited number of cuts on a small piece of pie, why bother fighting for something intangible? Not driving or drive as little as possible, not only saves but also benefits the planet Earth. Think about it. If we don't conserve and regulate, everything we do this century will come back to haunt us, in the form of starvation, deprivation, and warfare amongst the living. For the upper echelons, it may be easy to ignore the deprived, but when considering parts of your tax dollar go directly to the relief effort, would you dare being so indifferent? Our next generation can't win alone. Only after a forefront confrontation by the awakening masses will the harm be reduced. It may sound ridiculous, but with the repeatedly emergence of warning signs, we can only hope what the scientists are predicting is wrong - the imminent arrival of a global catastrophic meltdown.

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