Commodities | Dec 08 2010
By Greg Peel
As 2007 rolled into 2008, the benchmark oil price was about US$90/bbl, just as it is now. The GFC was only in its infancy as the “credit crunch” and a slow moving Fed had made sharp but as yet unsubstantial cuts to monetary policy, weakening but not destroying the US dollar. The oil price had begun 2007 at US$55/bbl, and more recently we saw oil at this price in mid-2009.
Before we knew it, early 2008 saw the “credit crunch” become the “credit crisis” as Bear Stearns was rescued. Only then did the world start talking global ramifications, rather than US-centric ramifications as had been the case previously. The Fed kept cutting and the US dollar kept weakening, and all eyes turned to China.
Chinese GDP growth had been running at double digits as we entered 2008, just as it is now (give or take). There was concern that the global credit crisis might derail the Chinese miracle, but a large school of economists and commentators disagreed. China was “immune” to US financial collapse, they shouted. Just look at its burgeoning industrialisation and urbanisation trend. Just look at its population. Oil demand, they said, can only grow exponentially in China, and in other emerging markets.
The stage was set. Goldman Sachs began lifting its oil price forecasts, and suddenly the world got on board. Oil is going to US$100, the crowd yelled. Oil is going to US$150. And finally, oil is going to US$200! Even legendary US oil man T. Boone Pickens agreed. Demand was rising fast, and supply was falling. Peak oil debates raged. The US dollar was collapsing at the same time, and the speculators were thick in the market. Hedge funds began buying physical volumes of oil and storing them on port-bound tankers.
In July 2008, oil hit its peak of US$147/bbl.
History now recalls that China was not at all immune, and that when Lehman Bros went under the US dollar turned around and ran back up because all other currencies experienced a belated collapse. While there are those who believe we haven't seen the “real GFC” which is yet to come, most assume that it's not going to happen again. Once again attention has turned to China's growing oil demand, and once again the Fed is “cutting rates” albeit this time in the form of QE2, with the US dollar weakening as a result. Only the latest European blow up has prevented a more substantial slide.
Once again Goldman Sachs has lifted its oil price forecast into triple digits. GS is not forecasting oil to reach US$100 in 2011, it is forecasting oil to average US$100 in 2011. To put that into context, oil is currently around US$90 but the 2010 average to date is only US$79. In other words, oil may yet spike in a similar fashion as it did in 2008.
This might seem like good news for oil exporters, and those invested in oil producer shares, but the reality is well known. Once past a certain point, the price of oil weighs heavily on all of the global economy – from input costs to the production of just about everything, to filling up the family people-mover. A too strong oil price is not a good thing.
But could oil really spike again?
The Wall Street Journal's Liam Denning thinks not. Denning has been making the same comparisons between late 2007 and late 2010 but has dug down into the detail more comprehensively. Here he has found some important differences.
There is more oil stored in the US now than there was then. Then there was only 19.5 days worth of inventory and now there is 25.4 days worth.
US refining capacity is running at only 84% at present. Then it was 89%.
Then OPEC's spare capacity was only 2.8m barrels per day, or 3.2% of world demand. Now it is 6.1mbpd, or 7%.
In 2007, the International Energy Agency forecast that by 2011, the world would consume 94mbpd of oil. The IEA has since revised that timing to be 2020.
Then the European Central Bank was threatening to raise its cash rate in the face of such inflation (it eventually did), sending the US dollar even lower on speculation. Now the ECB is performing on QE along with the Fed. As a result, the US dollar is not plunging.
Then US unemployment had not yet begun to increase. Now it's at 10%. At that level there is much less tolerance for high oil prices, and hence much less demand will follow.
Taking all of the above into account, Denning's conclusion is that while the oil price may indeed drift higher and even into triple digits, we are not experiencing deja vu.
