By Bill Baker, J.D.
Editor and Publisher, The San Bruno Beacon
Guess what folks? Oil is trading at about $111 to $112 per barrel and gas prices are down. Oil prices are down from the mid to high 140s per barrel range we saw in July. That is more than a $30 per barrel drop in one month and nobody had to do the Jackie Speier 55 MPH crawl for oil prices to drop. Note to J. Speier: That's because (and I'm being generous when I say this) going 55 MPH has almost nothing to do with $140 per barrel oil. $140 per barrel oil is the product of commodity speculation in the commodity futures trading pits.
Today's buzz word is demand destruction. Earlier this year, May (2008), I wrote an article in another one of my publications about oil's downside. In this May 22, 2008 article titled, OIL PRICES HAVE A HUGE DOWNSIDE. HOWEVER, I COULD BE WRONG, I wrote:
"Here's the case for oil prices caving in. More supply, more conservation, accelerated mainstreaming of alternative energy technologies, and a slower economy."
The factors mentioned in the previous sentence result in demand destruction for oil and lower oil/gas prices. In an August 12th Reuters article titled, "Biggest drop in U.S. oil demand in 26 years", it was reported that the Energy Information Administration (EIA) stated that U.S. oil demand during the first half of 2008 fell by an average 800,000 barrels per day (bpd) compared with the same period a year ago. This represented the biggest volume decline in 26 years. The article also stated that the EIA projected significantly lower oil consumption based on prospects for a weaker economy.
That being said, commodity markets are forward looking. Therefore, oil speculators are covering their short positions and otherwise being less aggressive on the short side as news about the US economy seems to get worse with each passing day. Simply stated, if consumers have less money to spend there is less demand for oil. Actually it is more complicated than that but you get the general idea.
However, before you go out and start buying put option contracts on USO or DIG, you should understand that oil prices are not based on logic; they are the product of fear, greed, and speculation. As such, oil prices can shoot up to $225 a barrel if open warfare between Iran and Israel erupts in the MIddle East or they can fall to the $60 or $70 or lower per barrel range if there is a depression.
Oil prices will continue to fall in direct response to a worsening international economy. The headline in my June 19th, 2008 Beacon article was titled, "ROYAL BANK OF SCOTLAND'S CHIEF CREDIT STRATEGIST WARNS, "A VERY NASTY PERIOD IS SOON TO BE UPON US, BE PREPARED". As the Bank of Scotland correctly predicted, from an economic standpoint, things have gotten worse.
FNM and FRE are on the the verge of total collapse and a government takeover that will totally destroy all stockholder equity in the companies. And now, we have Professor Kenneth Rogoff, a leading academic economist and former chief economist for the International Monetary Fund, saying that it is highly likely there will be a high profile casualty among the US banks.
Professor Rogoff is not talking about some tiny bank in west Mississippi here. He's talking about a huge money center bank with thousands of branches spread across the world, billions upon billions of dollars in assets, and hundreds of thousands of customers. A banking collapse of this size would threaten the FDIC fund and possibly lead to a run on banks. In addition, there would be a domino effect as smaller companies, that depend upon the business of the huge bank for most of their revenues, go out of business when the bank collapses. This is not a pretty picture.
However, the scenario described in the previous paragraph could bring oil prices down below $100, 90, 80, 70, 60, 50............ as things unwind. Too bad hundreds of thousands, perhaps millions of people will be financially wiped out in order to get these lower oil prices.
Oil pricing is pure evil. The price of oil will skyrocket if there is a major catastrophe like a war in the Middle East and the price of oil will plummet if there is a major catastrophe like a financial meltdown. Either way, you're screwed.
Back in my younger days when I worked at SOHIO on the financial end of the Prudhoe Bay oilfield project as a staff accountant accounting for assets and allocating costs between the oil company partners in the project, I read a book published in 1929 titled, "Oil and Peace". The book was dedicated "To the memory of John Simeon Shepherd, a man of peace and Charles Edward Reed, a man of oil". That is one of the most subtle, nasty dedications I have ever read.
Oil and gold are the things that drive men mad, start wars, build and destroy nations.
Oh, and if you were looking for some advice on how to play oil prices; think straddle. 