Fuel Price Mischief? Again?

Some experts predict that oil will drop in the near future.

Here is a Bloomberg Article that summarizes the thinking behind $20 oil

Also, here is an article from a money newsletter that I follow that more or less points to the same conclusion.

What's driving this year's oil rally?

We’re convinced this year’s oil rally hasn’t been driven by how much of the stuff is actually being consumed. It’s been down to a potent mix of investor overconfidence and speculation.

In contrast, the current oil supply and demand picture in the ‘real’ world is… well, rather boring. Oil consumption this year is set to drop by 1.6m barrels a day, said oil cartel Opec last week.

Global consumers need 84m barrels a day, a 2% drop on 2008.

Meanwhile, the planet’s production has exceeded demand by about 1m barrels a day.

This has led to oil supplies building up, with the Chinese stockpiling particularly hard. And even a small shift in this supply/demand balance can cause quite large changes in oil prices.

But so far, nothing even near the collapse in crude costs to $20 a barrel during 2009 that former-US government adviser and University of Calgary Professor Philip Verleger has just forecast. Could oil really fall to $20 a barrel?So what’s his reasoning?

Well, he reckons that a 100m barrel crude surplus will build up by the end of this year.

Current global storage capacity simply won’t be able to cope, so all the stockpiling will shudder to a halt. Opec may be making record supply cuts of some 2m barrels a day in response to plunging consumption last year, but this doesn’t deter Verleger, who says that “Opec doesn’t realize the magnitude of the cuts it needs to make”.

He believes oil prices would be much lower today but for all that stockpiling.

“The economic situation isn’t getting better”, he says. “Global refinery runs” – i.e. producing the likes of petrol – “are going to be much lower in the autumn. If the recession continues and it’s a warm winter, it’s going to be devastating”.

The net effect, he believes, will be to send oil prices plunging to levels last seen in February 2002. This may all sound just too apocalyptic. It’s certainly miles away from consensus thinking.

The average City analyst reckons oil will be around the $64 mark in 2009’s fourth quarter, says Bloomberg. Goldman Sachs predicts oil will rally to $85 a barrel by the end of the year. And demand from China, which has just announced annualised GDP growth of 7.9%, is expected to support the oil price.

But Verleger has a good track record. He correctly predicted that oil could go to $150 a barrel in 2008, and last September forecast that prices were heading for a “$50 to $70 world”. T

hat’s been exactly right for the last four months. And the more you look at his analysis now, the more sense it makes.

China’s rapid expansion could be an illusion.

As Christian Tegllund Blaabjerg at Saxo Bank says, most of the recent Chinese growth has stemmed from the government’s stimulus package, which has fired up record bank lending.
But “the Chinese government is postponing the inevitable”, he says. When “that injection of heavy liquidity” runs out, falling exports will curb the country’s growth rate. Verleger’s very clear. “China is in a real desperate situation”, he says. “US consumers aren’t consuming and Chinese manufacturers will get hurt. Economists are looking for growth in all the wrong places”. Then there are those speculators. “Excess speculation needs a constant inflow of new money to sustain prices”, says Jeff Korzenik on Efficient Frontiers.

“Just like a Ponzi scheme” – think Bernie Madoff paying off old investors with his latest cash coming in – “needs new funds to keep the game going”. If oil stocks build up like Verleger believes, and prices start to tumble as demand dries up, much of the cash that’s been chasing the likes of oil could evaporate very quickly.

As we pointed out a couple of weeks ago, more money piled into the 1,500 commodity funds tracked by Jennie Byun at JP Morgan Chase in the first half of 2009 than in any previous entire year. But if oil stops being flavour of the month, just watch that money find other homes – fast.

On the one hand, lower fuel prices means lower overhead for our industrial users, many of whom rely on trucking. The bad thing about dropping fuel prices is that change is, for the most part, bad for business. If you do not know what your costs are or are going to be, it is hard to accurately price your product.

I do not know where fuel is headed, it caught me completely off guard last year @ $150 a barrel and caused a lot of grief to many of our clients.