As I write this, Oil is priced at about $108 a barrel. On Tuesday it went as low as $105.46. $99 a barrel Oil appears quite possible, quite soon. Oil has now broken a price trend that has been in place for nearly 2 years:
"Countdown to $100 Oil?!?" is my contrarian series on the direction of Oil prices. But when I started this series four months ago, $150 and then $200 looked right around the corner. The idea that Oil might fall below $100 a barrel ever again was met with skepticism by some, to say the least. The premise of this series is that, even if we have arrived at the plateau of "Peak Oil", there will still be wild swings in its price (in fact, there already have been) and that demand destruction is taking place sufficiently such that oil will recross the $100 boundary before it ever reaches $200.
Over this last weekend, Oil at one point had declined nearly $10 a barrel in a day! This in spite of the fact that Russia is threatening oil supply pipelines to the West, in Georgia; and the shocking realization that in August there are Hurricanes in the Carribbean!
So what's going on?
There are a few trends that have been magnified or fed on each other in the last few weeks.
- There have been both oil platforms, and August hurricanes, in the Caribbean and the Gulf of Mexico for over 50 years. Katrina's occur, but not that often. The hype was overdone.
- The dollar has strengthened against other major currencies, notably the yen and the euro. When I began this series, I noted that about 25% of the run-up in the price of Oil was due to the collapsing dollar, and that sooner or later that collapse would end. That has happened, at least in the short term, as shown in this graph of the US dollar vs. a basket of other currencies:
The Federal Reserve stopped lowering interest rates. Economies in Europe and Japan have suddenly gone into contraction. Their own central banks are under enormous pressure to loosen their own monetary policy. Thus, relative to other countries, US rates are going to be tighter. [Relatively] tight monetary policy means our currency strengthens, means Oil as a speculative hedge has busted.
- Demand both in the US and internationally has declined more than originally thought. Within the last few weeks the EIA has reported that demand for gasoline in the US fell more than they originally reported, a dramatic 800,000 barrel a day decline. At the very same time, it was revealed that China's private oil companies, which had been ordered by the Chinese government to stock up on Oil in advance of the Olympics, were permitted to stop, and did so beginning in July. So much of that "extra" demand that was going to Asia, explaining the run-up in prices earlier in this year, turned out to be "Hoarding in Plain Sight" and when it ended, Asian demand declined significantly (surprise, surprise, supply and demand works in Asia too!).
- Margin calls. A large move like $10 a day in the price of OIl rarely has much to do with "fundamentals" but usually has something to do with one or more large participants in a market being caught in a financial squeeze. When Oil spiked upward from $121 to $139 a barrel at the end of May, it turned out that a large speculator had been caught in a "short squeeze" meaning it had to come up with funds to cover a bet that Oil prices would fall. The player subsequently declared bankruptcy.
It seems just as likely that over Labor Day weekend, the opposite happened, and one or more large players had to cover a leveraged bet that Oil prices would increase, i.e., they faced a margin call. (remember the roll margin calls played in the 1929 stock market crash). In order to meet that call, they were forced to sell their position in a hurry at whatever the market was willing to pay to a distressed seller. [NOTE: Subsequent to drafting this diary, my suspicions proved correct. The Wall Street Journal reported that
Hedge fund Ospraie Management, one of the biggest players in commodities, said it is shutting down its largest fund after significant losses. The Ospraie Fund fell 27% in August alone due to bets on oil, natural gas and structured products, and the fund has been selling off its holdings over the past three weeks....
At this point Oil has declined almost 30%. The only decline greater than this percentage-wise since Oil began its ascent in 1997, was the 35% decline in 2006, and that decline took almost 6 months to unfold:
This decline has unfolded in only 2 months. There is every reason to believe that the speculative unwinding of the Oil bubble is going to continue -- not in a straight line, but nevertheless continue.