This weeks Hot Topic is oil again. The price is dropping but the market is moving towards a significant rebound – or the world towards a depression where nothing is in demand anymore. I believe the world rebounds, that’s why I think oil is so very important to focus at now.

I hope you will read my view and comment.

Hot Topic – Oil part II – One day oil catapults higher.

I see two possible outcomes.

One, and not an impossible outcome, is that the current recession develops to a prolonged and deep depression where it feels like the world switches off. We all know it means asset prices somewhere down there, and same place for commodity prices.

If you believe in life after recession, then there is a second outcome. As follow up on the Oil Hot Topic for 2 weeks ago I continue to argue that the current oil price simply is too low.
Despite my bearish opinion on global economy since long time I have a faith in a turnaround one day. Read here why it’s wise to build an opinion about when and how to hedge oil, as the price will catapult one day.

The dropping oil price is short term mainly a function of a serious lower demand. IEA tells us to focus on the output decline as it is running at up to 9% per year. Most likely was the decline in production last winter a main reason behind the squeeze in the market.
As mentioned 2 weeks ago is an oil price around $85 per barrel necessary to attract new investments in oil production. We are now in a situation with enough known oil reserves to meet demand but it requires USD 350 – 360 billion in new investments per year until 2030.
We can all figure out that the current oil price limit new investments, while existing oil fields dry up. IEA expect the 2030 demand to be around 106 million barrels per day against 85 million in 2006.
The refinery capacity of course makes a huge part of new investments. The oil industry consultant Wood Mackenzie in a report lately said, that only 30 of the 160 refining projects announced since 2005 are now likely to be completed within the next two to seven years.

If IEA’s predictions about an oil price at $100 per barrel in 2015 and $200 in 2030 are right is also a matter of believe, but it includes rising production from other energy sources as well.

The common sense would say that when the world turns around again and energy demand jumps, then oil simply catapults. Other energy sources will grow all the time but the pleasant with oil is that it can be delivered where the consumer needs it without big infrastructure investments. Furthermore are the deliveries 100% flexible and tailor made to single client needs – as long as the production is sufficient…….

The speculative part of the market is always hard to judge. No doubt that some hedge funds and real money managers were long during the move up to the famous $147 per barrel. Some hedge funds might even participated in the downturn, but the hedge funds most likely are more quiet now as they need to keep high cash ratios these days.
Another, very interesting player – Mexico, has moved the market. During the summer / late summer the country hedged their total oil production until end 2009. In the market it’s said to be in the range $70 – $100 per barrel.
The hedging is done for several months ago, but as Mexico paid USD 1,5 billion for the hedge it seems to include some sort of option. This probably have delayed the market effect as the banks where Mexico traded, most likely sold oil at a later stage to hedge.
It is not likely that Mexico’s hedge is enough to pressure the market to an oversold situation, but it partly explains the abrupt moves on the downside in an oversupplied market.

The oil price is pressured by a current oversupply, but during such times one needs to decide about how act (read hedge).
These days I am working on different long dated oil strategies. It includes zero cost option hedges, mainly for corporate clients, or notes where the coupon is linked to rising oil prices, mainly for real money.
Even private individuals should consider bullish ETF Crude or long oil notes for their pension savings.

The drop in the oil price indicates a very serious slowdown in the world. If you believe in even lower oil prices, then it’s not too late to sell stocks as a lower oil prices indicates that the world is on the way directly into a depression.

Best regards

Peter

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