The Year Ahead In Energy
The Impact of an Improving Economy on Energy Prices might not be what you think. Oil prices may plunge as the economy gets better only to rebound in a demand driven rally.
- OPEC Oil Production on the Rise;
- Geo political risks: Show down with Iran/ Russia and the Ukraine.
To predict the fate of energy prices next year we need a brief overview of what drove energy prices last year. Oil was not driven so much by supply or demand but driven by the largest global economic intervention in the history of the globe. Global central banks around the world led by Fed Chairman and Time’s Man of The Year Ben Bernanke went to extreme measures to bring the global economy back from the brink of what was the greatest global economic crisis since the Great Depression. Not only that, Big Ben Bernanke and other global banks created a bull market in commodities. That was only the beginning.
This year was one where many oil traders had to forget everything they believed about supply and demand and so called wet barrels and dry barrels and instead was forced to focus on the intricacies of currency exchange rates and global macro economics and the relationships therein. Traders had to view a barrel of oil not so much as a commodity but as pawn in one of the greatest economic comeback stories in the history of the world. Oh sure there were those that failed to grasp the fundamentals of the crisis and tried to blame speculation for all of the economy’s ills, yet it is now clear to many in retrospect that markets acted just as they should.
Traders had to think about the price of oil in a different way. It was hard to do as many had false assumptions about what was driving oil before that. If you remember how the year started in oil, it was a time of great fear and uncertainty. The price of oil, like a lot of other commodities and stocks, was in the grips of a deflationary death spiral. Crude oil hit a low of $32.70 a barrel at the start of the year after a death defying plunge from the all-time high of $147.27 dollars per barrel in 2008. And that perilous drop was nothing compared to the demand drop. According to the Department of Energy the consumption of liquid fuels and other petroleum products in 2009 compared with the year before, had one of the steepest declines on record. Consumption fell by a stunning 1.25 million barrels a day as fear and the destruction of demand permeated the market place. The economy was crumbling and we were losing faith in everything. Bank failures and auto-company failures, industrial production grinding to a halt as the greatest economy the world has ever known started to totally meltdown and the rest of the world melted along with it.
Yet despite the dire predictions and the fear that all hope was gone, the market came back. It came back as the Fed and other world central banks came to the rescue and hit the economy with massive amounts of stimulus. And the most significant factor that happen in 2009 and what will be a major factor for the price of oil in 2010, was the day in March when the Fed printed a floor under the price of oil. Or in technical terms, it was the day the Fed went to quantitative easing.
Yes, 2009 was a time when the term "quantitative easing" came into play. For those who do not know it is a term that basically means we - The Fed - printed money. They lowered interest rates and went as low as they could to further stimulate the economy. The Fed and other banks around the globe turned to their printing presses and started printing currency by bucket loads to try to stop the deflationary spiral. Our economy was very sick and the Fed had to go to extreme measures to try to bring it back from nearly certain death and make it well again. We exchanged deflation and hoped for a bit of commodity price inflation because the alternative was extremely bleak. As the Fed pumped in more cash the dollar lost value and commodities soared and oil more than doubled in price. Oil futures reflected the improving mood by rising more than 64% from a low of $32.40 a barrel last December.
People ran to gold and oil seeking safe haven from the credit crisis because the dollar was falling. The subsequent commodity price rise along with the free flow of cash helped stabilize the banks and the economy and helped put an end to our deflationary mood. Quantitative easing was the equivalent of putting the economy on a high powered drug to alleviate fear and depression and stop the deflation spiral that was making our economy suicidal.
And after that major injection of fiscal laughing gas we are now starting to feel pretty good. The world is looking more like the worst is over; we are all feeling a bit woozy but better. The deterioration in the jobs market is slowing and near record productivity suggests that we may be seeing job growth return. We have returned to GDP growth and the recession may be technically over. Wow, these quantitative easing and zero interest rate drugs feel pretty good right now.
The problem is that we cannot stay on these drugs forever. Drugs can make you well but if you stay on them too long they will destroy you. In 2010 we will have to get off the drugs and it won’t be easy and we may have to focus on such frivolous matters of oil supply and demand.
At the beginning of 2010 we think that the removal of stimulus will be a bearish event for crude. We will see the dollar rally and the fear that higher interest rates will slow demand should cause a major break in the price of oil. But after a big drop, the low price of oil should create a buying binge caused by low prices. We should see sizable swings and opportunities similar to what we saw in 2009.The price of oil at that point will be predominantly driven by improving demand. But this demand has to be real and inspired by low prices and not artificial demand created by fiscal stimulus. Even the International Energy Agency, an energy advisor to consuming nations, says it expects consumers globally next year to use on average 86.3 million barrels a day, representing an upward revision of 130,000 barrels a day from the IEA's November report and growth of 1.5 million barrels a day from 2008. Still oil could fall as low as the $40 handle as the stimulus wears off and then a new bull market will be born. I then see exceeding $82 a barrel later in the year. RBOB gasoline will fall to the $120 before rising back to near $210 handle before and heating oil back to $110 before going back near $212. All markets should exceed slightly the 2009 highs.
As the stimulus slows and demand growth stimulus wears off, the market will have to work off a glut of supply that is high compared to historical standards. U.S. crude supply in early December was about 7.2% above the five-year average. Gasoline supply in the United States was 4.8% above the five-year average and distillate supply a whopping 24.7% above the five-year average. Globally, oil product stocks in the in the Organization for Economic Cooperation and Development (OECD) reached their highest level in several years in September in spite of OECD refiners reducing crude runs by 1.7 MB/D on average in the first three quarters of 2009 compared with the same period in 2008. That is based on data from the International Energy Agency. And even as demand improves, oil producers are anxious to meet that demand with more oil production.
As we enter the New Year of 2010, OPEC is now raising production and that will add to the bearish mood. Saudi Arabia, the world’s biggest oil supplier, raised crude production to as much as 8.5 million barrels a day and at the same time has an estimated four million barrels a day of spare production capacity. OPEC is confident that demand will grow and they are eager to gain back lost market share so we'll see them over produce until they realize that their excess added to a major break in price. That price break will lead to a production cut that will help oil resume its run to the highs.
Of course we have to look ahead to possible geo-political risks as well. Iran continues to thumb its nose at the world community ending the year by test firing upgraded version of an advanced missile capable of hitting Israel and parts of Europe. Russia and the Ukraine seem always to have a gas dispute for the market to contend with. But the year 2010 should be a year of the economy continuing to heal, even though that healing will not be painless, and a year of tremendous moves in energy and other commodities.
Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at email@example.com.