Gustav And Oil Pricing's New Calculus

Earlier this year, it did not take much to disrupt the price of oil and send it rocketing up. The market was inclined to believe that almost all news about crude was bad news. OPEC was aligned against US interests. Demand in China was insatiable. Speculators were making hundreds of millions of dollars manipulating prices higher to profit from their long positions.

Most of that has clearly changed, but the evidence from Gustav’s run through the Gulf shows that it has changed more than expected and that the alterations may be nearly permanent.

As recently as June, news of a supply interruption would move crude up a few dollars. A broken pipeline in Canada did it and so did concerns about storms in the North Sea and political unrest in Nigeria. Oil would move to $200 and nothing was likely to stop it.

In the case of Gustav, oil prices dropped $4 to $109 before the damage from the storm could even be assessed. Some companies made statements that there had been no devastation, but not one could state with certainty that they had not lost some capacity.

In just three months, the psychology of oil prices have moved from one of neurosis to one of normality.

The market cannot look to a unique event which may have turned thinking on crude 180 degrees. Traders do believe that speculators have been pushed out of the market. Falling prices hurt their calls on $150 levels. A threat of government regulation may have sent some into deep caves.

More important, Wall St. is willing to have faith that supply and demand are the critical drivers of price and demand is falling. American car owners and airlines have cut use. Anecdotal information from Asia is that consumption from emerging markets is dropping as their economies slow. The administration said it was willing to open the Strategic Oil Reserve if Gustav had done much to cut supply.

Falling crude prices may be one of the few examples of the sum of the parts being worth more than the whole. The long-term trend is almost certainly that oil supply will fall. OPEC ministers have said they do not propose to increase supply at their meeting next week.

But, for the time being, oil traders simply believe that the worst of high pricing is behind them and trading against that trend is dangerous.

Douglas A. McIntyre