The next oil shock: a stunning plunge in prices?

Oil prices amazed nearly everyone with how high they went.

Could the next shock be how low they soon might go?

Crude futures in New York fell today for the sixth time in seven sessions, losing $3.51 to $124.44 a barrel, the lowest closing price since June 4.

The government’s report of a larger-than-expected weekly rise in gasoline inventories helped spark the sell-off. Later, the Federal Reserve’s report on regional economic trends indicated the pace of activity had "slowed somewhat since the last report" on June 11. And that last report wasn’t exactly brimming with optimism.

Oil is down 14.4% from its record closing high of $145.29 on July 3. But given how many times traders and analysts were wrong in calling the peak over the last year -- $90, $100, $120, $130 -- there’s a natural reluctance to believe this time it’s for real.

"We’ve see this movie before," said John Kilduff, senior vice president of risk management at trading firm MF Global Inc. in New York.

Still, he said, "Things are a little different this time because of the economy."

Gasoline demand is shrinking in the U.S. as consumers retrench. Business conditions have deteriorated in Europe. Even in China economic growth has slowed this year.

Record energy costs "are destroying demand" for oil, said Peter Beutel, head of energy consulting firm Cameron Hanover Inc. in New Canaan, Conn. "Prices are way too high."

He say it’s still conceivable that oil could quickly run to $170 a barrel if a major hurricane hit oil and gas fields in the Gulf of Mexico, or if Israel or the U.S. attacked Iran. But barring a catastrophe, Beutel says, there’s nothing stopping oil from retreating back to $80 just based on economic fundamentals.

And the mad rush to $145, as speculators poured into the market since March, could ensure that the current sell-off also turns into a mad rush to exit the market, some analysts say.

Why? Because speculators are only interested in playing the price trend, whichever way it’s going, said Larry Young, senior trader at Infinity Futures in Chicago. "You can make money just as well on the short side when the price is retreating," he notes.

The next big test for chart-watching traders is the $121-a-barrel level, Kilduff said. If the price breaks through that mark, look out below, he says.

Comments

[Bill%20Riley]

We import close to 70 percent of our oil. Total crude oil imports averaged 9.657 million barrels per day in May. At $134.00 a barrel equals $1,294,038,000 dollars a day leaving the United States. Over a billion dollars a day we are giving away instead of drilling our own oil.

http://www.eia.doe.gov/pub/oil_gas/petroleum/data_publications/company_level_imports/current/import.html

Crude Oil and Total Petroleum Imports Top 15 Countries
May 2008 Import Highlights: July 14, 2008
Preliminary monthly data on the origins of crude oil imports in May 2008 has been released and it shows that two countries exported more than 1.50 million barrels per day to the United States. Including those countries, a total of two countries exported over 1.20 million barrels per day of crude oil to the United States (see table below). The top five exporting countries accounted for 66 percent of United States crude oil imports in May while the top ten sources accounted for approximately 88 percent of all U.S. crude oil imports. The top sources of US crude oil imports for May were Canada (1.840 million barrels per day), Saudi Arabia (1.579 million barrels per day), Mexico (1.116 million barrels per day), Venezuela (1.030 million barrels per day), and Nigeria (0.851 million barrels per day). The rest of the top ten sources, in order, were Iraq (0.583 million barrels per day), Angola (0.464 million barrels per day), Algeria (0.440 million barrels per day), Brazil (0.318 million barrels per day), and Kuwait (0.263 million barrels per day). Total crude oil imports averaged 9.657 million barrels per day in May, which is a decrease of (0.264) million barrels per day from April 2008. Total crude imports for May include 0.033 million barrels per day for Strategic Petroleum Reserves (SPR).

Canada remained the largest exporter of total petroleum in May, exporting 2.265 million barrels per day to the United States, which is a decrease from last month (2.534 thousand barrels per day). The second largest exporter of total petroleum was Saudi Arabia with 1.604 million barrels per day.

[Tom Owens]

This article shows how speculators drove up the price too high, and may now drive it down so low that we again neglect conservation and efficiency. Is this anyway to run a country. Should something so important to our national future be decided by speculators?

[smi2le]

What about a tax on low milage SUVs and PUs, that are partly responsible for the high gas prices the rest of us have to pay. The money could go to building more public transit, which would immediately create a lot of new jobs.

[David]

"Over a billion dollars a day we are giving away instead of drilling our own oil."

That's because we don't like to eat our fish with WD40 and Quaker State.

It is an amazing education for me personally to read all these articles and replies ~ I have started a collection of thousands of them.

I had not realized until now how stupid, how easily decieved my fellow Americans are by a gang of Wall St. suits who's IQ is only nominally higher than their own. Have we become so technocratic that we have forgotten that there are three types of lies: "Lies, Damned Lies, and Statistics?"

Don't people *think* anymore? Is there just a "blank out" when some self-appointed expert throws out things like..."Preliminary monthly data on the origins of crude oil imports in May 2008 has been released and it shows that two countries exported more than 1.50 million barrels per..."

My god. HE knows he's fuddling your brain, why don't you? Toss a few "preliminary datas" and a few numbers at people...is *that* all I had to do to buy and sell people?

If and when this measure passes the Senate, and the price of oil plunges, I expect that I will hear the "peak oil" bloggers no more. They will vaporize. It will be as if we always *knew* it was speculation, with no bribed journalists betraying the public they were supposed to serve, no US President betraying the poor suckers who elected him from his bully pulpit, no American plundering their fellow citizens wholesale via self-serving fear campaigns.

It will be like it never happened.

I realize that this has taken place a thousand times before. But I had not realized until just this week that my country is dead.

Which is what we deserve. We chose fear and security ~the salvation of the gutter- over freedom, and so we deserve neither security, or freedom. We let the home disintegrate while we chased a lifestyle obsession.

We deserve to be decieved.
We deserve $4 a gallon gasoline.
We deserve a President who wears his soul on his face while he mocks the camera with a puppy dog expression that is as tired and corrupt, as his thinly veiled contempt for the Constitution is real. Before this week I would have felt outrage for a group of thugs sitting in the same room as Lincoln and Jefferson once trod, sneering at the rest of us.
Now, I almost admire him.

[kathleen]

i have no doubt that gas prices will start trending down--isn't the republican (corporatist) candidate in trouble? the oil guys can afford to give their preferred president a short break to try and get him elected. then it will be more of the same.

[whs806]

The anti-energy policy of congress is responsible for this mess. They would rather buy oil from countries that don't like us than to produce oil and gas, coal, nuclear, wind, and solar energy domestically with Americans. Like the high prices? Do nothing, it's working! Don't like it? Replace the dip-sticks in congress with Patriots concerned about our country, it's citizens, and our economy!

[Matt]

IMO - I suggest you look a little further to find that most hedge funds increased the amount of capital invested into bullish futures of this commodity. They're just trying to get their returns in commodities while other investment classes moved into bearish territory over the past few months. They did the same with the Grain crisis back in February. All that money reinvested into oil futures just overinflated the price through spectulation.

The true economics of our increased demand for oil during this time frame did not justify the price increase, but losses in world stock and derivative markets because of the credit crisis did.

[Mike Koehmstedt]

To say that oil is going to make a 45% correction ($145->$80) is beyond hopeful. People who keep blaming the rise in oil price on "speculators" are ignorant.

Yes, there is speculation involved in the oil market, but speculation is always present. What we are seeing in the oil price right now is a normal correction that happens all the time in every market. A 15-20% correction, which would drop the price to right around the $120 price support seems appropriate.

Unless the USD makes a huge recovery, which it won't, I would fully expect the oil price to never drop below $100 again and probably not even below $110.

[Richard]

Agreed that a critical technical level for oil prices is around $121, but it will take more than a temporary dip below that level to start to unravel the speculation. The price needs to stay around $120 or lower until the next future contract expires in late August; this will force an unwinding of positions that could start the dominoes falling.

[wdw]

The comment by David is right on. Speculators and Bush and his cronies are oil men. It is no secret why they are bleeding the country- they do it for the money. They are traitors and international criminals that trade blood for oil. The peok oil pranksters than enable them are just as bad. Without their manipulation oil would be below $60 a barrel. People are stupid, greedy and dangerous and we put the worst of them in charge.

[Jay Colby]

In the run up to the 2006 election Goldman Sachs changed the composition of one their commodities indexes by decreasing the percentage of gasoline futures. This led to a big sell off in futures and pushed down the price of gas.

Could similar actions be causing the price pull back now?

[adoptivefather]

The Twelve Missing Gallons

In 1970, I was living just outside Houston Texas with my Mom and Dad, my five brothers and sister. Together we made up a family of nine souls. We lived comfortably yet frugally. My Mom became famous for her ability to make our budget stretch by clipping coupons every day.

At that time, the US was producing 9.6 million barrels of oil per day on US territory and our population was about 200,000,000 people. Looking back now, we realize that 1970 was the year the US peaked in the amount of oil it produced.

We all knew oil derived energy was essential and the nine of us awoke each morning with the comfort that somewhere in our country the equivalent of 18 gallons of oil were being produced that day to support our lives. We also knew that those 18 gallons didn't quite meet all of our needs. Our family actually needed about 28 gallons each day.

Those 28 gallons got my Dad to and from work, brought the police or ambulance when needed, grew our food and brought a multitude of other benefits that constituted our very comfortable American way of life. As for the 10 gallons of oil we needed beyond what was produced inside the US, we knew other countries outside the US had lots of extra oil to sell so the additional 10 gallons per day we needed could be imported at a very affordable cost.

Today the US is producing only 5.0 million barrels of oil per day of oil yet our population has now swelled to over 300,000,000 people. Our family of nine still needs about 28 gallons of oil per day but we are very worried because our family's share of oil the US produces domestically has now fallen to only 6 gallons of per day. We wonder how can this be when just 37 short years ago in 1970 our family had 18 gallons per day of domestically produced oil to rely on.

We are actually extremely worried now because we rely on foreign countries to provide nearly 22 gallons per day of what we use compared to just 10 in 1970. And we hear that many of those countries might not have the oil to sell to us in the very near future. Some of the countries we rely on for imports tell us they are now selling to other countries that need more and more oil for their own growing economies.

We found out just recently that Mexico is the 3rd largest exporter of oil to the US and that they won't have any extra oil to export to anybody in as few as six more (short) years!! They are warning us their oil production is dropping, just like it has been for the US since 1970, and that their own internal consumption is increasing.

Mexico is signaling that we should start to make other plans if we think we will still need their oil in the future. And at the same time Mexico and other countries have sent millions to our soil further increasing our dependence on foreign oil.

Our family's cost for oil has already risen to a level that we are trying to reduce the amount we use but we find that it is very hard to do. After all, how do you get to work without oil? Or take kids to school or soccer practice? Or get to the doctor's office? Every time we try to reduce we find that we really need the oil so we are trying to reduce spending on other things so we have enough money to buy the oil we need.

And we realize that much of the oil we use isn't used directly by us so we can't choose to use less. The police and fire departments must still respond to calls. The transit buses must keep their schedules. Farmers must grow and deliver the food we need. And the utility trucks must go out to do repairs. We enjoyed the spectacle but also wondered where all the fuel used by the military jets flying training flights over Torrey Pines during the recent US Open golf tournament. If others using oil on our behalf can't reduce the amount they use they must have to pass the cost on to us.

The most scary part about this situation is we know that the US will produce less oil next year and the year after while the US population keeps increasing by almost 3,000,000 new people per year. That means the US must have a new source of oil supply of about 9,200,000 gallons each day or everyone will have to cut back. That translates to over 3 billion gallons per year of additional oil we must have or we will be forced to reduce our consumption due to US population growth!

This is the true and sad story of our family and The 12 Missing Gallons.

Now I ask you, how many more gallons of oil per day can your family do without?

Do you have a long term plan to supply the oil you need or are you actually just an evil speculator on the short side of the market?

Do you think it is smart policy to keep adding more people to US population without a long term plan to provide the energy required to support the American way of life we have come to love and expect?

Each American currently needs 3.07 gallons of oil per person per day to support their quality of life.

[adoptivefather]

Ask yourself this question: Am I an oil speculator? Right down your YES or NO answer on a piece of paper before you read on.

Then think about this. Have you ever bought a car without simultaneously purchasing all the gasoline you would need to power it? If so you WERE an oil speculator with a MARKET SHORT position.

You bought on the belief that future gasoline would be available and cheaper than locking in a price at the time of purchase. You probably did so becuase your past long term experience led you to believe in cheap and plentiful gasoline. That by definintion is: SPECULATION.

[edwin jewell]

Theres plenty of untapped feilds in Iraq,we need to secure this area for future development for our own energy survival. This isnt about whats right or wrong anymore,this will be about our very own survival.

[martscan]

Mike Koehmstedt has it about right, except my rough rule of thumb starts at 100 +/- and peaks at 148+/-, and a 50% break has me buying in here at 121-124 with a double stop at 119.50 close only. I'm also simultaneously selling the dollar and the DJIA at the mkt...unfortunately, there is no margin break for this inter-market straddle. Futures markets are ALL traded technically, and oil price action is no exception to classic, basic patterns which a preponderence of traders act on, resulting in a high degree of self-fulfillment.

Regarding Richard's premise of a price collapse on the expiration of a contract, August, it is not so simply due to a contract expiration....have you not heard of the 'Goldman Roll'...Goldman or not, positions and percentages of longs/shorts can be maintained, as is the price trend, by simply switching into the new front month.

[Richard]

Much as I appreciate the way "adoptivefather's" point is the logical equivalent of a cute card trick, it doesn't really apply. Since the average person does not have the means of storing a lifetime's supply of gasoline, failure to buy that supply when purchasing a car does not constitute short speculation on the price of oil. One could do it notionally by buying oil futures, but the correlation between the prices of oil and gas is not perfect, and most people are not really in a position to buy futures contracts anyway.

The truth is that speculators really are a relatively small minority with a disproportionate effect on the financial markets, but there is no point railing against them. They usually get what they deserve in the long run because of their tendency to buy high and sell low.

[richard]

Martscan is correct that positions can simply be rolled forward, but if there is a loss, the investor is forced to settle up when the contract expires. In other words, as long as the upward price trend remains intact, the momentum can be sustained simply by rolling postions forward, but if that trend is interrupted, the momentum can be broken when those investors are forced to pull some money out of later contracts to settle losses on the current one.

[martscan]

Richard:

Contract expiration, while it forces liquidation of futures positions, has no more bearing on the money, margin, status of the account than if the position was under margined with months, or years, left in the life of the contract. Once the money amount drops below the maintenance level, a margin call is issued requiring margin be brought up to the initial margin level. If there is adequate margin in the account, the position can be switched regardless of it being at a loss or a profit. In fact, many mkts call for higher margins in the spot month, due to increased volatility and in some cases no limits, than later months, and the cash position relative to margin in a spot month position switched to a later month would result in a greater 'cushion' above maintenance margin. For example, say the initial margin on a contract is $1,000 and the maintenance margin is $700 in the spot month. The uptrend reverses and the status of the account indicates the equity has fallen to $825. No problem...and if the expiration date is at hand...or notices dates indicate you may be in line to catch delivery..you simply liquidate, sell, your contract and institute a new buy in the next, or later, contract month. Exactly the same as you would if the trade was profitable with, say, $1,900, or whatever, in the account. However, if prices drop and your equity falls to, say, $650..you will get a margin call for $350..to bring it to the initial level...this is true regardless of when during the life of the contract it occurs. Also, let's say your equity falls to $750, you have a losing trade, you have no margin call yet, its expiration time and you switch into a later, lower margin month by liquidating the current trade and simultaneously buying a contract 6 months hence. The new contract month may call for only $700 initial margin and $500 maintenance margin, ergo, in a perfectly equilibrium mkt you still have a loser but you are actually over margined and you did not have to 'settle up'..in the sense of coming up with more money just because your first position expired.

[Richard]

Certainly, martscan, it doesn't matter in theory when the money comes out of the market -- either during the contract's term, or at its expiration. Market history, though, demonstrates two things: 1) that contract expiration dates can be disruptive as they force recalculation of positions and 2) that when a market has been driven by speculation, losses tend to beget losses, until prices fall close enough to fair value to attract fundamental investors.

Of course, another couple bounces like yesterday's, and all this will be moot for the time being....

[Greg Grimer]

Unless the USD makes a huge recovery, which it won't, I would fully expect the oil price to never drop below $100 again and probably not even below $110. Posted by: Mike Koehmstedt
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Hmmm. $68 at the moment