I often reprint articles that I read that I find interesting in my blog. I recently read an article from Brian Davidson of Benchmark Mortgage regarding Oil Prices. This article is very technical but I found it to be very informative as well…take a read!
Why Oil Prices Will Soon Drop
This issue I want to take a closer look at inflation and particularly what lies ahead for energy prices. This is very important for not only the U.S. economy and stock market but also for the global economy.
On Thursday, the Labor Department reported that the Consumer Price Index (CPI) rose 0.3% in October, which was in line with Wall Street’s expectations. The core CPI, which excludes food and energy, rose 0.159%, which was also in line with forecasts.
Higher food and energy prices contributed a lot to the increase in the overall CPI—a 0.3% increase in food prices and a 1.4% jump in energy prices. However, oil prices are on the verge of falling. Economists are now figuring out that as oil prices rise…demand can drop! Wow, who saw that coming? Last week, the International Energy Agency (IEA) lowered its prediction for global demand growth for the fourth quarter. Some OPEC officials have said that they may consider raising their production ceilings as soon as next month. Clearly, the world is not about to run out of oil anytime soon.
Saudi Arabia’s oil minister, Ali Naimi, argued against “the pessimists,” who have driven up prices by predicting supply shortages. He told reporters, “The price today has really no reflection whatsoever with the fundamentals,” meaning, supply and demand. Obviously, he’s playing a bit of politics because he wants to deflect any of the blame of higher oil prices from away from Saudi Arabia. The oil producers naturally want to pin the blame on the lower dollar, geopolitical problems, and most especially, oil speculators.
This last point is being viewed in a suspicious light since several Wall Street trading desks had sold options to investors, including hedge funds, to buy oil at $100 a barrel.
Many hedge funds have bet heavily that crude would top $100 per barrel and they could make a quick profit by exercising their options.
The drawback is the same lesson we learned over the summer: If all the hedge funds do the same thing, it doesn’t work. Lehman Brothers said that the closer oil got to $100, the more investment banks had been buying oil to hedge the risk of losses on the contracts. This means that market speculation has been largely responsible for crude oil’s surge. In fact, nearly one-third of all options to buy crude at $100 on the New York Mercantile Exchange expired on Thursday and are now worthless. As a result, Wall Street firms no longer have to buy oil as a hedge, so crude oil prices have softened a bit.
Let’s turn from speculation and get back to supply and demand. The IEA’s monthly report suggested that the world’s oil supply-demand balance may be softer than it initially forecasted. The IEA said it was lowering its prediction for global demand growth for the fourth quarter by 500,000 barrels a day, mainly due to signs of weakening demand in the U.S. and the countries of the former Soviet Union.
The IEA said that world oil supply rose in October by 1.4 million barrels a day. One surprise performer was Iraq, where output from its northern fields is expected to top 600,000 barrels a day this month, which is the highest level since 2003 when the U.S. entered Iraq. The IEA also noted increased production from Angola, which is a new OPEC member, and that the country is emerging as an important supplier of crude to the United States. OPEC countries supply around 40% of the world’s oil demand, which now runs at just over 85 million barrels a day. Demand for oil has continued to climb in the developing world, but it has actually fallen in some European countries and has barely increased in the United States. The IEA said “strong indications” are now emerging that “high prices are depressing demand [in industrialized countries].”
The other good news regarding the supply and demand situation for crude oil is that Russia’s energy minister, Viktor Khristenko, said that the Russian government is considering new tax breaks to stimulate investment and boost production. After Saudi Arabia, Russia is the world’s second-largest crude oil exporter and is striving to boost its crude oil production to 10.4 million barrels a day compared with 9.8 million barrels a day currently. The country’s new oil production will likely come from projects in Eastern Siberia, offshore Sakhalin Island and the Arctic north. Khristenko warned that there would be no return to the stellar production growth of earlier this decade, when Russian crude oil output soared by more than 10% a year.
Khristenko’s remarks suggest that production growth in Russia, which is one of the world’s most important new sources of crude oil, may be constrained by that fact that after 2010 there are not a lot of new projects. Now that Russia has had a taste of the benefits from high crude oil prices, the country wants to boost its crude oil production further. The only stumbling block is that Russia took a controlling interest in its most successful fields and may have alienated major foreign oil companies. Russia now suddenly needs major capital investments to explore vast areas in the Arctic and Western Siberia.
The Russian government is considering a proposal to extend a tax holiday currently enjoyed by companies working in eastern Siberia to those in offshore regions. This break has already been applied to mature oilfields requiring costly enhanced oil recovery techniques to make sure that they keep producing.
The Russian government also wants to reduce a domestic excise tax on refined products. These moves may not be enough to squelch the protests that have been raised regarding Russia’s taxes on crude oil. Russia’s marginal tax take on revenue from oil above $27 a barrel is almost 90 cents on the dollar, so naturally major oil companies don’t want to work for 10 cents on the dollar. These hefty Russian taxes are collected in a rainy-day Stabilization Fund, which now stands at $148 billion. Russian oil companies say the high tax rate leaves them with little upside to profit from the recent price surge. However, if Russia changes its oppressive tax structure, then I expect an exploration boom.
Thank you to Brian Davidson!
Darryl Glade ~ www.DarrylGlade.com
Filed under: General Real Estate
