Tuesday, December 2, 2008

4 + 1 Market Overview

Featuring 4 things that matter a bunch to energy market prices, and one thing that should matter but is generally being missed by the market.

1) The Economy: It is official, the NBER called the recession yesterday - and post-dated it to December of 2007. The government has committed $7.8 trillion to prop up the economy - and the patient is still red-lining on the operating table. Without signs of life from the economy, it will be hard for energy prices to break the bearish trend of the last 5 months. Indeed, even China is having problems.
Currently, The Economy is bearish for energy prices.

2) Inflation/Deflation:
For years, we have been worried that low interest rates might cause inflation - that is, too much aggregate demand for a finite pool of resources which causes prices for goods and services to move higher. Currently, many observers are claiming the domestic economy is going through a deflationary period. Greg Mankiw discusses this economic phenomenon - the reduction in aggregate demand - in the NY Times. Commodities are bearing the brunt of the this deflation, with crude price decreasing $98 in the last 5 months.

However, with Ben Bernake's Fed trying to stimulate our economy with injections of cash, and inflation is an accepted side-effect. The question is: How far will prices need to fall before Bernake's policies begin to prop up the economy?
Deflationary pressure is bearish short-term for energy prices. Inflationary pressure is bullish intermediate-term for energy prices.

3) The Price of Crude:

OPEC member nations are going into budget shock - they had never anticipated that price could fall THIS FAR, THIS FAST. They will be forced to cut production at some point to gain control of the situation. Further, many of the tar sand projects at Fort MacMurray have been idled, as crude price has sunk below the marginal cost of production.
This is bullish (long term) for energy prices.

4) Inventory Balances:

The EIA reports that crude and unleaded product balances have been building for 10 weeks straight and that the inventories now sit on the high side of the 5 year average. Consumption has taken a significant hit - even in the face of lower prices.
This is bearish for energy prices.

And the one thing no one seems to be noticing:

+1) Future Growth

The world is still growing its population at an almost geometric rate, and the economies of China and India continue to develop. Certainly, the last 6 months have altered original near-term demand projections...but that does not change the fact that in the longer-term outlook, our world economy is still addicted to oil. And no one seems to be noticing!!!

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