It’s hard to believe the world’s largest economy is probably in recession this year while energy prices remain near all-time highs. In fact, I’d bet that by the end of the year, crude oil and the rest of the energy complex will suffer a long overdue correction as global demand slows amid a decline in consumption and growing inventories.
And I’ve got some smart money in the same company in 2008…
One of the legends in the oil industry is also making big bets against oil this year after riding the oil bull for the last six years all the way to the bank.
Soaring Oil as U.S. Growth Slows?
For the first time in the post-WW II period, the price of spot crude is actually rising at the same time the world’s largest economy is contracting.
From an all-time high of $110.33 per barrel on February 19, 2008, West Texas intermediate crude oil has declined to $100 this week. Still, prices are up over 60% over the last 12 months while other distillate fuels have also surged since March 2007. Gasoline, natural gas, heating oil, diesel, jet fuel – you name it, the entire complex has literally gone through the roof!
But what makes this a dangerous speculation at these lofty levels is the contraction in overall demand as the United States suffers a recession this year combined with a slowdown in most major and even emerging market economies. Plus, soaring oil prices have also reduced net demand as prices finally hit the upper end of what the market can absorb.
U.S. Demand Declining since 2006
True, the world needs oil. However, even a hot commodity like oil is forcing companies, individuals and governments alike to look beyond Black Gold and boost alternative fuels like coal, wind, solar, nuclear fuel and ethanol to supplement high prices. Alternative fuels remain very cheap relative to oil and gas and consumption is growing, especially for cheap coal and increasingly, nuclear energy where uranium prices have plunged more than 25% year-over-year.
According to the EIA or the Energy Information Agency, U.S. total demand for crude oil was actually unchanged in 2007 from 2006 levels at 20.6 million barrels per day. And consumption is slowing in 2008 as the economy suffers from the tribulations of a housing bear market, a credit crunch and broad-based consumer slowdown.
China Can’t Support High Oil Prices Alone
Total global energy demand continues to exceed supplies by approximately 1 million barrels per day, or 86 million barrels versus 85 million barrels of net supply. It’s hard to imagine that China, which continues to rapidly boost consumption, can offset declining U.S. petroleum demand without triggering a major correction in oil prices this year. The United States economy might not be the powerful force it was 20 years ago, but it still remains a formidable consumer of almost every raw material, including oil.
Investors and especially speculators wrongly assume that oil demand is elastic, or that high prices will command a buyer. That’s simply not the case and proof is the growing transition from energy-based fuel consumption to alternative fuels this decade amid Peak Oil. A high price for any commodity will ultimately encourage research and eventually, consumption into a cheaper alternative. This largely explains why we’ve seen a boom in nuclear energy, coal, wind and solar energy this decade; consumers won’t pay a high price indefinitely.
Texas Oil Maverick Turns Bearish
Inventories are rising for most refined products this spring setting the stage for a major price decline as speculators finally pull the trigger on one of the most lucrative commodity trades since 2002.
Recognizing the shift in consumption and rising inventories, Texas oil maverick, T. Boone Pickens, has turned bearish on oil in 2008. His hedge funds, which have earned a fortune for investors are now net short on oil. His funds, down 14% the first two months of this year and now scoring direct hits as crude slides from $110 a barrel last month. Pickens believes large speculators are heavily long crude oil and in the absence of demand-side fundamentals are priming themselves for a major spill.
Mr. Pickens, by the way, is not alone betting against oil in 2008.
Long-Term Bull, Short-Term Bear
My Commodity Trend Alert (CTA) service has been recommending a reverse-index exchange-traded oil fund since last fall. I expect oil and gas stocks to break down, a trend that is already underway as many energy stocks disconnect from the oil price recently – a bearish sign. Even with oil trading at $100 a barrel, we’re sporting a small profit on this trade since late 2007!
Longer term, oil prices are likely to head much higher as global economic growth accelerates and China and other emerging powers devour more energy and refined products derived from oil. The world is not replacing its annual production compared to 35 years ago, meaning we are consuming more oil than we can replace every year.
But no bull market is uninterrupted; commodities suffer violent corrections, particularly following blistering gains. Oil prices will decline this year, probably to the $75 or $65 per barrel range, depending on the severity of the U.S. economic recession and whether foreign economies catch a similar cold, or at the very least, downshift from a strong growth trend since 2003.
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