10% oil price fall is a bad omen for 2007

Supply and demand governs the pricing of commodities. But the dramatic extension of the declining trend in oil prices has caught analysts on the hop.

Perhaps it should not have done. Oil charts show a peak price of $78 a barrel last July and have been weakening since then. So the plunge to $53-54 a barrel is an extrapolation of a trend.

However, the breaking of the 200-day moving average price is a major event for chart analysts. Indeed, the most extreme case suggests that from this point oil could plummet to the early $30s a barrel within four months.

Market economics

Back to supply and demand: a very warm winter and a slowing US economy has reduced global demand, while at the same time new sources of oil are coming on stream and stock piles are full to the brim. This is just how any market works, and just because oil is the biggest commodity market of all makes it more likely to obey conventions, not less.

In fact the long term average oil price is $24 a barrel and in the text books markets always revert to their long term mean. Will it be different this time?

Opec will certainly be working to ensure that history does not repeat itself, and the cartel is acting with some discipline these days after a period of high prices. Opec has already agreed two output cuts: 1.2 million barrels per day from last November and 500,000 barrels per day from February.

This is a far cry from the increase in production in the late 1990s that sent oil prices down to $10 a barrel. May be the meeting of Opec heads of state scheduled for later in 2007 in Riyadh will be moved forward.

Long term bull market

Nonetheless, nobody should panic if oil goes through a correction in 2007 for this is most likely a bull market correction that will appear as a small dip in a long upward wave. Why can we be so confident?

Well, if we look at the length of past commodity cycles then the current bull market is not done. The length of previous bull markets has been 14-22 years, according to commodities guru Jim Rogers, and that leaves plenty of life left in this bull oil market, and the chance for serious profits on the rebound for the brave.

What could turn the oil market back up? Surely there is no need here to recap the long list of possible geopolitical events and instabilities in the oil producers. And these factors tend to happen when least expected. But that may not help us much right now.