Complex Made Simple

Can oil prices hold?

This week oil tripped past the $120 a barrel barrier. Yet it was only in January this year that we saw $100 oil for the first time, and this column wondered if that level would hold or mark a peak.

Well, the oil market has given its answer to that question, and we now have to consider a new all-time high of $123 and ask can that last?

The great billionaire hedge fund manager T. Boone Pickens cannot have had a good start to 2008. The oil price has refused to fall as he predicted and his funds are doubtless suffering as a consequence.

But it could be the legions of hedge fund managers who chose to enter the energy markets this year and place money on higher prices that are most to blame for the oil price tag.

You still have to wonder, however, where is all the money that is flowing into oil and gas futures and other energy related derivatives coming from?

The responsibility trail surely leads right back to the Federal Reserve. The loosening of US monetary policy, with interest rates down to 2%, is allowing hedge funds to take huge leveraged positions in the energy markets.

Monetary policy

Former Fed chairman Paul Volcker was right when he said in 2000: ‘Inflation is related to monetary policy. The issue of money is a governmental responsibility, and to use that authority in a way that leads to inflation is a system that fools a lot of people, and to keep fooling them you have to do it more and more.’

Who better to remind us of economic reality than the man who beat the 1970s inflation in the early 1980s, albeit with monetary policy that produced a deep recession and the collapse of thousands of local US saving and loans institutions.

But if we are really back to those bad old days of sky high energy prices and soaring inflation, and the Fed has indicated that it will do whatever is necessary to support the US economy, then the logical conclusion ought to be that $120 oil is just another step on the ride towards $200 or $300 oil, or whatever it takes to slow the world economy to lower consumption.

Figures that are backed by Goldman Sachs’ recent prediction that oil could climb to $200 per barrel within the next two years.

Dwindling oil reserves

At the same time, the fundamentals do not look good for lower oil prices. One million more cars are bought in China alone every year, and energy consumption is on an upsurge worldwide.

But the supply position is precarious, with output falling in the North Sea fields, instability in most geographical production centres, and new supplies not sufficient to replace dwindling reserves.

Perhaps then $100 a barrel was the important barrier to break in the oil market, and prices will go very much higher from here.

See also:
Oil prices propel GCC inflation surges
Kuwait seeks international avenues for oil revenues