Buy oil @ 90 /bbl

The release of 60 million barrels of oil from the SPR is unlikely to do much more to keep down the price of oil. My guess is that we have already seen the bottom for oil, and that – so long as Greece holds together – prices will firm from here.

The reason that the announcement date is likely to be where we see the largest price impact is that markets know this is a temporary increase in supply. As such (the hated) speculators will price in the temporary increase, and smooth the price adjustment by storing the oil and on-selling it later.

The cost of storage and opportunity cost of the capital bound this price smoothing. Folks have to pay cash upfront for the oil, and also must pay storage costs – so they must expect a higher future sale price, else they would not store it. These costs rise with time until the sale, so the proportion of the oil the IEA releases that is held by speculators for later sale is likely to decline with time (if storage was free and interest rates zero, speculative storage may totally smooth out the temporary increase in supply).

As a result, the of oil price will not fall by as much as would be expected given an unexpected 2m bpd (~2.3% of the 87m bpd of current production) permanent increase in supply. The maximum impact is likely to be when the release is announced, as current oil purchases will be put off until later — when increased supply is expected to make it cheaper. However, at this point, buying by speculative accounts for later sale will also be around its peak.

As the IEA’s ‘gushing month’ passes, these speculators will prevent the price from immediately rising all the back by (re)releasing their recently acquired reserves — and we will glide back onto the price path determined by market forces over time as their supply approaches zero.

I am a believer in the great Eastern story, so i think demand will keep rising more quickly than supply, and that as such oil prices will resume their uptrend. To my eye, this dip has us back on the uptrend line marked out by the mid 2009 and mid 2010 lows.

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12 Responses to Buy oil @ 90 /bbl

  1. ssec says:

    Personally I think oil prices will be flat to lower for a while, or until the “soft patch” passes. It looks like at the end of QE2, it is now clear the biggest threat to the already weak economic recovery is oil prices.
    Then, longer term, if the dollar strengthen (and so does the Chinese currency), it will also help keeping oil prices in check.
    Oil at these levels is already very high in historical terms.

    PS: almost time to update your very cool “Google Unemployment Index” for June. :-) cheers

    • Ricardo says:

      I agree that oil is the biggest threat. I always thought we were witnessing the birth pains of a united Europe — but it seems like a very close run thing up close, doesn’t it?

      Sent from my iPad

  2. The Lorax says:

    Is a soft patch still a “patch” if still hasn’t passed a decade from now?

    As for the “Great Eastern Story”: Chinese demand for cars (and oil) has to grow strongly in coming years because they’ve already built the roads!

    Extraordinary, simply extraordinary. All those new roads, all that debt, all in anticipation of millions of cars. Its like the Cross-City Tunnel a million times over.

    Why is it always the sentinels of free market economics (like our esteemed host) that never see any problem with a command economy going on a massive credit-and-construction binge?

    • Ricardo says:

      I do see huge problems with it – but what is there to say? Beware, communism is wasteful and inefficient? I think that headline is 20 years out of date

      Sent from my iPad

      • The Lorax says:

        Today’s unshakeable belief in China’s economic infallibility reminds me of Japan in the 1980s. Japan’s economic model also worked wonderfully for 20 years … until it didn’t. It ended with an investment binge and real estate bubble as well.

        China today has all the hallmarks of a bubble economy; massive mis-allocation of investment, a huge credit binge, bad loans being hidden or forgiven, and vast swathes of unoccupied housing bought only for capital gain. But for some reason, almost everyone believes it will be different this time.

        • Ricardo says:

          I agree, it looks like it will go Japanese, but that is a long way off just now… Folks are still very poor in china.

          Sent from my iPad

      • The Lorax says:

        I’ve heard this argument several times: China is earlier down its development path than Japan was in the late 80s, ergo, it won’t crash like Japan did.

        But why is this so? Japan didn’t have a massive credit/investment/housing bubble this early in its development path either. China’s bubble has come early, but then its development has been so much faster as well. Maybe this is price China pays for its supercharged development over the past decade?

        • Ricardo says:

          Could be. It has been 30yrs since the Japanese property bubble bust, and it is still very expensive. These Asian bubbles go a very long way before they explode. If you are right, I think that it has a bit to go before it busts.

          Sent from my iPad

  3. The Lorax says:

    Er, I think we can well and truly say Japan’s asset bubble has busted!

    Prices were highest in Tokyo’s Ginza district in 1989, with choice properties fetching over 100 million yen (approximately $1 million US dollars) per square meter ($93,000 per square foot) … By 2004, prime “A” property in Tokyo’s financial districts had slumped to less than 1 percent of its peak, and Tokyo’s residential homes were less than a tenth of their peak

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