Tuesday, October 3, 2006

Markets zig & zag. Markets don’t zig & zig.

Today someone asked me: “If there is an Oil supply problem coming in the near future, why is the price of Oil going down?” A fair question, I believe. I casually replied that markets zig & zag (these are technical terms), they don’t zig and zig. Let me translate: markets such as that for crude oil move up and down for a variety of reasons: seasonal, political, economic… they do not move up and up or down and down or flat and flat. If they did, why the hell would we need traders, bankers, economists, analysts...

I have no definitive answer for the price movement of any security, commodity, property, etc… in the short term. If I did, I wouldn’t need to be gainfully employed (nor would any of the professional economists we hear so much from in the media). That disclosure aside, oil, like any commodity, trades at the margins. It’s that last barrel that moves prices up or down, not the million before it. 1% too much oil can move the price of 100% of the oil down 25%, (we just saw that in the last 6 weeks with oil falling from $78 to $58). The mirror image is true, too. 1% too little oil and the price might be $75, $85, $100…

That, in my humble opinion, is where we are going (and where we have been). We will continue to see substantial volatility in the price of oil in the spot and front month markets as we move back and forth from 1% too much, to 1% too little. Now pay close attention – the price of oil just zagged, hard (now please see title of article).

China, India, the Former Soviet Union, and most of Asia with the exception of Japan, demand more and more oil to power their economies - and winter is coming (Unless it gets called off again). Although the U.S. consumes 25% of the world’s oil, it’s the MARGINAL consumer that matters. Why are the Asian economies the marginal consumer? To paraphrase Willie Sutton – because that’s where the growth is; because that’s where major industrialization is taking place; because that’s where the population is. If China’s population enjoyed our lifestyle, they would be consuming over 80 million barrels of liquid petroleum products per day – about 95 % of what the entire world now consumes. Where is that oil going to come from? What country? What field? What province? We have identified the marginal consumer - where is the marginal producer?

1% too little will be here before you know it.

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