Monday, July 25, 2011

Oil: Up or Down?

Steve Levine has an interesting blog post pointing out the financial market actors are increasingly betting that the price of oil will rise:
Oil traders are betting as a herd that they are on the cusp of potentially their most profitable period since the Libyan uprising stoked fears of Saudi Arabian oil being lost to the market. Hedge funds, among the biggest players in oil futures, are leading this charge, according to the U.S. Commodity Futures Trading Commission, which tracks such data. They have upped their bets on a serious rise in oil prices three weeks in a row -- the first time that has happened since late February-early March, Reuters reports.
The reasoning?

What is causing this betting frenzy? Some will say it's a widely expected tightening of oil supplies later this year. But that explanation is not exceedingly persuasive because the long bet has come abruptly. Something more immediate is likelier at work -- such as the federal debt acrimony in Washington.

Look at the price of gold, for example -- it continued breaking records over the weekend, crossing $1,615 an ounce, a play by bettors perceiving higher investment risk out there.

So it is with oil. The bet is that, even if President Barack Obama manages to strike a debt-ceiling deal with Republicans in the coming days, it will not include sufficient budget cuts to satisfy rating agencies such as Standard and Poor's. The reasoning is that, should S&P downgrade the U.S. credit rating to say AA, traders in the casino will sell off the dollar. When that happens -- when the value of the dollar is driven down -- the price of oil will likely go up.
This could be. However I'm also reminded of early 2008 when, as the housing market and the stock market went south, initially these kinds of financial flows led oil prices even higher. Compare the Dow Jones which started going down in about October 2007:

To oil prices:

These peaked eight or nine months later. Ultimately however the effects of the real economic contraction on oil prices took precedence and prices fell sharply.  However, if you'd bet at the beginning of 2008 that oil prices would have to fall, you'd have had a very nerve-wracking few months before being proven right.


Susan Kraemer said...

Why would people invest in oil because the US defaults? I am outside of this world you inhabit so well, and I am not able to connect those particular dots.

Stuart Staniford said...

Susan: I think the reasoning is that the US might default temporarily but it won't be too serious. Thus it might cause a decline in the dollar, but not too much damage to the real economy. In that case one might expect that oil priced in dollars would go up (because the actual supply and demand for it hadn't changed much but the unit of measurement - the dollar - had shrunk).

I'm not sure I buy the thesis myself, but then I'm finding it pretty hard to project what this means in general.