Tuesday, December 16, 2008

So was Goldman Sachs wrong on oil?


Earlier this yr, Arjun Murti an oil analyst at GS was said to be as a strong driver of oil prices as OPEC's Secretary General mainly because GS had a very strong commodities business but specifically strong reputation in oil futures and derivatives. So when he predicted oil prices rising to $150-200 when they were $100 in March, what did investors do? Dived in and by May, GS was comfortable to put a duration on its prediction i.e. between 6months-2 years. The net effect was that oil prices did gallop on their way towards $200 as speculators now threw themselves in in order to pick up $40/50 lost in equities.

In June, everybody recognised that the credit crunch was real and here to stay. Suddenly some of the fundamentals that underpinned the initial rise in the price didn't look so strong. These were BRIC's growing middleclass and possible Middle East escalations. Then the speculators starting having to find funds to support capital requirements for losses elsewhere and of a sudden we had a drop off the cliff.


However, what does the future hold for oil prices? The price direction will in my opinion depend on the following:

i) Substitutes (ii)Reserves (iii) New oil fields (iv) Drilling technology
(v) Political dynamics in the ever exciting ME (vi) expectations of BRIC recovery
(vii) OPEC production decision

Bottomline: The current price is below the equilibrium if you look at the average price in the last couple of years (I believe the prices prior to April 2007 accurately reflected fundamentals). As such, I'd expect prices to go back upto to $60+ by Q1 of 2009.

5 comments:

Ssembonge said...

Low oil prices are the result of the strengthening US dollar (and demand destruction). Without the appreciation of the dollar, oil would have been trading in the $60's to $70's.


With all the liquidty going around, I hate to think what effect it will have on oil prices once the credit markets stabilize.

That said, I think GS got ahead of themselves.

MainaT said...

Ssem-wat liquidity? Wish you could tell some of these banks about it...
The dollar rose because most our looking for safety. So it'll take a while for safety ro become a lower priority.
Yes 60/70 is the equilibrium level as i said on the post

Kip said...

The OPEC meeting resolved to reduce fuel supply and this will have an effect on the price per barrel and is likely to rise in due course to above $60 and you can guesss the effects locally.

MainaT said...

Kip- OPEC production cuts normally tend not to work well because of the non-members but also non-enforcebility

coldtusker said...

Game Theory... check it out... it will explain why OPEC's actions are short-term and will generally flop...

The rise in oil prices was SPECULATION in the futures market not pure demand & supply....