Yesterday's cave-in hit the energy sector proportionally harder than the markets as a whole, as had been the case with other triple-digit downturns over the past six weeks.
Yes, there was a pullback coming.
No, there are no fundamental reasons why it should have been as deep as what we have experienced.
Of course, the doomsday predictors are as loud as ever. But lately there's a hollow ring in their rhetoric.
The justification for the more than 20% dive in crude oil prices has a bit of circular reasoning behind it.
"The decline in demand has resulted from the excess amount of crude oil on the market," they chant, almost in unison. "And the excess supply is causing the decline in demand."
We could certainly turn to manipulation of the futures market by those playing major across-the-board shorts, or the curious "phantom barrels" that have been showing up in inventory figures globally.
But I am not interested in this morning's latest conspiracy theory. The short players have been successful in depressing the price of oil and making money in the process. These same folks will be attempting to make money by jerking the price upwards once the floor hits.
Right now, we are significantly oversold in both the futures price and in the energy sector as a whole. That is setting the stage for a rebound, and it will take only a tiny spark to ignite.
Maybe that "spark" will be the collapsed talks between the "Big Six" and Iran, now guaranteeing the EU boycott of Iranian oil on July 1.
Or perhaps it will be recognition of the strange fact that, despite the widespread assumption from the talking heads on TV that stockpiles of oil products are way too high (many of these being the same guys shorting the market as soon as they leave camera range, by the way), refinery capacity utilization is much more elevated than would be warranted.
Or perhaps the actual OPEC and International Energy Agency (IEA) global demand figures may finally sink in; they point to the highest per-day average crude oil usage in years.
Yes, both agencies have cut their projections from earlier in the year, but they are still indicating more than a 1.5% rise in overall worldwide consumption in 2012.
Right now, we are approaching less than four million barrels of surplus capacity internationally. Virtually all of it is Saudi. Oh yes, and access to virtually all of that would require passage through the Strait of Hormuz.
And that brings us back to the accelerating crisis with Iran.
July 1 is Approaching Fast
Given the sanctions already in place, Tehran has had difficulty processing currency exchanges for the crude it can sell, reducing the revenue flow.
With world prices diving, they are in an even more desperate situation. (Some 90% of Iran's budget is financed by oil sales proceeds.)
Some in Iran have openly suggested they may obstruct the two-mile wide strait in response.
(And that may be soon.)
On July 1, not only will Iran lose 24% of its monthly exports (the amount that normally goes to Europe), it will also face additional sanctions that would penalize insurers, bankers and shippers trafficking in Iranian oil.
When the major Chinese insurer declared recently that it would no longer cover Iranian consignments for Chinese shipping companies, the country that had been Iran's dominant oil trading partner suddenly fell to number two (India is now leading). This development is of serious concern to Iranian authorities.
All of this will be hitting the market shortly. And there is little that the short artists can do about it but ride the price upwards on the other side of the trades.
Still, emphasizing suppressed demand and lowering the price not only makes the sanctions harsher (remember, the ultimate objective here is to steer Iran away from its nuclear ambitions), it also buys Brussels some time to figure out how to overcome the shortfall in imports.
But that would bring us back into the realm of artificial manipulation—this time for political reasons—and yet another conspiracy theory.
The Prophecy is Wrong
There is one way in which this self-fulfilling prophecy is just dead wrong. It is not simply a misapplication of data. It is simply flat-out incorrect.
Commentators continue to talk about volume coming on line. In other words, not only is demand sluggish, but there is a considerable amount of new supply available to further depress the price.
The problem is simply this. The supplies they refer to are either reaching their infrastructure limits (shale oil in North Americas, where a considerable amount of midstream capacity needs to be constructed to move it to the western and eastern portion of the continent, where imbalances persist), or they will not be flowing for three to five years.
This is not readily available additional supply. It is, at best, future supply.
Commentators will bring up major fields like Kashagan off Kazakhstan, the largest find in the last 40 years. Yet there will be no volume of consequence entering the market from the field until 2016 at best.
Then there is much optimism about improving export figures to come from Iraq. Baghdad has signed a series of important contracts with international majors to ramp up production at existing fields. Once again, however, that volume is not coming next month (as the pundits would have you believe), but is still several years off. And there are major problems with getting the new oil out of the country without constructing expensive export faculties.
Remember, all of these expenses are passed on to the consumer.
Throughout all of this, the global usage figures will continue to advance as more areas feed a need to develop.
There is also one other result of the current low prices. Reduced prices for oil and oil products have always occasioned more usage of them.
That means, as the price goes down, the rise in demand assures the prices will be going back up.
We will have a period here of subdued prices, but the prophecy of impending doom is hardly warranted. Think about it. For a justification of low prices to remain, the proponent must conclude a significant worldwide recession (or worse) is assured.
I don't know any bear east of Yellowstone who really wants to argue that. It results in the cruelest of ironies.
Gasoline prices will decline to the level that people can finally afford to fill up the SUV.
Of course, when they get in, they no longer have jobs to drive to.
Seems to me we have been there before.
Kent Moors
Oil & Energy Investor
