Which Way For Oil?

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The price of oil has come down significantly over the last week or so falling from over $147/barrel to $126/barrel as of this writing. Is this the top of the chart and if it continues to fall what can we expect for metals?

Some are still predicting $250/barrel for oil next year, though others have called $50/barrel. Both seem extreme but the price fall this month has largely been attributed to investors, speculators, call them what you will, pulling out of the market in the realization that a slowing US market has resulted in a drop in demand from the world’s largest consumer. Lehman Brothers says global demand growth will be 47% lower than initial forecasts this year because of declining US consumption and slowing world growth. The issue then becomes what is the new level likely to be? For the time being, the price has settled around $125-127/barrel, balanced between a perception of a world shortage, political tensions over Iran, and monitoring of stock levels and demand during the summer season in the US and the Beijing Olympics in China.

So if prices were to continue to slide how far could they go? Back to sub $50/barrel? No we doubt it but at current levels there is such a rate of demand destruction that the $250 level is likewise untenable too. So in reality, we are probably looking at somewhere between $85 and $120/barrel. If that were to happen what would the impact be on other forms of energy such as thermal coal and natural gas? They would come down too. All forms of energy are interrelated. If oil were to fall dramatically, there would be a switch from coal or gas to oil and the price of those commodities would come down. Natural gas prices have already come down from a peak this year in the US, driven by similar sentiments to oil.

If energy costs come down so will one of the major planks underpinning the price of a whole range of metals from aluminum to zinc and everything in between. Not only is energy needed in the production of the material itself, but often the constituent parts also require a large power input; for example, the production of ferro silicon that goes into steel making. China has closed at least 10% of their aluminum production capacity in recent months because of high power costs ” 30-40% of the cost of making aluminum is power. When the oil price surged last month, aluminum hit a new high. As the oil price decreased last week, aluminum fell. Speculators know if power costs fall the idled Chinese production capacity would come back on stream increasing supply and depressing the price of aluminum.

There is a long chain of events here: falling oil demand causes a decline in the price feeding through into lower power costs and less support for high prices for energy intensive metals. So if your main concern over the oil price was the pain each time you filled up your tank then think again, further falls in oil could mean lower metal prices and that could be just the double flip the economy is looking for. Mind you if the economy picks up and with it consumption so will the oil price.

Oh no here we go again!

–Stuart Burns

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