This article first appeared at The McAlvany Intelligence Advisor on Wednesday, January 7, 2015:
Most prognosticators are concentrating on their understanding of economics to inform their predictions on how much lower crude oil prices can go. It's a simple matter of supply and demand: supply is increasing, demand is decreasing (and it's inelastic, to boot), so when demand meets supply – and “clears the market” as economists call it – crude will find a bottom.
One analyst at CNN expects oil to drop into the $30s, declaring that “we could go back to price levels in late 2008 and early 2009 – down in the $30s. There's no reason why it couldn't happen.” Another, Jeremy Warner of the Sydney Morning Herald, got lucky with his call a year ago that crude would drop to $80 (while it was trading well above $100), and decided to push his luck:
If on to a good thing, you might as well stick with it; so for the coming year I'm doubling up on this forecast. Far from bouncing back to the post crisis “normal” of something over $100 a barrel … my view is that the oil price will remain low for a long time, sinking to perhaps as little as $20 a barrel over the coming year before recovering a little.
And there's the technical analyst who told CNBC that current chart trends point to the possibility that crude has three downside target areas where it could find support – $44, $35, and then, if those don't hold, all the way down to $13.65 a barrel.
Most are celebrating the drop as unalloyed good news. For drivers, it's equivalent to a $750 annual tax cut. For consumers it's a reduction in their cost of living, not only at the grocery store but at department stores and in their utility bills. Truckers are enjoying the ride as well as restaurants, airlines, and those manufacturers which use enormous quantities of energy. All of this, they say, is going to show up not only in an improved standard of living and a better “consumer sentiment” (à la University of Michigan's recent positive readings) but a boost in the country's overall gdp, estimated by some to lift it by at least one half of a percent if not more in the coming year.
Some are noting the downside: marginal oil and gas producers are already cutting back, or are being forced to do so by reluctant banks and a junk bond market that is now suddenly treating energy junk bonds like pariahs. And no wonder, as producers have sold more than $200 billion worth of bonds to finance their capital-intensive businesses while at the same time borrowing more than $300 billion from banks.
And then there's the global derivatives market, estimated by some to exceed $700 trillion, with much of it directly or indirectly related to energy. That exposure also provides a reasonable explanation as to why banks were so happy to have their derivatives-laden trading departments now covered by the US taxpayer, thanks to that little mod that showed up in the CRomnibus bill that was approved last month.
With oil prices below $50 and falling, the end game isn't pretty: without the jobs growth in the oil patch the country would still be in recession. Without the fracking boom, related industries like manufacturing, health care, and housing would still be foundering.
But at some point, so say those focusing exclusively on the economics, crude will find a bottom, and soon, thus limiting any permanent damage to the economy.
The problem, however, is politics, and it really began back in September, about the same time that OPEC announced that it wasn't going to cut back production in order to stabilize prices. Instead, it determined to keep on producing, with the predictable result being the collapse of oil prices. Some have said it was to force marginal producers in the US to cave, cutting production and allowing OPEC to reap the reward as prices rebounded.
But careful analysts with a broader and perhaps more realistic view have concluded that Saudi Arabia saw declining prices as a way to punish its enemies Iran and, to a lesser extent, Russia. Back in September, Secretary of State John Kerry held a critically important meeting with the king of Saudi Arabia, allegedly to drum up support for US attacks on the Syrian extremist group known as Islamic State. As the Wall Street Journal reported:
At the palace, Secretary of State John Kerry requested assistance up to and including air strikes, according to U.S. and Gulf officials. “We will provide any support you need,” the king said.
That moment, more than any other, set in train the U.S. air campaign in Syria against Islamic State, according to U.S. and Gulf officials….
The [agreement] gave the Saudis leverage to extract a fresh U.S. commitment to beef up training for rebels fighting Mr. Assad [Syria's president], whose demise the Saudis still see as a top priority.
Who is supplying those rebels? Russia and Iran. Andrew Topf, writing in Reuters, noted the connection and the opportunity through lower oil prices – much lower oil prices – to punish both Russia and Iran:
By opposing Syria, Abdullah [the king of Saudi Arabia] grabs the opportunity to strike a blow against Iran, which he sees as a powerful regional rival due to its nuclear ambitions, its support for militant groups Hamas and Hezbollah, and its alliance with Syria, which it provides with weapons and funding.
The two nations are also divided by religion….
The conflict is now a full-blown proxy war between Iran and Saudi Arabia….
Knowing that the demand for gasoline is relatively inelastic – drivers don't necessarily drive more miles just because it's cheaper to do so – and that the economic slowdown in China would provide a tailwind to the decline in demand, the king got a bonus: punishing both Iran and Putin. Obama also got a bonus: if the collapse in oil prices also results in a shrinkage in the oil patch, his environmentalist supports will likely celebrate that as unalloyed good news.
BenSwann.com: Expert: U.S. Has Leveraged Economy On Shale Oil, Which Saudis May Be About To Crash
Casey Research: Make No Mistake, the Oil Slump Is Going to Hurt the US Too
The Economic Collapse blog: Who Is Behind The Oil War, And How Low Will The Price Of Crude Go In 2015?
OilPrice.com: Did The Saudis And The US Collude In Dropping Oil Prices?
Finance.Yahoo.com: U.S. is in an oil war with Russia and OPEC: Katusa
Wall Street Journal: Deal With Saudis Paved Way for Syrian Airstrikes
Reuters: Saudi Arabia is playing chicken with its oil
246WallSt.com: It Has Arrived! What Oil in the $40s Means
The New American: Voters Finally Learn What's in the CRomnibus Bill Passed by the Senate