What will be the oil price at Christmas?

In talking about the market in crude oil we often looks for items, events, and structures that repeat themselves. We pin some kind of faith on them because we are unable to see the future with any real clarity. For regular readers of this column, you will realise that this is the start of an explanation as to why we predicted crude oil would be $66.60 at Christmas. But - as well as begging the readers' forgiveness - when these events fail to repeat, we can be sure something new is afoot.

Firstly, we would like to point out that last year our prediction for Christmas Eve was spot on at $61 a barrel. This year we felt that a similar process of shorting the market in the run-up to Christmas, as had happened in 2004, 2005 and 2006, would take place. Fourth time unlucky. It did not.

Although there is a huge amount written about the oil market, what is genuinely supporting the price of oil are the fundamentals. There is not enough spare capacity in the world and there has been increasing demand from certain areas, notably the US, China and India. This is not the fault of OPEC; it is not the fault of "speculators"; it is not the fault of "terrorists" and Middle Eastern governments. It is structural, it is the onset, however you see it coming - and this column does not think it is geological as such -- of a peak in global oil production.

Whether the peak is at the current figure of 85 million barrels per day or can sneak up to 95 million barrels per day over the next decade is neither here nor there. In historical terms we are on the cusp. What is slightly worrying at the moment is how that cusp is taking shape.

In normal times, a recession dampens oil demand. But at the moment we see many people in financial difficulty, we see a credit crisis, and we also see doggedly high inflation. But instead of weakening oil prices, those prices have stayed firm. After oil breached $99 per barrel in the last month, it fell back to $86

per barrel, and many like us thought it would drop further due to impending signs of economic weakness. It did not.

In plain speaking, this is getting worrying. A recession is bad enough, but a recession with high inflation starts to create stagflation. If oil stays at, or around, the prices it achieved in 2007 then we could be in for some serious troubles. Remember that oil prices do not knock through into economies straight away, the impact is delayed, maybe as much as 18 months in some cases. For example in the European Union food prices have boosted inflation to 4.1% - those food prices have been boosted by energy, by oil.

As an example, the credit crisis has not suddenly exploded over one night, one speech or one erroneous political statement. There was no single factor that blasted it into the public consciousness. Instead we had the slow drip effect. Some people had been warning for years that printing extra money to stave off recession - by creating false liquidity - was merely postponing the hurt. It may even end up making that hurt worse.

So the bubble by all that lovely extra cash sucked up more energy at a time when major nations were emerging from the economic hinterland, notably China and India. The result has been the fundamentals that drive the oil price - short spare capacity, creating commodity inflation, creating booming costs, which in turn hinder new projects coming on stream. A vicious circle, a bubble awaiting a pin prick.

What this column has said is that the pin to prick that bubble will be the U.S. elections next November. An excuse the system can make to unload all that uncertainty in the form of a chunky recession, let us hope that like our prediction for $66.60 at Christmas, we are wrong.

Courtesy: http://www.resourceinvestor.com