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Thanks SAT :) My first TOD post in October 2005 was about deflation, and I've been at it ever since. The writing has been on the wall for a long time. Liquidity can dry up incredibly quickly as a credit bubble implodes.
I'm not surprised about oil at $77 for now, but I think it's probably peaked. If it was still $77, let alone higher in a month or two, I'd be very surprised indeed. I agree with what Nate said over the weekend - that $50 oil is almost a mathematical certainty. In fact, if I were a betting person, I'd bet on lower than that.
As I've said before though, a lower nominal price doesn't necessarily translate into greater affordability, depending on what's happening to the money supply. Purchsing power could easily be falling faster than price.
Stoneleigh,
When deflation follows a credit boom, it is usually due to the fact that demand doesn't keep up with production capacity. In the near future, we may see this in such areas as office space in Dubai, many Chinese industries (which export to the entire world), but is it true of the oil industry? Even with the enormous amounts of liquidity and credit that have washed over the world economy in recent years, oil production is currently stagnant. Chinese industrial production has been growing 20% a year for a decade, there are almost as many cranes in Dubai as people, but oil production is stagnant. I'm not saying oil prices still can't fall if this gets ugly, but it won't be because the credit boom has led to a large increase in production capacity. Do you think we should expect this credit bust to have more of an impact on the prices of homes, commercial property, cars, t-shirts than on the price of oil?
Thanks for your reply.
Can I just clarify something, in your first factor, you say that if the credit crunch leads to a slow-down in the US economy then oil will tend to go lower.
But in your reply to Stoneleigh about deflation following a credit crunch, you seem to resist the idea of a fall in oil prices.
So, I'm guessing that there is some complexity within the term "credit crunch" which can lead to different outcomes. Can you (or Stoneleigh, or anyone) elaborate on this?
Cheers,
Peter.
BP,
A, "credit crunch," in the absence of 2 and 3, would obviously send oil prices much lower. Factor 2 is not present at the moment. In my question to Stoneleigh, I was alluding to the role factor 3 may have played in the, "credit boom," which now seems to be ending. Why have the massive amounts of easy credit available during the last few years not lead to an increase in oil production as would normally be the case?
Sorry about the delay in replying, but I've been away from my computer for a day or so.
My view of the future for oil prices is that a sharp downward spike due to deflation (which should occur in most asset classes across the board), would probably be followed by a rebound to new all time highs, although I don't have a clear idea about the time frame. I would definitely expect international contagion, which I agree with you would tend to push the dollar higher temporarily. In fact I think we may see a short squeeze in the dollar that could lead to a substantial spike, but I don't think that would last long. Eventually the dollar will go the way of all fiat currencies.
I would say there are strong competing forces driving oil prices in different dierections, the outcome of which is likely to be high price volatility, potentially for quite a while. Deflation drives prices down, partially due to the effect of activity in the financial markets swamping the energy markets, and partly because demand presupposes purchasing power and a strong contraction of the money supply could cut purchasing power very substantially. However, with oil production peaking and many geopolitical risks on the verge of being realized, there is likely to be strong upward pressure on price, especially if the realization of geopolitical risk involves a significant impact on supply (ie sabotage, terrorism, piracy, civil war in oil producing regions, a global resource grab etc).
I think deflation will dominate initially, but probably not for long (at least relation to oil). My guess is that a global resource grab is likely to result in oil supplies being tied up in bilateral contracts, and hence the demise of a global oil market. If, in the (potentially violent) process of securing supplies, oil production or delivery infrastructure suffers substantial damage (I would expect this to happen), then supply could fall very quickly. Supply, and therefore price, could then vary enormously both between regions and over time. That kind of extreme risk would tend to remove private capital from the game, so I would expect national oil companies to play a much larger role in the future.
The one thing we can count on I think is an exceptional degree of disruption. Business as usual simply can't happen, because all the assumptions it is built on are about to be abruptly invalidated IMO.