You must get ready to pounce when the time is right

The oil price continued to fall from Friday’s all-time high. Oil lost over $10 in the last two days… but the long-term oil bull case is still intact.

We may see further dips in the coming months. Grim news continues to come out of the American economy. However, I still don’t see the “bubble bursting” as some commentators fear.

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Predictions of $50 oil defy market fundamentals, which I will come onto in a moment. But let’s look at the reasons for the 7.3% fall over the last two days.

Three factors combined to cause the fall:

Ben Bernanke’s dire assessment of the US economy; Opec’s reduction in its demand forecast for 2008; and Wednesday’s surprise increase in US inventories.

Mr Bernanke didn’t say anything we did not already know. But it is the first time that he had officially recognised how dire the situation is. This generated fear, which prompted profit taking.

Opec also reduced its oil demand growth forecast for 2008. The cartel said that it now expected that world oil demand growth this year would be 1.20%. It had earlier forecast 1.28%.

This was to be expected.

The high oil price will obviously curtail demand. The most important thing to note, though, is that demand is still expected to grow – even at these prices.

Then we have US inventories.

The weekly US oil inventory figure rose by almost 3m. Petrol inventories also added 2.4m barrels.

Both were expected to show a slight fall. That they rose is a direct result of a slowdown in US petrol consumption as high prices bite.

These three factors combined and oil bulls became fearful…. they took their profits and ran.

The market remains susceptible to shocks

You still have to remember, though, that the fundamentals of supply and demand are keeping the market tight. Any news of a supply disruption will send the price in the opposite direction.

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The real cause of high oil prices is the industry's lack of investment. Production capacity has been neglected over the last 25 years. Because of this lack of investment, we are in the middle of a supply crunch. This crunch will not be reversed any time soon.

There is a shortage of drilling rigs - and new oil discoveries are likely to be in deepwater, or from unconventional sources.

This means any new discoveries of oil are likely to be higher than the current long-run marginal cost of production of $50 a barrel… and it will take years before they can turn on the taps.

Then there’s Iran.

I believe that the bombing of Iran by the US administration is almost inevitable. This prospect will continue to rear its head over the coming months, injecting the oil market with a further booster shot of fear.

The main reason the oil price will not snap back is the development of emerging economies.

Any fall in demand in the US is likely to be filled by demand from Asia. The Chinese economy is charging ahead – and it is very different from any other market in the world.

The Chinese economy is not a consumer-driven economy. Growth is being driven by infrastructure development on a scale the world has never seen before - and may never see again. This demand will not slip away. Consumer confidence does not drive the Chinese economy - massive state-sanctioned projects do.

This morning’s GDP figures showed that growth in China cooled marginally in the first half of this year. The country’s economy grew at 10.4% in the six months to the end of June. This is down from 11.9% in 2007.

The fourth-largest economy in the world looks set to continue its double-digit growth for many years to come. This should easily take up the slack from any fall in US consumption.

To discover how to profit form the coming oil-price dip click here.

Regards,

Garry White
Editor
Smart Commodities UK

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