Has Oil Risen too Much too Fast? - Outside View by Asad Dossani

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Has Oil Risen too Much too Fast?
Mar 1, 2011

The previous week has seen crude oil jump on the back of political unrest in Libya. Brent crude touched $119 per barrel, a level not seen since oil had its big run in 2008. The financial press is once again concerned with high oil prices, and the effect of this on the global economy. Prices have risen very quickly - around 20% in a single week. Is such a rise justified?

The most recent reports suggest that oil production in Libya has fallen by 75%, and this represents a reduction of 1.2 million barrels per day. This is about 1% of daily oil consumption - an amount that is small but still significant. Obviously, we expect that a fall in oil production will lead to rising oil prices. But is a 20% rise in a single week a sensible reaction to a 1% fall in oil supply?

The answer is no if Libyan production is the only factor affecting the price. It is clear that markets are pricing in a potential larger fall in supply triggered by further unrest in the Middle East. Protests in Tunisia were followed by protests in Egypt, and now there are protests in Libya. The domino affect is apparent, so it is no surprise that markets are worried that another country's production could be affected. There are reports of protests across other Arab countries, and steps taken by various leaders to make reforms in their countries, as they fear popular uprising.

When crude prices reached close to $150 per barrel in 2008, it was all about demand. Investors were worried about a demand explosion from emerging economies, and this continued to push prices up. Of course, many Western countries were entering recession, and emerging market growth was slowing at this time. Crude subsequently corrected in the following year. What we know about oil demand is that it is more predictable and stable than oil supply. Oil demand is strongly correlated with GDP growth, which tends to be stable for most countries over time. Therefore, a large rise in prices that is based on expectations of soaring future demand is probably unsustainable. Demand will grow over time, but not in an explosive way.

Today's oil price rises are all about supply. The market may have already lost 1% of its daily supply, but this number could easily go up in the near future. The factors that determine supply in the short term are all political factors. This makes the price very volatile and unpredictable. Speculating on the oil prices is for now equivalent to betting on whether another revolution will occur in the Middle East.

Going back to the initial question, its probably true oil prices have gone up too much too fast, but this is on the assumption that no other countries' oil supplies are affected. As oil prices are heavily dependent on political factors in the short-term, the price movements are volatile difficult to predict. For investors, it is probably wise to stay out of this market until things calm down a bit.

Disclosure: I do not hold the currency/commodity viewed/opined in this column

Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Has Oil Risen too Much too Fast?". Click here!

  

More Views on News

Quantum Mutual Fund: Hum woh nahi hain (The Honest Truth)

Apr 29, 2020

Ajit Dayal on how the mutual fund industry robs you of your wealth.

This One Trigger Could Turnaround Yes Bank's Stock Price (The 5 Minute Wrapup)

Oct 16, 2019

If Yes Bank manages to do this, it could be the start of a much-needed turnaround for the bank.

Gold could Hit 40,000 Sooner Than Expected (Profit Hunter)

Aug 16, 2019

Domestic gold prices are firing on both engines now. Gold prices could touch 40,000 faster than you could imagine.

3 Rebirth of India Opportunities Are Racing Ahead in These Gloomy Times... podcast (Views On News)

Jun 28, 2019

Tanushree Banerjee shares an update on the Rebirth of India and reveals her top 3 trends...

How to Separate Fact from Fiction (Vivek Kaul's Diary)

Feb 5, 2019

Vern Gowdie talks about what happens when there's too much debt in the system.

More Views on News

Most Popular

Protect Your Wealth from Fund Managers (Fast Profits Daily)

May 14, 2020

Do you know how much you are paying in fees to your mutual fund? In this video I'll share with you my views.

Of India's 20 Trillion Stimulus Package and the Swoosh Index for a Swoosh Recovery (Profit Hunter)

May 13, 2020

For India's rapid economic recovery, hopping on to the Swoosh index is a must.

How Commodity Prices Tell You When Stocks Will Go Up (Fast Profits Daily)

May 20, 2020

Commodity prices often provide clues to big moves in stock markets. In today's video, I'll explain this link.

This 'Essential Product' Smallcap is a Must Have for a 'Covid-19' Immune Portfolio (Profit Hunter)

May 19, 2020

This smallcap company needs no stimulus measures to do well in the long term.

Why Buffet - and you - should study Quantum Liquid Fund (The Honest Truth)

May 14, 2020

Ajit Dayal on how Quantum Liquid Fund and Warren Buffett have similar investing styles.

More

How to Trade the
Coronavirus Crash

Coronavirus Crash
Get this special report, authored by Equitymaster's top analysts, now.
We will never sell or rent your email id.
Please read our Terms

MARKET STATS