Thinking about Oil



Billionaire energy investor T. Boone Pickens, Jr. voiced his belief that oil prices above $100.00 are unsustainable in the short term. According to a brief CNBC interview, he is short oil, expecting a $10-$15 decline in per barrel prices in Q2 2008. Pickens cites the very fundamental reasons mentioned in previous posts - increasing supply, indeed US Crude inventories increased yet again this week, coupled with declining demand from a weakening global economy. This scenario is deflationary, but only if one discounts the effect of a declining US dollar.

A further decline in the US dollar caused by the government’s $150+ billion stimulus package, lending of reserves to financial institutions, and further rate cuts, would increase, and support higher oil prices. Deflationary pressures from a slowing economy can be countered by inflationary pressures from a devaluing dollar. Here is a quick, overly simplistic way to think about it.

+,+ | Oil Demand Increase, Inflation Increases
Oil prices should increase due to increasing demand and a slide in the purchasing power of the US dollar.

-,+ | Oil Demand Decreases, Inflation Increases
Oil prices, I conjecture, would stay flat, or trade within a narrow range. Decreased demand puts downward pressure on the price of oil while inflation devalues the dollar, keeping oil prices relatively stable.

+,- | Oil Demand Increases, Inflation Decreases
Here, oil prices would increased due to increased demand (assuming supply constraints) while a decrease in inflation would increase the purchasing power of the US dollar, again, keeping oil prices relatively stable.

-,- | Oil Demand Decreases, Inflation Decreases
This is the exact opposite of the +,+ scenario. A strengthening US dollar coupled with decreasing demand should push oil prices lower.

This is a simplistic, but reasonable way of thinking about where oil prices may go.

February 21, 2008 | Filed Under Commodities, Energy, Etc 

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