Story #4 – Oil’s Wild Ride

During the 2000’s oil traded between $17 and $145. The first major move occurred when prices plunged following the terrorist attacks of 9/11. Generally, geopolitical events cause oil prices to go higher and on September 14 (the first day of trading after 9/11), oil gained $2 a barrel. However, by September 24 oil had dropped $8 to a two-year low. The dollar was strengthening from a flight to safety and concerns were mounting that the recession would cause energy demand to drop worldwide. But starting in 2002, emerging economies in Asia and South America withstood the recession remarkably well and energy demand was surprisingly strong. Additionally, the aggressively accommodative monetary policy in the U.S. caused the dollar to weaken, further bolstering oil prices. This began an alignment of bullish conditions would cause oil prices to rise tremendously from early 2002 until the middle of 2008.

Oil's Meteoric Climb 2003 - 2008

Conditions Driving Bull Market in Oil:

• Blossoming demand from emerging economies
• Stagnating supply due to under investment during long bear market from 1980 to 2001
• Weakening dollar
• Rising geopolitical risks

In early 2008, oil continued to climb with no end in sight. Talk of $200 oil filled newspapers and airwaves. But as the second half of the year started, concern grew that the Global Recession would lead energy demand to ebb. Then, in October 2008, the financial crisis exploded and oil proved all too susceptible to the panic. Massive deleveraging throughout the market forced selling into an already weak market. Prices tumbled even more as deflation became a serious threat. Now, emerging economies appeared vulnerable and the dollar was strengthening – all the bullish factors that had existed for years were gone. Oil went from $145 in July 2008 to $31 in December.

Eventually the panic subsided and normalcy returned to the market. Deflation did occur for the first time in the U.S. since the 1950’s^vi but it was short lived. As the economic and financial market recovery began in March, oil prices rose as well, finishing the year just short of $80 per barrel.

Despite the drop in the second half of 2008, oil prices more than tripled during the decade, rising in eight out of ten years. After mostly staying in a $15-30 range for nearly 20 years, the last decade was amazingly volatile. Oil prices moved by more than 50% in four out of ten years (2002, 2007-2009).

For the next decade, oil prices will depend mostly on three factors: OPEC, geopolitics and inflation. First, how well can OPEC maintain effective quotas to control supply? Second, will there be a significant political event which shocks the market in Iran? Iraq? Nigeria? Third, what happens with inflation globally and domestically coming out of the financial crisis? Global inflation will determine the natural drift of oil prices and domestic inflation will determine how the dollar moves which can dramatically affect domestic oil prices.

Next...Rise of BRIC