The Phallacy of a Spike

7/4/09 – Independence Day

No, this isn’t a pondering about energy independence. That concept is not only impossible to achieve, undesirable in the global economy, but is disingenuous and holds out way too much of a false hope for the masses.

Today I want to ponder the magnitude, timing and duration of a price spike in energy. As you have noted by now, I have taken some liberties in the spelling in this title as I feel that some think they have real control of any spike with all the macho egos seen in the industry, the phallic symbolism the shape of that spike, its eventual correction may take.

How does the industry react to a spike?

1) To start with we need to have relatively low prices, from either poor demand or an excess of supply or both. This potential spike is coming off a severe global recession cutting demand. While energy suppliers have curtailed a lot of their production, the supply overhang is in the form of historically high inventories.

The producer sees reports on domestic inventories. And these are components that are actually measurable. And even that measurement by the API and the EIA leaves a lot of room for improvement.

2) Then the producer is aware of the “off shore inventory”. This supply overhang is not measured. But the producer knows that those tankers out there are just waiting for room in onshore tank farms to open along with a hoped for increase in price to offer competition to the producer’s desire to get back into the game.

3) As inventories do get worked off, prices will start the correction from recent depressed levels. The industry then factors in a higher “price deck” into its outlook. Remember the “Anchoring Phenomena” from Step-1 of the report, Confessions of an Energy Price Forecaster: A 12-Step Program to Enlightenment, where the psychology is that what is going on today will go on forever.

4) Finally, and usually at the peak of the spike, the industry puts its money where its mouth is and adds more supply. In many cases this added production is more than the economy needs bringing on the next downward correction from the current spike. Thus the phallacy of counting on a spike.

The current spike, if it really is one.

Currently those who think they have that control appear to be investors who, dare I say, are speculating on a global economic recovery that will be reflected in renewed demand for energy. Energy in this case is represented by oil. This belief is further enforced by the recent speculative (?) rebound in the stock market and the continued weakness in the dollar, I discussed in the Points to Ponder “The flight to (black) gold (9/20/08)."

While steps 1 and 2 above seem to be in place, I doubt that the current speculation is reflected yet in step 3. Indeed, we seem to be seeing real technical resistance and a bit of reality at the $70 level. So where short-term prices are going is anyone’s guess.

Point to Ponder

So why is this spike primarily oil? Oil remains the master BTU measure of energy globally. As seen above oil products like RBOB gasoline and Heating Oil are tagging right along and have even shown a larger spike. At the same time, other forms of energy such as natural gas are marching to the fundamentals of supply and demand rather than speculation.

Since the beginning of the year, oil and its products saw this range with pretty much a straight run up starting in 4/09 to the 6/30/09 levels noted below.

  1/1/09 Minimum Maximum 6/30/09
Oil 46.34 33.98 72.68 69.89 (and correcting)
H.O. 1.48 1.13 1.86 1.72
RBOB 1.11 1.04 2.07 1.90
While natural gas showed the following range.

  1/1/09 Minimum Maximum 6/30/09
Natural Gas 5.97 3.25 6.07 3.84

Anyone got any ideas? This beats to @#%& out of me. That’s why I’m pondering.

Click here for more information about Confessions of an Energy Price Forecaster: A 12 Step Program to Enlightenment

Click here for John Tobin's full bio


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