Energy prices are here, there and everywhere. Oil was trading at around 55, then went to 59, USD, March 07 futures are trading at 61 USD, and May 07 Futures are trading at 69 USD. Between now and May oil would have to increase 25%, which is a hefty premium.

A reader of my previous energy update said what I was thinking:

Doesn’t it seem strange that futures prices are higher than current prices? What products sell this way? Think about it, if you were going to buy something, like a computer or a TV, would you be willing to pay MORE for delivery in six months than to take delivery today? Of course not. You would just by the TV or computer today and be able to enjoy it today while saving money.

Doug’s thinking is interesting and worth the read. I agree with him that some big players (hedge funds, etc) are being squeezed and oil could become very volatile. Part of the reason why there is a glut of oil is because non-OPEC members are filling in the slack that OPEC is cutting.

With gasoline going up in price, and heating oil going up, from its low points refineries are making more money. This makes me think about looking at refinery stocks.

Let’s look at the price of oil. Doug is saying that oil prices are headed down. I don’t disagree and as I have been saying in the past the trading range should be 55 to 65. I did say in the past that oil would drop to 45, but stepped away from that. I would love to say, “yes oil will drop to 45”, but I don’t think it will happen.

Here are the things I am thinking about:

Using technical analysis oil is going down. Technical analysis is effective when there are no sudden events. And a sudden event, more specifically a nagging feeling about Iran bothers me. I am not demonizing Iran, what I am saying is that Iran has some serious internal issues. Add on the complication of Iran being part of the equation in Iraq, and I am getting butterflies in my stomach. If we were to put the squeeze on Iran then Iran would unite and put the squeeze on us.

Comments (1)

Good point about Chavez and all of the OPEC regimes, because how OPEC responds to falling prices is the big unknown. OPEC as a cartel, does not have to respond in ways that classical economics suggests. So, when prices rise, which should lead to more supply, OPEC might chose to push prices higher by maintaining or even cutting output. Likewise, classical economics suggests that if prices fall that OPEC will cut production and reduce supply, supporting prices. Expectations that this will happen are a major part of the price equation in oil markets. But will they respond this way?

History suggests that they will not. After the great run up in the 1970s, OPEC started INCREASING supply as prices fell. What drove this behavior? Another economic axiom – the desire for even consumption over time. Having grown accustomed to the huge revenues that high prices gave them, most OPEC countries were unwilling to stick to their quotas, they wanted to be able to continue to have the same income they had had when prices were high, so they actually INCREASED their volumes in an attempt to realize higher income. Now, if only one member of the cartel cheated, supplies would have remained tight enough for them to enjoy that higher income, but since all of them were playing the same game, huge supplies drive the price of oil downwards for two decades, finally hitting a low of under $11 in 1998.

Chavez, the Mullahs of Iran and other regimes rely on being able to dole out the oil money liberallly in order to keep key elements of their societies happy. Like all rackets, those who are paid off under the scheme are not likely to take kindly to the idea that business is a bit tight, we will have to scale back your cut. When the restaurant has a bad month, Tony Soprano had still better get a fat envelope. Problem is, who do you short when every one you have to pay is a Tony Soprano? Faced with the consequences of a light envelope, you cheat on your production quota – break a different law. You pump a few more barrels to make up the difference. So do all of your other fellow OPEC members, and we are on the way to an oil glut.

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