$100 per barrel oil on the horizon

Surprisingly, there has been little clamor about the chance for $100 per barrel oil. It is more surprising that there have not been the gloomy stories about the high price of crude oil as a tax on consumers. In fact, if you look at the stock market, you would think that oil prices have been hitting the lows for the year. The stock market is less sensitive to oil because energy intensive industries are a lower percentage of the key market indices. However, the story of oil has always been about the consumer’s ability to pay for energy relative to other demands on their pocket book. It is likely that we have adjusted to high oil only to the extent that we are will to make other sacrifices. Real income is growing but that does not mean that consumers are saving more. Behavior, under this current environment, requires a “grin and bear it” mentality. The current increase has not been sustained long enough to get a significant change in behavior.

Is $100 per barrel oil in reach? Absolutely. You can buy a September ‘08 call struck at $100 for about a dollar. If you just follow the numbers based on current prices and volatility in the market, you will find $100 oil within two standard deviations. You add a drift term to prices and you are within easy reach of $100 per barrel in the next year.

The cause of this increase is a combination of both short and long-term effects. OPEC production is down as part of an attempt to hold prices steady. They forecasted slower growth in the US. What happened was a surprise increase in global demand. Coupled with this lower production is the fact that we have had isolated short-term declines in production in some key countries as well as some large production fields reaching maturity. Nigeria has seen more rebel activity. Iraq has still not got its production numbers up. Recent reports suggest that Venezuela has not been able to meet production quotas. Iran has been embroiled in the uranium enrichment problems with the UN. All lead to a tight crude oil market.

We are not predicting $100 oil but it is within grasp. There has not see major changes in response to the latest increases. The $17 move since the beginning of the year has been viewed as temporary; nevertheless, we may have to wake up to a continued oil tax.