The decline in crude oil prices has been as amazing as the run-up and does not seem to have found a level. Natural gas has also been on a sharp decline which is nothing short of falling off a cliff. Part of the explanation is a simple demand story or as the pundits have been calling it, "demand destruction".
The price increases have caused a change in behavior of buyers. The demand in the US for gasoline is down over 3% from a year ago. There also has been an increase in subsidized prices in some countries which is biting into demand. An income effect is also present with slower economic growth leading to lower income and a cut-back in overall energy demand. Nevertheless, the sharp change in price seems more exaggerated than what would be expected from the price and income effect. The links between fundamentals and price have been broken.
The run-up in price of crude occurred during the initial period of the credit crisis. The price of crude was at $80 on October 1 of last year. This was after the credit crisis began and there already was talk of a recession in the US. The price of crude then increased by 55%. There was over a 40% increase sine the beginning of the year when data was showing a US slowdown. The price of crude was at $100 near the end off the first quarter which was even later in the US recession cycle.
Current prices are still 15% above the year-end levels and 35% above the end of third quarter 2007 levels. The potential for further price declines is great even though crude inventory build-up is still less than expected; however, this still leaves an explanation for the 2008 run-up unclear. There can now be a stronger story for speculative excesses as investors moved money from equities to commodities during the first half of the year.
The evidence of a global slowdown may be the key to the price decline, yet the quick shift in demand is surprising, 0ver 20% in less than a month. With Europe showing growth declines and inflation affecting Asian economic demand, the slide in oil may be just beginning.
The price increases have caused a change in behavior of buyers. The demand in the US for gasoline is down over 3% from a year ago. There also has been an increase in subsidized prices in some countries which is biting into demand. An income effect is also present with slower economic growth leading to lower income and a cut-back in overall energy demand. Nevertheless, the sharp change in price seems more exaggerated than what would be expected from the price and income effect. The links between fundamentals and price have been broken.
The run-up in price of crude occurred during the initial period of the credit crisis. The price of crude was at $80 on October 1 of last year. This was after the credit crisis began and there already was talk of a recession in the US. The price of crude then increased by 55%. There was over a 40% increase sine the beginning of the year when data was showing a US slowdown. The price of crude was at $100 near the end off the first quarter which was even later in the US recession cycle.
Current prices are still 15% above the year-end levels and 35% above the end of third quarter 2007 levels. The potential for further price declines is great even though crude inventory build-up is still less than expected; however, this still leaves an explanation for the 2008 run-up unclear. There can now be a stronger story for speculative excesses as investors moved money from equities to commodities during the first half of the year.
The evidence of a global slowdown may be the key to the price decline, yet the quick shift in demand is surprising, 0ver 20% in less than a month. With Europe showing growth declines and inflation affecting Asian economic demand, the slide in oil may be just beginning.
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