Wednesday, September 3, 2008

Oil at $80 a Barrel?

Oil at $80 a Barrel?

In recent years, energy traders plus an active hurricane season have usually meant one thing for oil: higher prices. Yet with the departure of Hurricane Gustav, a rally for the embattled greenback is overshadowing new storm systems churning away in the Atlantic and showing how the prospect of a choppy U.S. economy is scaring traders far more these days than turbulent weather.

The price of a barrel of the benchmark West Texas Intermediate crude for October delivery dropped nearly $6 on Sept. 2, to settle at $109.71 on the New York Mercantile Exchange (CME). That's the lowest level since early April, and a slide of $37.56 since the record of $147.27 on July 11.

While Gustav appears to have delivered only a glancing blow to oil and gas assets in the Gulf of Mexico, the influence of Mother Nature has waned among traders and investors. The souring U.S. and global economies, alongside a strengthening dollar, are weighing heavily on oil prices, analysts say. In fact, the oil "demand destruction" implied by weak U.S. economic growth currently dwarfs both weather and geopolitical worries in determining oil's price. "If you can't rally with a hurricane up your nose—and 2 million barrels of refining capacity and 96% of your offshore supply under threat—it's hard to see what will cause a rally," says Peter Beutel, a veteran analyst with the energy risk management firm Cameron Hanover.

Back to Reality

Oil prices have slid so far and so fast that the retreat has led analysts to predict further puncturing of what they call a speculative bubble. Many analysts don't see a floor at $100, but rather at levels as low as $70 or $80. "This is start of a fall to $80 crude by the end of the year, maybe as early as September," says Joel Fingerman, principal of, a Chicago-based energy consulting firm.

"Oil prices are dropping because they are inflated," says Fadel Gheit, senior energy analyst for Oppenheimer (OPY). "You cannot sustain an artificial price forever. At the end of the day supply-demand fundamentals will take over."

Oil traders and some analysts have been blaming high oil prices on rising demand from developing economies, but now troubles in the U.S. economy are spreading across the globe. "A few months ago it was all about Chinese demand," says Stephen Schork, an energy consultant in Villanova, Pa., and editor of The Schork Report, a daily energy newsletter. "But a lot of the strength [in oil's price] was hype and hot air."

In addition to a gloomy economic environment and lower demand, a strengthening dollar is also behind oil's recent drop. Since July 15, the dollar has gained 8.5% against the euro. "The rise in the dollar is the best explanation of oil's drop," says Beutel.

Airline Stocks Ascend

While energy companies' stock prices fell on Sept. 2, airline stocks jumped at the prospect of cheaper fuel. Northwest Airlines (NWA) gained 13%, to $11.07. UAL (UAUA), the parent of United Airlines, was up 9.5%, to $12.16, and AMR (AMR), American Airlines' parent, jumped 8.7%, to $11.23. In 2008, airline shares have traded inversely to crude.

Despite the drop in crude prices, the market remains volatile. That's why some analysts say the market could again cede ground on supply and demand, resuming a trek upward. Earlier this year, several investment banks made headlines with reports forecasting a "super-spike" for crude, based on producers' inability to keep pace with soaring demand from China and the Middle East. Goldman Sachs (GS) energy strategist Arjun Murti was among those in that camp; he predicted $200 per barrel in coming months.

Indeed, crude prices could recover if the dollar weakens again or if oil-producing countries trim their output to keep prices high, as some analysts have speculated. OPEC is scheduled to meet on Sept. 9 in Vienna and has indicated it may defend a price of $100 per barrel.

Hanna on the Way

There is also ample meteorological uncertainty. On Tuesday, Tropical Storm Hanna was predicted to come ashore in Georgia and South Carolina late in the week and could regain hurricane strength later in the day. Tropical Storm Ike formed late Monday in the Atlantic Ocean and may become a hurricane in the next day or two as it approaches the Bahamas. Meanwhile, Tropical Storm Josephine formed in the eastern Atlantic, and the National Hurricane Center said it could near hurricane force as it moves west.

The verdict? The only certainty in the oil market remains volatility. "I have no idea where oil prices are going from here," says Gheit. "Go ask Goldman Sachs."

  • Energy Stocks with Room to Run
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