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The New Normal: Oil at $100/Barrel

20 September 2012 in Trading Ideas

Late last week, the price of crude oil surged above $100 a barrel before a minor pullback in the days that followed.

Despite the fact that this climb marked crude’s return above the century mark for the first time since May, it also wasn’t particularly extraordinary. Not only has just about every asset class enjoyed a bull run since the beginning of summer, but oil spent much of the first half of 2012 in that rarified air – at one point moving above $110.

The Black Gold motif is up 3.3% in the past month, and 9.5% in the past three months.

The usual suspects are getting the credit:  the anticipation and execution of the Federal Reserve’s new stimulus plan (“QE3”), as well as escalating tensions in the Middle East.

Lost in the short-term chart-watching, however, is the steady multiyear rise in the general trading range of the price of oil. The 200-day moving average for crude prices now sits at just under $97 a barrel, and oil has not been below $75 since the fall of 2010.

Those investing in oil stocks may wonder – are we just in another post-recovery upsurge in demand for crude or has the oil industry drifted into a new world order, complete with an updated oil-price floor?

According to oil industry analyst Gregor McDonald, it’s the latter. His take is that the period of 2002 through 2008 resulted in a new equilibrium price of oil at $100 a barrel — or more specifically, into a range of $90-$110 a barrel, where, coincidentally, oil has mostly traded since the beginning of 2011.

As McDonald puts it, within this range, supply from new resources and continued “less-elastic” demand from the developing world have created price stability. Prices above $90 result to attract new supply, which keeps production levels slightly flat. Meanwhile, the prices roughly balance the continued decline of oil consumption by developed economies. This can help offset greater consumption outside of the developed world.

McDonald suggests a key secular change has taken place. Global growth, as little as that may be, is no longer funded by oil. The sluggish economic rebound in the developed world is beginning to favor other energy forms, while in developing countries, the consumption of oil (despite growing demand) is dwarfed by the use of coal.

This could set the stage for another, even higher, resetting of oil prices in the next 10 years, but volatility associated with investing in oil could be considered the default expectation.

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