The price of sweet light crude oil, as represented by the futures contract, slipped back below $100 a barrel on Oct. 21, for the first time since the July 4 weekend, and now looks like it could stay below that magic level for some time.
Is cheap(er) oil going to be the fuel (ha!) for an economic renaissance of the U.S.? Maybe. But don’t bet on it just yet.
OIL AND THE ECONOMY
The $100-a-barrel marker for light crude has traditionally been a line in the sand for the U.S. economy. Below it, the economy may sputter but functions pretty well, and the further the price drops, the better the economy does. Above it, the economy starts to contract, sometimes dramatically. In America, everything depends on oil, from the price you pay for watermelons to how much money you spend at Wal-Mart.
But the old equation is breaking down, and we don’t think you can accept that traditional $100 marker at face value any more. Here are three factors that need to be considered.
1. The yardstick is changing, so we don’t really know the continuing price of oil. The price of oil, as denominated in U.S. dollars, depends on how much the U.S. dollar is worth. And over a long time-frame the U.S. dollar is steadily losing value. When oil sheiks realize the dollars they are paid for their oil are worth less, they increase the price per barrel. The recent decline in the U.S. dollar index, which compares the dollar to a basket of international currencies, pretty much explains the current short-term decline in the price of oil.
2. Demand destruction and technology change. We have entered the age of what some critics call “peak cheap oil” – in other words, we aren’t running out of oil so much as we are running out of oil that is easy to find and cheap to pump. This increases the price of oil, but it also drives technological developments that help reduce demand and drive prices down.
For example, it is now commonplace to buy cars that get 50 mpg; a generation ago, 15 mpg was closer to the average. In fact the rate of oil consumption in the U.S. has been steadily declining, and China is now a larger importer oil than the U.S.
3. U.S. foreign policy. Almost exactly 40 years ago Saudi Arabia led an Arab oil embargo that sent U.S. prices skyrocketing and caused long line-ups at gas pumps across the nation. No one is suggesting that the same thing will happen again – the U.S. is now better positioned to defend against it, for one thing.
But the Saudis are seriously annoyed at the U.S. for what they see as insufficient enthusiasm in fighting for Saudi interests in Syria, and a possible renewal of U.S. ties to Iran. The outcome in unpredictable, but it could include a closer relationship between Saudi Arabia and Israel (!) and the re-entry of Iranian oil production into the world market. Stay tuned, because while we don’t know what will happen, we do know it will affect the price of oil – and thus the US and world economy.
WHAT HAPPENS NEXT
Oil prices are manipulated. Virtually every market is manipulated now, but oil prices, along with gold and equity indices, are especially sensitive to whatever political wind is blowing this afternoon. Given the known unknowns, we think it is pointless to make longer-term pronouncements about the oil market.
But the price chart gives some pretty good insight into the likely short-term developments. Here’s what we see.
Oil broke down its long-term triangle support line at $100.70 this week and pushed further down toward the former breakout zone $99.01-$96.15. The recent decline is changing the direction of the intermediate-term uptrend.
However both the short- and intermediate-term time-frames have an oversold condition, so we could see a short-term bounce. The bounce is not likely to change the short-term downtrend.
The bounce may stop below $101 to test the short-term momentum resistance lines and later resume to the downside again. A break below 95.35 level will be bearish. We are then likely to see the price go down further towards (or below) the long-term support line around $90-$89.
Chart caption: Oil Futures, continuous contract (CL)
Naturus is the web name of Polly Dampier, who is the brains behind www.naturus.com, a subscription service for active traders.
Read Dampier’s market commentary each Tuesday morning on TraderPlanet.
