Tom Nicholls: Oil Is the New Gold, Says CERA

We could see $120 a barrel oil or more as spooked investors stampede into commodities, warns Cera. But the gathering storm clouds over the US economy probably mean that, eventually, prices will ease Oil has become the new gold – a financial asset in which investors seek refuge as inflation rises and the dollar weakens, claims Daniel Yergin, chairman of Cambridge Energy Research Associates, a consultancy. “The credit crisis has been fuelling the flight to oil and other commodities, and that will last until the dollar strengthens or the recession becomes more pronounced,” said Yergin. Oil prices surged yesterday in response to further declines in the dollar, as the Federal Reserve made its latest cut in US interest rates – this time by 0.75 basis points – in an effort to stave off economic crisis. Prices cooled off slightly today, but remain just a few dollars short of the all-time highs set at the start of this week: $111.80 a barrel in the case of New York light oil futures for April delivery and $107.97/b for May Brent, both substantially higher than the previous inflation-adjusted record high (for US futures) of $103.59, set in April 1980 (according to Cera’s calculations).

This week’s oil-price rally has been largely attributed – consistent with Yergin’s new-gold theory – to panic-stricken investors diverting money into what is being seen as the relatively safe haven of commodities. The latest stampede into oil was blamed on falling share prices, following the rescue of US investment bank Bear Stearns, the latest victim of the global credit crisis, and the continuing devaluation of the US currency as the Fed loosens interest rates to try to stabilise the US’ precarious economy.Another factor holding prices up is that the cost of producing oil has risen exponentially, meaning that higher oil prices are needed to support development of new oil projects. “Shortages of equipment and personnel are dramatically raising the cost of developing an oilfield,” says James Burkhard, an analyst at Cera, which claims oilfield costs have doubled in the last three years. “Adding to this pressure is increasingly heavy fiscal terms on oil investments in the form of higher taxes and greater state participation in oil projects.”Cera believes that further weakening of the dollar compounded by higher industry costs, could push the price of oil to new records – perhaps above $120/b.But will recession reverse oil’s rise, the consultancy asks? Maybe – if economic downturn spreads beyond the US, which would both weaken demand and strengthen the dollar against other currencies.Stephen Schork, editor of the influential Schork Report, does not believe that the rally can continue. The crack spread, he points out, has turned negative this week, meaning that gasoline is trading at a discount to crude. The price of gasoline, he says, is a better reflection of the health of the economy, because it is bought and used directly by consumers and influenced less by the speculative market hype that can easily move crude prices – of late of mixture of worrying about the dollar and an assortment of geopolitical events.”There is so much dollar hype that you can price into a bubble before that bubble bursts,” says Schork. And the economic fundamentals that will, eventually, begin to dictate price levels are not encouraging, he adds: with high energy prices eroding demand, consumer confidence at a low ebb and the US jobs market under pressure, gasoline consumption in the second and third quarters is likely to ease. Schork says gasoline-demand growth will, at best, remain stagnant, but will probably fall by 1-1.5 basis points, given the unfavourable outlook for GDP. That means, at some point, some downside for oil prices.Much depends on the economic headlines coming out of the US in the next few weeks and on whether geopolitical problems – which have taken a back seat in recent weeks — once again start to play on traders’ minds.