Thursday, May 22, 2008

Hard to find a happy ending...

To the oil picture. (Unless, of course you own some wells) As the argument rages on - with powerful logic on both sides - between speculation and fundamentals as the cause for commodity price increases, I think I am wandering between the camps debating a which is the chicken, and which is the egg.

First, the case for oil, which may be the core driving commodity. The fundamentals all seem to eventually point to China.
Are such projections plausible from the point of view of potential demand? During 2006, China used about 2 barrels of oil per person. For comparison, Mexico used 6.6-- Chinese oil consumption could triple and they'd still be using less per person than Mexico is today. The U.S. used almost 25 barrels per person. According to the data collected for a new research paper by Max Auffhammer and Richard Carson, there were 3.3 passenger vehicles per 100 Chinese residents in 2006, compared with 77 in the United States. Yes, I would say that these astonishing numbers for potential future Chinese oil demand are not at all inconceivable. [More of a very readable analysis]
At which point, who wouldn't want to place a bet on oil prices? Just like stodgy old money returning to farmland (Prudential just bought a chunk near me, I heard yesterday), where are you going to get the returns we've seen in the commodity markets?

I think we can rule out the mortgage industry, for example. While many farmers would like to cast commodity speculators (or perhaps today better labeled "investors") as oily wheeler-dealers, if you depend on a pension payment for your retirement income, these guys are White Knights.

The big question we producers are all trying to wrap our mind around is how do I know when to get off this rocket? While we will likely be fixated on wheat production and corn yields, because of asset allocation of index funds, maybe we should concentrate on oil, the Leader of the Pack.

There are two good reasons for this. as has been noted before, high oil prices protect the ethanol industry better than any subsidy, so some of those future plants might actually be built if oil continues to climb. That corn/acre source issue seems secure to me.

Second, though I expect oil demand to begin to drop here in the US (we will drive less and more carefully) everything I have seen indicates to me developing countries can more than absorb our drop. This is China's demand growth curve, for example.

Further, even if we struggle through a long bout of "recession-like" conditions, it doesn't look like the rest of the world will follow. Our share of the global economy probably has peaked.
The question now is whether investors have taken too much comfort in the Fed's ability to keep markets functioning. While the Fed's willingness to lend to financial institutions should prevent another Bear Stearns-like calamity, some observers believe the last two months' rally reflects a rosier view of the markets and the economy than is warranted. [More]
Bottom line: learn to farm and live with as little fuel as possible. Apply fertilizer with an eyedropper. Study electricity fundamentals and deploy its power every chance- our link to our only cheap energy: coal. Finally, expect a ferocious margin squeeze starting in about 2010 as costs rise to pressure the maximum prices grains can be sold at.

But I'm ruling out a calamitous collapse of oil prices, such as many believe will echo the 70's. Like grains, oil could drop a bunch and still be painfully high. It will simply take lots of misery to force the oil supply and demand curves to intersect in the future.

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