Wednesday, December 17, 2008

Oil Going Down the Tubes, Along With World's Economy

Earlier this month I had mused about whether an OPEC production cut would be a worthwhile investment play. Cut they have, and play it is not:

Oil fell below $40 a barrel for the first time in more than four years as OPEC failed to convince traders that the glut in crude will diminish and the U.S. government said supplies climbed for the 11th time in 12 weeks.

Previous production cuts have ususally led to predictable jumps in the price of oil. The failure of prices to climb this time suggests something deeper is amiss. I posted my typical pithy commentary on Clusterstock today:

If a cut of this magnitude can't provide support to oil prices, then demand destruction must be extremely severe. OPEC tried to shift the supply curve to the left by inducing a supply shock. The problem is that the aggregate demand curve has also shifted leftward.

These two big curves slamming to the left don't necessarily mean the equilibirum price in the market today will be supported. If the demand curve is shifting faster than the supply curve, the market price will keep falling even at much lower levels of available global supply. If oil is going a lot farther south because of Great Depression 2.0, then no way am I prepared to guess at a floor price. I'll take a second look in about six months.