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By Robert Rapier on Nov 30, 2007 with no responses

Beginning of the Correction?

It’s no big secret that I think oil prices ran ahead of themselves in the past couple of months. I don’t think they should have cracked $90 this year (and despite mass amnesia by analysts, as of August 99% were in that camp as well). But today, WTI traded into the $80′s for the first time in over a month. Of course prices may reverse before the close today (especially since it sounds like the Fed may cut interest rates again), or they may reverse next week. But I have a feeling that this is the beginning of the correction I have been expecting (and mentioned in this week’s TWIP).

It’s not that I don’t think oil is inherently worth $100/bbl. My objection to the price had more to do with how fast the price changed. Oil ran up by over 30% in just a couple of months, and this does not allow enough time to establish the new supply/demand balance. Did the fundamentals change that much in just a couple of months? No. Yet every piece of bullish news drove prices up, and bearish news did not drive it down. But lately I have been warning that traders would be wise to heed the signs that supply was increasing and demand was falling.

In spite of this, I was treated to an unending stream of rationalizations for why $100 was going to be a brief stop on the way to $150. Never mind that rising prices should be expected to moderate demand. Never mind that we hadn’t had enough time to establish the effect that $95 oil would have on demand. No, oil was going straight to the moon. I was told multiple times that speculators are not actually a factor – that the price was near $100 because of the fundamentals.

Speculators who were “in the money” suddenly became very clever, and I got treated to several lectures on how supply and demand worked – and why that favored $100 oil. I was told that “inventories were plunging”, even though it was quite easy to confirm that they were at normal levels (having fallen from ultra-high levels). And these are the very same people who confidently told me earlier in the year that Saudi was completely tapped out – even though I was predicting they would raise production later in the year.

But the tinfoil hat crowd is out in full force today. Because oil prices are down, I have seen suggestions that 1). The public is suffering from mass delusions; 2). Oil companies are manipulating the price; and 3). The government is manipulating the price. After all, “Peak Oil is here. How could oil prices fall? It must be manipulation and conspiracy.” Or, maybe Peak Oil is not here. That just doesn’t seem to enter the equation; that the supply/demand dynamics are changing. No, if you already know the answer – Peak Oil is here – then oil prices behaving contrary to that must have some other explanation.

The big stories over the next couple of weeks will be the OPEC meeting on December 5th, in which members are expected to announce another production boost, and the Fed meeting on December 11th, where another interest rate cut is forecast. Those meetings should set the direction of oil prices for the rest of 2007.

I think Saudi is going to have a tough time getting consensus on the production boost they reportedly desire, especially with oil prices already falling away from $100. There will probably be a compromise; perhaps a token production boost. Anything more substantial – 500,000 or more barrels per day – will probably put oil back in the lower $80′s. On the other hand, with oil prices down, the Fed may be more emboldened about making a bigger interest rate cut. Lately, each cut has been met with a falling dollar and rising oil prices. They may feel like they have a little more room to work with than they would have when oil was near $100.

December is going to be an interesting month.