Oil at $126, heading for $150-200?

This week oil tripped past the $120 a barrel mark for the first time and touched $126. Yet it was only in January this year that we saw $100 oil for the first time. That barrier has been decisively breached, and perhaps for oil the only way is up with $150-200 within 18 months to two years being forecast by the experts at Goldman Sachs, not a firm to take lightly.

Billionaire hedge fund manager T. Boone Pickens can not have had a good start to 2008 as the oil price has refused to fall as he predicted and his funds are doubtless suffering as a consequence. Now the bulls are in control of the oil market, and the lack of additional physical supply in the market is adding fuel to this fire, and news of an emerging civil war in Lebanon is hardly going to help calm fears about Middle East instability.

But it could be the hedge fund managers who chose to enter the energy markets this year and place money on higher prices that are most to blame for $123 oil, and who will drive the price still higher. You still have to wonder though, where is all the money coming from that is flowing into oil and gas futures and other energy related derivatives.

The responsibility surely rests with the US Federal Reserve. The loosening of US monetary policy, with interest rates down to two per cent, is allowing hedge funds to take huge leveraged positions in the energy markets, and food and other commodities for that matter. This is the direct root cause of this inflation.

Former Fed chairman Paul Volcker was correct when he said in 2000: ‘Inflation is related to monetary policy. It’s related to the issue of money. The issue of money is a governmental responsibility predominantly, and to use that authority in a way that leads to inflation is a system that fools a lot of people, and to keep fooling them you have to do it more and more.’

Volcker after all was the man who beat the 1970s inflation in the early 1980s, albeit with monetary policy that produced a deep recession and the bankruptcy of thousands of local US saving and loans institutions.

But if we are really back to those bad old days of sky high energy prices and soaring inflation, and the Fed has indicated that it will do whatever is necessary to support the US economy, then the logical conclusion ought to be that $120 oil is just another step on the ride towards $200 or $300 oil, or whatever it takes to slow the world economy to lower consumption.

The fundamentals just do not look good for lower oil prices. One million more cars are bought by the Chinese every year, and energy consumption is on an uptrend worldwide. But the supply position is precarious with production falling in the North Sea fields and Russia, and new supplies insufficient to replace dwindling reserves.

Prices could go very much higher from here, albeit a seasonal summer dip in prices might still be expected. It may take a far deeper US slowdown with a global impact next year to really bring oil prices back to earth. Goldman Sach is probably right, and oil will take gold and silver up with it, along with food prices, and the consequent social unrest.
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