$100 Oil Once More on the Horizon

We did a story in October detailing five reasons to worry about oil getting to $100/barrel by the end of next year, and another five reasons to worry that oil would indeed reach that price. A number of big banks thought that $100/barrel was well within reach, while the largest trading houses though $70-$85/barrel was a more reasonable estimate.

Today, in an interview on Bloomberg Television, Tom Petrie, vice chairman of Bank of America Merrill Lynch, said that “the forces are lining up that will take us very close to $100, if not through it.” The effects of the second round of quantitative easing, growing demand from India and China, and the increasing deficit caused by the recently agreed US tax bill are the main reasons Petrie gives for the $100/barrel price.

Certainly the weaker dollar, which is a result of quantitative easing, will have an impact. But offsetting that impact, as Petrie admits, is an even bigger worry about European debt and the euro. The dollar is weakening, but it’s not happening as fast as everyone thought it would.

Demand from China and India is certainly growing, but supply projections match demand, commercial stocks are at near-record highs, and spare capacity stands at about 5.5 million barrels/day, more than double its level in the price spike days of 2007.

The effect of the agreed-upon US tax bill could cause crude prices to rise more, but the bill has not been passed yet. Because the tax bill is, in effect, a second economic stimulus package, the US economy is expected to expand as much as 0.6% more than previously believed. That expansion could push US GDP growth above 3% for 2011. That’s good, but hardly inflationary, and a spike in crude prices could dampen that growth considerably.

Petrie also notes the de facto moratorium on drilling in the Gulf of Mexico, which has so far reduced production by about 150,000 barrels/day and  could double or triple  over the next three years. That seems overly pessimistic, but is certainly possible. New regulations, brought on by the Macondo well disaster, could also play a role in slowing more drilling activity in the gulf.

Another interesting bit in the interview is Petrie’s dismissal of the role of speculators in a price rise above $100/barrel. He notes that if oil “gets much beyond $100—$110-$120, we will hear again about speculators, and there will be some element of truth perhaps to it.” No big bank is going to admit that its commodities trading desk could possibly be contributing to higher crude prices.

We may get a chance to see what effect speculation has when the US Commodity Futures Trading Commission issues proposed rules later this month on position limits in the commodities markets. Should position limit rules and other regulations that promote transparency in the commodity markets be proposed, we’ll be able to tell by the noise how much impact these rules would have on the banks’ trading operations.

-Paul Ausick