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Oil Could Fall Hard, Very Soon

Thursday, 12 Jun 2008 09:34 AM

Oil prices rallied again yesterday, after pulling back a bit during the previous two days. However, trading volume was light and oil prices failed to move above their prior highs. Yesterday’s trading action suggests that oil prices will fall considerably within the next few days.

Meanwhile, growing political uproar over record oil prices could scare off investors, forcing oil prices lower.

For instance, U.S. presidential candidate Barack Obama recently suggested that oil companies should pay a 20 percent tax on every barrel of oil that is priced above $80. In my opinion, a “windfall profits tax” would do little to curb the supply-and-demand equation and therefore have no lasting impact on the price. However, political rhetoric promulgated by persons like Obama could scare away oil speculators in the near-term and lead to a decline in oil prices.

The threat of action by Congress also could push down prices. According to congressional testimony from hedge fund manager Michael Masters on May 20, speculation by institutional investors in the commodities futures market has largely been responsible for the dramatic increase in oil prices over the past four months. Of course, Masters acknowledged that the functional demand for oil has risen in the past five years, but he said that oil supplies have kept up with that increase in demand.

However, Masters pointed out, commodity index funds, such as the PowerShares DB Commodity Index Tracking Fund, are the biggest culprits behind rising oil demand. These funds are required to hold a certain percentage of physical oil to back their funds. Investors have flocked to these relatively new funds to take advantage of rising oil prices, which has, in turn, created an upward spiral in the price of oil. And that has caused overall demand — functional demand plus index-fund demand — to rise significantly above supply.

Although many stock market pundits and so-called oil experts claim that increased demand for oil from China has been the primary cause of the overall increase in oil demand, Masters pointed out that demand for petroleum futures over the past five years has risen by almost the same amount as the demand from China.

With the four-year congressional and U.S. presidential elections just around the corner, my experience suggests that Congress could soon implement measures to curb the fervent speculation in the commodities market. If Congress does take steps to limit the demand for oil from institutional investors, oil prices could fall sharply from their current levels.

Meanwhile, recent comments from Treasury secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke to halt the decline in the value of the U.S. dollar also could cause oil prices to fall, given that oil is priced in dollars.

Over the longer-term, oil prices may continue to trend higher in the event that large consumers of oil don’t begin using alternative forms of energy. However, I don’t buy into the argument that oil prices will rise to several hundred dollars a barrel over the next couple of years, or that gasoline prices will rise to $6 a gallon by 2010.

In direct contrast, my experience suggests that consumers, businesses, and governments will quickly find substitutes for petroleum when the prices of those products reach a certain level. And, my research indicates we’re now at that point.

In fact, I recently spoke with a car salesman who said that business has been great because vast numbers of consumers have recently been trading in their gas-guzzling SUVs for small, fuel-efficient automobiles. Meanwhile, recent statistics from local governments show that the number of consumers using public transportation systems has increased dramatically over the past two months.

So, I urge you to not get caught up into the recent hype about oil prices going to $200 a barrel by the end of this year.

Go Here for more of David Frazier's market insights and investment advice - Get the 'Secret Code' today.

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Oil prices rallied again yesterday, after pulling back a bit during the previous two days. However, trading volume was light and oil prices failed to move above their prior highs. Yesterday’s trading action suggests that oil prices will fall considerably within the next few...
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