Monday, June 02, 2008

Can the Price of Oil Return to $70?

Buenos Aires, Argentina May 30, 2008

*** Four months ago China was brought to its knees in the face of the most ferocious meteor of the last 50 years, succumbing to its vulnerability to the uncontrollable and unmanageable force of nature. Today those knees have been literally broken after another dramatic and uncontrollable event for China: a devastating earthquake in Sichuan province, in the South West that killed and buried more than 56,000 people (and that number is rising every day…), injured 300,000 and 30,000 are still missing.

China normally enjoys a position of worldwide domination and control when it comes to internal policies that silence their opponents, and the development of an economy that exports deflation, and in protecting its industry and monetary competitiveness. However, in the face of these natural disasters, China find it can do little more than kneel and beg for aid from the very world it attempts to dominate whenever possible.

Chinese agriculture has once again been adversely affected in Sichuan as well as in other zones of disaster in the last few months. 34,000 hectares of farmland and irrigation systems have been destroyed in some areas: ““up to 100,000 hectares of rice paddies might have to be used to grow alternative crops”, the China Daily reported. Additionally, farming machinery and facilities have been damaged and 12.5 million head of poultry and livestock has been killed….

As the country’s leading agricultural province, Sichuan provides 6% of the nation’s total grain output which includes 5% of the national total summer grain production, 8% of the total vegetable oil crops and 5% percent of the total vegetable production, said Wei Chao’an, Vice Agriculture Minister, speaking to the China Daily.

China food inflation surged to 22% in April. Through enacting price controls in areas hit by these disasters, the government is trying to cap inflation, that came in at 8.5% for April.

It is important to note that China has also been imposing agricultural export restrictions, increasing tariffs and imposing export quotas after inflation skyrocketed to its highest level in 12 years during February while at the same time 40% of the country’s inflation comes from the international price increases, according to Chinese economists.

It is like trying to extinguish a fire using a bucket of gasoline.

Also, China continues to import products that keep rising in price, from food to energy. We must remain aware that oil and corn are part of our everyday life in the form of plastics to toothpaste.

On the other hand, China is net exporter of agricultural products, which means that higher export restrictions will actually create the opposite effect to what they are trying to avoid in the process – that being it will bring about inflation. In restricting the international food supply they are generating a greater increase in international prices.

China has also increased subsidies to farmers in hopes they will raise more pork and cultivate more grains. Ultimately these measures do little more than to create relative price distortions while at the same time they discourage farmers from producing more of the same.

As quoted in the China Daily, Qi Jingmei, a senior economist at the State Information Center, noted that “The Chinese market is linked to the global market by thousands of threads. You can’t cut them off completely”.

As the country is imposing restrictions to food exports, it is opening its state food reserves of wheat, rice and pork in a move to contain inflation. Huang Jikun, of the Chinese Agricultural Policy Center noted that: “The potential for prices to go up may well rise in future, because you can’t always tap the grain reserves.”

These reserves could in turn run out in a few months, especially if the farmers decide to turn to the production of more profitable commodities in the face of depressed domestic prices. And if you combine this scenario with a policy of export restrictions an explosive cocktail could be generated when the world finds out that China is returning to participate actively in the world-wide grain purchase.

A great commodity play is the ETF PowerShares DB Agricultural Fund, (AMEX:DBA), launched in January 2007. This fund tracks the Deutsche Bank Liquid Commodity Index-Optimum Yield Excess Return, invests in futures contracts for corn, wheat, soy beans, and sugar. It is the largest ($2.6 billion in assets) and most heavily traded (3.1 million share three-month average trading volume) agricultural commodities ETF. The fund collateralizes its futures contracts with 3-month U.S. Treasuries.

*** With so many market gurus, investment banks, even the Iranian Energy Minister forecasting a worldwide debacle – that is the price of oil reaching $200 a barrel, is there any margin for an oil price correction?

Arjun N. Murti, an analyst at Goldman Sachs (NYSE:GS), predicted oil would reach $100 a barrel. Many laughed.

Today, he thinks that oil prices will keep rising and will stay above $100 going into 2011. Murti’s prediction three weeks ago is that oil will climb to $200 and gasoline to $6 a gallon within two years.

Others think that oil will collapse if the speculators begin to sell their oil positions.

Currently Murti is one of the most listened gurus on Wall Street, and his investment reports are followed by many investors before deciding which destinations or sectors in which to put their money.

And no matter how hard somebody disagrees with its predictions, it matters little for `Goldman is always Goldman’.
“Even if you disagree with their views, the problem is that Goldman does carry so much credibility. There are a lot of traders who are going to buy based on their reports.” said Nauman Barakat, senior vice president for global energy futures at Macquarie Futures USA to the New York Times.

There are other analysts who are predicting that the price of oil could return to US$ 70 a barrel towards year end.

There are so many opinions regarding whether there is a sufficient demand for oil, if its supply is diminishing, if oil will run out before we imagined it would, if the situation is a supply or demand matter, or if it is simply a speculator’s market- as analysts tend to think.

Citigroup (NYSE:C) analyst Tim Evans said to the New York Times that trading commodities these days is like “sticking your hand in a blender.”

Oil is in vogue and we all want to make predictions, as crazy as they might seem. But one thing is certain: Americans are addicted to oil. And if a strong recession does not shake up the United States, the probability of seeing oil back to $70 is striking to say the least.

Probably, another sure thing is Evans’ statement.

Until next Friday,

Paola Pecora

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