Goldman Oil Bull a Nutcase: Here's Why Crash Coming Soon

Henry Blodget | May 22, 08 9:24 AM

China and India scarfing up so much oil that we're headed to $200+ a barrel? Please. Supply is increasing and demand is about to crash. So argues Ambrose Edwards Pritchard in this Telegraph assault on the peak oil story.

Pritchard's bottom line? That crap you're hearing about supply constraints is flat-out wrong: In fact, there's more supply coming online all the time. And then there's the other half of the equation: demand. What do you think will happen to demand when the US, Europe, China, and dozens of emerging economies finally lower the boom on spiraling inflation?

Pritchard:

The perfect storm that has swept oil prices to $132 a barrel may subside over the coming months as rising crude supply from unexpected corners of the world finally comes on stream, just as the global economic downturn begins to bite... The forces behind the meteoric price rise this spring are slowly receding.

Specifically?

• Nigeria has boosted output by 200,000 barrels a day (BPD) this month, making up most of the shortfall caused by rebel attacks on pipelines in April.
• Iraq has added 300,000 bpd to a total of 2.57m as security is beefed up in the northern Kirkuk region.
• Saudi Arabia is adding 300,000 bpd in response to a personal plea from President George Bush, and to placate angry Democrats on Capitol Hill.
• The US Energy Information Agency says non-Opec supply will edge up by 600,000 bpd over coming months as Brazil, Azerbaijan and the Sudan raise production. By next year, the US itself will be producing enough extra oil to shave its import needs.

This increased supply has actually created a surplus in recent months:

• Opec's monthly report says that demand this quarter will average 85.75m bpd. Supply was 86.8m bpd in April. The fresh output from Nigeria, Iraq and Saudi Arabia may push it significantly further into surplus.
• Opec says that stocks held by the OECD club of rich countries are above their five-year average, with "comfortable" cover for 53 days' use. US stocks have edged up for the last four months, though they fell last week.

So what's driving those crazy prices CNBC can't stop talking about? Speculation. Specifically, the oceans of cash flowing into commodity index funds, as investors agree that commodities are a sure thing

Lehman's latest report - Is it a Bubble? - says commodity index funds have exploded from $70bn (£36bn) to $235bn since early 2006. This includes $90bn of fresh money. Energy takes the lion's share. Every $100m flow of investment money into oil lifts crude prices by 1.6pc, it said.

"We see many of the ingredients for a classic asset bubble," said Edward Morse, Lehman's oil expert.

Meanwhile, demand is actually falling:

The International Monetary Fund has cut its forecast for world growth for 2008 three times since last autumn to 3.7pc, and the United Nations is predicting just 1.8pc - technically, a global recession. The major oil forecasters have halved their estimates for crude demand growth to 1.2m bpd.

The bulls say that the US housing crash and spreading contagion in Britain, Spain and Japan do not matter much for oil in the changed world of rising Asia. The US added just 7pc of crude demand growth from 2004 to 2007, compared with 34pc for China, 25pc for the Middle East and 17pc for emerging Asia....

But this could change. Egypt - the most populous Arab country - has just raised petrol prices by 40pc. Rumours swept China yesterday that Beijing was preparing to lift fuel prices.

And then there's that spiraling global inflation thing, which will cause central banks to hit the brakes:

Almost all emerging nations have to slam on the brakes in coming months to curb inflation before it starts spiralling out of control. Inflation has hit 30pc in Ukraine, 22pc in Vietnam, 8.5pc in China, and double digits across most of the Gulf.

The countries that account for the most of the growth in oil demand over the last two years are almost all nearing the limits of easy economic growth.