Forecasters who last summer were predicting $100/barrel crude oil have long since gone into early hibernation. Because bad news tends to sell better than good news in media outlets, these forecasts got a great deal of coverage in the summer of 2006. But it's now clear that these wild predictions were based mostly on fear — not fundamental realities. The oil market completed a 56-month bull market in July 2006, the longest since the 1980s when the bull market lasted for 54 months. No other bull markets in energies have come close to these two in terms of longevity.
The law of economics has not been repealed. I use this statement often because it's so true. Keep the price of any commodity too high too long and the public will find a way to use less of it, use something else or to produce more. In the case of oil, the world is accomplishing all three. Consider the following:
There has not been a true shortage of oil in the U.S. since the 1973-74 Arab oil embargo. Since then, there has never been a summer shortage of gasoline nor have we ever run out of heating oil during the winter. There had been off and on again logistical snags, but no shortages.
Global demand (China and India particularly) has been one of the primary reasons for the bull market of 2006. That is now being followed by a weakening global economy and pollution problems in China, which are resulting in a stronger shift to nuclear energy in that country.
Because of the high energy prices, five or more new nuclear plants are estimated to come on the drawing board in the U.S. this year — the first time in over 30 years.
According to the American Petroleum Institute, U.S. oil drilling in the first half of 2006 alone was nearly double the level of activity during the mid 1990s.
Other oil producing countries have also stepped up exploration activity this year resulting in a worldwide surplus rather than a deficit.
High oil prices have been a strong encouragement to the expansion in the ethanol industry, adding further competition to oil prices.
Auto manufacturers worldwide have responded with more fuel-efficient automobiles and, more importantly, hybrid automobiles that will dramatically reduce the demand for gasoline in the U.S.
The bottom line: A perceived shortage of oil in 2006 is now resulting in a large surplus coupled with ever-increasing supplies and declining demand. Oil prices are now in the midst of at least a two-year bear market.
How Low Can Prices Go?
Frankly, that's not a question we should be asking. The most important element to recognize in energy prices is that the long-term major trend is down. However, for those of you who like numbers to “shoot for,” a basic 50% correction of the bull market started in November of 2001 at $17/barrel and peaked in July at $78/barrel — giving you an objective of $47.50. This is likely a very reasonable objective and prices could go even lower.
What is the impact on farming decisions? First and foremost with the major trend down in energy prices, the first clue for everyone is to put off purchasing anything energy related as long as possible. Diesel fuel, gasoline and anhydrous ammonia are on top of the list. Just because prices appear to be “cheap” compared to where they were a year ago, it's not a fair comparison. Compare prices to where you anticipate they are going — not where they have been. Be patient and wait.
Richard A. Brock is president of Brock Associates, a farm market advisory firm, and publisher of The Brock Report. For a trial subscription and information on Brock services, call 800-558-3431 or visit www.brockreport.com.