Take the two lead stories on the News Ltd business web page: “BHP to slash resources output” and “Oil ‘could slump to US$25.‘”

It’s an interesting proposition. And it further highlights why Western economies will not suffer from deflation. Sure, prices for some things may be falling - such as oil and petrol. But will that filter through to other areas of the economy?

We’ve spent the last four years ridiculing central bankers for discounting fuel and food costs from their inflation models, so we aren’t about to discount fuel when it is falling.

With the new policies of ’super-easy’ credit from the RBA, the Fed, ECB and Bank of England, the main concern remains inflation.

When the bankers and economists talk just of prices when they consider inflation they are only looking at half of the picture. Their argument goes that because the economy is slowing, business and consumers will spend less money. Thus prices will fall, and that could lead to deflation.

Their solution is to set interest rates as low as possible. They are backing that up by issuing as many bonds as possible to soak up excess capital. This is excess capital that the banks don’t want to lend to anyone apart from the government.

Governments are then going out and, erm, lending the cash to the sort of companies - other banks, auto manufacturers, etc. - that the banks wouldn’t dream of lending money to.

Once that source of cash dries up - and it must soon in the US based on bond prices and yields - the only other option left open is to print more money and spend it. Some of it may be for worthwhile projects. But the key is that as worthy as the projects may be, it is simply increasing the supply of money in the economy, which as anyone can tell you, is inflationary.

Yet, this is being overlooked in favour of spreading the false fear of deflation. Why? Simple, a government that spends money is seen to be doing something. Telling the public and business that the best course of action is to let events work things out for itself would never be palatable - people may start asking why the politicians are there in the first place.

It’s the Oil Supply Not the Demand That Matters

But back to the oil and resources story. Oil is a strange beast. The price of crude oil climbed over USD$100 a barrel between 2003 and 2008, until it reached a peak of nearly USD$150.

During that time production and demand increased, setting off fears of global shortages. Of course, the price was also influenced by other issues such as terrorists and hurricanes. And most of all by China.

Today, recession is in the air and now all the talk is of slowing demand and OPEC production cuts.

Analysts from Merrill Lynch now believe the price of crude could dip “all the way to USD$25 a barrel.” But remember, most of the analysts on Wall Street and elsewhere were not convinced that oil prices would rise in the first place. They were constantly playing ‘catch-up’ with their analysis.

As the price ratcheted up ever higher they would call the top and then suggest prices would stabilize. Now the price is falling and they show their true thoughts.

Trying to pick the future price of any asset is hard. Even harder for something as volatile as oil. Despite the likelihood of a global slowdown, it is arguable whether it will necessarily be reflected with a big drop in demand for crude.

You only have to take a look at the traffic on the roads in the last few weeks. There is little doubt that more and more people have ditched public transport and fired up the cars again.

The main influence is not so much the demand - which most of the mainstream seems to be concentrating on - but the supply. OPEC is terrible at trying to control production levels from member states.

As we mentioned recently, there is the constant struggle between supporting a higher price and producing as much as possible to take advantage of the price.

The structure of the national oil companies within OPEC is also of importance. Even if the price of crude falls to near or below breakeven, they will not stop extracting the oil. One reason is that it would lead to civil unrest in already unstable countries as thousands of jobs are lost.

And secondly, even though viable alternative energy may seem to be decades away, a decision such as OPEC closing down unprofitable wells would be the catalyst to speed this process up. It’s amazing what can be done in the face of real adversity!

Lead by oil and metals, especially copper, the downward march of commodity prices continues apace.

Oil fell under $US44 a barrel yesterday; it’s more than $US103 down from the July peak of $US147.47 a barrel. Oil is at a three and a half year low.

Non-traded spot prices for coal and iron ore are weak. 

Vale, (CVRD), the big Brazilian iron ore and nickel miner, yesterday chopped its global workforce by 2.1%, or 1300 people. More than 6,000 others will be sent on unpaid leave or be retrained.

Copper fell again, off another cent and pushing the US front futures price under $US1.50 a pound: yesterday’s finish was around the lowest since early, 2005. 

Copper is down more than 70% from its May peak of  $US4.2605 a pound. Copper fell 9.75% on Thursday alone.

The same is happening across the board: even gold remains hesitant, the fear of recession and sluggish demand is undermining confidence.

The Reuters-Jefferies CRB index, a major global benchmark for commodities prices, dropped to its lowest level since 2002 yesterday when it fell to around 218: the index has plunged 60% from July’s record of 473.97.

The drop came after oil prices fell to fresh three-and-a-half year lows on successive days.

Oil is the main driver, especially with OPEC’s odd decision last week to sit still and not cut production. Prices hit a four year low overnight Thursday of around $US43.60 a barrel, down almost 7% in one day.

UK analysts wonder if there’s a split in the group between countries which need extra output (Nigeria and Venezuela) and those who see the dangers from sparking another oil price surge, or the futility of trying to in the midst of a global recession

OPEC said at a weekend meeting in Cairo that it would delay production cuts until mid-December, when it will convene again in Oran, Algeria. 

Futures prices see the global price falling to $US40 a barrel in the next couple of months: it could come earlier than that, by year’s end given the flood of depressing news about the global economy, despite rate cuts and other pump priming measures.

Merrill Lynch said in a report on Thursday that prices may dip below $US25 a barrel next year if the recession spreads to China. Without a recession in China, the firm saw prices around $US50 a barrel.

Much will depend on the Oran meeting of OPEC, when the group is expected to cut output by 1m-1.5m barrels a day. 

But even that confidence has been undermined by news that the financially-strained Kuwait and the United Arab Emirates reportedly told some of their larger customers in Asia that they would supply them with more oil in January than in December.

The group has so far cut about 1m to 1.2m barrels a day of a promised 1.5m b/d cut.

Copper and other metals have eased despite suggestions that China is buying metals for a national strategic reserve.

China is certainly attacking the iron ore and coking and thermal coal supply contracts held by Australian, Indonesia, Canadian and other suppliers to drive down prices next year. Volumes will also fall.

Copper prices fell to the lowest since July 2005 on growing worries that the price is heading for the important $US1 a pound market thanks to the growing global slump.

That’s being reflected in the surge in London Metal Exchange stocks of unsold metal. (The LME is a terminal market, so when its stocks rise and fall, you know that demand is strong or weak. At present it’s weak to getting weaker). Copper stocks are running around 293,000 tonnes, the lowest since mid 2004.

The slump has produced a flood of decisions this week from major producers and processors.

Freeport-McMoRan Copper & Gold Inc., the world’s largest listed copper producer, suspended its dividend and will reduce output over the next two years. 

Freeport said it will now produce 4.1 billion pounds (1.86 million tonnes) in 2009, down from the October decision to lift output to 4.3 billion pounds. That’s around 90,000 tonnes less.

Its 2010 output will fall 11% and the company yesterday said more cuts would happen if the price weakened.

Freeport is really hunkering down: besides cutting out and suspending the dividend it is more than halving its capital expenditure in 2009 to $US1.1 billion from October’s estimate of $US2.3 billion.

In Japan, Nippon Mining Holdings Inc, Japan’s leading copper producer, is considering cutting production by 10% to 20%. It expects to make a decision by month’s end.

An output cut by Nippon Mining, which has an annual copper production capacity of about 610,000 tonnes, would follow curbs at its Chinese competitors.

Tongling Nonferrous Metals, China’s second largest copper producer, has reduced copper output due to low prices.

If The Nippon Mining cuts output, it will buy less copper concentrate in 2009.

According to the London based Bloomsbury Mineral Economics, global copper production will outpace demand by 244,000 tonnes in 2009, a 109,000 tonne surplus.

Last week RBS Capital analysts reckoned next year’s surplus would be 250,000 tonnes and possibly double that in 2010.

In September, the Japan Copper and Brass Association cut its estimate for Japanese copper demand to 977,000 tonnes for the year to March, a decline of 2.1 percent from the previous year.

Lead dropped to a two-year low in London after Ivernia Inc., the former supplier of 3% of world output, was given the greenlight to resume an 8,000 tonne shipment from Western Australia. Aluminum prices hit four year lows. 

That missing metal has seen lead stocks fall this year by just over 5%. But the Ivernia news came as stocks jumped 2.7% in a day.

Three month lead fell 11% on Wednesday on the news to $US975 a tonne after touching $US970 a tonne, the lowest since June 2006. lead prices recovered slightly Thursday 

The Financial Times reported that China was looking to buy commodities:

“China, the world’s largest metals consumer, is considering a plan to build up state reserves of base metals to help fight the impact of the global economic slowdown, according to an industry association.

“Wen Xianjun, vice-chairman of the China Nonferrous Metals Industry Association, told a conference that central government was considering buying all types of base metals to boost domestic demand.

“It was the second time this week that Chinese officials had suggested that the country might buy base metals.

“On Monday, in a statement greeted with widespread scepticism by the market, the government of Yunnan province, a base for significant Chinese metal production, said it would buy 1m tonnes of base metals.

“But Zhang Liqun, director of the financial research institute at the State Council, the country’s cabinet, said on Wednesday that the government’s goal was still to force a restructuring of inefficient mining companies.”

Yet the futures markets were telling us otherwise. The SFE Target Rate Tracker had a 1% cut fully priced in and was even pricing in a small chance of a 1.25% cut. But that was never really going to happen.

The RBA cash rate is now down to 4.25%. That’s the lowest point that rates got to while John Howard and Peter Costello were trying to run things. Only time will tell if Rudd and Swan decide to make any capital out of the low interest rates.

But that isn’t enough. Now the market wants another 1% cut as evidenced by the futures markets. As of yesterday, the futures prices have already built in a 98% chance of a cut to 3.25%. But they’ve got a long time to wait as the next RBA meeting isn’t until February.

We won’t go into detail on the rate cuts. Quite frankly there isn’t much more to add. Apart from the amusement of seeing politicians and the mainstream media urging consumers to spend, spend, spend. Obviously they have quickly forgotten the reason for the recent credit nightmare.

Either that, or in typical fashion they are only interested in the short term benefits of a spending spree against the longer term benefits of moderation.

Oil - $30 or $150?

So, instead of that, this. What is going to happen to the price of oil?

As of this morning, the price of crude oil has dropped below USD$50 a barrel. Not that long ago it was trading at nearly USD$150 a barrel.

OPEC is trying its best to cut production so that the price remains elevated. It’s been talking about that for a few months now. Even so, it hasn’t stopped oil from nearly halving in that time.

With global economies moving into recession, forecasts are for oil demand to wane. For the time being. Don’t forget that the margin between supply and demand is still very tight at only a few hundred thousand barrels per day. That’s out of a global demand of about 85 million barrels per day.

John Kilduff at MF Global told Agence France Presse (AFP), “if they [OPEC] expect to have any chance of halting the current price slide and reaching their goal of maintaining anywhere near a 75-dollar price level, a clear demonstration of unity is necessary. They must take more oil off world markets. Stockpiles are clearly at very high levels.”

That’s a tough task. The reaction from OPEC nations to the falling oil price is just like the stampede to exit the stock market when prices are falling. They know that pumping out more oil at these prices is going to drive the price down, but they also know that if they don’t then other nations will and the price will fall anyway.

Now the price has broken through the USD$50 a barrel mark, and with negative economic headlines for the world economy, there is a very real chance that crude could head towards USD$30. That would be a price level not seen since 2003.

We aren’t game to predict that, because we just don’t know. To be honest, the fall from USD$150 down to the current level has happened a lot quicker than we expected.

But. As we know, markets tend to over-react to the upside and the downside. The fundamentals of oil supply have barely changed. Apart from the hopeless activities of OPEC.

The issue of Peak Oil has not gone away, and alternative energy sources still need to be considered. The question is whether there will still be the same urgency with oil at USD$40.

Some would argue that there was only marginal urgency when it was three times that price, and that nothing will change.

Stay tuned for another upturn in oil prices once global economies start to recover.

As we mentioned in our last update (September 11), the main target for the 2-months decline on oil prices has been the 61.8% Fibonacci ratio of the 18-months bullish trend occurred between January 2007 and July 2008 (between points A and B on the chart).

Click to Enlarge

Oil prices have therefore declined by 38.9% between the historical high posted on July 11 and the recent low posted on the Fibonacci level at $90.4 on September 16 (point C). There are two contrarian forces that should struggle to determine the future price action. On one hand, the action plan decided by the US authorities to fight the financial crisis is likely to create new US Dollars. This will damage the Greenback’s current value and should symmetrically increase commodities prices (as the US Dollar has been negatively correlated with energy prices). On the other hand, the recession and slowing growth around the world contributes to decrease the demand on energy. A weak US currency and a lower oil demand are consequently being the key fundamental factors that the market will highlight.

In the mean time, the technical indications will remain the market’s best friends. The rebound started last week from the Fibonacci support has already brought the prices until $110 a barrel (a bounce back of 22% in only a few trading sessions).

The momentum and oscillator tools turned bullish. The RSI triggered a positive signal on September 17 when it crossed above its signal line, showing that the oversold configuration was over and that the buyers were now surpassing sellers. The MACD confirmed this 2 days later (last Friday) when it turned upward and crossed above it signal line. The Commodity Channel Index is also now well oriented. Those elements argue for a further rebound.

The next objectives are respectively $112, $119 and $126. Those levels correspond to the previous Fibonacci levels (38.2% at $112 and 23.6% at $126), while $119 is half the way of the recent bearish trend (between points B and C).

On the downside, the $90 area is still valid and is the main support of the current pattern. There is another support horizontal line around $85.

China will dance around the world investing in countries the U.S. deems unsavory and locking up their oil reserves for years to come. They’ll drill just a stone’s throw off our borders while we fight it out among ourselves.

Nuts like Chavez will nationalize their oil industries, and offer us a take it or leave it deal; stealing the billions of dollars of infrastructure development we’ve invested.

Meanwhile, OPEC is basically running the energy show for industrialized nations, or at least they did until recently. But still despite the recent skirmish between the Saudis and their counterparts at the meeting, OPEC will still meet and decide how much oil to produce…

I find it unfathomable that we’ve allowed these countries to decide the fate of the U.S economy.

If we’re going to change this, then we need to get on the ball. If I was in charge of our energy policy, I would be working towards an independent program. I would be convincing leaders to take another look at the untapped reserves we have a little closer to home…in the Gulf of Mexico, and off the east and west coasts.

However, sadly I just don’t see this happening anytime soon. We’re a little too complacent to change our old oil ways. But, looking to the future, as we continue to exhaust energy reserves around the world, we will usher in a whole new generation of cleaner, renewable alternative energy…

Well, it was up till Friday when it suddenly became a very different story.

And this morning, a switchback, with oil under the $US100 a barrel mark in New York trading early today as damage from Hurricane Ike wasn’t as bad as feared.

The US dollar fell Friday as the slide in the euro came to an end; the Australian dollar bounced a couple of cents; gold, copper and several other commodities rose and Hurricane Ike was the big influence.

But the big question was whether Friday’s bounce was due to Ike coming ashore and apparently not leaving too much damage to the oil and gas producing, refining and distribution facilities along the Texas coast between Houston and Galveston.

At least 13 refineries in Texas were shut for the passage of Ike.

That was 3.64 million barrels a day of refining capacity.

But as we have seen after storms in the past month, once the situation is clarified, then the prices of oil, petrol and gas will ease quite quickly.

And that’s what seems to have happened after Ike as oil fell in early electronic trading in new York to $US99.25 after dropping to $US98.75 a barrel early this morning, our time.

The October New York contract briefly dipped to $US99.99 on Friday, falling under the $US100 level for the first time since April 1.

But Nymex crude in New York rose 31c to close at $US101.18 a barrel.

In London, October Brent North Sea crude eased 6c to settle at $US97.58 a barrel.

Oil prices are down $US47.29 a barrel since the peak of $US147.47 on July 11.

For all the sound and fury of Ike, the real story remains the continuing dip in American consumption of oil-based energy products.

US energy consumption is down 3.8% over the past four weeks compared with the same period in 2007, while petrol consumption is down 2.1%.

The United States Department of Agriculture said on Friday that the hugely important corn harvest won’t be as big as thought because of widespread dry, warm weather last month.

The USDA said farmers will harvest 1.8% less corn than forecast last month, while the soybean harvest will be down 1.3%, but wheat output will be higher in both the US and globally.

The USDA forecasts steeper increases in corn and soybean prices, which have eased from the record levels set earlier in the year.

December corn rose 30 USc, or 5.6% on Friday to $US5.6325 a bushel in Chicago. That pushed prices up 2.7% this week. That left the price of the most active contract down 30% from the all time high of $US7.9925 in late June.

November soybean futures rose 26c, or 2.2%, to $US12.02 a bushel in Chicago. The price rose 2.1% last week. Beans are down 27% from the all time high of $US16.3675 hit in early July

The USDA said the average cash corn prices in the crop year that began September1 were $US5.50 a bushel, compared with $US5.40 estimated in August and $US4.20 in the most recent year.

The Department said cash soybean prices will average $US12.35 a bushel this crop year (which started on September 1), up from last month’s estimate of $US2.25 and up from $US10.15 in the previous year.

The USDA said it expects US carryover stocks on May 31 (the end of the wheat crop year) will be around 574 million bushels, while exports will total 1 billion bushels, matching the forecasts made in August by the USDA.

December wheat futures fell 7c to $US7.1925 a bushel on Friday, down 4.3% over the week and 19% this year.

The USDA also increased its estimate of global production to a record 676.3 million tonnes, up from last month’s forecast of 670.8 million tonnes.

Canadian farmers will harvest 25.4 million tonnes, up slightly from the August forecast of 25 million tonnes; European Union output will be 147.2 million tonnes, up from 143.2 million tonnes in the August forecast and these will offset declines in Australia and Argentina: Australia will produce 22 million tonnes, down from the 25 million tonnes in the August forecast and Argentina growers may harvest 12.5 million tonnes, 1 million tonnes down on the August estimate.

According to the USDA’s forecast, the US is expected to be the largest exporter of wheat, followed by Canada, Russia, Australia, Ukraine and Argentina.

Comex December copper futures added 7.15 USc, or 2.3%, to $US3.194 a pound. The price was up 3.1% last week

The metal climbed from Wednesday-Friday, as signs of declining mine output increased concerns that supplies may be tight next year. Some analysts, especially at Citigroup, are forecasting demand to run ahead of production next year.

Copper was also supported Friday by a fall in Chinese stocks.

Stocks overseen by the Shanghai Futures Exchange dropped 29% to 13,554 tonnes, the lowest level since 2003.

On the London Metal Exchange, three month copper rose $US192, or 2.8%, to $US7,122 a tonne, or $US3.23 a pound.

Gold jumped Friday, ending a nine-day losing streak, thanks to the US dollar’s fall against the euro.

The euro rose as much as 1.5% against greenback, but ended off 0.3% for the week.

The Australian dollar finished at $US82.36 in New York, up from $US80.48 in Sydney on Friday afternoon and $US81.64 in Sydney the week before.

It was a rare gain for the currency, the first for a month or more over the week and the strongest daily performance for weeks.

Gold fell 4.8% over the week, despite a $US19 dollar an ounce rise on the day.

Comex December gold rose $US19, or 2.5% to $US764.50 an ounce in New York. The metal had fallen 11% from the end of August to last Thursday

Silver also had a rare rise, finishing up 24c, or 2.3%, to $US10.795 an ounce for the December contract. The metal still dropped 12% last week and is down 28% this year.

Gold is down 26% from the record $US1,033.90 reached in March and is off 8.8% in 2008.

 .

These are the real tough guys. Not the sort that talk big but then have to get a hitman to ‘take you out,’ these will do it all for themselves. These are the people who when you hear them being interviewed on CNBC don’t talk with a normal voice; a voice that sounds as if they’ve had their voice box ripped out and replaced with a supercharged V12 engine.

I’m talking about crude oil traders.

What makes them take out the award for toughness? Well, let’s take a look at the oil price over the last couple of months. As recent as early July the price of crude oil had raced ahead to nearly USD$150. At that stage the talk was all about the price reaching USD$200. The oil analyst at US investment bank GoldmanSachs even put out a research report saying so.

And it still may do that, but since then the price of crude oil has only really gone in one direction – down. In fact it is down by approximately 25%, trading overnight to as low as USD$110 a barrel.

Anyone would think that the world has fallen asleep since the start of July, but of course it hasn’t. We’ve had supply disruptions in Nigeria; we’ve had war – albeit a little one – between Russia and Georgia; we’ve had threats from Russia to reignite the Cold War; we’ve had hurricanes in the Gulf of Mexico; nationalizations in Central and South America.

Yet despite all that, the oil traders have sat back and said “so what,” “seen that before,” “what else have you got?” I even dare say that they’ve shouted “BORING!” at their computer screens.

What does that mean for you? Well, one thing it definitely does not mean is that the price of crude will never go back up again. Because it could. And it will if supply continues to be constrained, and if demand continues to rise.

Risk is Being Priced Out of Oil
What it does mean is that traders have now removed some of the risk premium from oil. Terrorist strikes in Iraq were removed long ago, no-one cares anymore. But a major hurricane in the Gulf of Mexico hadn’t been taken out until now. A potential military conflict in the Caucasus wasn’t even seen as a risk until it happened, and was then just as quickly removed as a concern.

Even so, with all these factors having been stripped away from the price of crude oil it still remains more than four times higher than it was in 2002.

This leaves us with the major factor that the oil market really cares about, and the one that will take you all back to your high school or university economics classes – Supply & Demand.

Crude oil is now priced at around USD$110 a barrel based almost exclusively on whether there is enough supply in order to meet demand. If the price falls a bit then it is because the market believes there is enough. If it rises a bit then it is because the market believes there isn’t enough.

As this chart shows us, in 2007, total world supply of oil and oil-like products was 85.6 million barrels per day…

Yet also in 2007, the demand for oil and oil-like products was… 86.1 million barrels of oil per day. In other words the world wanted 500,000 barrels of oil more per day than it was able to produce during the year.

Tough Guys Keeping Down the Price of Petrol

Readers, driving to work this morning in our Sportswagon – and we don’t mean the fancy new Holden version either, we’re talking the vintage 1996 Hyundai Lantra edition – we realized who the tough guys are in the markets.

These are the real tough guys. Not the sort that talk big but then have to get a hitman to ‘take you out,’ these will do it all for themselves. These are the people who when you hear them being interviewed on CNBC don’t talk with a normal voice; a voice that sounds as if they’ve had their voice box ripped out and replaced with a supercharged V12 engine.

I’m talking about crude oil traders.

What makes them take out the award for toughness? Well, let’s take a look at the oil price over the last couple of months. As recent as early July the price of crude oil had raced ahead to nearly USD$150. At that stage the talk was all about the price reaching USD$200. The oil analyst at US investment bank GoldmanSachs even put out a research report saying so.

And it still may do that, but since then the price of crude oil has only really gone in one direction – down. In fact it is down by approximately 25%, trading overnight to as low as USD$110 a barrel.

Anyone would think that the world has fallen asleep since the start of July, but of course it hasn’t. We’ve had supply disruptions in Nigeria; we’ve had war – albeit a little one – between Russia and Georgia; we’ve had threats from Russia to reignite the Cold War; we’ve had hurricanes in the Gulf of Mexico; nationalizations in Central and South America.

Yet despite all that, the oil traders have sat back and said “so what,” “seen that before,” “what else have you got?” I even dare say that they’ve shouted “BORING!” at their computer screens.

What does that mean for you? Well, one thing it definitely does not mean is that the price of crude will never go back up again. Because it could. And it will if supply continues to be constrained, and if demand continues to rise.

Risk is Being Priced Out of Oil

What it does mean is that traders have now removed some of the risk premium from oil. Terrorist strikes in Iraq were removed long ago, no-one cares anymore. But a major hurricane in the Gulf of Mexico hadn’t been taken out until now. A potential military conflict in the Caucasus wasn’t even seen as a risk until it happened, and was then just as quickly removed as a concern.

Even so, with all these factors having been stripped away from the price of crude oil it still remains more than four times higher than it was in 2002.

This leaves us with the major factor that the oil market really cares about, and the one that will take you all back to your high school or university economics classes – Supply & Demand.

Crude oil is now priced at around USD$110 a barrel based almost exclusively on whether there is enough supply in order to meet demand. If the price falls a bit then it is because the market believes there is enough. If it rises a bit then it is because the market believes there isn’t enough.

Who’s Afraid of the Dark?

And as we can see in this chart, demand forecasts by the IEA are set to continue to increase over the next two years. The IEA does not have a forecast for supply over the same period, which unfortunately leaves us all rather in the dark.

Perhaps that is why oil traders are the tough guys in the markets. They aren’t afraid of the dark.

The banks and financial stocks had their 15 minutes of fame during the worst of the credit crisis…but now it’s the energy sectors turn to rule the fickle whim of the market.

Of course, oil prices control more than just stocks. I don’t have to tell you what US$150 does to the overall economy and more specifically to your own personal wallet. I know I changed my spending habits since gas climbed above US$4.10 a gallon.

Earlier this summer, we all watched as oil steadily climbed to the once unthinkable level of US$147 per barrel. As a result, it seemed the entire country went “green” overnight. You started hearing phrases like “let’s conserve,” and “we need to find alternative sources of energy.”

But look how easily we slipped right back into our old habits as soon as oil prices slipped below the “manageable” level of US$115.

Old Oil Habits Die Hard

A few weeks ago, everyone was chattering nonstop about gas prices. Everyone was moaning about how much more each trip to the grocery store cost.

You heard friends talking about what kind of bicycle they were going to buy if gas climbed much higher. You even heard the talking heads chattering about how wind, water and nuclear power would save us from these sky-high gas prices.

Then, magically we wake up one day, and gas is down to a “reasonable” US$3.70 a gallon. Life is good again…for now.

But what happens when oil rises again? It’s worth considering because right now tropical storms (aka hurricanes in training) Gustav and Hanna are swirling around the U.S.’s main source of oil.

If they should hit us where it hurts the most - in the country’s oil reserves in the Gulf - then we’ll be right back where we were earlier this summer.

My Own Personal Connection to Our Oil Reserves

I spent almost eight years working as a geologist offshore in the Gulf of Mexico. Among other tasks, my job was drilling wildcat, exploratory oil and gas wells. So I know what it’s like to be on a drillship, hundreds of miles from the nearest piece of dry land when a hurricane is heading straight for you.

As an experienced oil driller, I can tell you there are hundreds of drilling rigs and production platforms sitting in the Gulf.

Every single one of them has to be “prepared” for the worst in case a hurricane hits. When a storm is coming, all drilling stops, wells are shut in, and all personnel are transported by boat and helicopter to shore.

With Gustav’s current projected track, I’m sure this process has already begun. Wells have stopped pumping, workers are headed home and everyone is sitting tight, with their fingers crossed and hoping for the best.

All the refineries along the Gulf Coast are also going through their emergency preparation shut-down plans. The refineries themselves are huge, complicated and potentially dangerous industrial complexes. That means they can take a long time to power down. Right now, I’m sure their fingers are on the “off” switch in preparation for what could be devastating storms.

This means, the refineries have lost one week in preparation for the storms, and another week in getting back online.

The Hits Just Keep On Coming…this Time with Hanna

And just as Gustav blows through - Hanna is sitting on its heels. Currently, Hanna looks like it may turn a little more North and run up the east coast of Florida, but there’s really no way to be sure this early.

Now if you’re in charge of the oil and gas wells, refineries and personnel for the Gulf, then you’re faced with a difficult decision. You have already stopped all drilling, pulled the drill pipe out of the hole, secured the rig and shut down in all production. The refineries are on emergency hurricane shut-in and the workers have gone home to be with their families.

So do you call everyone back as soon as Gustav passes and hope Hanna is a no-show? Or do you just plan to wait it out another week? From my experience - they’ll wait it out. It’s just too expensive and much too dangerous to risk it.

Could Russia Knock Us Out for the Count?

And then there’s Russia - and this could turn out to be the knock-out punch.

You see, as Russia occupies Georgia, the Russian oil supply becomes a real concern for all of us. The pipeline that crosses Georgia can pump slightly more than one million barrels of crude oil per day, or more than 1% of the world’s daily crude output. That 1% may not sound that bad, but in a world where we actually use more oil than we produce every single day, 1% can make a huge difference.

The 1,100-mile pipeline carries oil from Azerbaijan’s Caspian Sea fields. It’s estimated to hold the world’s third-largest reserves. This pipeline is already vulnerable. We saw that last week when it was sabotaged, apparently by Kurdish separatists.

Most of the oil is bound for Western Europe and with only so much oil to go around, what the pipeline carries affects prices everywhere.

So, what are we to do?

Well if you’re trading oil or natural gas short-term, you may just get a quick spike up in price. Take this as a gift as I believe the longer term trend for oil over the next few months is down and will settle in to US$100 per barrel +/- $10.

This won’t last forever. The hurricanes will pass. Russia and Georgia will eventually sort out their differences.

But in the meantime, look for oil to spike once again. It’s a virtual certainty with hurricanes waiting to pummel the Gulf.

Revenues of $144 million, and a net profit (including asset sales) of $242 million. The company has got a bundle of cash, $348 million and only a marginal amount of debt after selling a 60% stake in its assets to Chinese oil company Sinopec.

The company managed to secure an average oil price of USD$109 a barrel for the 1.379 million barrels that it extracted last year.

The share price remains a long way below the peak it reached last year of $11.40.

LONDON - European stock markets closed mostly firmer on Tuesday, recovering from early losses as investors cheered better-than-expected but still weak US consumer confidence figures.
London bucked the firmer trend, with the FTSE 100 index fell 34.90 points, or 0.63 per cent, to 5,470.70 points.

FRANKFURT - The DAX was up 43.57 points, or 0.69 per cent, to 6,340.52.

PARIS - The CAC 40 index added 12.68 points, or 0.29 per cent, to 4,368.55.

TOKYO - The benchmark Nikkei-225 index lost 99.95 points , or 0.78 per cent, to 12,778.71.

HONG KONG - The benchmark Hang Seng Index fell 48.13 points, or 0.23 per cent, to 21,056.66.

WELLINGTON - The sharemarket improved during the day after an early slide, but failed to make it into the black despite some solid company results.
The benchmark NZSX-50 index closed down 5.91 points at 3,321.0.

SYDNEY - The Australian stock market is expected to open in positive territory after US stocks ended mostly higher overnight.
At 0740 AEST on the Sydney Futures Exchange, the September share price index futures contract was up six points at 4,992.
Today, the Australian Bureau of Statistics (ABS) releases preliminary data on construction work done in June.
Companies releasing annual results include IOOF Holdings, Westfield Group, Transurban Group, PrimeAg Australia, Hastie group, Regional Express Holdings, Macquarie Media Group, GPT Group, Gloucester Coal, Australian Vintage and Australian Infrastructure Fund.
Woodside Petroleum’s interim results are due.
The Australian share market closed marginally lower yesterday, with mixed performances from many sectors after a weak US lead overnight provided little direction.
The benchmark S&P/ASX200 index was down 7.4 points, or 0.15 per cent, to 5,007.5, while the broader All Ordinaries shed 7.8 points, or 0.15 per cent, to 5,082.3.

NYMEX

Oil prices rebounded on Tuesday on concerns that a strengthened Hurricane Gustav could damage energy facilities in the Gulf of Mexico.
New York’s main contract, light sweet crude for delivery in October, climbed $US1.16 to close at $US116.27 a barrel.
In London, Brent North Sea crude for October added 60 US cents to settle at $US114.63.
Oil bounced higher as Gustav grew from a tropical storm into a hurricane Tuesday.
The storm barreled into Haiti, packing powerful winds and heavy rains that were likely to cause massive destruction throughout the desperately poor Caribbean nation.
Gustav was also on a path to strike Jamaica and Cuba, and possibly offshore oil rigs in the Gulf of Mexico later in the week - a threat that led to a spike in oil futures prices.
Anglo-Dutch energy giant Royal Dutch Shell meanwhile said it was planning to evacuate some staff from its Gulf facilities because of Gustav.
Earlier on Tuesday, oil prices had fallen as weak German data stoked concerns about slowing global economic growth and lower demand for energy.
Heightened tensions between Russia and Western countries over Moscow’s military action in Georgia also stoked supply concerns.
Investors were worrying that a new standoff could interrupt the pipeline flow of Azerbaijani crude from the Caspian Sea to the Turkish port of Ceyhan on the Mediterranean.
Oil prices have tumbled from record highs above $US147 set on July 11 after breaking through $US100 at the start of the year.

COMEX
Gold futures for December delivery added $US2.40 to $US828.10 an ounce on the Comex division of the New York Mercantile Exchange.
Silver for September delivery increased 0.205 US cents to settle at $US13.575 on the Nymex while September copper fell 0.0430 US cents to settle at $US3.4385 a pound.

Asian stocks, including Australia fell last week, sending the region’s benchmark index to its lowest in more than two years.

But Friday’s quick reversal of Thursday’s commodity price spike, led by oil, should steady markets in the region today, and Australia’s bounce on Friday off the back of the higher resource stocks, could be sustained if resource stocks are resilient..

Oil prices fell more than 5% on Friday in the biggest one-day slide since 2004 as dealers completely reversed the previous day’s madcap chasing of oil and commodities. A weakening British pound helped push the US dollar higher.

Wall Street kicked higher Friday on the slump in oil and suggestions Lehman Bros might be rescued by a Korean Government-owned bank coming to its aid with a generous deal to buy 50%. It’s only a maybe, but some on Wall Street treated it has a fact and sent Lehman shares higher.

What should worry investors more is Warren Buffett ruling out any interest from his Berkshire Hathaway company in helping rescue Fannie Mae and Freddie Mac shareholders. He says his company was a shareholder eight years ago but sold when he realised the two companies were producing quarterly profit results to suit Wall Street and not reality.

The Standard and Poor’s 500 added 14.48 points, or 1.1% Friday to 1,292.20, the Dow jumped 197.85, or 1.7%, to 11,628.06 and Nasdaq was up 1.4%, or 34 points to 2414.71.

For the week to Friday, the Dow fell 0.3%, the Standard & Poor’s 500 Index lost half a per cent and the Nasdaq lost 1.5%.

Traders said the market was the thinnest since last Christmas. Only 888 million shares were traded Friday on the New York Stock Exchange, the lowest volume since December 26.

JPMorgan Chase & Co. strategists said investors should buy more financial stocks and US companies that rely on discretionary spending by consumers and sell energy and raw- material producers. But big institutional investors have been doing that since May.

That’s why financial stocks haven’t followed Fannie Mae and Freddie Mac lower. But Morgan failed to tell clients the downside of buying these shares, except for a rotation of investment objectives. 

US banks and retailers face a year of misery with the banks having no money to lend and consumers no money to buy anything but essentials.

In Asia the MSCI Asia Pacific Index lost 0.8%t to 121.97 to take its losses so far in 2008 to 23%.

It was the 4th weekly fall in a row as Asian markets seem to be ignoring the up trend in the US.

Japan’s Nikkei Index fell 0.7% Friday, China’s CSI 300 Index lost 1.5% but Australia’s S&P/ASX 200 Index added 1.2% on the resource-driven rebound that will be tested today, despite the futures market showing a 70-plus point rise for the opening today. Friday’s rise cut the week’s losses to 1%, the 12th weekly fall in 14 weeks.

The ASX200 rose 56.2 points, or 1.2% to 4931.4 while the broader All Ordinaries gained 60.6 points, or 1.22%, to 5010.2.

BHP Billiton lifted $1.20, or 3.08%, to $40.15, Rio Tinto gained $2.10, or 1.77%, to $121.00 and OZ Minerals surged 19.5 cents, or 11.57%, to $1.88.

Babcock & Brown closed up 26 cents, or 11.71%, at $2.48, compared to $4.51 on Monday.

Among the banks, Commonwealth Bank was up 78 cents to $41.38, NAB was steady at $23.55 and Westpac added 34 cents to $22.00. The ANZ was up 8 cents to $15.67 after delivering a report explaining its controversial involvement with collapsed securities lender Opes Prime.

Insurance Australia Group reported a $261 million annual loss, but says its performance should improve this year. Its shares rose 6 cents to $3.75.

And Caltex Australia reported a fall in first-half earnings due to refinery shutdowns affecting production, and a narrowing of refiner margins.

Caltex shares finished 20 cents higher at $11.95.

Energy stocks were higher Friday and that will reverse today after that sharp fall in oil prices. Woodside finished $1.85 higher, or 3.35%, to $57.00, Santos 72 cents to $18.90 and Oil Search 12 cents to $5.69.

Woolworths dipped 84 cents, or 3.11%, to $26.14 ahead of its results this week while Coles’ owner Wesfarmers slipped 95 cents, or 2.89%, to $31.95 as investors continued to give it the thumbs down for the poor Coles numbers in its report on Thursday.

European shares had the best day for a fortnight Friday rose the most in two weeks as investors speculated takeovers may increase and the plunge in oil prices sent car companies and airlines higher.

Europe’s Dow Jones Stoxx 600 Index added 1.9% to 283.82, the biggest rise since August 5 and cut the week’s loss to 1.5%.

Despite the optimism of Friday it was the worst week for shares in the region for a month as reports signaled faster-than-forecast inflation in the US and Germany and a shuddering halt to growth in Britain where second quarter growth stalled, according to figures out Friday.

But the optimists in Britain looked at the lower oil price, some corporate activity in insurance, saw the possible Lehman Bros deal and said yippee!

The FTSE 100 jumped 135 points or 2.5% to be up 0.9% over the week.

Oil fell sharply. Turning Thursday’s big rebound in commodity prices into a one-day wonder that only confirmed the weakness in sector.

At one stage crude prices dropped more than $US6 a barrel, dropping the most in percentage terms since December 2004, as the US dollar also rebounded from Thursday’s weakness.

The main driver of Friday’s fall was BP restoring shipments on a Caspian Sea pipeline through Turkey, and a belated realisation that a tropical storm was delivering rain, but not high winds to oil producing and distributing regions of the US Gulf of Mexico coast and Florida.

New York oil futures dropped $US6.59 over Friday to close at $US114.59 - the biggest one-day drop since 2004. That took its fall back over the 20% from the peak of $US147 a barrel reached in mid-July. Oil hit a low of $US112.87 on Monday. 

The dollar climbed 0.9% Friday to $US1.4772 per euro in New York from $1.4899 on Thursday, when it fell 1%.

In London October Brent crude oil dropped $US6.24, or 5.2% a barrel to close at $US113.92 a barrel.

Comex December gold fell $US9.50, or 1.1%, to $US829.50 an ounce in New York.

That cut the week’s gains to 4.7%, which came after an 18% fall over the previous five weeks.

But it recovered in after hours trading to finish off $US5.90 an ounce at $US833.80.

Comex December silver futures dropped 28.8 US cents, or 2.1%, to $US13.555 on Friday. That cut the fall this year to 5%.

LME zinc jumped 9% to $US1,825 a tonne last week, while nickel rose 11.5% per cent at $US20,850 a tonne, also helped by short covering.

This simply isn’t the same oil bull market we saw in the 1970s. For starters, the energy sector is not as reliant on U.S. domestic consumption compared to 10 or 20 years ago.

Compared to the last oil shock in the 1970s, China was barely a factor in global consumption. Today China is the primary reason why most commodities are in a secular bull market. That’s also the case regarding oil. It’s a primary demand-driven trend that won’t end anytime soon.

The Chinese are becoming big global consumers. Total domestic retail sales in China grew a formidable 23% year-over-year through July compared to just 0.1% in the United States. The Chinese are avid consumers and of course, major exporters. The economy will continue to grow and that means the consumption of raw materials, including oil.

Compared to the 1970s when China was barely a dot on the consumption map, today they   devour excess supplies of most commodities - especially on corrections or when prices dip lower. The Chinese hoard commodities during big corrections.

Barely Any Demand Destruction in China

What some investors fail to understand is the primary source of new oil demand comes from the emerging markets, not the United States or Europe.

According to Merrill Lynch, oil demand growth in the emerging markets has never contracted year-over-year in the modern era. Although demand destruction has started in the emerging markets, the overall trend for consumption remains long-term bullish.

Total oil supplies remain in deficit to the tune of roughly 2 million barrels per day or 87 million barrels of demand compared to 85 million barrels of supply. That discrepancy in supply and demand has been consistent for over a year and remains threatened by supply bottlenecks in many oil-producing markets and threats of regional conflicts.

Oil Stocks are Cheap

A stable dollar is a plus for world growth because a lower dollar will help moderate inflation for many emerging market currencies. This should stimulate economic growth and demand for oil and other distillate fuels at a time when the global economy is slowing.       

Provided that U.S. interest rates remain low for the foreseeable future, and they will, global economic growth will continue. Oil prices will find a floor. That makes energy stocks a great buy at these distressed levels.

I’ve been busy buying oil and energy services companies over the last few weeks following big price declines. Most oil stocks are not priced for US$75 oil let alone oil prices north of US$100 per barrel. And compared to banks, energy stocks have real assets and real earnings!

Cash-flows for the majors in the United States, Canada, and Europe are bulging and dividend payments are still increasing. These stocks now trade at 52-week lows and should form a bottom over the next several few weeks or sooner as oil prices finally trough.

Thank God for the Chinese!

To recap, the global macroeconomic picture is nothing like it was in the 1970s. This is perhaps the most significant bullish point I can make about this big correction for raw materials. We don’t have skyrocketing interest rates and double-digit inflation.

China is now a major player with regards to commodity consumption. It was almost insignificant 30 years ago. Thank goodness for the Chinese. If they didn’t exist the bear market in U.S. stocks and bonds would be far more severe, the dollar would be near-worthless and commodities would be trading in the basement.

Provided that global interest rates remain historically low and the United States and Europe can eventually stabilize the ongoing credit crisis then global economic growth should reaccelerate later in 2009.

A stable dollar will also mitigate inflationary pressure globally and that’s a positive development for new consumption. Also, slowing growth and lower commodities prices now will eventually open the door to central bank rate cuts in 2009 - a boon for commodities.  

The time to buy or accumulate new positions in the energy sector is now. The oil majors and the oil drillers have been smashed hard over the last six weeks and offer great value in an otherwise sluggish earnings landscape. Earnings for the oil majors and the drillers will continue to flourish even at US$75 oil, which I don’t expect unless the Chinese economy collapses. And that won’t happen anytime soon.