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.

But a look at the statistics from the International Energy Agency (IEA) tells us that there isn’t exactly a big buffer between the amount supplied and the amount demanded.

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.

Let’s talk about oil and gas. Right now, you’ll be hard pressed to find a bigger influence on the stock market’s movements than energy prices.

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.

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.

The majority of energy stocks have struggled this year as oil prices raced to a record high of US $147 a barrel. Stocks simply couldn’t rally as the bear market in global stocks applied downward pressure on the entire complex.

Oil futures tell a completely different story. While major U.S. and international oil companies rose only 3.5% from January 1 to July 11, oil futures rose an astounding 63%. Over the same period, the S&P 500 Index tanked more than 10%.

Admittedly, the recent peak in oil prices was extreme and indicated a short-term “bubble.”

Commodities have been the prime beneficiaries of the global institutional boom. Industry players have already created a flurry of exchange traded funds to take advantage of this commodity bull market.

Also, hedge funds have turned to commodities to gain exposure to one of the few remaining profitable segments of the market. In fact, hedge funds’ “big trade” over the last 12 months has been riding the wave in commodities, including oil and shorting or betting against financial stocks. That trade violently reversed last month.

Another dose of bad news for commodities lately is the dollar’s rapid recovery. With the dollar in a freefall over the last few years investors had scrambled to hedge their portfolios against rising inflation and a decaying currency. But that trend is over, at least for now.

The article had something to say about the oil correction too.

“The price of oil will slide back to its marginal production cost of $60-$80.”

Eighty bucks is a possibility. But the thing for you to consider here as an investor is not whether oil prices will come back in line with production costs. It’s where costs are going.

They’re not standing still, reader. Here’s how future oil production looks.

If you think peak oil is occurring now…and we do…then the marginal production cost of oil can only go higher. The less there is of something, the more expensive it is to get at it. And if the costs are going up, so is the price. In the long term, anyway.

Employment Numbers Rise

The statistics bureaua served up some new employment numbers yesterday. Analysts spat them out in disgust. Maybe the garnish wasn’t right.

They came in low. Quite low. Almost 11,000 people found jobs in July.

But analysts are still calling for a rate cut. It seems odd. Wasn’t the RBA worried about a “wage-price spiral”? Weren’t rising incomes threatening to derail its plans to destroy domestic demand? If job demand is still high, the price of jobs is likely to be rising too.

This is just a blip on the radar, says the analyst community.

We’re not overly concerned if it is or not. You can make more money selling things to Chinese than Australians these days. We have a direct link to the hottest market in the world. People are gradually forgetting that, now that things aren’t as great as they used to be.

Instead of worrying about what retail financial stocks are doing in response to interest rates…we’d just rather find companies with a piece of China. Still.

Oil is trading just below US$119. That’s almost a 20% decrease since its high.

If you’re following the oil price closely, you’ll know that the market is one-eyed at the moment. It has picked oil demand as the indicator to rise and fall on.

We know this…because traders are ignoring most other things. Neither a tropical storm in Texas nor looting attacks in Nigeria triggered spikes on crude oil prices. They’re both key oil precincts.

And the same day that Iran tested a new missile in the Persian Gulf, a barrel of the slick stuff dropped below US$120.

Yes, the main price driver now of is lower demand from developing and emerging countries. Many of those countries were subsidizing their energy prices. This maintained artificially low petrol pump prices. That created an excess of demand.

More and more those countries are giving up this practice. And petrol pump prices spiked since June: +30% in Vietnam and Indonesia, +16% in China, +19% in India.

Investors are also worried by the slowdown in developed countries, mostly the US and in Europe. The IEA (International Energy Agency) is now forecasting a consumption decrease of 600,000 barrels a day from next year in those rich countries.

As for the charts?

Technically, the price should fall lower. As we said in our last update (July 22), the first support of the price correction was the level of $120. It’s now broken.

The 50-day technical momentum indicator has plunged under the 100-level and clearly shows that the developing price action is oriented toward negative territory.

The 14-day RSI confirms this and shows that oil is not oversold. The current bearish countertrend can extend further.

Remember that the price action has crossed below the medium-term support line that was valid since February. It has been tested and validated several times (points A, B, C and D). The rally drove prices from $85 to $148, a rise of 74% in only 5 and a half months. The breakout of this medium-term support line is a clear bearish signal. And the break below $120 confirmed this bearish move.

Consequently the next targets are around $111, $98…and the main one is around $83. In short, the slide has further to go.

The devil I am talking of here is oil. Oil in a relative sense is going no-where short term but has already done the damage. But the devil has also had devil helpers in the form of raw materials and labour. All of these have pushed inflation up world wide. In Zimbabwe it now takes a Billion dollar note to buy a loaf of bread - if you can find a loaf - although that country has its own set of inflation problems. But don’t laugh, in history some of today’s modern nations have had laughable inflation levels.

We knew inflation would get out of control and we smarty economists told you so a long time ago. But in fairness to you, inflation is insidious – whilst we are enjoying the party the inflation demons are at work and by the time the party is over it looks like a rampant virus and carriers out of control. Like a virus it takes a good time to get it under control.

But our boys behind the Reserve Bank Bus are experienced fighters and are doing a sterling job despite fears of political or consumer pressure. They like such buses and will do what it takes to get us there.

Most oil charts show an ABC pattern suggesting we will see some range trading. But I have found one chart – a 30 week that differs and this shows a possible scenario of maybe a little lower first and then a move up to $160.

A pullback to sub $120 a barrel may be heaven sent but in a relative sent it is very high and we still have to live in fear of such freakish levels as $160. The only saving grace is that there is some time before that will happen – 2009 – and we know anything can happen before then.

But back to oil and a chart for oil as I cant live without my charts: