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.