Why have oil prices retreated?

[woody]

People often ask me why oil prices have come down so much in the past few months. My usual response is 1) prices went too far up too fast, 2) demand weakening due to global economic woes, 3) tight supplies means more volatility as the market reacts to every little bit of news, 4) other stuff like hedge funds unwinding long oil positions and the strong dollar.

This post over at The Oil Drum brings up some other points. The first point is the most interesting.

The Oil Drum | Why are oil (and gasoline) prices so low?

1. Credit problems of oil intermediaries

The oil industry has many more players than most of us are aware of. The International Oil Companies use contractors to do many functions that we think of as oil company operations. Oil is shipped by oceangoing vessels and by pipeline. Refiners are often separate from the oil company that produced the oil. Gas stations are often independently owned.
One of the issues is that sellers want to be sure that they are going to be paid for their product. They are unwilling to sell to buyers with poor credit. This is removing some players--and some demand--from the system.

2. Liquidation of positions by hedge funds and other speculators
3. Hedging of future oil prices by oil companies
4. Rise in the value of the dollar
5. Trend Trading or Systematic Trading
6. Drop in Asian growth
7. Small size of the oil (and other commodities) market, relative to the rest of the market
8. Increased volatility when supplies are very tight

 

[charlesdwright]

9. Because it was a bubble.

 

[woody]

#8 listed leads to bubbles.

Another interesting post over there.

http://anz.theoildrum.com/node/4656#more

If you are not interested in the network discussion, scroll down to the first posted reply. Some interesting tidbits:

The Baltic Dry Shipping index, an indicator of the health of global shipping trade, is down again today, and down over 90% from it's May levels. Below is a brief analysis of the correlations of the TED spread (measure of health of credit market), the Baltic Dry Shipping Index and crude oil (WTI)


I used Bloomberg data for the past 12 months. Over that time, the TED spread had a -.44 correlation (R^2) with crude oil. The Baltic Index had a .31 positive correlation with crude prices. (the TED spread had a -.59 correlation with Baltic Index). Nothing overwhelming. I hypothesize this would also have been the case over longer periods.


However, if I just use prices since July, the TED spread had a -.88 correlation with oil and the Baltic had a .96 !!! correlation with crude oil (Baltic and TED = -.92) I assume the correlation with $/Euro and Euro/Yen would have even been closer to 1 for 1 with financial selloffs.

The top post adds to the idea that the credit crisis is hurting commodity prices.

When credit is unavailable, resellers cannot buy items (such as grain), so it does not go on ships, and does not get delivered--but it will be weeks before you notice the delivery failure.

The Baltic Dry index is an index of shipping rates in the world's top ports.