There could be a potential “tax break” the no one in the news has really picked up on with this ailing economy – a big drop in the price of oil. Although the media hype price increases, oil prices are dropping and could be heading toward lows not seen since 1999.
Philip Verleger, a business professor at the University of Calgary and visiting fellow at the Peterson Institute for International Economics [1] told CNBC’s July 8 “The Kudlow Report” how the cost of oil might drop. Verleger explained why the current price of oil – at $60 a barrel, off its $72 highs [2], is still way too expensive for the market and why it could come tumbling down to $20.
“The $20-oil story is relatively simple,” Verleger said. “I picked $20 as where it could go briefly at the bottom. Oil was $31 in December, got up to $70 a few days ago. The price shouldn’t have increased. We have a huge surplus on the world market even with the OPEC cuts. It’s running a million and a half barrels a day. I’ve been following this since 1971. We have never had a 12-month stretch with such a large surplus.”
The current run up, going back to mid-January has been a result of government, Verleger explained.
“So why has prices come up?” he asked “Well the answer – well, there are two answers and they both go to kind of the effects of government intervention.”
According to Verleger, part of the current run up in oil has been that Federal Reserve policy – Term Asset-Backed Securities Loan Facility (TALF) has made it inexpensive to buy and hold oil.
“When I said investors raised the price, I meant the forward price,” Verleger said. “Six-months forward oil was selling at $16 premium to cash oil. So there’s an example where Morgan Stanley a month ago, J.P. Morgan a month ago according to Bloomberg bought two million barrels of heating oil, put it on a new tanker and parked it in the Mediterranean. Turns out when you do the numbers, they’re earning a risk-free rate of return of 50 percent, maybe 40 percent, and they borrow the money under the TALF [Term Asset-Backed Securities Loan Facility] program for 3 percent. If you can make 50 percent and borrow at 3 percent, why not do that? So what’s happen is roughly $30 billion has gone into stockpiling oil and it’s all been created by the market conditions.”
He also said that same Federal Reserve has instituted policy that has made the dollar weak and has encouraged investors to buy oil as a hedge against the volatility of the dollar. As the dollar has fallen in value, oil, priced in dollars, has gone up.
Even David Pursell, head of macro research at Tudor, Pickering, Holt & Co. Securities, Inc., who was skeptical of the $20 price tag, also appeared on Kudlow’s program and said he estimated $50 oil could be in the short-term future.
“We’re a $90 long-term shop. I’m going to tell you we’re at $50 for the back half of this year,” Pursell explained. “There’s no question the oil market is fragile here.”
Verleger has decent track record at calling these oil prices events. An August 20, 2004, article [3] in The Washington Post cited a report he issued to his clients warning oil prices go far beyond their $47-a-barrel price, which was considered high at the time.
“‘Prices may rise to $50 per barrel, or $60 per barrel, or even $70 per barrel,’ he writes in a recent report to clients. ‘They will likely remain there until growth in petroleum demand slows down enough to match available refining, logistical and productive capacity.’”