jb were like nexus, page-3

By Greg Peel

A glance at the graph below indicates clearly just how the oil market went beserk when it hit triple digits. Note not only the sudden sharp upward shift in trend but also the increased volatility, as evident by the widening of the weekly ranges. There is not so magic a number as 100 - just ask any cricketer. It is quite normal for a cricketer to relax after getting the ton and begin "swinging the bat". If a cricketer then makes it to a double ton, the second hundred will almost invariably be scored at a quicker pace than the first.

In a sense, this was the case with oil, although this time the quickened pace reflected increased, rather than decreased, anxiety. All of a sudden, after a relatively orderly bullish trend that saw oil push towards triple digits on increased global demand running ahead of new supply, the world decided that not to be in oil was to be left out. The speculative bubble began.

The next thing we knew was the price of oil was pushing rapidly through US$110, US$120, and $130/bbl. At this point the call went out: "Oil is going to US150!". And just as surely as oil breached US$140 and saw that goal in its sights, the next call was a media-frenzied "Oil at US$200!".

It was at this point FNArena called oil at US$90/bbl, but let's not dwell on that.

The bubble soon burst, as surely as night follows day. Bubbles don't always need an obvious prick, for once the last buyer is set there lies a vacuum underneath. I thought perhaps George Bush might be the prick were he to release US strategic reserves, but in the end he didn't need to - oil found its own level of demand destruction. When the world realised that Americans, in particular, would not pay that much for their gasoline, then doubt crept in. When it became apparent the global economy had begun quite rapidly to slow it was all over for oil.

Ironically, it was oil-based inflation which was largely responsible for that slowing, given central banks across the globe were unable to reduce rates to deal with the credit crisis - US excepted.

The next set of cries you heard were those of "Cannot fall below...". They were prices of US$120, $110 and, most emphatically, US$100/bbl. But have a look at the chart again and note that all the "work" was done between the US$90-100 level. That was where oil had to head. That was also a case of returning to the greater trend line of the last few years. It is that trend line that the "super-cycle" dictates. Super-cycle does not imply prices go only up forever.

Just as investors, hedge funds, commodity funds and even pension funds got on the oil bandwagon, so too did commodities analysts. It was Goldman Sachs that first called oil to US$200/bbl. The Goldman analysts were afforded a reasonable amount of "cred", because it was they who said oil would reach US$105 when it was at US$50 and everyone laughed.

To be fair however, the Goldman analysts were taken out of context by the media, can you believe it. As oil was pushing higher at the same time the US was approaching the summer "driving season", the analysts suggested there could be a spike to US$150. Were the geopolitical situation to deteriorate, then, and only then might it even reach US$200, they added. At the time, there was a very real possibility the US would launch an attack on Iran. But the analysts' expected 2008 average price estimate had remained at US$128.75/bbl, and their long term price at US$85.

There was a scramble amongst other analysts to re-rate their own oil prices estimates on the basis of the upward price move.

And today, on the basis of the latest price move, Goldman Sachs has lowered its 2008 average price estimate from US$128.75 to US$115.88/bbl. The reduced estimate also "better reflects oil demand uncertainty", the analysts suggest. Which is another way of saying, "Stuffed if I know what the price should be". Goldman has also reduced its 2009 estimate more aggressively, from US$140 to US$110/bbl. Does this mean the analysts are simply chasing their tails?

No. What the analysts are doing is bowing to a sharp turn in sentiment. Their "bullish macro view" is still intact.

Perhaps this is best reflected by the actions of Goldman's local analysts today - those of GSJB Were - who have removed Australia's leading oil producer Woodside Petroleum (WPL) from their "conviction list".

GSJBW has this strange beast called a conviction list, which singles out particular stocks for which the team has a Buy or Sell rating as being those for which the analysts are more emphatically convinced. Woodside was previously rated by Weres as a "Buy with conviction" but is now only a mere "Buy". A cynic might say the latter rating is really "Buy, but don't come looking for us".

The retention of the Buy rating means Weres still has a longer term bullish view on oil and gas prices, and indeed the analysts still rate Woodside as the pick of the sector. They believe there is potential for the oil price to rebound from the low-90s in the December quarter, but that 2009 will not see quite as much price pressure as they had earlier assumed. This is the result of current global economic uncertainty.

The reason for the late 2008 bounce call is that the analysts are still forecasting 3.7% global growth in 2009. (Actually it is Goldman's economists making that call, and in a big shop you have to accept your colleagues without question). The oil price is however trading as if there was about to be a global recession, the oil analysts note, so thus it has overshot to the downside.

It may yet overshoot further, although even if global recession calls are correct the analysts would still call US$75/bbl the bottom. It is the nature of all markets to overshoot on both the upside (US$147/bbl) and the downside (?).

Nevertheless, having hit a price of under US$92 this week, oil has rebounded strongly in the fallout from Lehman and AIG, and is still pushing higher today to over the US$97 mark. Have we seen the bottom already?

The short answer is not necessarily, given the global economic slowdown story is not only still underway but has become exacerbated by this latest, and greatest, round of financial market turmoil. There are a number of reasons why oil has suddenly posted a US$6-7 rally.

(1) Everyone was short, and the price has fallen from high to low without barely a correction; (2) the gold price last night shot up on recognition of its "safe haven" status, and oil is arguably an even safer haven than gold when currencies are in crisis (gold won't get you to work); (3) hurricanes Gustav and Ike have caused a temporary collapse of gasoline and other oil product inventories; (4) geopolitics are back on the agenda, with Nigerian rebels declaring all-out war.

While all of these factors may prove to be "micro" in the more "macro" view of global economic slowdown, and subsequent reduced demand, there is also a strong case to suggest oil below US$90 is not a given.

One factor is pointed out by experienced commodity market watcher Dennis Gartman. He notes that as oil approached US$100 on its way down the forward price curve was still in a significant contango. This means the latter months are trading at a premium to the front month, and that implies the cost of storage of oil was significantly high - no room at the inn. However, the forward curve has now slipped back to slight backwardation (latter months trading below the front month), implying there is now no availability of storage space. Inventories have been run down.

Gartman suggests this development "is sufficient to turn us from being manifestly bearish of energy to being incipiently bullish".

Back to Goldman Sachs. The reason the analysts maintain a bullish macro view is because if one takes a step back from all the noise and volatility of inter-day trading, the world still has limited spare production capacity and a "lacklustre" supply growth outlook, they suggest. Despite the sharp uptrend in the oil price over the last five-odd years, there has "still not been a meaningful build in crude oil production capacity". And remember, Goldmans stills expects the global economy to grow, not recede, in 2009. So far most all other analysts agree. Goldmans has also pushed out its predicted peak of the current up-cycle to 2011 from 2010.

The tea-leaf readers have a different tack, and technical chartists at Barclays Capital (proud owner of Lehman Bros' good bits) believes the break-down through US$100 is signalling a fall to US$85 (which is quite possible) and, if that is breached, to US$71 (which might be pushing it).

If the macro bullish story makes sense, then it follows that investment for the longer term in knocked-down oil and gas stocks also makes sense at these levels.

GSJB Were has put Woodside at the top of its list, followed by Oil Search ((OSH)). In the small caps the analysts like Australian Worldwide Exploration ((AWE)) and Nexus Energy ((NXS)).

JP Morgan has today provided investors with a list of "safe haven" trades in each sector. In the energy sector big caps the analysts prefer, in order, Santos ((STO)), Queensland Gas ((QGC)), Oil Search and Woodside. In the small caps they like ROC Oil ((ROC)) and Beach Petroleum ((BPT)).

If you can keep your head while all about you is losing theirs...