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The “Black Eagle” and the Price of Oil.

By chutay | 10/28/2009 | 1:24 PM

In the last blog I forecasted that oil prices would be in the $65-$75 range until mid- 2010 and end the year in the $80-$90 range. When I wrote that forecast on October 1, oil was trading at around $65 a barrel. Less than a month later, oil topped $81 a barrel, already in the range  predicted for the latter half of 2010. What happened? Did I miss something?

Many would say I am missing the imminent crash of the U.S. dollar or a "Black Eagle". According to the Chicago Mercantile Exchange, October aggregate bets against the dollar rose to the highest levels since July 2008.

Oil is traded globally in dollars and the fate of the dollar is a major factor in the price of oil and consequently the price of transportation. Generally, as the dollar declines, oil prices increase.

The International Monetary Fund estimates that in the long term a 1 per cent depreciation of the dollar correlates to gains of more than 1 per cent for oil. Hypothetically, if the dollar suddenly dropped 25%, oil would surge over $100 a barrel.

There is no oil supply/demand reason for a 25% increase in oil prices in one month. There is plenty of oil in the world right now. The proximate cause of this increase is this extreme negativity about the dollar and speculation it will soon crash and push oil prices much higher.

Granted, it is hard to imagine a happy future for the dollar. Debt, bailouts, deficits, unemployment, bankruptcies and money printing lead eventually to currency depreciation or taking the painful cures of fiscal and monetary discipline.

The Fed views deflation, not inflation as the most immediate danger. Currency depreciation is a powerful and proven way to stimulate the economy out of a liquidity trap e.g. pays the debt off with cheaper currency in the future and makes U.S. exports more competitive.

The U.S. government and citizenry have a low tolerance for the painful, but more effective long term cures. So currency depreciation is the unofficial and unspoken policy of the U.S. Government and the Federal Reserve. It is a risky, but so far successful.

The last time there was this much pessimism about the dollar was right before the world economy began to crash in 2008. In that panic, a "Black Swan" not a "Black Eagle" showed up and the dollar's value jumped 20 per cent between July 2008 and March 2009.

When the world panicked, investors rushed back into the currency of the country with the richest stable democracy and strongest military. They did not demand Rubles, Reals, Renminbi, Rupees or even Euros. They demanded the perceived safety of the dollar. As confidence and risk taking have returned, this has reversed and the dollar is back down to pre-crash levels.

In my opinion, the rumors of the dollar's imminent death are much exaggerated. This perceived "safety", warranted or not, will not change quickly. Asians and the Persian Gulf States will continue to subsidize U.S. debt and growth to maintain their export markets and military protection.

Most recognize that relying on the U.S. and the dollar to ensure global stability is in the long term best interest of no one including the U.S. However, this precarious "balance of terror" of economic mutually assured destruction will continue for now because there is nothing readily available to replace the dollar.

My oil price forecast assumed no sharp declines in the dollar. In fact, I see a strengthening of the dollar through early 2010 which will lower oil prices back to $65 to $75 range. The world economy is not out of danger and the slightest signs that the nascent recovery is faltering will send the dollar higher as investors again seek safety.

The real crisis for the  dollar will come as world petroleum production falters and demand outstrips supply. This will be the topic of my next report.

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About Chuck Taylor

Chuck Taylor

Chuck Taylor has held senior management positions with Nabisco Brands, Ryder System Inc., Burlington Northern/Santa Fe Railroad, Mercer Management Consultants, Tri Valley Growers, American National Can, ServiceCraft Logistics, and Norbridge Inc. and recently founded an organization called Awake! He founded Awake! out of concern the supply chain profession is not informed about the critical changes facing it with the end of cheap oil. One goal is to raise awareness so supply chain professionals will understand the stakes and take an active role in shaping energy policy.

Video: Chuck Taylor talks about the impact of oil prices on the supply chain.



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