Is The Slippery Commodity Slipping Up?

Nearly - but not quite - time to gloat.

Oil Prices Retreat; natural gas at three-year low
LONDON Oil prices retreated Tuesday after an overnight rally lifted crude futures by almost US$1 a barrel on worries that the recent drop in prices could prompt OPEC to cut production. Natural gas hit a new three-year low.
Oil prices are down 21 percent since hitting a record of US$78.40 on July 14.

I've thought oil prices were way too high and headed for a fall for a long time now (here and here). The principal reason isn't so much that emerging market growth rates are slowing as it is that oil is driven by two types of demand: genuine and speculative. The overall genuine demand for oil - i.e. demand created by higher fueling requirements as a result of increase in number of cars on the road etc. - is certainly on the increase, but for far too long, the speculative demand, created by traders looking to make a quick buck, has been far too high.

Speculative demand is put about by two principal fears: that the emerging economies will end up consuming all the world's natural resources in their unstoppable path to world financial domination, and that terrorists accross the middle east are going to blow up Israel or America or Britain. Both these scenarios, we know from a reasonable assesment of history, are less likely than the counter-scenarios of terrorists running out of money and support for their causes, and emerging economies just running out of steam - at least to a point of relative stagnation. There's also a lot of confusion in the middle east fears too. Principally, it's that terrorists do not control oil, big companies do. Terrorists have no real power to shut off the world oil supply. And countries like Iran and Venezuela are hardly likely to turn off the taps either, given that it's pretty much their only source of income.

While the scenario of OPEC cutting supply is likely, it will only be in parity with genuine demand, which should in theory leave no net effect, which in turn should leave that layer of speculative capital out to dry. Amid the speculation, there's been talk of every type of inconceivable invention, even a Euro denominated Iranian oil market to compete with US commodity derivatives exchanges.

Now the speculative capital is starting to ease out of the markets, predictably enough spiking and deflating. My guess is that the oil price will probably hit a low of $35 and bounce back up to stabilise at $45. If this sounds unbelievable, it's worth remebering that it was unbelievable too once that fiber optic cables - that commodity which was about to hold up the entire communication infrastructure of our world - would one day be practically worthless.

*Update - October 01, 2006* And there's more. Apparently, some stations in Knoxville, Tenesse are selling gas for under $2 now. (Via Instapundit)