Wednesday, May 28, 2008

Risks Of Oil Price Optimism

The oil price fell by more than $3 from outrageous $130 per barrel to I-still-can’t-believe-it level of just below $129 per barrel. However, based on the media, it would seem that the camel’s back had been broken and we would be seeing more ‘reasonable’ prices shortly.

CNNMoney had this to say today in its report: “"You usually see prices bid-up before the holiday," Stephen Schork, an oil industry analyst and publisher of the Schork Report. "Today we're seeing some of the air let out of the balloon." If the market follows its typical seasonal pattern, Schork thinks crude's "highs have been put in." Though he added that the market has seen "a tremendous amount of support" and the seasonal pattern may not hold this year.

USAToday was also very optimistic in its article, which it titled “Pump prices may have peaked.”

While it is nice to see oil prices coming down a bit from profit taking due to concerns about slowing U.S. economy, it is not indicative of the change in the direction of the price of oil or gasoline. This is prudent to note, as we are now about to enter the hurricane season. If a major hurricane hits of even skirts the gulf coast, the production of gasoline and oil drilling in the gulf will be disrupted, causing a spike in oil and fuel prices once again.

National Oceanic and Atmospheric Administration (NOAA) is forecasting an active hurricane season in 2008 with up to nine hurricanes in the Atlantic Ocean with five of them being major. While NOAA had been predicting more hurricanes in the past two years than actual, there were still six hurricanes in 2007 (out of 10 that NOAA forecasted) and five hurricanes in 2006 (out of nine that NOAA forecasted).

More signs that the 2008 hurricane season may have a substantial impact on the oil and fuel prices comes from, Colorado State University, and CSU, according to Bloomberg: “ and Colorado State University both said the 2008 hurricane season, which runs through Nov. 30, would be more active than usual.”
Additionally, CSU “said both the East Coast and the Gulf of Mexico coast, home to dozens of oil and gas rigs, have a 45 percent chance of being hit by a major hurricane. That compares with a 30 percent chance historically.”

Therefore, based on four separate professional meteorological opinions, the consensus is that 2008 season will be more active than typical. If NOAA’s trend of its forecast being about 55% to 60% of the actual, then the U.S. may see about five hurricanes with about two of them being a major one. Applying a 45% chance of the gulf region being hit by a major hurricane, that gives us a good chance that roughly about one or two major hurricanes may affect the gulf region substantially enough to disrupt or slow down the oil production and processing.

Given that any slight negative news is able to send the oil prices skyrocketing, I do expect to see the oil and fuel prices not easing anytime soon. If we have a hurricane similar to Katrina, then expect to see gas lines in the U.S. once again (picture: 1979 gas line; source:

Ed Kim
Practical Risk Manager

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