A Melman Minute — March 11, 2008

Wow!! Talk about a “Reversal of Fortune”, that is precisely what we saw just one hour before financial markets were set to begin trading in North America when the American Federal Reserve Board, in concert with the Canadian Central Bank and their European cousins decided that they would have to react to the cries of “Do Something!” about the looming international credit crisis.

The monetary authorities had several choices. First, they could do nothing, letting the free market sort out which companies and markets would suffer contraction, but perhaps, in the long run, still coming away with a viable financial system. Second, they could act as the Fed did under the leadership of Volker and Reagan, which is to take the bull by the horns, drive interest rates artificially but sharply higher, and slow economic growth in order to shrink inflation out of the system. Then there is the third choice, the one associated with Fed Chief Bernanke’s nickname of “Helicopter Ben”, namely to throw unlimited amounts of newly-created currency values at the problem.

That is clearly the choice these worthies opted for. Bernanke’s Fed is leading the way with a massive (all quotes in US$) two hundred billion dollar contribution to provide additional liquidity to the staggering financial system. Other central banks quickly followed suit with stimulative packages of their own.

Within moments, security markets took off like a shot. European markets, after trading slowly for several hours, suddenly roared ahead while trading in S&P and Dow Industrials futures contracts exploded upward. As can be seen by the accompanying short term chart of the Dow Industrials, within minutes of the opening bell, the Dow was ahead by over 250 points while Canada’s TSX gained even more, up by almost 300 points.

Perhaps the most attention-grabbing headline on the overnight newswires was the fact that crude oil had soared to almost one hundred ten dollars per barrel in overnight trading, which leads to the question regarding petroleum, “just what is going on?”

One of my favorite heroes was the immortal chess master, Emanuel Lasker, who held the world championship in that immensely popular game for more than a quarter-century, from 1894 - 1921. He had a habit of making pithy remarks about opponents, and of one prominent foe, he said, “He can follow the wrong path with more determination than any man I know!”

I am reminded of Lasker’s comment when I note that many petroleum analysts still publish reports that the entire rise in petroleum is a chimera, that the rise is unfounded in logic, that there are abundant supplies of petroleum and refined products and that the price of crude oil is set to collapse. They have been saying this almost monthly for years and they are still adhering to their stand - despite the fact that crude oil continues to push ever-higher, as illustrated by the long-term chart of that commodity. As can be observed, since late 1998, the trend in crude has been relentlessly higher, despite several small corrections and two important ones in 2001 and 2006.

The only plausible explanation for the stupendous rise in crude oil from barely US10 per barrel a few years ago to almost US$110 offered by those forecasting lower crude prices, is that it is nothing but a speculative boom, brought about by excess funds washing around in various capital pools. They should better concentrate on the quality and quantity of underground crude oil pools, as production from many of them is in decline.

We have noted recently that supply from Mexico, Venezuela, the North Slope and North Sea has already begun to diminish and important crude pools in Saudi Arabia are now becoming suspect as huge injections of water are now required raise the crude toward the surface in order to enable continued production - a process which clearly cannot go on forever.

At the same time, refineries are running near capacity around the world just to meet ongoing needs and reserve capacity for future growth has almost vanished.

In the face of these two supply limitations, demand continues to rise powerfully and relentlessly, pressed higher by huge growth in China, India, Russia and Brazil - among rapidly-emerging nations. Coupled with steady to slowly-increasing demand in already-industrialized nations (like Canada and America), the trend toward higher petroleum demand is well established. Currently at about 87 million barrels per day (mbpd), the Energy Information Agency estimates worldwide demand will soar to almost 120 mbpd within two decades.

Given the staggering rate of demand growth in the nations noted earlier, our own estimates are even higher. However, in the face of this huge anticipated growth in demand, serious questions about future supply remain unanswered - and the combination of those two factors, in our opinion, is what lies at the heart of the tremendous rise in crude oil prices.

It does not appear at all to be an easily resolvable question and we believe that petroleum prices could rise much higher over the next twelve to twenty-four months.

In today’s early trading, aside from advancing financial markets, precious metals are mostly unchanged, base metals moderately higher on balance and long-term interest rates have also moved upward. In currency trading, the C$ is hovering near US$1.006

DISCLAIMER

The information presented above is based on data which we believe to be from reliable sources, but the accuracy of which cannot be guaranteed. Any opinions or predictions contained herein are those of the editor and are likewise offered also for information purposes only.

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