Oil Prices Could Hit $130 a Barrel

July 16, 2008

It’s a super busy day, so I haven’t gotten a chance to really blog about the markets. However so far oil prices are down $6 a barrel - for $13 over the past 2 trading days.

I wrote this post on How Far Could Oil Prices Fall? last week, which is quite applicable to today’s price action:

By now, everyone should realize that oil prices are determining monetary policy. This is true for the US as well as other central banks around the world. Central bankers have been very worried about price pressures and we know that most of the pressure comes from oil.

Oil prices are impacting not only monetary policy, but also stocks and the US dollar. The rebound in oil prices today and geopolitical tensions are driving the US dollar lower. Iran reportedly test fired 9 missiles in the Persian Gulf and according to the Associated Press, the missiles could reach Israel, Turkey, the Arabian peninsula, Afghanistan and Pakistan.

These geopolitical tensions will probably ease as Iran’s test fires prove to be nothing than muscle-flexing. At that time, oil prices will continue to fall. Speculators are driving the move in oil prices and if the selling exacerbates, these traders will be quick to abandon their long positions. Yesterday’s drop in crude was the largest since 1991, but we could see another $10 drop before prices hit a bottom.

As indicated in the following oil chart, prices started to really take off in 2006. The move however has not been vertical. Between 2005 and 2008 there have been many corrections and on average, the corrections have ranged between 10 to 15 percent.

The second chart gives a closer look of the price action in oil over the past year. Even though crude hit an all time high of $145.85 on July 3rd, that was not before a series of retracements.

Therefore another $10 drop in oil prices is feasible even if oil remains within an overall uptrend and that would be bullish for the US dollar (Q3 Outlook for US Dollar).

oil0708_1
Source: Bloomberg