Crude oil inventories are rising, commodity funds have liquidated positions, and concerns over slowing economic growth here and in Europe have sent crude oil prices tumbling over the past several weeks. But that shouldn’t worry corn producers banking on strong ethanol markets.
At the same time, though, crop and livestock producers should not expect their costs to drop substantially moving forward. A good average planning price for diesel fuel for the next 12 months or so is probably close to $3.50 to $4.50/gal—if crude oil prices remain near $100/barrel as analysts expect.
On May 12, the U.S. Energy Information Administration announced that U.S. crude oil inventories rose by 3.8 million barrels in the first week of May and that gasoline stockpiles rose by 1.3 million barrels, which suggests that U.S. demand for crude oil and gasoline is softening.
“It’s not about America,” says Tom Grisafi, speculator and owner of Indiana Grain, Valparaiso, Ind. “There are 6 billion people in the world and we are only 300 million. It’s a world market.” As the largest consumer of oil, the United States plays a huge role in prices, but the BRIC countries of Brazil, Russia, India, and China are playing an increasingly larger role.
“China’s demand growth is something we’ve never seen before,” says Jack Hunter, risk management consultant with INTL/FCStone, Kansas City. “Consumers in India, Brazil, and China want the middle-class American lifestyle—refrigerators, cars, washing machines—and that takes a lot of energy to produce.”
The Role of Speculators
Hunter says both fundamentals and speculation have played a role in today’s crude oil market volatility. According the March 8 Commodity Futures Trading Commission Commitment of Traders report, combined net long positions—people expecting prices to rise—were six times larger than they were in spring 2008 right before crude oil prices hit all-time highs near $150/barrel. Since, then net longs have dropped as funds have liquidated their positions in crude oil futures or taken new short positions, indicating they expect prices to fall further.
“One would be naïve to think that price volatility isn’t the direct result of speculation from the investment community,” says Hunter. “The speed in which prices rise and fall is probably directly tied to speculation, but the current price levels for the most part are supported by fundamentals.”
Grisafi agrees that speculation may have pushed prices to unsustainable lows in 2009, but argues that crude oil price are now trading in a long-term range. “When silver fell from $50 to $32 in a matter of weeks, that was pure speculation,” says Grisafi. But oil is in high demand worldwide.
“The odds of $30 to $40 oil is unlikely because the world economic machine is moving forward,” says Hunter. “For prices to drop that far, we’d need to see a panic situation that causes the funds to pull out entirely.” Another worldwide recession or an unforeseen catastrophe, such as an earthquake on the U.S. West Coast, might qualify.
“The oil market will try to find a balance around $100/barrel,” says Hunter. The biggest upside threats are hurricanes that damage either or both U.S. refineries or Gulf of Mexico production rigs.
“Prices will remain volatile within a range, with $80 to $120 the sweet spot, barring any geopolitical upheaval,” Grisafi says. “If crude stays at $100/barrel, there’s no way you’ll have cheap corn. And as long as the dollar is cheap and other currencies are strong, crude oil prices will remain high.”
Eventually, $100/barrel will be the new norm, if it isn’t already.