Government action revitalizes markets

Feb. 4, 2008
Fears of recession and unauthorized trading at an international French bank battered equity markets, forcing government action that caused US energy prices to rebound in late January.

Fears of recession and unauthorized trading at an international French bank battered equity markets, forcing government action that caused US energy prices to rebound in late January.

During Jan. 14-18, US stocks posted the steepest weekly drop since July 2002 after reports of lower-than-expected home construction, retail sales, and manufacturing numbers reinforced speculation that the economy is entering a recession. But US markets were closed for holiday Jan. 21 during a large sell-off in global markets. At first the sell-off was attributed to fears that failing credit markets could drive the US economy into recession.

But later Societe Generale said a rogue trader in its Paris office had for months made unauthorized trades that cost the bank some $7.2 billion. That prompted speculation that it was Societe Generale’s attempts to close out the fraudulent trades that had rocked European markets.

Olivier Jakob, Petromatrix GMBH, Zug, Switzerland, said, “Currency markets were building some expectations that other central banks might follow in the footsteps of the US Federal Reserve, but with Societe Generale creating doubts as to what triggered the equity rout, the chance of a more coordinated action on interest rates has become more remote and the dollar index has been under pressure.”

On Jan. 22, the near-month crude contract dropped to $86.11/bbl in intraday trading before climbing back to just below $90/bbl in New York as the Federal Reserve reduced its overnight lending rate by three quarters of a percentage point to 3.5%. It was the first time since Sept. 17, 2001, that the Federal Open Market Committee changed the federal funds target rate outside of a regular meeting.

“When oil comes tumbling down, the Organization of Petroleum Exporting Countries pulls an emergency cut and when the Dow Jones Industrial comes tumbling down, the Fed does the same,” Jakob said. “The Fed emergency cut came coincidently at the crucial time when West Texas Intermediate was starting to test the support of the previous correction and makes...a nice double bottom at $86/bbl.”

The crude futures price tumbled to a 3-month low below $87/bbl Jan. 23 as recession fears continued to flail the market. But energy futures posted the biggest gains in 3 weeks on Jan. 24 with the March crude contract jumping $2.42 to $89.41/bbl Jan. 24 on the New York Mercantile Exchange after President George W. Bush and Congressional leaders generally agreed to an economic stimulus package that will give tax rebates to most US taxpayers.

The crude contract continued climbing to finish the week at $90.71/bbl Jan. 25 on the New York market. “Markets continued to rally behind federal actions, and energy was no different,” said analysts in the Houston office of Raymond James & Associates Inc.

Since the start of 2008, oil prices have fallen 10% primarily because of US economic worries. While the US comprises 30% of total oil demand, Raymond James said, “It is the developing world, particularly China, that is the key driver of today’s oil demand growth.”

Natural gas outlook

Meanwhile, Raymond James analysts said: “In the short run, the US has very limited, if any, ability to switch from crude to natural gas as a fuel source. This is one of several factors that have helped provide us with confidence that oil and US gas prices will not average the typical 7:1 btu parity in 2008 or even in 2009. In the long run (beyond 2010), oil and gas should eventually return to parity on a global basis. There will be many forces that will ultimately lead us back to parity. The most important and timely driver will be the build-out of a global LNG and natural gas infrastructure [that] will include regasification terminals, gas pipelines, gas storage, and gas-fired consumers in regions other than the US. For example, we just cannot imagine China being willing to pay two or three times as much (per btu) for energy than the US. The global gas build-out will happen. It is just a matter of how long it will take to accomplish.”

Raymond James analysts said, “In addition to natural gas and LNG becoming a more fungible global commodity, the next decade will likely see (1) an increase in natural gas-fired electricity generation, (2) a decrease in the use of oil as a heating fuel, and (3) the ability to use natural gas as an automotive fuel source. The bottom line for investors is that we do not believe that oil and US gas prices will be linked to the typical 7:1 btu price parity ratio over the next few years.

(Online Jan. 28, 2008; author’s e-mail: [email protected])