Plunge In Oil Prices Claims Another Major Casualty

The US dollar, inspired largely by plunging oil prices and growing pessimism over the economic health of the EU and the U.K, is going gangbusters of late. It traded at $1.4455 Wednesday, a seven-month high against the euro.

On the other hand, oil prices continue downwards to $107.48 a barrel, as Hurricane Gustav’s path of destruction was less severe than anticipated.

Coupled with the US government’s release of 250,000 barrels of oil from its strategic reserve to ease disruptions in energy production from the Gulf of Mexico, the hurricane became little more than a storm in a teacup.

With such steep declines, it is not surprising to see the commodities market yield another major casualty. Ospraie Fund Ltd, one of the largest commodity hedge funds with $3.8 billion in assets at its peak, collapsed due to consecutive wrong-way bets on oil, natural gas, mining, among others.

Ospraie’s assets shrunk by 40% this year on the back of astronomical losses from a terrible six week period, starting in July. Another round of bloodletting is expected to follow the demise of Ospraie and the financial sector will not sit pretty either.

Lehman Brothers, owner of a 20% stake in Ospraie, have nothing going right for them since the subprime crisis surfaced. Barely solvent from the massive write-downs of mortgage instruments, they have already suffered a 75% loss of their stock value. The closure of Ospraie is the last thing they need while fund-raising activities are ongoing.

Can Lehman Brothers avoid Bear Stearns’s humiliating fate? News on the vine have pinpointed Korea Development Bank as a likely candidate to take a 25% stake in Lehman for up to $5.3 billion, and banking giant, Tokyo Mitsubishi, may also bid.

Some traders have questioned if Ospraie Fund’s panic sell-off has aggravated the plunge in oil prices, self-fulfilling the prophecy of a commodity market crash. Given how much profits speculators have made in the past year or two, I will say the misery is just starting. In fact, at the current rate of decline, a growing list of oil fund casualties is a safe bet.

Last month, I listed down some reasons for oil prices to decline but even then, I have to marvel at the speed in which energy speculation dissipates. Previously, oil traders bid up prices aggressively as they were emboldened by the infallibility of Peak Oil Theory.

That is, the world’s oil supply is on an irreversible decline but demand is ever increasing due to the economic expansion of China and India. Currently, consumption has tanked due to a global economic slowdown and prices have to reflect this reality. For me, the fundamentals of Peak Oil Theory are still sound but we shall discuss this in other posts.

Meanwhile, I see oil’s downward trend reversing if economic fundamentals remain strong. Also, if more bad news emerge from the financial sector, the dollar may weaken and cause oil prices to head upwards, since oil is priced in dollars,

Another factor is the influential oil cartel (OPEC) which can artificially boost oil prices by reducing output below demand. In fact, Iran will be doing just that. At OPEC’s meeting in Vienna next week, they will be lobbying hard for fellow members to cut crude output.

Saudi Arabia may not agree due to US pressure and politically, Saudi and Iran are on opposite side of the fence. Nevertheless, Saudi may be tempted to moderate its extra production in July which boosted supplies to more than 9.5 million barrels a day, the highest level in more than 25 years.

I am comfortable with oil prices dropping to the $80-$100 region, but if it plummets to $40-$50 per barrel, we must prepare for the worst – the dreaded Depression. Bad news for Singapore which is highly dependent on foreign investment and free trade.

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