Oil price dive raises spectre of depression
Oil prices crashed through the $100 mark in spectacular fashion Monday, in the wake of big flame-outs in the U.S. financial sector.
After briefly dipping to US$99.99 on Friday, benchmark crude lost $5.47 in New York to close at $95.71, its lowest level since February.
That sent the oil-heavy Toronto Stock Exchange down more than 500 points after the bankruptcy of U.S. investment bank Lehman Brothers and the sale of Merrill Lynch sent investors running for the exits in every corner of the globe.
“The TSX is being hit in a big way by what’s happening in the U.S. financial industry,” said Elvis Picardo, an independent strategist based in Vancouver. “There’s a contagion effect at play here.”
The drop comes after hurricane Ike blew over Texas without causing major damage to refineries and production facilities in the Gulf of Mexico.
Walter Zimmermann Jr., a vice-president with United Energy ICAP commodity brokers in New York, said the same forces that drove oil prices to record highs are responsible for forcing them down as speculative hedge funds are forced to liquidate portfolio positions to raise cash.
In an interview, he raised the prospect of the “D-word” — a death spiral of deflation or outright depression that sparks panic-selling and sends oil prices below $50. In a liquidity crisis, cash becomes king, he added.
“It’s a vicious cycle. We think a lot worse is yet to come,” he told the Herald. “Suddenly money has vaporized, credit has vaporized.
“Who wants to have money tied up in a hedge fund? They all came into this year massively long on commodities.”
Ujjayant Chakravorty, an energy and environment expert at the University of Alberta, said prices could fall below $70 by the time the current shakeout is through.
“The rate at which the prices have gone down is phenomenal,” he said. “It supports people’s anticipation that the market is froth. The big question now, is what is the floor?”
Bear markets in commodities typically end when the price meets the nominal cost of production.
Given that Canada is arguably the high cost producer when it comes to specific products such as oilsands, there is concern that even $70 or $80 a barrel would threaten more than $100 billion worth of oilsands expansion projects on the books for northeast Alberta.
Chakravorty, who recently emigrated to Edmonton from Florida, complained he has been unable to determine the current marginal cost of a barrel of synthetic crude.
But existing projects, which were built in a $30 to $35 world, should be able to withstand a short, sharp drop in prices, he said.
“I would think if it (oil prices) were to fall to $60, the economics would still be pretty good.”
Certain sectors have already been hit harder than others. The Venture exchange, which is home to many junior oil and mining stocks, was already down more than 40 per cent on the year.
On Monday, it fell another five per cent, losing 73 points to close at 1534.81.
Even before Monday’s rout, analysts blamed credit woes south of the border for the dismal performance.
“In my opinion, it’s all about liquidity,” said Kirk Wilson with Calgarybased Clarus Securities.
“The credit crunch has been the catalyst for most of the malaise in the economy. It’s really put a lot of pressure on the junior market. This liquidity thing is going to take a while to work through.”