What's down with Oil?

Oil is now down to $35 a barrel, back from a high of $147 a barrel. I suspect this is likely to stay. For one, the price of oil at $147 was really a speculation or a bubble, and not driven by fundamentals. World oil demand has increased by 2-3% per annum since '80s. An increase of 200% in a year, and that too from a point where people thought the oil was already very expensive, really speaks volumes about the speculative nature of the increase.

Well, that's history now. The bubble has burst. So where do we go next from here? I expect the oil to drop further than this. Yes, this is ridiculous. But here is the logic. When oil was trading at $147 a barrel only a few months ago, some traders were expecting further increase. Many bought futures and since the price was shooting fast, longer term contracts made better sense. But since the oil price moved down fast, the same traders have two options - get rid of the futures at a loss now or wait for things to turn around. Getting rid of the futures only postpones the problem to someone else, except that the next person has a better price. So, when future becomes current, delivery has to be taken.

Point is that the when oil price was moving up, lot of people bought futures in the hope of making profit and artificially pushed the oil demand. That led to more production and more supply. A lot of new production became alive. But, with the economy going down, demand is already fallen. On the top of it, those who bought the futures want to get out so demand is depressed even further. Now that there is more supply and less demand, guess what happens to price. It goes down.

OPEC can cut the production but what about all the new production that just became alive in past few years. They cannot close their businesses. Can OPEC continue to cut its production only to be substituted by new production? Or alternative energy? Remember, OPEC also needs that money to buy other goods and to bolster their economies. So, they cannot continue to cut down on their production forever. If the production in past few years has produced enough supply for next couple of years, I doubt OPEC can afford to cut their production enough to balance the supply and keep it going for two years. In any case, I would expect some Oil companies or businesses to go bankrupt before the oil prices head back. Before that happens, these companies will continue to produce as long as the oil price can support their profit. By cutting the production, OPEC will only be providing a lifeline to these companies. And as long as these companies survive, oil supply is not going down. In other words, worst is yet to come in this business.