The "Two Catastrophe" Rule Of Oil Prices: A Move To $120

There was a great deal of hope expressed as oil moved back to $100 last week. It is laughable that people would be excited about $100 oil, but crude had moved over $110.

The theory about the drop in prices was that an economic slowdown would cut demand. That does not take into account the sucking sound in China, India, and other developing nations which need more oil every day. It also skirts that issue of aging oil fields in the Middle East and Arctic Circle. It ignores the aging pipeline and refineries which may have to be replaced taking capacity off-line.

Leaving all of that aside, oil moved back toward $108 primarily because someone or someones decided to blow-up a major pipeline in Iraq. The potential interruption in demand caused a minor panic and crude spiked up.

The market can probably handle one catastrophe at a time. A big storm which cuts production in the Gulf or North Sea. A break in a pipeline in Canada or the Middle East. An interruption due to political problems in Nigeria or Venezuela. But, it is unlikely that the market could suffer two big events which threaten oil supply. The psychology of oil pricing is too close to paranoia. The anxiety about two events is greater than one. In geometric fashion, three big problems would be much, much greater than two.

The law of averages, or the inevitability of fate, is likely to put two catastrophes next to one another in time. If oil is anywhere North of $100 dollars, a 20% spike is not just possible, it is likely.

The only open question is how long it will stay so high.

Douglas A. McIntyre