I've said it many times and I'm going to say it again — the laws of economics have not been repealed. And so it goes for the energy market. If ever there was a market that has made a more classic top, I don't know what it is. Keep any commodity at a high price for too long and people will find a way to use less, use something else or produce more of it. That's exactly what's happened once again in the energy market.
What was even more helpful in calling a top in crude oil this time around was the bullish news out of Wall Street. Many of you will recall in August an energy “guru” from a leading Wall Street firm predicted $104/barrel crude oil when the market hit $70. This most likely was the same person who predicted high-tech stocks would continue screaming for the sky in March 2000. The news is always the most bullish at tops — and this one was no different.
Some of us are old enough to remember the first energy crisis in the 1970s. Right at the top of the market both General Motors and Ford announced new lines of smaller and more efficient automobiles. A year later gas prices collapsed and both auto manufacturers were stuck with huge inventories of small cars that no one wanted.
This time around the reaction is a little different. Hybrid cars are going to catch on in metropolitan markets, but will not likely have much future on the farm, at least not yet. But wait another six months and Americans will be wanting Suburbans, Explorers and Durangos just like they did two or three years ago.
How can I be so confident this market has peaked? Nothing is ever 100% guaranteed. But the psychological elements discussed above are almost perfect for defining a major top. At the same time, demand has been cut and oil companies are drilling new wells. Inventories are at near-record levels and the market survived through the hurricane season without any other major spikes in prices. That's enough confirmation for me.
Now let's take a look at history. The chart below shows the last three major tops in crude oil. They occurred in 1990, 1996 and 2000. Now we have one in 2005 as well. The time between the peaks is four to six years — this one is right on target. What's even more interesting is what happens after the peaks. The bear market that started in 1990 lasted 38 months and crude oil prices declined by 67%. The next bear market lasted 24 months and prices declined 62% — $26.90/barrel down to $10.30/barrel. Following the peak in 2000, prices declined for 14 months losing 74% in value from $37.90 to $17/barrel.
Where does that leave us now? The peak occurred in August at $70.60. A 60% decline in oil prices would take the price of crude to $28. Sound impossible? Maybe so, but $40/barrel certainly seems to be in the cards. This means significantly lower diesel fuel, gasoline and natural gas prices.
How much lower? Don't worry about it. Just recognize that the current drop in energy prices is not a correction in a long-term bull market. This is, in fact, the beginning of a long-term bear market that will likely last one to two years and decline to price levels that most people now seem to think impossible to obtain.
Wait To Buy Fuel
For this spring, the drop in energy prices is unlikely to have a huge impact on your input prices. Many of your energy related inputs were manufactured before this price drop began. Some will experience minor declines, but most benefits won't show for a few months.
There will, however, be a fairly immediate impact on your fuel prices. The last couple of years have been years to buy ahead — this one is not. Put off purchasing fuel in energy related inputs as long as you can. While the prices of manufactured products may not decline substantially, the risk of them of going up is slim.
This will also result in lower transportation costs, which will result in improved basis levels throughout the Midwest over the next couple of months. Any way you look at it, this is good news for producers — unless you own oil or gas wells.
Richard A. Brock is president of Brock Associates, a farm market advisory firm, and publisher of The Brock Report. For a trial subscription and information on Brock services, call 800-558-3431 or visit www.brockreport.com.