Oil has fallen below $70 in the wake of a slowing global economy and massive deleveraging by hedge funds.

Monthly Crude Chart

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When oil was consolidating near $100 I thought that was it. It was plain to see that the global economy was slowing, and it was clear that fundamentals were not in favor of another move higher.

I should have known better, because that is not how trends end. Trends end when every disbeliever (or nearly every disbeliever because my tune never changed) gets religion and hops on the bandwagon in spite of rapidly changing fundamentals. The same thing happened in housing in 2005, and in the blowoff top in 2000 in the Nasdaq, and more recently in various currencies like the Australian dollar and the British Pound.

Indeed, we saw analysts who disliked oil at $50 calling for it to rise to $200 or even $300. People who never heard the term “Peak Oil” before, and probably still do not understand what it means, suddenly found a new religion.

Bulls touting the China story started coming out of the woodwork. The neighbor’s kid was telling me about the growth in China. If his cat could talk I probably would have heard about China from the cat.

Pension plans wanting to get in on the commodity boom before it was too late, turned to hedged funds and commodity funds that started rolling over ever increasing numbers of oil futures. This put upward pressure on prices in spite of rapidly deteriorating fundamentals.

Everyone who thought they were a genius simply because they have heard the China story and know the two words “Peak Oil” have hopefully learned a lesson. That lesson is: what everyone knows has long ago been priced in.

Yes peak oil is still a factor, and yes I am a believer in the peak oil theory. However, current demand is a bigger factor in the short to intermediate time frame.

As for here and now, oil prices crashed and that is exactly what they should have done. I steadfastly held to my target of $70 and here we are. Given that global conditions have accelerated to the downside, $50 or even $40 are now likely targets.

OPEC Holds Emergency Meeting

In the face of this steep decline, with oil falling over 50% from the peak, OPEC moves emergency meeting forward.

Opec has moved an emergency meeting to consider a cut in production forward to next week after US oil futures prices neared $70 a barrel.

Abdalla Salem El-Badri, the Opec secretary general, said the cartel had decided to re-schedule an extraordinary meeting scheduled for next month would now be brought forward to October 24th.

Opec on Wednesday said it would need to pump about 31.3m barrels a day in the first quarter of next year to balance the market, well below its current output of 32.2m b/d. The forecast opens the door for a large production cut at the emergency session. Iran, one of Opec’s most hawkish members, on Wednesday reiterated that the cartel should cut production.

Opec, warned of “dramatically worsening conditions” in the credit market and a “negative impact on the real economy”, and Rio Tinto, one of the world’s largest mining companies, signalled that Chinese commodities demand was weakening.

Fool’s Mission

Attempting to hold the price of oil up by cutting supplies is a fool’s mission. Saudi Arabia and a couple other members are likely to cheat. However, should the cartel be successful in forcing prices up, risks to the global economy will increase. The last thing the world needs right now is a supply shock in oil and/or artificially high prices.

There are those who claim the drop in oil will help consumer consumption. It will do no such thing. Oil prices are falling because the world economy is heading into a recession. Massive numbers of layoffs are coming. The Christmas retail season is going to be a disaster. Falling oil prices are a symptom of that disaster as opposed to a benefit that will support increase spending elsewhere.

Consumers out of a job are not going to increase spending and falling oil prices are just one of the signs that more layoffs are coming. Expect downward pressures on oil prices (in fact on nearly all consumer prices) regardless of what OPEC does or does not do. I am looking for the CPI to go negative within a few short months.

Mike “Mish” Shedlock
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