Oil: Up, Up, Up

With a surprise drop in inventories, crude crosses $133 a barreland many see further gains

Oil prices raced past $133 a barrel for the first time on the New York Mercantile Exchange as traders responded to a May 21 inventory report that showed supplies lower than many analysts had expected. The price on the July contract for West Texas Intermediate surged 3.2% to $133.72 before retreating to a new settlement record of $133.17. Retail gasoline prices, meanwhile, reached another record high of $3.81 per gallon.

The same day, U.S. oil company executives told the Senate Judiciary Committee that oil prices whould be between $35 and $90 a barrel if they were based on production costs and supply and demand. Representatives of Shell (RDS-B), BP (BP), ConocoPhillips (COP), Chevron (CVX) and ExxonMobil (XOM) testified at the hearing, called "Exploring the Skyrocketing Price of Oil," and will do so again before the House Judiciary Committee May 22.

Crude has surged 95% in the past year. Amid all that buying, many analysts see few obstacles to $150 or $200 barrels. Peter Beutel, president of the energy risk management firm Cameron Hanover, noted May 21 that traders once put little weight on weekly stockpile reports. These days, with political instability, inflationary threats, and a weak U.S. dollar, almost any spot of news drives prices.

"We used to ignore [inventory] reports, but now they're a matter of life and death," Beutel says. "Now anything can move prices. I'm convinced that if my lawnmower leaked a few drops of oil it would generate buying."

Imports Fall

Still, analysts are quick to note that few strong conclusions can be drawn from the inventory report. "You can't learn much from [these] weekly numbers," says Stephen Schork, an energy consultant in Villanova, Pa., and editor of The Schork Report, a daily energy newsletter. "If there's another huge draw next week, we could have the makings of a trend."

With oil prices up from under $65 a year ago—and gasoline up 19%—analysts are debating whether there's an end in sight to the runup. They cite traditional supply-and-demand issues like rising demand from China and India, as well as the sinking dollar, as reasons for the price spike. Another school of thought says that increased inflows of speculative funds are continually bidding up the price (BusinessWeek.com, 5/21/08).

U.S. commercial crude oil inventories decreased by 5.4 million barrels from the previous week, according to the Energy Information Agency's (EIA) weekly report. Analysts had expected a modest increase. Motor gasoline inventories decreased by 800,000 barrels last week. Inventories include product being stored in the U.S. by refineries, terminals' storage locations, and pipelines.

Doug MacIntyre, senior oil market analyst at the EIA, says the inventory numbers shrank because imports were down this week. Crude oil imports fell 7% to 9.24 million barrels a day, the EIA report showed. Imports have averaged 9.86 million barrels a day so far this year, down 0.9% from the same period last year. Analysts say that as prices rise refiners may be cutting back on imports and that weather issues in the Gulf of Mexico interrupted transportation.

Investment Flows Impact Prices?

Further pressuring prices, the dollar continued to slide against the euro. On May 21 the euro climbed 0.8% to $1.58, though still shy of the Apr. 22 record of $160.19. Investors are using commodities like oil as a hedge against inflation and a weak dollar, rushing into the crude futures market when the dollar's value declines.

Some analysts say the declining dollar and a troubled stock market are spurring massive investment inflows into commodities, causing the current price spike. On May 20 a hearing before the Senate Committee on Homeland Security & Governmental Affairs attempted to address the price impact of the so-called swaps loophole. The loophole refers to the Commodity Futures Trading Commission's (CFTC) allowing investment banks such as Goldman Sachs (GS) to take unlimited positions in futures markets. Institutional investors like pension funds, meanwhile, enter into swap agreements with these banks.

While analysts at Goldman Sachs insist supply and demand are the prime factors in the oil markets, others say investment flows are creating a self-fulfilling prophecy of high prices. "Performance-chasing financial inflows to commodities cause prices to rise, thus delivering good performance, and attracting even more inflows," Lehman Brothers (LEH) analyst Edward Morse wrote in a May 16 report, Is It a Bubble?

"The temporary self-sustaining nature of financial inflows means the bull run in commodities has potentially more to go," he added, saying crude could reach $150 or $200 before a correction.

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