Factors That Pushed Oil Price Up Are Now Pushing It Down

By Steven Mufson
Washington Post Staff Writer
Saturday, September 16, 2006

No matter what theory oil analysts used to explain the spike in petroleum prices over the summer, this week those analysts were saying that those factors -- geopolitics, supplies of refined products and hedge fund speculation -- are working in reverse to drive prices down.

"The whole perception has shifted," said Peter Fusaro, co-founder of the Energy Hedge Fund Center LLC, which tracks 520 energy hedge funds. Put the factors together, said oil consultant Philip K. Verleger Jr., and "you have a setup for one heck of a price washout."

Oil traders, who once fretted that tensions between the United States and Iran would spill into oil markets, now discount the chances of any conflict. And as political anxieties have faded, the fundamentals of the market -- a plateau in demand and rising oil inventories -- have moved to the forefront.

Yesterday, even suicide bombers attacking Yemeni oil facilities failed to inflame oil markets. While oil installations weren't damaged, the mere attempt over the summer might have sent prices soaring. Instead, the price of crude on the New York Mercantile Exchange settled up just 11 cents yesterday, at $63.33 a barrel, finishing down 4.5 percent for the week and down 20 percent from the July peak.

While still at a historically high price, crude oil is the cheapest it has been since March. Spot market prices for wholesale gasoline have plunged by more than 90 cents a gallon since Aug. 2.

Abdulsamad al-Awadi, a European oil consultant and former executive in Kuwait's oil industry, said the easing of political tensions was one reason. He said that Israel's inability to vanquish Iran-backed Hezbollah in its war in Lebanon made it unlikely that the United States would confront Iran directly over its nuclear program. "Had Israel won decisively the fight with Hezbollah, things would be completely different," he said. Instead, he said, the Lebanon war "has definitely allowed more time for the Americans to rethink their aggressive strategy." Awadi said oil traders expected new talks with Iran soon.

In the United States, summer glitches in the gasoline supply chain -- caused by companies dropping one additive and switching to ethanol -- have disappeared. Now, with ethanol supplies and oil inventories growing and the summer driving season over, refining margins have collapsed from a peak of about $26 a barrel to around $6 a barrel. According to Friedman Billings Ramsey Group Inc., refinery margins fell 21 percent last week alone.

"This is a gasoline story," said Verleger, an independent analyst who discounts political tensions as a factor in oil prices. He argues that gasoline shortages pulled up crude oil prices and weren't pushed up by them. Now, he said, swelling gasoline stocks are pushing crude prices down.

Finally, the wave of pension fund and other money flowing into commodity index and hedge funds may be ending or changing directions. Verleger said that for years, financial advisers have been telling pension fund managers and other investors that commodities were investments as reliable as stocks and bonds. As a result, he said, more than $100 billion has poured into oil and gas commodity holdings, buttressing prices on spot and futures markets.

Now, Verleger said, those funds could accelerate the drop in oil markets. Asked how low prices could go, Verleger said, "This is a commodity market. There's no floor."

Fusaro said he expects pension funds to continue to boost investments in commodity and energy hedge funds, bolstering commodity prices. But, he said, prices could still drop in the short run. And if they did, he added, hedge funds would "probably exacerbate any price decline by running to the exits."

For now, hedge fund managers and oil traders are looking closely at supply and demand figures. Yesterday the Organization of Petroleum Exporting Countries lowered its forecast for fourth-quarter oil demand by 300,000 barrels a day. The group said it expected a relatively modest 1.5 percent increase in world demand next year.

In its weekly report, the Energy Information Administration noted that Iraqi oil production in July and August was higher than at any time since 2004 and that the disruption caused by a leak in a BP PLC pipeline in Prudhoe Bay in Alaska seemed less severe than initially. Furthermore, the agency said, "mid-September has arrived without a single hurricane affecting oil facilities in the Gulf of Mexico and with no storms likely to arrive within at least the next week."

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