Oil's Recent Rise Not as Familiar as It Looks

By Steven Mufson
Washington Post Staff Writer
Monday, November 5, 2007

After a week of new records for crude oil prices, the question is: How high can they go?

In the past 10 weeks, the price of crude oil has shot up $25 a barrel, closing at $95.93 in New York on Friday, near an all-time inflation-adjusted peak. Unlike earlier spikes in oil prices, which came on the heels of war in the Middle East, this latest ascent does not appear to be linked to any one conflict or to any physical shortage.

Instead, traders who treat oil like any other commodity are widely thought to be driving prices upward, bolstered by a weak dollar and money flowing out of stock markets and other investment vehicles.

So far U.S. consumers have not felt the full impact. Sluggish U.S. gasoline demand over the past two months has made it hard for oil giants to pass through higher costs; refinery profit margins, which hit records in the spring, have been squeezed. But if high crude oil prices persist, they will flow through to the gas pump. Yesterday, the Lundberg Survey reported that the average retail price of regular gasoline is up 16 cents in the past two weeks to $2.96 a gallon.

Many veteran oil analysts say this is a bubble. Oil is historically a cyclical business. Modestly higher production by the Organization of Petroleum Exporting Countries, a warm winter, slower U.S. economic growth and a flattening of demand in the United States could puncture these lofty prices.

"It just seems that the market is spasming here," said Adam Robinson, an oil analyst at Lehman Brothers. If slowly declining petroleum inventories start to build again, he said, "the radical increase we've seen to the upside can repeat on the way down." Oppenheimer & Sons analyst Fadel Gheit says oil is $30 a barrel overpriced.

But analysts also say that the past 10 weeks have demonstrated the power of traders at investment houses. Deutsche Bank oil economist Adam Sieminski, who spent six months on the bank's trading desk, said it is important not to underestimate the role of sentiment and technical factors, such as patterns of price movements and the need to hedge risks in other markets. Now, when investors hold a large number of options to buy oil at a price of $100, he says, "it's almost like magnetism. It draws prices to that level."

Traders say that they are not buying and selling on whims, however. The unusually thin cushion of excess oil production around the world and the rapid growth in consumption in China and India make this rise in prices different from earlier oil price spikes, they argue. That combination, the traders add, leaves the oil markets one incident away from an even steeper increase.

"There is no current shortage, but no one deals on today's market. They make deals based on tomorrow's market. And that's what they're worried about," said Joseph Stanislaw, an oil consultant and senior adviser to the accounting firm Deloitte & Touche.

The weekend declaration of a state of emergency in Pakistan, which has no direct effect on global oil supplies, won't calm nerves.

"It would be silly if we waited until things were not available," said a veteran energy trader at a U.S. hedge fund, who spoke on the condition of anonymity to protect his business relationships. He said traders have become convinced that military conflict between the United States and Iran is inevitable. He added, "People react to perceptions of what will happen. That's not idle speculation."

Last week, nonprofit group Securing America's Future Energy engaged in some speculation. The group invited former Cabinet members and top U.S. officials to act out how a U.S. administration might respond to an oil supply disruption. The exercise assumed that a key oil pipeline was cut by explosions in Azerbaijan, an insurgency continued in Nigeria's oil-rich Niger Delta, and cuts in oil output were made by Iran and Venezuela as a result of souring U.S. relations. In this hypothetical scenario, oil prices hit $160 a barrel.

CONTINUED     1           >

© 2007 The Washington Post Company