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 Posted - 09/09/2008 : 10:15:37
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What's behind oil volatility is hard to grasp
12:00 AM CDT on Tuesday, September 9, 2008
JIM LANDERS
WASHINGTON – Oil prices went up. Oil prices came down. So was this all a bubble?
Since hitting their peak on July 11, oil prices have fallen more than $40 a barrel. The fall came despite hurricanes threatening Gulf of Mexico drilling and refining and Russia invading Georgia, with its crucial energy pipelines.
Some point to this as proof that speculators have been to blame all along.
Evidence supporting the bubble theory came last week when Ospraie Management LLC shut down its largest hedge fund after losses of 38 percent in oil and natural gas trades. Other financial players in the oil market are taking hits as well.
Others say a shrinking supply and growing demand drove the price spike.
The Commodity Futures Trading Commission and the U.S. government credit the recent drop in prices to a big slide in oil consumption. U.S. demand is off 800,000 barrels a day so far this year, the biggest drop since 1982.
With economic weakness spreading, prices could fall to $90 a barrel, Guy Caruso, head of the Energy Department's Energy Information Administration, said recently.
The rapid price descent has spurred OPEC countries to meet today in Vienna to ponder altering production to halt this slide. That's a dramatic turnaround from June, when Saudi Arabia hosted a global oil summit to halt the jump in prices.
Yet fundamentals make for a confusing explanation of the rapid rise and fall of oil prices. Even with the drop in U.S. consumption, global demand is half a million barrels a day greater this year than in 2007.
Oil producers haven't changed the picture that much, either. There was enough oil to meet consumer demand in the first half of the year, and there's enough to meet demand today.
Bruce Bullock, head of the Maguire Energy Institute at Southern Methodist University, argues that a mix of factors is at work. Financial players who were looking to oil and other commodities as investments are leaving the market. U.S. consumption has fallen, and the global economic outlook is creating uncertainty about oil demand.
"Fundamentals did change," he said. "I'm more surprised, quite frankly, by the speed both when the oil price went up and when it came down."
"We probably overshot the fundamentals on the upside and will probably overshoot on the downside as well," he said.
Oil analyst Philip Verleger contends that it was all about government intervention. In December, Mr. Verleger told a congressional committee that the U.S. government was inflating the demand for "sweet" (low sulfur, low viscosity) crude oil with its purchases for the Strategic Petroleum Reserve.
Although it was a small amount of oil – 40,000 barrels a day in a world market of 85 million barrels a day – Mr. Verleger argued that these purchases made the difference between oil selling for $60 a barrel and $120 a barrel.
The Energy Department stopped filling the reserve on July 1. Oil peaked July 11 at $147.50 a barrel in intraday trading but is now below $107.
Mr. Verleger says another kink in the market played a big role. Last year, the United States and the European Union compelled refiners to produce ultra-low-sulfur diesel fuel. Europeans have been using the fuel for some time, but the addition of several countries to the EU created a demand surge.
As refiners bid against each other for low-sulfur crude supplies, diesel prices shot well above gasoline. With an auto fleet much more reliant on diesel, European motorists started sucking in the fuel from refiners worldwide.
This diesel craze is ending, however. Mr. Verleger says refiners are getting better at producing ultra-low-sulfur diesel from less premium crude oil. The value of the euro is falling against the dollar, raising the oil price pain for European motorists. European economies are slowing as well.
Mr. Verleger expects oil to fall back to $70 a barrel.
Mr. Bullock won't go there. He expects oil prices to remain volatile, especially while rising demand from China remains an inexact but large factor in the world supply balance.
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