What's Driving Up the Price of Oil?

Ever since oil lifted over $50 I’ve been saying that speculation is the cause. Actually, the lower dollar (caused by speculation) is a good part of the cause and inflation speculation is the rest. What is not driving oil up, it seems, is actual supply and demand. That’s the assumption in the market, anyway, and it’s probably correct.

But there are some fundamentals influencing oil to the upside that are worth noting. One is Nigeria and the other is Venezuela. Both have collapsing governments and economies that have been well noted in the press but I think the combination merit some consideration as a bit of fundamental winds to the upside for oil pricing.

In Nigeria, the government has started a new chapter in the MEND saga. That’s the group of guerrillas in the oil-rich southern Delta swamps that steals oil (reportedly in cahoots with elements of the national army), supposedly for the benefit of impoverished locals but also largely for their own coffers. The locals get all the pollution but few jobs and few benefits from the royalties which go to the central government in the north. Now the federal military is taking on MEND in direct combat for the first time, saying they want to eliminate them.

MEND is putting up a good fight against the military. In addition it has shut down a lot of Nigerian oil production, thus far having stopped about half of Nigeria’s 2.4 mb/d capacity. MEND is now vowing to shut down the entire Nigerian oil industry. That’s a lot of oil off the market and there could be a lot more. Nigeria’s oil is prized for it’s high quality and a lot of it goes to the U.S.

In Venezuela oil production has been falling over the past year as major contractors like Exxon-Mobil have had their production contracts canceled. Recently Chavez seems to have gone off the deep end, no doubt because reduced oil prices compared with last year and reduced oil production are combining to put a severe strain the on the supply of dollars flowing into Chavez’ treasury. He depends on federal bribes to keep him in power. As Mary Anastasia O’Grady, the Wall Street Journal’s expert on South America wrote today in a piece titled “Chavez’s Cash Crunch”, Chavez requires a generous helping of oil-generated dollars to keep his government alive.

Indeed, the Venezuelan economy itself, as well as the government, is starving for dollars because, as O’Grady writes, the country depends on imports for a great deal of its food and other living staples; imports must be purchased in dollars. Increasingly oil is the only viable Venezuelan export that produces dollars to pay for imports. Chevez has strangled a good deal of the free market and entrepreneurial spirit out of the Venezuelan economy.

Recently Chavez has sent his military to take over more oil production assets of foreign companies as Venezuela has struggled to pay their charges. One problem with this expropriation strategy is that the companies seized employ fairly sophisticated technologies for re-pressurizing old fields that would otherwise decline rapidly. O’Grady says that Venezuelan oil field personnel lack the sophisticated skills needed to keep this equipment operating. Without it, Venezuelan oil production could decline much more rapidly than it already has done over the past year.

In addition to falling production, Venezuela has made deals with China to ship increasing amounts of Venezuelan crude to them instead of to their traditional market, the U.S. Thus there are several forces working against the ability of the U.S. to access two of its primary suppliers, Nigeria and Venezuela. This adds to the oil import problem America already faces with its two largest suppliers, Canada and Mexico. Canadian production is flat. Anticipated growth in oil sands production has been put on hold. In fact, environmentalists are trying to prohibit the importation of oil from the oil sands. Meanwhile Mexican exports are falling rapidly as their fields decline, as has been frequently discussed in the press lately.

To some extent these impediments to oil imports from Nigeria, Venezuela, Canada, and Mexico may help account for the recent fall in U.S. oil inventories. Or perhaps not. I’m not sure anyone knows that definitively. It’s hard to believe that there is actually any real shortage of oil supplies, given the substantial recession-induced drop in demand: probably 3 - 4 mb/d globally and 1 - 1.5 in the U.S. Nonetheless, these forces for lower oil supplies are worth bearing in mind as we see the oil price climb once again.

I’m not suggesting that speculation and the lower dollar aren’t the main cause of oil rising. They are, and because they are, there could be a substantial pull back in the oil price because there is still very likely a substantial glut in the short term oil supply. But there are a few elements of fundamental supply shortage starting to creep in to the market.

Comments

[jimboy:]

Thanks for an excellent article with some interesting information Nigeria and Venezuela, two situations that were only vaguely on my radar. Another factor on the demand side which doesn't get much attention is the growth in emerging market car ownership, particularly in China and India. Recession or not, monthly vehicle sales in China recently passed the million-a-month mark for the first time. Meanwhile in India sales of the Nano, a car costing only $2k, are being described as "explosive". Even with weak economies in the West, the world car population (600m approx) is still growing rapidly and will underpin the oil price for a long while. Gushing money supply and less-gushing oil supplies from places like the North Sea and Mexico will do the rest.

Jun 02 01:03 PM

[User 353732:]

it seems to me that, recently, oil has become an important tool for risk management , in addition to its traditional uses.
The general family of risks that people are trying( the analytical tools are still being developed) to manage using oil is called Bad Government.
Bad Government can take several forms. For example , blatantly unjust treatment of a segment or class or ethnic group of citizens by an oppressive government in a poor country, leading to desperation manifesting itself in a violent struggle over oil assets and income. Or government cowardice and military weakness when faced with assorted kinds of domestic and imported terrorism which creates geopolitical risk for the entire oil market. Or government collusion with and sometimes sponsorship of terrorism which threatens oil production and logistics, again creating geostrategic risk for the entire market(i.e the impacts cannot be locally contained). Or bad government that systematically loots the oil assets of a nation to finance corruption and entrench a brutal oligarchy which creates the conditions for viloence and sabotage by the internal resistance. And of course, in 2009, bad government that deliberately debases the dollar causing reserve currency risk.
In the past , people used the dollar to manage oil risk, now some people, at least are turning to oil to manage dollar risk. The rising price of oil may in some important way be signalling the rising use of oil as a risk management tool.

Jun 02 01:30 PM

[Sober Realist:]

Speculation, animal spirits - yes. Fundamentals - no.

This news item from yesterday cracked me up:
11:22 AM China's top energy official suggests oil's recent rally may be hard to sustain as brimming oil inventories push down demand. Oil +1.6% to $67.36.
online.wsj.com/article...

Jun 02 01:30 PM

[HardwoodFlo...:]

This question might seem a bit far fetched but has anyone thought that "higher" prices might be a desired affect to political stability (e.g. Russia, Saudi Arabia).

Jun 02 03:36 PM

[HardwoodFlo...:]

If it is true that "higher" oil translates into political stability what else does the American taxpayer/consumer need to subsidize? We are subsidizing foriegn governments that do not have our interests at heart, we are subsidizing the UAW (they now own 25% of GM and 55% of Chrysler) and, of course, the banks which are still not lending to small business. How much more can we bear- $3 trillion in debt?

Jun 02 03:43 PM

[stockferret:]

Hasn't OPEC taken 3-4 mbd off the market in the past 9 months? Its not like it has disappeared as they could drop that into the market on pretty short notice. No doubt the Saudis are tempted as they have sacrificed so much more than their cartel partners.

Add all of the oil in storage on land and on tankers around the world and the economy would have to be going full bore for a long time to get out from under that overhang.

I understand that in the long term oil supply will not match oil demand but even if we recovered to previous GDP growth tomorrow it would take a couple of years to use just what we have laying around now. Anyone buying oil now based on supply and demand (or Peak Oil) will be sitting on dead money until 2011 at least until the excess oil works itself out.

Jun 02 05:13 PM

[Alan von Al...:]

posted 4 days ago:

Certainly, some risk can be attributed to perceived dollar weakness, massive U.S. Treasury requirements, and worries about inflation. A barrel of oil tomorrow will cost more dollars than today.

But war risk seems to be front and center in the minds of oil ministers and traders, as far as I can judge from press reports. There are too many trouble spots to say that one or two are pivotal. Rather, the background worry of peak oil has magnified a dozen supply and transportation threats into an overall sense of foreboding and a bit of paranoia about global oil insecurity.

North Korea www.ibtimes.com...

Nigeria www.voanews.com...

Israel-Iran www.presstv.ir/...

US national security blogs.wsj.com/e...

Iraq supply www.forbes.com/...

Ukraine-Belarus www.charter97.o...

Myanmar-Malacca transit www.atimes.com/...

Russian paranoia www.hstoday.us/...

China www.upi.com/new...

links work on my Instablog seekingalpha.com/insta...

Jun 02 06:00 PM

[dcb:]

Can you say goldman sachs. it is funny to mae that just a short while ago many pro's were saying there was no need for it to be above 50. the world hasn't changed that much in two weeks. there was never a reason for it to be 147.
it is a reflection of the new world order where our government allows market manipulation in order to prop up the s&P and raise consumer confidence.

There was a time during the dot com bubble where people justified the price of those stocks, there was a time when people justified that the prices of housing would always go up, when the pe of china was 60 and things were OK now the PE in emerging markets is 30.

I hate when people attempt to justify irrational market behavior post facto.

the internet, hedge funds trading in and out all day, painting the tape with 2 minutes to go on friday then selling equity today. there ceate massive capital flows and distort the reality base of the market. (by the way, at one time our government would have prosecuted firms that painted the tape and then sold stock).

BofA, JPMorgan, others raise $19 billion
Tue Jun 2, 2009 10:24pm EDT

On Jun 02 01:30 PM Sober Realist wrote:

> Speculation, animal spirits - yes. Fundamentals - no.
>
> This news item from yesterday cracked me up:
> 11:22 AM China's top energy official suggests oil's recent rally
> may be hard to sustain as brimming oil inventories push down demand.
> Oil +1.6% to $67.36.
> online.wsj.com/article...
>
>
>

Jun 02 10:41 PM

[dcb:]

I think goldman got into the game of renting tankers to store oil.


On Jun 02 06:00 PM Alan von Altendorf wrote:

> posted 4 days ago:
>
> Certainly, some risk can be attributed to perceived dollar weakness,
> massive U.S. Treasury requirements, and worries about inflation.
> A barrel of oil tomorrow will cost more dollars than today.
>
> But war risk seems to be front and center in the minds of oil ministers
> and traders, as far as I can judge from press reports. There are
> too many trouble spots to say that one or two are pivotal. Rather,
> the background worry of peak oil has magnified a dozen supply and
> transportation threats into an overall sense of foreboding and a
> bit of paranoia about global oil insecurity.
>
> North Korea www.ibtimes.com...
>
> Nigeria www.voanews.com...
>
> Israel-Iran www.presstv.ir/...
>
> US national security blogs.wsj.com/e...
>
> Iraq supply www.forbes.com/...
>
> Ukraine-Belarus www.charter97.o...
>
> Myanmar-Malacca transit www.atimes.com/...
>
> Russian paranoia www.hstoday.us/...
>
> China www.upi.com/new...
>
> links work on my Instablog seekingalpha.com/insta...

Jun 02 10:43 PM

[Alex Trias:]

This was an amazing article. You know what I think is driving the price of oil? Idiots like me. Yep. I don't care what it is. If it moves, and it wanders into the proximity of a moving price average, I can trade it. Cotton, oil, stocks, volatility options, I don't care. And hey, I'm not even a pro. There must be millions of guys out there like me.

Honestly, you could train a doggy to do what I do. I know about as much as a doggy knows when it comes to politics and economics and stuff, but it's not like I care or anything. I make money using technical analysis and ergo, I don't question it. And I won't as long as it makes me money. So too with the millions of doggies out there like me. I think that explains the price of oil more than anything else. Woof woof.

I don't think oil is in price a bubble. I think something more basic is in a bubble. It's an investment technique that goes under the rubric of technical analysis. At some point, it must stop working because it is silly and widely used. But until enough doggy traders get fried, you will see asset prices outside of alignment with economic fundamentals.

Markets are not perfect; they are merely the least imperfect mechanisms for pricing assets. We should lower our expectations of their efficacy.

Jun 02 10:52 PM

[johngonole:]

I agree that there is probably a lot of dollar hedging going on in the rising price of oil. The question is whether or not this is legit. We have been exporting dollars for some time. Now more dollars are being printed at home so we can continue export dollars. Dollars are required to buy oil. More dollars in circulation mean more are required per barrel of oil. More cars also equal more demand in the future. Thats the bull case for oil. On the otherhand if supply is increased to meet the increased deman than the supply increase may match that of the increase in dollars. The point is that industrialization of economics helps support our dollar. Who knows but I wouldn't bet against oil.

Jun 02 11:50 PM

[sethmcs:]

I have noticed the media must have a rational explaination for every movement of oil. Believe me if Chavas could control the price of oil he would or even OPEC for that matter. The market appears to ignor the fact that there are at least 84 million barrels of oil stored at sea or the fact that the refiners are cutting back due to decreased demand and squeezed margins. I predict that the trend will be down after the 4th of July.

In the meantime, here is a great conspiracy theory. The government wants the price of oil high to foward its green agenda. GS has been given the secret assignment to drive oil up and make a fortune. Much like the previous administration's need for the people to be in constant fear of terrorist this administration needs the constant theat of an oil shock to move its agenda forward.

If that doesn't suit you then how about this. More long buyers than shorts.

Jun 03 12:37 AM

[TinyTim:]

"What is not driving oil up, it seems, is actual supply and demand. That’s the assumption in the market, anyway, and it’s probably correct."

Same as $4 gas two years ago

Jun 03 01:57 PM

[Sober Realist:]

The EIA publishes its weekly stock numbers on oil and other petroleum products each Wednesday. www.eia.doe.gov/oil_ga...

or you can look at the raw numbers here:

tonto.eia.doe.gov/oog/...
(Click on the Data 1 tag)

This week analysts thought stocks would drop by some 2 million barrels. Instead they increased by 2.866 million.

May 29, 2009 365.977 million bbls
May 22, 2009 363.111

That’s a 5 million bbls error which is huge. But it doesn’t begin to capture just how insane the oil market really is. This is the crude oil stock number from last year at this time.

May 30, 2008 306.757 million

We are currently carrying 59.22 million bbl more this year than last year. This is in large part due to the fact that the economy is doing so much worse this year. But that is rather the point. Supply is through the roof. The economy sucks, and the near oil crude future has doubled from its low of $30.28 which it hit on December 23, 2008 at the bottom of its collapse from the previous speculative binge, --or if you prefer the 2009 low, $34.03 on February 12, 2009.

tonto.eia.doe.gov/dnav...

What this screams is manipulation. It is a subsidy for oil producers, a windfall for investment banks, and a hidden tax on already cash strapped American consumers.

Jun 03 08:23 PM