Oil Breaking $100 a Barrel - But Why?

Crude oil reached a record high on Tuesday, and there's an embarrassing oversupply of theories to explain why.

Some opine that the oil market is still on edge over Venezuelan President Hugo Chavez' decision to cut off sales of crude, gasoline, and diesel to ExxonMobil. But this is old news, and I thought the market's modest initial reaction when the story first came out last week was the right one. Presumably Chavez is going to sell the same oil to somebody else, and ExxonMobil could then purchase crude from that buyer's previous vendor. It's not trivial to do this logistically, as Geoffrey Styles observed last week:

US refiners would have to scramble to purchase cargoes of oil from more distant suppliers, driving up the cost of shipping and bidding up the price of the nearest substitute grades of oil. Coming at a time when the output from West Africa has been reduced by problems in Nigeria, it could take a couple of months to arrange suitable alternatives. In the interim, commercial crude oil inventories, which have recently recovered to more comfortable levels, would fall dramatically, unless bolstered by releases from the Strategic Petroleum Reserve. ...

Meanwhile, just as US refiners would drive up the price of non-Venezuelan oil in their search for substitutes, PdVSA would have to discount its oil twice, to keep it flowing. That's because the cost of shipping it to Europe or Asia would be much higher than for the short voyage from Maracaibo to Houston, and because few refineries elsewhere are configured to extract maximum value from the heavy sour crudes that make up much of Venezuela's output.

A lot of nuisance for the sake of political theater, but that's never stopped Mr. Chavez before.

On the other hand, Cattle Network blames the latest oil price move on new developments in troubled Nigeria:

A person claiming to be a spokesman for the Movement for the Emancipation of the Niger Delta said that Henry Okah, believed to be the group's top leader, had been killed by gunfire in Nigeria.

The purported spokesman, Jomo Gbomo, said in an email to Dow Jones Newswires that the group is giving the government 24 hours to clarify reports of Okah's injuries.

"Failure to do this will bring bloodbath in that region and beyond," the spokesperson said. "We will not take prisoners from the military or oil workers."

Instability in Nigeria has been a critical factor underlying crude's run back toward $100 a barrel in recent weeks. More than 500,000 barrels a day of Nigerian oil production has been halted amid security concerns, leading the country to produce about 2.07 million barrels a day in January, according to the International Energy Agency.

Most business reports also mentioned speculation that OPEC will cut production quotas when it meets March 5. My own view is that "OPEC quotas" is better translated as "Saudi intentions". I had interpreted the recent gains in Saudi production as signaling that the Kingdom has had success in replacing some of the lost production in northern Ghawar with other fields. But I was surprised that satellite photos indicate that much of the recent surge in Saudi drilling effort has been concentrated on northern Ghawar itself, which by my reading should not be a favorable omen for future Saudi production. But if this is the explanation for the recent move in oil prices, it's not clear who has some hard news to trade on.

Another common explanation raised in the business press is Monday's explosion at the Big Spring refinery in Texas. But I would have expected this to matter more for the price of refined products than crude itself.

One possibility I didn't see mentioned by the financial commentators but that worries me a bit is speculation that Shiite cleric Muqtada al-Sadr may announce his intention to abandon his participation in the present Iraqi cease fire within the next few days; (hat tip: Hot Air). Oil production in Iraq had picked up in the last half of 2007 and is presently making a significant contribution to world oil supplies.

Iraq daily crude oil production in million barrels/day. Data source: Iraq Index (.pdf)

Speculation as to possible factors seems to be the one thing we have in abundance. But what of those who say, like Joe Friday, "all we want are the facts." Well, here are some. On the same day that crude oil gained 4.8% in price, gold was up 2.6% and copper shot up 5.8%. The latter in particular could have little to do with geopolitical events in Venezuela, Nigeria, Iraq, or any other scary place, but instead seems better accounted for by the following:

Copper rose beyond $8,000 a ton in London to a four-month high on speculation that China, the world's largest user, will import more of the metal. Aluminum and lead also climbed....

Copper has risen 21 percent this year as demand from China is forecast to expand 11 percent in the first quarter, following last year's 17 percent jump.

Aha, I hear some of you saying, so it's all driven by expectations of resurging inflation! But before you declare the case to be closed, let me bring up one more fact that I believe may be quite pertinent. The expected fed funds rate implied by the April fed funds futures contract shot up 7-1/2 basis points Tuesday. Whereas traders last Friday were anticipating an average fed funds rate of 2.415% for April, Tuesday's closing price brings that up to 2.49%.

Now, if you really try, you can still fit that last little nugget into your inflation meme. Say, traders know that $100 oil will scare the Fed into worrying more about inflation so Bernanke will have to slow down lowering rates. Or something.

Or you could try a line that to me seems a bit more natural: incoming data aren't confirming the initial notion held by many that a recession began in December. If so, it means that the Fed's easing will come to an end within a few months, and that the demand for oil, copper, and most everything else is going to be stronger than many of us had been anticipating as of a few weeks earlier.

If so, $100/barrel might not be as bad news as you thought.

Comments

[rodcore]

Although you think you're conclusion is smart because of how convaluted it is. It's wrong because its circular. So I will give you something even more convaluted to ponder. Even if your thesis is correct and the economy is not in such bad shape... a few more months of All time high food prices + All time high energy prices + all time high personal debt will invariably trigger a true recession in the United States and will lower the price of oil. Sometimes the market gets it wrong. I got it wrong for most of 2007. Its wrong right here too.