Oil Price Fundamentals: Ignore the Hype

Includes: DBO, OIH, OIL, USO, XLE
by: Bob Zieger

Last week, Marketplace had an interesting report on the growing trend of “contango” in the oil industry. For those of you who are not familiar with the practice, contango occurs when investors sit on a commodity because the future price is higher than the spot price. In this case, that results in full oil tankers sitting offshore, waiting for the price to rise before they unload their 50 million barrels onto the market. So a quick buck is made by those holding the inventory on the high seas, but what happens when those barrels eventually reach a port ? We’ve got a glut of material again, which forces prices down. This type of profit-taking merely adds to the volatility of the market, but has little influence on macroeconomic fundamentals.

Frankly, it seems as though the oil/energy sector has the most interesting bag of tricks when it comes to speculation, rhetoric, and other market manipulation. But all the headline grabbing stories aside, oil is just like other commodities in that pricing is governed by supply and demand. While contango, Somali pirates, and accounting tricks can be a source of market volatility, these games don’t have a long term impact on pricing.

In my opinion, what is far more interesting is how OPEC production cuts and the current Middle East turmoil suddenly don’t seem to impact oil prices. Despite Saudi Arabia’s announcement of further production cuts on Monday, the price of oil continued to fall. And as the Wall Street Journal reported, many analysts also see a decoupling of oil prices from the value of the USD. These are major departures from historic influences on oil prices, and they really drive home how sluggish demand is right now.

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