Crude Oil: Up And Away?

Includes: OIL, USO
by: Market Blog

By David Berman

Rising crude oil prices have a lot of people asking a lot of questions – like, how high is this going and what is the likely impact on the economy? There aren’t any clear answers, of course, but no one seems to be ruling out higher prices and bigger problems ahead.

The benchmark West Texas Intermediate touched a nine-month high on Friday, approaching $110 (U.S.) a barrel, and settled back just 85 cents on Monday. Brent crude, the European benchmark, surged above $125 a barrel on Friday, hitting its highest level since 2008.

These are not only high prices, but they also represent sharp gains. This year alone, West Texas crude has risen 10 per cent and Brent crude has risen 16 per cent, far outpacing most other commodities. For example, the Thomson/Reuters Jefferies CRB index of 19 commodities has risen just 6.6 per cent this year. From their lows in October, oil prices have surged about 30 per cent.

Oil had risen last year with concerns about the military conflict in Libya. That conflict had turned off the country’s export tap – a small amount of oil relative to the world’s daily consumption, but enough to send prices up sharply. Now, of course, the threat to exports comes from tensions with Iran – involving U.S. sanctions and the threat of military action to thwart Iran’s nuclear ambitions.

James Hamilton at Econbrowser rejects the notion that the Federal Reserve’s promise to maintain exceptionally low interest rates through 2014 is the biggest reason for the price gains. After all, you would think that low rates would affect all commodities – but crude oil seems to be in a world of its own.

Instead, he has an interesting chart showing the rise in the number of Google searches for “Iran war.” Curiously, they have spiked since October, coinciding almost perfectly with the rise in the price of oil. Meanwhile, he points to improving U.S. economic conditions, subsiding concerns about an oncoming European financial crisis and a rising outlook for Asian economic activity – all of which could be giving oil a lift.

Ed Yardeni at Yardeni Research trotted out the much-used observation that the best solution for high commodity prices is high commodity prices – in that rising prices tend to cut into consumption, driving prices down. Still, he is not quite ready to let up on his overweight recommendation on energy stocks just yet, largely because consumer confidence measures and the stock market have yet to reflect any pain.

The latest U.S., French and South Korean sentiment indexes rose slightly, and the S&P 500 has been rising with the price of oil, if at a slower pace.

“Higher oil prices aren’t necessarily bearish for the stock market, up to a point,” Mr. Yardeni said in a note. “There has been a very strong positive correlation between the two since the second half of 2008. That’s partly because the Energy sector accounts for 12.3 per cent of the market capitalization of the S&P 500. Moreover, the S&P 500 Energy sector tends to outperform the S&P 500 when the price of oil is rising.”

Meanwhile, the technical charts are also in favour of oil right now. According to Mary Ann Bartels, technical research analyst at Bank of America, the break above $103-$104 a barrel suggests that prices could rise to last year’s high near $115.

“A retest of the 2008 high near $147-$148 is not ruled out,” she said in a note. “In our view, a move of this magnitude could derail an equity market rally and trigger a pullback. But we remain buyers on dips in the U.S. equity market.”

Disclosure: None