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Marching to $100/bbl oil

Sam Fletcher
Senior Writer

When the front-month crude futures contract fell $3.45 to $91.17/bbl Nov. 13—the lowest level in nearly 2 weeks on the New York Mercantile Exchange—after the International Energy Agency reduced estimates of global oil demand for the fourth quarter through 2008, many analysts declared the march to $100/bbl oil had finally fizzled. Imagine their surprise when the January crude contract jumped $3.39 to a record closing of $98.03/bbl Nov. 20, climbing as high as the Nov. 7 record of $98.62/bbl in intraday trading. The price continued climbing to $99.29/bbl in early electronic trading Nov. 21 before closing at $97.29/bbl, down 74¢ for the day on NYMEX. But the push for $100/bbl oil may not be over.

The volume of crude traded Nov. 19 on the New York market was "the lowest level of the last 55 trading days," said Olivier Jakob, managing director of Petromatrix GMBH, Zug, Switzerland, in a Nov. 21 report. In a low-volume, preholiday market, a large pension fund buying oil assets with the weaker dollar could trigger a rally.

Analysts in the Houston office of Raymond James & Associates Inc. blamed the record-low weakness of the US dollar for driving up crude prices. "Credit spreads widened following the Federal Reserve's cut in its growth outlook for next year to a growth of only 1.8-2.5%. This, coupled with the US 10-year Treasury yield falling below 4% for the first time since 2005, sunk the dollar to a new record low [of] $1.4850 vs. the euro," they said.

Moreover, Raymond James said, "Oil was trading up premarket on expectations of colder weather in the Northeast and supply setbacks in Canada and Mexico." Fire damaged a 155,000 b/d oil sands upgrader at Royal Dutch Shell PLC's Scotford refining complex near Edmonton, Alta., on Nov. 18. The upgrader and Shell's adjacent 98,000 b/d refinery were operating at reduced rates Nov. 20. Oil produced by the upgrader is processed through the refinery.

Dollar value
However, analysts at Barclays Capital Research, a division of Barclays Bank PLC, London, claim the weakness of the dollar against other currencies has limited effect on oil markets. "A widespread misconception is that the value of the dollar and the price of oil are linked by a clear indirect relationship. This belief has grown stronger over the past 3 months fueled by the simultaneous acceleration in the fall of the greenback and the move up in oil prices. In our view, the relationship between the two is far more tenuous that many might think. Firstly, there is no evidence that periods of dollar weakness are associated with higher oil prices, and, historically, a wide range of behavior has been displayed," they reported Nov. 21.

"Arguably, a weaker dollar makes oil cheaper for nondollar consumers, whereas it squeezes profits for non-US producers, which should prove supportive for prices over time," said Barclays analysts. "While the magnitude of the effect is far from clear, its transmission would involve substantial time lags. Refiners are often insulated from fluctuations in the value of the dollar as both their inputs and outputs are denominated in the same currency, and any knock-on effect induced by higher-end user demand would likely be in the region of quarters and years rather than days. On these grounds we see very little substance to those explanations which base the latest move-up in oil prices on the deterioration of the dollar, and by contrast we see the tightening of the physical market balance as having a far better explanatory power."

They predicted, "Severe constraints on the supply side and limited room for maneuver by the Organization of Petroleum Exporting Countries in the short term will keep prices vulnerable to supply disruptions and a faster-than-expected erosion of the inventory cover."

OPEC's summit meeting Nov. 17-18 in Riyadh was only the third meeting of member heads of state in the group's 47 years. At that meeting, President Hugo Chavez of Venezuela and President Mahmoud Ahmadinejad of Iran urged that the cartel quit pricing its oil in US dollars in favor of a basket of stronger currencies. Saudi Arabia opposed that move.

Analysts at Barclays Capital Research see little chance for such a change. "It would necessitate a major overhaul of the existing pricing system, given that OPEC crudes are currently priced in terms of dollar adjustments from dollar-denominated benchmarks. The absence of non-US dollar alternatives (the only exception being the yen-denominated contracts traded on the Tokyo Commodity Exchange) would therefore require moving away from current market mechanisms and setting up a brand new pricing system, which we believe is unfeasible," they said.

(Online Nov. 26, 2007; author's e-mail: samf@ogjonline.com)



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