Oil Prices Explode

Prospects for a weaker dollar and worries about the Wall Street bailout send investors flooding back into the oil market

By Moira Herbst

Crude oil, the newest safe haven? Amid high-profile implosions on Wall Street and the prospect of massive new U.S. government debt, investors rushed into crude oil futures on Sept. 22, sending prices up a record 16% in one day. The price of a barrel of West Texas Intermediate crude oil surged more than $25, to $130 on the New York Mercantile Exchange (CME), before settling at $120.92. The one-session rise of $16.37 rise set a record.

Investors were also betting on whether the U.S. government's $700 billion plan to buy troubled mortgage assets from banks would help the economy to rebound, keeping demand steady. The Bush Administration has proposed that the federal government acquire sour debts from U.S. financial institutions for the next two years. The measure gives the Treasury Secretary authority to buy mortgage-related assets and would raise the statutory limit on the national debt from $10.6 trillion to $11.3 trillion.

Adding to the crude buying, the October crude contract expired on Monday. The expiration led to a "squeeze" on traders who had bet short, or that oil prices would drop. Prices can soar as short-sellers who want to avoid physical delivery of the product are forced to cover their positions. At one point, the October contract gained as much as 24%. "Someone [who] was short had to cover his positions on the last trading day, and got squeezed," says Phil Flynn, an analyst at Alaron Trading in Chicago. "That definitely caused the market to run up." Meanwhile, crude futures contracts for November delivery rose only $6.62, or 6%, to settle at $109.37 per barrel. Some analysts say the November contact is a more accurate indicator of where prices will settle because it is not influenced by contract expiry.

Greenback Blues

The dollar also weakened, creating an incentive for commodities to serve as a currency hedge. The U.S. Dollar Index, which tracks the dollar's value against six other currencies, fell 1.4%. The dollar took a hit on investor concerns about how much the financial industry bailout will cost and what it could do to the budget deficit, inflation, and the current account shortfall.

The price surge came as a shock to the oil market after prices had been heading down for weeks (BusinessWeek.com, 9/15/08) amid concerns that strained economic growth would hurt oil consumption. The price of oil fell to a seven-month low when it touched $91.50 on Sept. 16.

The jump also prompted regulators at the Commodities Futures Trading Commission to say they would examine the day's trading for any irregularities. "CFTC enforcement staff will scour today's trading activity to determine whether anyone engaged in illegal manipulative activity," Stephen Obie, acting director of the enforcement unit, said in a statement. "No one should be trying to game our nation's commodity futures markets."

The New York Mercantile Exchange briefly stopped electronic crude-oil trading after prices surpassed the $10 daily limit at 1:31 p.m. ET. But trading resumed five minutes later, after the limit was increased to $20 from the 1:31 p.m. trading price. Nymex spokeswoman Anu Ahluwalia says such a move is permitted under the company's bylaws. She said the exchange hiked the limit to "maintain an orderly marketplace." The flight to hard commodities came as stocks traded sharply lower, with the Dow Jones industrial average dropping 372 points and the Standard & Poor's 500-stock index losing nearly 48, or 3.8%.

Analysts are debating where oil prices are headed from here. "With this new rush into commodities, the bailout has overridden the fact that demand is down," says Peter Beutel, president of Cameron Hanover, an energy risk-management firm in New Canaan, Conn. "I don't know where we'll end up by the end of the week—$150 or under $100, I haven't got a clue."

Herbst is a reporter for BusinessWeek in New York.