Is oil ready to tumble? You would certainly think so judging from government reports on inventories. The Energy Dept. announced on Apr. 6 that U.S. commercial stockpiles of crude oil rose for the eighth straight week, hitting 317.1 million bbl., 8% more than a year ago and above average for this time of year, when refiners are gearing up for the summer driving season. Growing inventories usually signal that supply is exceeding demand -- the prime condition for a price fall. For weeks, forecasters have cited the growth in inventories to argue that oil prices are bound to decline. On Apr. 5, Federal Reserve Chairman Alan Greenspan said in a speech that the growth in buffer stocks of oil, if sustained, could "damp the current price frenzy."
So far, though, the frenzy is pretty much unabated. Oil prices fell just 19 cents on the inventory news, settling at $55.85 a barrel for May delivery on the New York Mercantile Exchange. Oil has soared around $12 a barrel since the start of the year. And gasoline prices are ratcheting up in tandem: They hit a record national average of nearly $2.22 a gallon for regular as of Apr. 4, up 36 cents since the year began, according to the Energy Dept.
Why are prices so high when crude inventories are above average? Because traders are looking past the inventory numbers to the potential for trouble ahead. With spare global production capacity so short, today's inventory levels provide much less insurance against a spike in oil prices than they would in quieter times. "If you're using history as a guide here," says Tina J. Vital, an oil-company equity analyst at Standard & Poor's (MHP), "you're going to get the wrong answer."
Inventories are intended to carry oil companies over brief dips in supply and blips in demand for their product. But the risk now is for more than dips and blips. If world economic growth remains strong and producers can't add to their production capacity quickly enough, worldwide demand might exceed all-out production capacity. That would quickly exhaust inventories, and prices would soar until the cost of oil dampened demand. In a Mar. 30 report, Goldman, Sachs & Co. (GS) predicted that oil prices would average $50 to $60 a barrel this year and next. But it warned that if strong consumption growth collides with inflexible supply, a "super spike" could carry oil prices as high as $105 a barrel. Reflecting a bit of that fear, oil for delivery in December 2005 settled at $58.10 on the Nymex on Apr. 6 -- even higher than the May price.
For now, there's still some slack in the system despite strong growth in demand from the U.S. and China. The International Energy Agency estimated last month that oil stockpiles in the industrialized nations in the first quarter amounted to 51 days of consumption, which is considered adequate. But the agency is predicting worldwide demand of 86.1 million bbl. a day in the fourth quarter of 2005, up 1.9% from the end of 2004. Based on its forecast for non-OPEC production, the agency says the "call" on OPEC to plug the gap and meet total demand would be 29.5 million bbl. a day in the fourth quarter. But meeting that target won't be easy for OPEC. Platts (MHP), an energy information service, calculates that the most oil OPEC has ever produced is 30.3 million bbl. a day, which it did last October. So OPEC would have to produce almost as much as it ever has in a single month, and do so for an extended period. Possible? Yes. But hardly a sure thing. "We're at a level of spare capacity where no matter what the inventory level was, the market would still be nervous," says Rick Mueller, a senior analyst at Energy Security Analysis Inc. in Wakefield, Mass.
Inventories could suddenly matter again if the projected demand doesn't materialize this year. In that case, inventories might accumulate so quickly that oil companies would run out of room and have to put the stuff on sale. For now, though, people who put their faith in inventory levels to push prices down are being sorely disappointed.
By Peter Coy in New York