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Some analysts say record highs are only the beginning. Traders betting on rising global demand could push prices up further
Crude oil prices continued a months-long bullish run with another record-setting day: On Oct. 17, the price for a barrel of light sweet crude surged above $89 on the New York Mercantile Exchange, the highest mark recorded since contracts started trading on the exchange.
What's driving the latest bull run? Many analysts point to growing global demand amid tightening supplies. In the latest development, Turkish legislators on Oct. 17 approved sending troops into northern Iraq to pursue Kurdish guerrillas. Concerns that such actions could disrupt oil supplies in the Middle East drove prices higher yet again, for a seventh session, capping a $9 rally that started last week.
Speculators Dominate the Market
Still, some analysts say that the latest price spike has less to do with market fundamentals than with momentum traders and speculators. As they push prices up in pursuit of profits, several experts say crude could hit triple digits. "The surge has less to do with fundamentals and more to do with irrational exuberance, and we could head higher," says Tom Kloza, chief oil analyst for the Oil Price Information Service, a consulting firm in Wall, N.J. "We don't need an extraordinary circumstance to take us to $100. With more investment money in oil and a weak dollar, we could hit that level."
Over the past several years, hedge funds, investment banks, mutual funds, and institutions including Goldman Sachs (GS) and Morgan Stanley (MS) have invested heavily in oil (BusinessWeek.com, 1/16/07) at rates that compete with levels of global oil demand. Their weight in the market allows them to magnify what might otherwise be small price movements based on demand projections, geopolitics, and weather concerns.
Speculators currently have bullish bets on oil and are holding contracts worth 69 million barrels in this direction. That's a significant share of the oil market, in which global demand runs to approximately 83 million barrels per day. "Hedge funds and other players are supremely in control of this market," says Stephen Schork, energy consultant and editor of The Schork Report. "It's a case of the tail wagging the dog."
Demonstrating the resilience of bullish sentiment, the Energy Dept. reported Oct. 17 that inventories of crude and gasoline rose more than analysts had expected. That report tempered crude prices briefly, until news of the parliament vote in Turkey reenergized the buying. "We are a lot closer to $100 than I thought we were a few months ago," Schork says.
This Bubble, Too, Shall Burst
The heavy influence of speculators could also send prices south in a hurry. Fadel Gheit, senior energy analyst for Oppenheimer (OPY) points out that oil prices historically have spiked in anticipation of major events and collapsed soon thereafter. That was the case with the Arab-Israeli war, the Iranian Revolution, the Iran-Iraq war, the Iraqi invasion of Kuwait, Desert Storm, the 2003 invasion of Iraq, and the 2006 Israeli invasion of Lebanon. He says today's outlook appears no different.
"Industry fundamentals do not support prices above $60, let alone $80," writes Gheit in an e-mail message. "We think the surge in prices reflect excessive speculation about potential supply disruptions in the event of a major crisis in the Middle East." He does think that there will be military action in the Middle East, but he thinks that will be the beginning of a drop in oil prices, rather than a new increase. "We think the current cycle will end with the U.S. bombing of Iran military sites," writes Gheit. "The oil bubble will burst, and the price decline will be exacerbated by speculators dumping their long positions."
Some analysts refute the argument that speculators and financial institutions are driving the market. "This is not a speculative run-up," says Phil Flynn, an analyst for Alaron Trading in Chicago. "It's an acknowledgment that global demand is surging while supply is tight."
Flynn says that whatever speculative "froth" is built into the price is useful to world markets because it helps moderate demand, which would otherwise rise without constraint. "Speculation has a function," says Flynn. "It keeps the market in check so that demand doesn't spiral out of control."
Refiners Feel the Pinch
The rise in crude prices has not yet affected gasoline and heating oil prices in the U.S., but it is squeezing oil refiners' profits (BusinessWeek.com, 10/10/07). On Oct. 10, Valero Energy (VLO) warned that its third-quarter profits will fall short of Wall Street's forecast, following announcements by Chevron (CVX) and refiner Marathon Oil (MRO) a day earlier about their starker income outlooks. Houston-based ConocoPhillips (COP) kicked off the gloomy reports Oct. 3, saying its global refining margins would be "significantly lower," hampering financial results. ExxonMobil (XOM) is scheduled to report results for its latest quarter on Nov. 1.
Whichever way oil prices go from here, financial institutions will play a key role. On Oct. 12, Energy Secretary Samuel Bodman said that suppliers like OPEC have lost some control over oil pricing and markets now can move more on expectation than the fundamentals of supply and demand. "Prices are now set in trading rooms of New York and London and Frankfurt and Tokyo," Bodman said.