Whither oil?

By Megan McArdle

When will it stop, beg my friends with long auto commutes. At $83.84 a barrel, perhaps it's time to think about trading that gas-guzzling Prius in for a bicycle.

``The storm threat and falling dollar are pushing us higher,'' said Nauman Barakat, senior vice president of global energy futures at Macquarie Futures USA Inc. in New York. ``We will see even bigger inventory draws in next week's statistics as a result of the evacuations in the Gulf.''

Crude oil for October delivery rose $1.91, or 2.3 percent, to $83.84 a barrel at the 2:30 p.m. close of floor trading on the New York Mercantile Exchange. Futures touched $83.90, the highest since the contract began trading in 1983. Prices are up 39 percent from a year ago.

. . .

U.S. crude-oil supplies fell 3.87 million barrels in the week ended Sept. 14, the 10th drop in 11 weeks, the Energy Department reported yesterday. The drop left inventories 7.4 percent higher than the five-year average for the period, the department said.

``The market is relentless,'' said Tom Bentz, a broker at BNP Paribas in New York. ``The fundamentals don't justify these prices but the prices are holding firm. We are due for a correction but nobody is willing to step in front of this.''

The dollar dropped to a record low against the euro today on speculation U.S. interest rates will extend declines, making oil cheaper in the countries using other currencies. Oil rose after the Federal Reserve cut rates this week to bolster the economy, which has been hit by subprime-mortgage losses.



Lower US interest rates make US assets less attractive, which decreases the demand for dollars, which makes the dollar fall. That's why the monetary nationalists among my friends are instant messaging me to moan about the American dollar's newfound parity with the Canadian dollar, a state of affairs that has not prevailed in decades. Since oil contracts are denominated in dollars, the relative price of oil is falling in other countries, which means those lousy foreigners are going to buy more of the stuff, which means there will be less here, which makes our price rise.

The interest rate cut also makes it less likely that we'll have a recession, which also pushes up the price of oil, because economic growth increases American demand for black gold, and American demand is one of the major factors determining the price.

Yet with inventories high, temporary closures like the one in the gulf shouldn't cause such big spikes. One way of looking at it is that the market is irrational, but no one's willing to short it because, as the aphorism goes "the market can stay irrational longer than you can stay solvent". But another way of looking at it is that there are so many potential problems with the oil market on both the supply side and the demand side, that people are pretty sure that today's inventories will be very valuable in the future, even if they don't know which of the potential military, economic or political problems will make them so. I am finding the latter more convincing these days; analysts have been proclaiming a "speculative bubble" in oil markets since 2004. But perhaps I am only buying into the bubble at the top.

This article available online at:

http://www.theatlantic.com/business/archive/2007/09/whither-oil/1960/