Global Insight Perspective | |
Significance | Closing at US$104.42 p/b yesterday, NYMEX front-month crude futures are now at their highest-ever level, even when adjusted for inflation. |
Implications | Market sentiment and speculative trading have produced the latest spike rather than underlying fundamentals. Sentiment was affected yesterday not only by the OPEC decision, but also by news of lower imports and inventories than expected in the United States and tensions between Colombia and Venezuela. |
Outlook | Record oil prices may not be supported by supply-and-demand fundamentals—and Global Insight expects them to abate somewhat over 2008—but they are nonetheless a grave concern for the United States and global economy, weighing on economic activity and sustaining inflation. |
Another Record
Oil has yet again hit a new high, with the NYMEX front-month crude futures contract rising to as much as US$104.56/b during intraday trading yesterday. Prices then went on to close somewhat lower, but still a record in itself of US$104.42—a jump of US$5 over the previous close. In London, April Brent futures on the Intercontinental Exchange (ICE) also closed up, US$4.12 to US$101.64/b. The primary drivers of the latest jump in prices appear to be twofold, namely the decision by OPEC to roll over production levels, and the news from the United States that crude inventories had shown an unexpected drawdown. Another lesser factor in the mix is the tension between major oil exporter Venezuela and Colombia.
Turning first to the question of inventories, the Energy Information Administration (EIA), the statistical arm of the Department of Energy, revealed yesterday that U.S. crude oil stocks dropped by 3.1 million barrels on the week. This was the first drawdown of the year thus far. Since January, crude oil stocks had been increasing every week, from 282.8 million barrels to 308.5 million barrels last week. Crude stocks in the country now amount to 305.45 million barrels—some 18.8 million barrels lower than over the same period last year. Most of the fall appears to have been in West Coast (PAD V) crude stocks. By contrast, gasoline (petrol) inventory levels rose by 1.7 million barrels, to 234.3 million barrels—up 17.9 million barrels on the year. With refinery throughput rates higher, and with crude imports dropping by 521,000 b/d in the week to 9.437 million b/d, the drivers behind the drop in inventories are clear.
OPEC Braves U.S. Backlash
Speculation as to what OPEC would do with output had been feverish before yesterday, with both a production cut and an increase possible. In the event, the cartel, which met in Vienna, Austria, officially decided to keep production unchanged. The decision has prompted a wave of vitriol from the United States, which believes oil markets are undersupplied, and OPEC, which believes the opposite. OPEC has gone as far as to accuse the United States of “economic mismanagement”, effectively wiping its hands of responsibility for the state of oil prices. OPEC also pointed to the role of the financial speculators, who have fled from securities into commodities. Some OPEC members, including Algeria and Iran, had even been pushing for an output cut.
U.S. President George W. Bush, who is struggling to keep the United States out of recession, said earlier in the week that a roll-over decision by OPEC would be a “mistake”. Officials said yesterday that they were "disappointed" after the announcement, but tougher words may well follow today. This is now the second time this year Bush has been rebuffed by OPEC; in January he travelled to Saudi Arabia to press for increased production. The United States' leverage is limited given its huge thirst for oil, and OPEC knows it is in a position of strength.
Should the tensions continue to rise they could have negative consequences for the United States' wider diplomatic priorities. Sharpened tensions with "friendly" states in the Middle East would further complicate efforts to find a breakthrough in the Israeli-Palestinian conflict, for example. Relations with the likes of Venezuela and Iran were already very tense, but these could be further exacerbated. Bush this week underlined the United States' need to pursue renewable energy options vigorously to reduce the country's dependence on imported oil, but it will be a number of years before this starts to make a meaningful difference. The administration also says it is prioritising measures to cut consumption, but its efforts (such as tougher mileage requirements on automotive manufacturers) have been rather unambitious to date.
Outlook and Implications
Crude prices had only just broken their all-time inflation-adjusted high on Monday (3 March), and even that event had been preceded by a spate of new records over the last few weeks. Oil prices have climbed so high in large part due to large investors taking positions in commodities to hedge against a falling U.S. dollar and equity markets. The U.S. dollar has been falling in value relative to other major international currencies as concerns over weakening performance in the world’s largest economy have sharpened. With crude prices continuing to climb almost in step with U.S. crude inventories since January, the stage was very much set for further rises. At the time of writing, NYMEX April crude futures were trading down somewhat, standing at US$103.98/b. Over the longer run Global Insight expects prices to fall back (albeit to high levels by historical standards) as the supply-and-demand realities assert themselves better and the stampede of investors into commodities abates.