Foreign Policy Blogs

Oil prices rise but is there fundamental support?

Oil has finished higher during 16 of the last 20 trading sessions and seven straight as it continues to rise from lows in February. Although it looks set to close lower today as traders cash in on recent gains, the price has increased over 110% over the past four months. But the fundamental drivers over that time have not changed much: demand remains muted and despite a recent fall in US crude oil and gasoline stocks, supply has not dropped substantially to warrant the price change. Simply oil is trading on something other than fundamentals (read: supply and demand).

oil-pictureOil has risen due to several factors. One, it has jumped with equity markets which have been on a tear lately, surging over 2.5% yesterday as some economic data – including manufacturing reports showing that China and India output has improved – hint that the worse of the economic crisis may be over. Traders believe that greater economic activity should raise demand for oil and therefore its price. Two, oil has also risen as the value of the US dollar continues to fall (As oil is denominated in dollars in the international market, this has kept the oil price constant with other currencies). Three, investors may also be plowing into commodities as they are concerned about potential inflation as governments spend more to stimulate the economy. (Commodities are often a place for refuge to protect against inflation.)

There are two likely short-come outcomes. One, oil continues to trade on expectations of economic growth and rises to reach $75-85 by year’s end and continue. Two, prices moderate (read: fall) in the near-term until the fundamentals of supply and demand fall in line with historic levels and begin drive up price levels. Unless fundamentals catch up with current market expectations prices have little support to be at near $70/bbl levels. (Note: Although this discussion has been about oil, the same could be said about natural gas. It has even larger supply issues that make holding the recent increase in price, which has risen with oil, more difficult.)

Tomorrow’s release of EIA numbers should give some greater insight into fundamentals. The consensus opinion according to Platts energy, a leading supplier of energy research, is that stocks should fall slightly due to the beginning of summer driving season. The market reaction to the release should begin to give an indication of oil’s path.

 

Author

David Abraham

David S Abraham has expertise in the analysis of geopolitical and economic risk as well in energy issues. At the White House Office of Management and Budget, his work included overseeing natural resource and foreign assistance programs, and serving on the interagency trade policy committee. In his previous role as a sovereign risk analyst with Lehman Brothers, subsequently, Barclays Capital, he advised the firm on geopolitical and economic risks in developing countries. He has also consulted for a variety of organizations including the United Nations Support Facility for Indonesian Recovery, RBS Sempra Commodities, ClearWater Initiative and a small German consultancy. David earned degrees from Boston College and The Fletcher School at Tufts University and proudly served as a Peace Corps Volunteer. His written work has appeared in a variety of publications, most recently in The New York Times, The Providence Journal, and CFR.org. He speaks Lithuanian and is a Term Member at the Council on Foreign Relations.

Area of Focus
Geopolitics; Economic Risk; Energy Issues

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