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Price continues to surge due to reasons beyond supply, demand
By Kevin G. Hall
McClatchy Newspapers
Published on Sunday, Mar 09, 2008
WASHINGTON: Record high oil prices notwithstanding, the Organization of Petroleum Exporting Countries said last week that its members wouldn't boost production to rescue a U.S. economy that's suffering from what it labeled as self-inflicted ''mismanagement.''
''If the prices are high, definitely they are not (high) due to a lack of crude,'' Chakib Khelil, OPEC's president, said in Vienna, Austria, where the 13-member cartel met to determine what it considered the right level of production.
President Bush had warned OPEC members that if they didn't boost production, they'd risk killing a golden goose by allowing high prices to harm the economy of the world's largest oil-consuming nation.
Both leaders are right.
High oil prices are sparking inflation and hitting the wallets of American consumers. Oil is hardly in short supply; its price is being driven up by factors beyond supply and demand.
Here's a look at what's behind the high prices for oil and its finished product, gasoline.
Q: Is the weaker dollar to blame for high oil prices?
A: To some degree, yes. Oil, like many commodities, is sold or traded mostly in dollar contracts. Although oil-
producing nations earn dollars, many — particularly economies in the Middle East whose currencies also are pegged to the dollar — buy most of their imports from Europe, where the euro is the common currency. With the euro at record highs against the dollar, these oil producers are seeing the buying power of their oil earnings reduced. That's why they're demanding more dollars for the same barrel of oil.
Q: What else is driving up oil prices?
A: According to the statement from OPEC, the global market is ''well-supplied, with current commercial oil stocks standing above their five-year average.'' Current prices don't reflect market fundamentals, OPEC said, but the weakness of the dollar, rising inflation and the ''significant flow of funds into the commodities market.''
Q: Is OPEC blaming speculators for driving up oil prices?
A: One man's speculator is another's smart investor. The U.S. stock market has lost about 15 percent of its value this year, but the markets where commodities are traded are surging.
Oil and other commodities now are considered an alternate asset class, and when stocks sag or are volatile, money flows into commodities markets. There, hedge funds and other institutional investors place big bets on what generally are changes in the movement of often small markets.
In a research report last week, Barclay's Capital noted that over the past few weeks the prices of soybeans, corn, gold, platinum and tin have hit record highs — though not all of them inflation-adjusted highs — while cotton, cocoa, coffee, silver, palladium and aluminum are near record highs. The price of coal is up more than 50 percent.
''The price appreciation of some commodities is supported by strong fundamentals and that of others have merely come on the back of a broader bull market,'' the report noted.
The Futures Industry Association said last week that trading volume in agriculture-futures contracts grew 32 percent globally last year over the prior year. Trading volumes for industrial metals and energy products grew by 29.7 percent and 28.6 percent, respectively.
Q: So supply and demand have nothing to do with today's high oil prices?
A: Not exactly. None of this price run-up could be possible without the unbridled consumption of oil in the United States, by far the largest oil user, and the soaring consumption of rising economies such as China and India. Increasing political tensions make shortages a possibility, and markets factor in that risk, which drives prices higher.
''I think the biggest problem is pure fear. Right now there is no supply problem,'' said David Wyss, chief economist for the New York rating agency Standard & Poor's. ''What happens if Venezuela goes to war in Colombia? What happens if various crises in Nigeria get loose? Iran is always making noises.''
Fearing the potential for shortages, investors are willing to pay a premium.
''They're not buying oil, they're buying insurance,'' Wyss said.
Q: Are these rising commodities prices a bubble?
A: Could be. If there isn't some underpinning of supply and demand, there's a chance that the steep hike in prices can be met with a drop as steep or steeper. Many analysts have called oil prices a bubble, however, only to watch prices keep marching up.
A stock market investment is a bet that the value of a particular company will go up. Futures traders, however, can ''go short,'' that is, bet that prices will fall back. Or they can ''go long,'' betting that the price of a certain commodity will go up.
That means that these speculators can bid commodities prices up or down. The perception of risk to supply and demand is as important as the actual supply and demand.
Hurricanes Katrina and Rita drove home how little spare production capacity exists. The U.S. invasion of Iraq changed the perception of geopolitical risks. In January 2003, before the March invasion, futures markets projected a $25-a-barrel cost for oil in December 2003.
WASHINGTON: Record high oil prices notwithstanding, the Organization of Petroleum Exporting Countries said last week that its members wouldn't boost production to rescue a U.S. economy that's suffering from what it labeled as self-inflicted ''mismanagement.''
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