The Oil and the Glory

Why high oil prices aren’t here to stay

Why high oil prices aren’t here to stay

Some people are becoming excited, and others agitated, over the leap in oil prices — they will average over $100 a barrel next year, say venerable voices such as Goldman Sachs, and gasoline will cost more than $3 a gallon. Over at Seeking Alpha, Joseph Meyer predicts $200-a-barrel oil next year and $300-a-barrel in 2012. And indeed, oil yesterday surged to $90.76 a barrel, its highest price in two years. Shares of ExxonMobil, a proxy for oil prices, are well out of the troughs of July and trading near a 52-week high. So are we at an inflection point from which oil spirals into the stratosphere?

Not if one listens to the coolest voice on the street, which belongs to Ed Morse at Credit Suisse. It’s true that oil demand is up, and record storage of crude oil is down. But Morse — the only major Wall Street voice courageous enough to challenge the herd in the absurd, speculator-driven price runup of 2008 to $147 a barrel, and Goldman’s forecast of $200 a barrel — cautions that this time what we are seeing is a blip.

A confluence of “a series of one-off re-enforcing factors” is driving up prices, he wrote in a note to clients yesterday. Morse predicts that, once these factors go away, oil prices will return to Earth and average just about where they were prior, or $85 a barrel next year (which is still pretty expensive when you consider historical prices). Over at the Wall Street Journal, Liam Denning agrees that the fundamentals conflict with the oil bulls.

Javier Blas plays out Morse’s reasoning at the bottom of an otherwise bullish oil price story in today’s Financial Times, but here essentially is what Morse argues:

  • 2.9 million barrels a day of oil has been taken off the market over the last three months because global refineries have been doing their yearly refurbishments;
  • a French port and refining strike removed another 2 million barrels a day of oil products from the European market;
  • meanwhile, in this tighter market, terrible weather in Europe temporarily sent up heating oil demand on the continent;
  • China, wishing to meet its 2010 commitments to curtail CO2 emissions, suddenly ordered coal burning curtailed and in some cases stopped, forcing a huge surge in demand for burning and hoarding diesel.

Seeing all of this taking place, oil traders have jumped in to profit. Says Morse:

There is no doubt that the daily volume of trading increased dramatically over the five days of last week – but this was not the only five-day period in the recent past in which this was the case.

As in 2008, traders — the folks who watch for events impacting global supply even on a minuscule scale in order to bet short or long on price movements — have been all over this temporary supply disruption, resulting in the current price runup.