Supply issues continue to place a floor on the oil price, and that floor is too high.
Last day of the month and the impact of the better-than-expected U.S. GDP numbers are covered in the various watch list comments.
This week we have been focusing on oil and the U.S. dollar.
The price of oil currently at $115 a barrel is still too high. A rising oil price or a price that is too high in a recession will create a massive change to the economic landscape.
And so all this week we have watched the U.S. dollar try to rally and the oil market put on gains as well.
The U.S. central bank wants a strong dollar. The logic is that it will help bring the price of commodities down, thereby lowering inflation. The U.S. government will try and strengthen the U.S. dollar in the hope that the oil price will fall.
Bernanke’s message is clear, we will jawbone the currency up, we may even intervene to buy dollars, and we will encourage other central banks to buy U.S. dollars. If we are successful then the inflation problem will go away and commodity prices will fall.
If oil keeps rallying...
The Fed will struggle to keep the dollar up and economists will have got it wrong again. If the economy slows and the price of oil rises, Bernanke is in big trouble and the asset markets will implode. If this trend continues then the U.S. economy is in big trouble, and the ramifications could be catastrophic.
The rest of the world continues to consume oil at a pace never seen before. Supply issues, be it hurricanes, refineries, country risk, or plain old lack of supply continue to place a floor in the oil price. The floor is too high to assist the U.S. economy during a slowdown. This means that the U.S. is in a protracted period of stagflation. We wonder what the price of oil would be if the U.S. was in a growth phase.
And so it comes as no surprise that with a hurricane in the Mexican gulf and oil prices on the march, the International Energy Agency (IEA) said it would tap strategic stockpiles if Tropical Storm Gustav disrupts energy production in the Gulf of Mexico.
This type of intervention is fruitless really. What it does show is how concerned the governments of the world are about the oil price going up or even staying at $115.
It is fruitless because it tries to stop the market reacting as it should – rallying on the threat and selling off after the fact.
Herein lies the problem: the last time the IEA coordinated a stockpile release among its 27 members to counteract U.S. supply losses was after Hurricane Katrina. Then the oil price peaked at $80 a barrel and as a consequence the press labeled the year as an annus horribilis.
Now a couple of years later and oil is $115.
It likely that the oil price that will be the first to show signs that its price is no longer driven by demand, but by supply. This will effectively create a floor in the price of oil, regardless of demand. In time, this will spill over to other commodities.
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