Crude oil supply/demand situation not enough to justify current prices.
Around the beginning of the year, I predicted that the United States (or, more specifically, the Republican Party) would “launch an attack” on the price of crude oil – as lowering the price of gasoline is a tried-and-true method of currying favor with U.S. voters, and a fall election is looming.
With crude oil prices now pushing $130, that prediction looks very silly at the moment. However, I stand by one point. I still firmly believe that the U.S. tried to drive the price of crude down – but failed. For evidence, one need only consider that George Bush Jr. has made two tours of the Mid-east this year already – despite his lame-duck status. He even sent his side-kick Darth Vader... I mean, Dick Cheney… on a tour of the OPEC nations as well. It is no secret that Bush has been constantly pressuring Arab OPEC producers to increase production – as a production increase, combined with the U.S. dumping crude onto the market, would have been the catalyst for a big slide in prices.
OPEC nations refused to comply, a sure sign that U.S. influence/power is waning. But if that explains why crude hasn't fallen in price, it still leaves open the question: Why have prices risen so much, so fast?
Yes, I believe in “peak oil.” Yes, I believe that inadequate supplies will/would drive oil up to this level (and higher) at some point. However, current supply/demand fundamentals simply do not support a crude oil price of $120/barrel – when compared to the prices of all other industrial commodities.
To take a specific example, current copper inventories are at least as tight (if not tighter) than crude oil stocks. While no one is talking about “peak copper” (since there is still plenty buried in the Earth's crust), up to this point the mining industry has shown itself to be unable to ramp-up supplies – while demand keeps growing. So, if oil should be at $120, then copper should be currently priced at $6-$8/lb.
Which brings me back to the original question: What is going on with crude? Again, my answer is “manipulation,” but in this case, manipulation higher. While there are several suspects (Russia has shown a willingness to drive up prices for political and economic reasons), my bet is on the Arab OPEC producers – because they are the big winners in this scenario.
First, many of the Arab OPEC producers have currency “pegs” to the U.S. dollar – which have resulted in those countries “importing high inflation” because of the terminal weakness of the greenback. While those nations have talked about ending their peg to the dollar, such a move would create open friction with the U.S. government.
However, by pushing oil as high as it is, those OPEC producers have effectively insulated themselves from surging inflation. With most of their economies' revenues derived from the sale of crude oil, if the price of crude rises two (or three) times as fast as real inflation (dismissing the phony, absurd CPI), then regardless of how high inflation goes, inflation will have little overall impact on their economies.
As for how this manipulation is taking place, that's simple. All the OPEC producers have to do is buy-up significant amounts of each other's production on the spot market. Effectively, this accomplishes two things. First, as mentioned, it allows them to sell their oil at a much higher price. Second, it effectively acts as a cut in production (without officially cutting production) – allowing them to sell more oil in the future, at even higher prices.
Finally, there is the geopolitical argument. As I recently posted on my blog, sky-high crude prices are an incredible war-deterrent – specifically a deterrent against any further U.S. aggression in the Middle East (and more specifically vs. Iran). Previously, when a U.S. military assault (against Iran) was discussed, various commentators warned that such action could drive up crude oil prices “as high as $100/barrel.”
That was considered to be an extreme, and troubling, scenario. Now that crude oil has left $100 in its rear-view mirror, when people talk about the consequences of irresponsible U.S. (or Israeli) military action, people are talking about $200/barrel crude.
The U.S. war machine is the most gluttonous consumer of crude in the world. Only a couple of years ago, the U.S. military ranked as the world's fifth-largest consumer of oil – by itself. So the higher the price of crude goes, the more the U.S. would cripple itself economically by undertaking any destabilizing military action.
Ultra-high crude oil prices are the ultimate insurance policy for Arab OPEC states. They indemnify those countries from the effects of inflation, and deter potential U.S. military action more than any build-up of defensive, military capability could ever accomplish.
As I suggested on my blog, the spike in the price of crude may have made petroleum-fueled war-machines obsolete. While $100+/barrel oil will inflict hardship on many, it may ultimately end up saving a lot of lives.
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