July 2nd, 2005

A Perfect Storm

A perfect storm seems to have formed around the crude oil market, causing recent prices to skyrocket over $55.00/barrel several times. Let’s look at the forces that have come together to cause these elevated high prices for crude:

The US Dollar
The dollar is the standard currency used to pay for oil in the world markets. As the dollar has continued to weaken in value (by 8% since December) against the EURO and other currencies, sellers want more dollars to hedge against the loss in value.

Demand remains very strong, even though many oil brokers maintain that there is no shortage of oil anywhere in the world. Yet OPEC continues to pump two million barrels per day over their agreed limit of 27.5 million BPD, and is very close to reaching their full pumping capacity. In fact the only OPEC country that has the capability of increasing their daily output is Saudi Arabia. In the US, inventories of heating oil remain below normal levels even after the heating season has passed. This is helping to keep the price of distillates (heating oil & diesel) higher than normal.

OPEC has already announced that they will not attempt to raise production any further. OPEC controls about 40% of global petroleum production. OPEC will want to avoid a glut of oil at all costs as this would cause the price of oil to fall rapidly and it would take many months of reduced production to correct for an oil glut. As a result, oil brokers are concerned that at some point OPEC may actually seek to reduce production to maintain prices. One oil speculator commented that crude will probably hit $60.00/barrel before prices may begin to fall.

U.S. Refinery Output
U.S. refineries were operating at about 89% capacity in the last few weeks, down from the 96% level they had been at previously. A Houston, TX refinery capable of processing 265,000 BPD was down for repairs and a fire at a BP refinery in northwest Indiana has raised concerns among oil brokers, even though BP claims the fire has not reduced the refinery’s output. In the last few weeks refinery output has crept back up but production has been centered on distillates in order to increase inventories.

Middle East Politics
Iran has warned the US that an attack upon Iran would cause that nation to retaliate against the middle east oil industry. Since 40% of the world’s crude oil must pass by tanker through the two mile wide Strait of Hormuz which Iran can effectively control, they could easily block the Strait if they wanted to. An Iranian politician was quoted as claiming that any military action against Iran will send crude prices over $70/barrel.

At Home
President Bush has resisted calls from consumer groups that he open up the strategic petroleum reserve which would reduce fuel prices in the US. Instead the President is calling for opening of the Alaska Wildlife Refuge (ANWR) to oil exploration and drilling and to resume construction of nuclear power plants. In a recent speech he quoted Dept. of Interior statistics which claim that 10 billion barrels of oil can be pumped from a portion of the ANWR targeted for oil exploration.

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