The WTI price is flirting with $100 a barrel, with gasoline at $3.44 a gallon registering a record price for this time of the year.
In a previous post [“The Strategic Relationship between the Oil Price and the Stock Markets”, http://www.zawya.com/blogs/shawkat.hammoudeh/091016204743/], I indicated that there are certain times of the business cycle when oil prices follow equity indexes. Now is one of those times. Stock markets are forward indicators of future movements of economic activity. They could predict economic activity five to nine months ahead. Stocks are telling us that the growth rate of the U.S. economy in the fourth quarter may exceed 3%. This means a greater demand for oil, gasoline and other refined products in the United States in the coming months. This is one major explanation of the current price of nearly $100 a barrel. Another explanation is the strong economic growth in China, the fastest growing economy in the world, which may soon exceed 10%. China is consuming more than 10 million barrels a day in 2011. It's expected to consume close to 12 million barrels in the next two years, an expected increase that exceeds more than 50% of OPEC's current excess production capacity.
The two above explanations are demand-side factors. They suggest that a higher price be needed to fit demand to supply. They also indicate that there is a need for more oil in the future and the exploration of alternative oil sources is warranted.
On the supply side, there is a decline in the supplies of oil, gasoline and diesel relative to their five-year supply averages in the United States. Oil and diesel supplies are about 7.5% below their respective five-year averages, while gasoline supply is about 3% below its five-year average. The oil supply in the Midwest is about 5.7% than last year. The oil storage of WTI in Cushing, Oklahoma is 17% less than last year. Part of the shortfall has to do with higher consumption in the United Sates and greater oil exports, particularly of diesel and gasoline. The price differential between Brent and WTI have has contributed to a lower spread between them as more of the WTI is being demanded by U.S. refineries. The oil production in Nigeria, Syria and Yemen is affected by geopolitical tension in these countries. Oil production in Libya is expected to take more time than was first expected. There is also a delay in the construction of the Keystone Pipeline XL.
We should not finish these fundamental explanations of the current higher prices without indicating that there is a rise in confidence about the economic and political stability of the euro-zone after the change in governments in Greece and Italy. More changes in Europe may follow and that may reinforce the confidence.
The stock markets and oil prices are actually making a smart prediction of the future. WTI seems to be more optimistic in its predictability than Brent, as can be seen from the spread bridging between these two global benchmarks. Moreover, WTI seems to focus more on the brighter U.S. future economic growth, while Brent is keener on the European debt crisis.
Having said all that, oil prices and stock markets’ visions may not be long-distanced. They may be more accurate about the short-run future economic growth in the United States and China, but their visions about European economic and political stability may be short-distanced, and therefore less accurate. The problem in Europe has grave and pervasive consequences. However, the question now is: how do we rate the relative strengths of the above four explanations of higher oil prices now? I would give Europe’s woes the greatest weight which means that this explanation commands more than one fourth of the total explanations. Therefore, we should give more attention to the fourth explanation than the first three ones. The relative importance of the fourth factor may be interpreted as the relative importance of idiosyncratic shocks coming from the euro-zone debt crisis.
The end of this year should improve the acuteness and the range of our vision particularly on the European economic and political stability, or lack thereof, backwardly and forwardly, in the near and longer distances.
These fundamental supply and demand factors explained above do not include the rising geopolitical risk in the Middle East. There is a geopolitical risk related to the violence in Syria spreading into other parts of the Middle. There is also the rising tension and mutual threats between Israel and United States on one side and Iran on the other side. There are now reports which predict that the price of oil could research $275 a barrel if a war breaks out between these countries. If the Iraq war has not finished in eight years, expect a war between Iran and Israel and the United States to last between 10 and 20 years,
In conclusion, these are bullish days for the oil price. The confluence of fundamental and geopolitical factors strongly indicates higher oil prices.
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