Has the Great Oil Rally of 2011 Run Its Course?

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Has the great oil rally of 2011 run its course?

Rising oil prices have become a fixture. The IMF declared this week that costly oil is here to stay, after a 12.5% average annual price increase over the past decade. Wall Street is betting the ranch on further increases. With crude hitting $110 a barrel in New York Thursday, up 17% this year, it's not looking like a bad bet.

Peak gasoline?

But for all the talk of global economic growth and unrest in Mideast oil hotspots, there are signs that oil prices are already too high for pinched consumers to bear. U.S. gasoline demand, for instance, dropped 3.7% over the past four weeks -- which energy tracker Stephen Schork calls a "material decline."

Yet U.S. gas prices hit $3.70 this week, their highest level since the summer of 2008. Retail prices are also soaring in the U.K., where the per-gallon price is nearly double the one here thanks to taxes, and in China, where the government is trying to get a hold on commodity prices by pushing down demand.

But rising prices and falling demand can't co-exist for long, which is why some market watchers argue that oil prices are headed for a fall unless new problems emerge -- such as another flareup in the Middle East.

"The market is pricing in a lot of risk and a lot of fear right now," says Richard Soultanian of NUS Consulting in Park Ridge, N.J., which advises companies on energy prices. "What we're looking at right now is really irrational, and unless we get another shock you're going to see the prices come down."

So why are prices so high if demand is tepid? Look no further than Wall Street, where speculative bets on rising oil prices via futures and options amount to the equivalent of 323 million barrels -- four times what Gluskin Sheff economist David Rosenberg calls a normal level.

He says that simply reducing that position by a third, to levels seen last fall around the start of the Federal Reserve's second quantitative easing program, could bring the crude price down to $85 to $90 a barrel.

Schork says $90 oil is entirely plausible, given how little economic fundamentals have changed since the speculative run in oil started at the end of 2010. He attributes much of this year's gains to hedge funds and other traders levering up to bet on commodity prices, which have obliged by surging since Ben Bernanke promised in late August to support the economy with looser money.

The Fed's latest senior credit officer survey reported increased use of leverage by investors such as pension funds and hedge funds.

"The Fed is giving these guys money so they can bet on prices going up," Schork says. "There is probably a $15 or $20 premium in the market because of it."

Soultanian too says a price in the $85-$95 range looks likely once the speculative run ends, for whatever reason. How or when this streak might end isn't clear, obviously, but it's evident that higher oil prices are often short-lived because of the economic slowing they cause.

He likens this year's runup to the one in 2008 that briefly took the oil price to $147.

"We were telling clients then that the forecasts for even higher prices were wrong," says Soultanian, whose firm advises big companies on oil price hedging. "We're telling them the same thing now."

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IN BUSH AND CHENEY TIME EURO WAS 1.49 IN OBAMA/BIDEN TIME IS 1.45

@ Robert from AZ

I am 100% for free markets. However, we learned this lesson once already. In the late 1920's we allowed unregulated pools of money to utilize as much as 10 to 1 leverage to buy and sell stocks. What was the result? Those pools of money drove the stock markets to astronomical levels using massive amounts of leverage, the end result of course was the stock market crash and the subsequent Depression. Over the course of the next 15 years, those pools of money, then called mutual funds, were completely regulated and barred from using leverage except in certain circumstances.

Today, we are repeating that mistake. We are allowing unregulated pools of money known as hedge funds to use as much as 10 to 1 leverage to buy and sell commodities. The only difference between now and then is that then anyone could invest in a mutual fund, now only the wealthy (excuse me "accredited investor") can invest in hedge funds. Why we allow the wealthy to invest by different rules than everyone else, I will never understand.

All of that said, there is a simple solution. The Commodity Futures Trading Commission already has the authority to curtail the use of leverage. Indeed, they simply need to institute margin requirements on all derivative trading by "financial companies", aka hedge funds. It is a simple fix and would not need any additional regulation or legislation.

What makes Oil speculation particularly dangerous is that oil production is conrolled already by OPEC, so the quantity of oil is regulated by producing nations who form a cartel. The speculators insert themselves into the industry and artificially increase the demand for a commodity that the world runs on. There should be regulation put in place to limit oil trading only to those firms that can take physical delivery of oil they purchase. On the other hand the oil supply is at an end so the high prices make it pssible for oil companies to get oil from places they would have never done 20 years ago due to the cost.

Article after article, report after report, interview after interview--they all basically say the same thing--the speculators / investors are to blame. I APPEAL TO REGISTERED VOTERS to get a strong grass roots opposition and appeal to our legislators to GET THESE GREEDY PEOPLE UNDER CONTROL!

Stop Investors' Greed Now! == SIGN, the acronym for the movement.

@ Posted By TM Sugar Grove, IL: April 8, 2011 9:55 am The refining capacity in the US is decreasing, and yes, that might be a problem now and in the future. The issue is that no State wants a refinery built in their soil, so we are in a vicious circle. See the example of the Nothern Indiana refinery expansion plan, it was derailed by Chicago politicians, as if Chicago didn't pollute the lake...

@Posted By Robert, Phoenix AZ: April 8, 2011 11:29 am I am all for free markets, but they only work if the power of the agents is balanced. In the commodity oil market we have, on one hand, producers and end-users, and on the other hand, hedge funds, pension funds and banks(other financial institutions). The former have no power, even combined, to move the market, the later do have that power, ironically helped by the Fed (low cost of money compared to the high return on speculating over future oil price). Once the later agents are out of the picture, the oil market would be more transparent, and yes, closer to a free market.

In bush and cheney time Euro was 1.49 now in obama/biden time is 1.45

I Love those people who are for free markets are the same ones who blame speculation. Suddenly their a big fan of regulating.

I voted for Obama because he said he would take a hardline against oil speculators. Instead they forced a healthcare package? People need to realize that energy is the reason our economy wont recover. Every time there is a glimmer of hope, oil rockets up. That brings consumer confidence down and consumer spending down.

Central U.S. industry oil storage facilities in Cushing, OK are approaching full. Traders will soon be forced to sell futures contracts at any price, because they will not be able to take physical delivery. This will likely push the WTI price back to $90 maybe lower.

Interesting how twop years ago the mere mention that the Fed Gov was going to look into speculation caused the bubble to instantly burst. No action was taken .. Now,Fed has said NOTHING! Could it be that they WANT the higher prices ??

What is the worry... Remember steam? Water is still a renewable resource as well as wood/coal to fire a steam engine.... Oh too much work to get that old steam engine running.

I tried getting into the oil game in 2007 when I saw oil prices climbing then. I bought into a couple oil joint venture projects in Oklahoma and Kentucky. I can tell you from first hand experience that oil is messy on all accounts. Both in the business and the actual production. I was appalled at the amount of water and natural resources it takes to get a small amount of oil out of the ground. I lost all my investment money and take responsibility for making an indelible scar on our environment. It's a shame we've built our nation on roads instead of rails. We were put on this course by cheap oil over the years without foresight that supply would peak at some point. I blame myself more than my government and plan to use public transportation and walk whenever possible...

We need no further regulation than to say that you can't buy any commodity unless you can prove you have the capacity and intention to take delivery.

THE PRICE OF OIL HAS ONLY ONE THING THAT IS MAKING IT GO UP

GREED

This just goes to show that the market place is not based in realism and does not reflect true balance between supply and demand. It is time to OUTLAW all this futures trading. If you are not in the direct line you don't belong in the game.

It's not the supply that causes the pinch at the pump. It's the refiners. Right now speculators are betting on prices for delivery months ahead. What's happening is that refiners are loathe to expand capacity because it's extremely capital intensive and it keeps prices high. Why build more when we can charge more?

In Chicago's suburbs the prices are just hitting $4/gal even though the market price for a barrel of oil is still $37 less than what the peak was in 2008. Why? The refiners and soon there will be a pinch when they start to switch over to the warmer weather grades to include ethanol.

The market price does affect the price at the pump, but it is usually delayed. It all comes down to the oil companies and their refineries.

Well it looks like my contribution to helping the economy will not be happening. Due to the crazy, out of control fuel prices, I will have to cancel a vacation planned. When I budgeted a vacation fuel was a dollar a gallon less and it looks like by this summer it will be about 2 dollars more than it was in December. The trip may no longer be affordable. Wonder how many other people will cancel vacation plans? Total cost on the economy??? The only way to keep this country on track for recovery was to control fuel prices. With low prices, people will spend and engage in growth. Now I will go back to save mode. Thanks!!!

@ ME

Better yet, that Americans actually buy into their ---- and believe whatever these select people and their puppets, typically politicians with an R next to their name, say and do.

This is a classic case of speculation driving up the price, to profit from it. As per usual, its impact on the United States or Americans means nothing to them.

Some say drill drill driil. One guess who will profit from the high oil price, and it's not going to be average Americans - never has been.

The con of the century is that the wealthy in United States apparently worked for their money, while the other 290 million of us apparently have not.

Isn't it interesting how rising oil prices are always due to increased demand and/or lack of supply and have nothing to do with speculation right up to the point where prices get so high that the experts are forced to admit that it's speculation and the current prices aren't justified.

Are we over actiong, or is some people tilling make a killing at the cost of others. But, the oneson Wall Street dont care about the little guy, who gos to payto pay check, the single parent who has a hard time putting food on the table for their kids. You add in the extra cost of gas, like 30 to 50 a month, some is going go hungry. Wake up we have oil here in the US. Stop paying the ones who are trying to kill us

I don't know how or if it could be eliminated but something as strategically important as oil should not be subject to the vagaries, speculation and potential manipulation of an open commodities market. Perhaps the governments could set up an oil exchange on which only those that actually use oil to make products (gasoline, lubricants, plastics, etc) can deal? And do the same thing for gasoline - if you aren't a producer, distributor or retailer you can't enter the market. I'm not naive enough to think it would stop all the manipulation and speculation, but surely it would help reduce it.