And One Cent

Oil futures finally closed above $100 per barrel yesterday, yet the context could not have been more different from the first time the market flirted with this level, last November. Then, the global economy was still perceived as growing strongly, albeit overhung with housing and debt troubles, and the US stock market was 7% higher. Now, the world economy is losing momentum, and the push above $100/barrel seems less like a bold move into uncharted territory and more like the late-race effort of a tired marathon runner.

Reading the market has never been easy, and it is even more challenging when the trends and underlying fundamentals shift out of alignment. Although the oil market's $4.50/barrel move yesterday was apparently prompted by several superficially bullish news items, upon further reflection at least two of those look bearish. OPEC's contemplation of a cut in production, which helped push prices higher, must be seen as a purely defensive measure, a tactic to forestall a precipitous drop in oil prices when winter's higher demand abates and economic growth continues to weaken. OPEC learned some bitter lessons in this regard in the late 1990s.

Another event that fueled the market's jitters yesterday was the unfortunate accident at AlON USA's Big Spring, TX oil refinery. But with due deference to the injured workers and their families, it requires a deep-seated bias to view this event as anything but negative for oil, and mildly positive for refining margins. The shutdown of a 70,000 barrel per day refinery, representing less than 0.5% of US refining capacity, will put more oil into a market in which inventories have been growing steadily since the first week of January. Big Spring runs high-sulfur crude oil, so the differential between West Texas Intermediate and West Texas Sour should widen. That seems a poor reason for WTI to spike, unless the market is being driven by investor psychology and technical indicators, not fundamentals.

With the equity markets weak and the debt markets in a funk, there is a lot of money floating around looking for a big return, somewhere. At the same time that forecasts of 2008 oil demand are still being revised downward, investors are piling into oil futures in search of a fast buck, creating a recipe for higher volatility. It's hard to see $100+ oil being sustained, barring some event that actually takes a big slice of production off the market, rather than merely increasing anxiety about such a prospect, a la Venezuela.

As I've noted before, the price of oil is a peculiar indicator. Until it passes through the value chain and emerges as higher prices for petroleum products and the goods and services that require oil as an input, it remains a highly theoretical barometer for most people. Weak refining margins have buffered consumers from the full retail effects of the recent excursions into the high $90s, and with US gasoline inventories well above their seasonal norms, marketers will have a hard time passing on yesterday's uptick, except in the area directly served by the Big Spring refinery. The larger question is whether yesterday's $100 close will affect the behavior of consumers or investors, and if so, how? Perhaps having breached the magic mark, we will tuck it away in the backs of our minds until oil hits the next psychologically-significant milestone, as we seem to have done with $3.00 per gallon gasoline.