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A brave new oily world
The current spike isn't like the oil shocks of yesterday ... tight supply is here to stay.
March 21, 2005: 9:30 AM EST

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NEW YORK (CNN/Money) - The view that becomes clearer and clearer in the oil market still bears repeating as we see once again that global bond and stock markets remain fixated on petroleum prices: We are not going back to the future in the oil market because the situation now is not like the 1980s or 1990s when oil prices spiked higher on a supply shock.

This is a price move based on tightening supply as OPEC pumps near capacity versus a brave new world where the US of A is no longer the lone gas guzzler because demand is rising from LA to Beijing to Delhi.

I asked Joe Terranova, director of trading for MBF Clearing Corp. at the New York Mercantile Exchange, why oil keeps going up and up. "Simple, the cat is out of the bag!" according to Joe. "Traders now recognize, for the first time since oil futures have traded, that there truly exists a demand to supply problem."

He pointed out that in the past, during "troubled times" like the Gulf War, the "front of the crude board" -- in other words the nearby traded crude oil futures contract, or spot contracts -- would rally much more than those one year to five years out.

"The assumption back then was whatever problem we are facing in the near term can be alleviated by OPEC opening the pumps to capacity and flooding the market with oil in the coming year, supply overwhelming demand," Joe notes. "Now, OPEC has said they have a 'full house,' meaning they can pump as much as needed; the market is laughing and saying 'show us your cards.'"

The bottom line in traders' eyes: "OPEC doesn't have the capacity anymore to solve the demand problem in the long term. Demand will eventually outpace supply," he says.

Joe says traders talked about that concept all last week (and remember this was the week that OPEC announced it was boosting production by 500,000 barrels a day) and the market proceeded to take oil to a new intraday high at $57.62 a barrel.

Consider this point from Mr. Terranova as well. He says that last week the spot month oil contract rose by $2.29, while the further out months, for example, December of 2008, climbed from $46.22 last week to $50.76 this week -- a $4.54 rally in one week, double what the spot contract did. Think about it folks. This is why when we journalists keep dutifully reminding you that in inflation-adjusted terms the price of oil was the equivalent of eighty dollars a barrel back in the early 80's it's in some ways a misleading comparison.

It's true that in some sense oil prices at current levels don't hurt as much because in inflation-adjusted terms they don't take as big a bite out of our family incomes as they did back then. But it's foolish to dismiss this episode as one that will turn out like the last one, i.e., prices come tumbling back to earth and we can all hop back in our SUV's and ride off into the sunset.

If it's truly global demand that is pushing prices up, and if the oil producers' ability to pump more of this stuff is limited, as the market is betting for now, then we are going to remain at much higher prices for a much longer period time than we did back then and the economic bite that takes out of us remains to be seen.

Check commodity priceshere.

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-- Kathleen Hays is economics correspondent for CNN and contributes to Lou Dobbs Tonight.  Top of page

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