The mystery behind surging oil prices

Latest inventory report shows big drop in crude. But overall supplies are still high, and U.S. economic growth is slowing. So what's pushing prices up to $80 a barrel?

By Steve Hargreaves, staff writer

NEW YORK ( -- What's driving the run-up in oil prices to Wednesday's record $80 a barrel?

Some short-term factors are plain to see. There's the big drop in crude inventories and a reported shutdown of nearly 200,000 barrels from Alaska's North Slope - a fourth of the region's total output - and a gathering storm in the Atlantic.

Yet at the same time, crude inventories, while declining recently, remain above average for this time of year. And the United States has seen a string of weak economic numbers over the last several weeks, so weak that nearly all analysts expect the Federal Reserve to cut interests rates at their next meeting.

Add to this the end of summer driving season and the rise of oil prices to eight times what they were in the late 1990s remains something of a mystery.

Experts explain the increase in prices by pointing to industry fundamentals.

Take inventories, for example.

In its weekly inventory report Wednesday, the Energy Information Administration said crude stocks plunged by 7.1 million barrels last week.

There have been concerns that OPEC production cuts from earlier this year and rising demand for oil have diminished crude supplies worldwide.

Still, EIA said crude inventories in the United States remain above average for this time of year.

But traders are focusing on the fact that crude inventories are below last year. Plus they say that while summer driving season sparks big demand for gasoline, it's actually winter that sees the largest demand for crude as people worldwide use heating oil and power plants burn oil to provide electric heat.

"Crude stocks are not crazy high anymore," said Antoine Halff, head of energy research at Fimat in New York. "Plus, heating season is ahead of us."

Another factor pushing up crude prices was renewed confidence in the economy as markets have stabilized after August's subprime-induced roller coaster.

How confident should people be that economic growth will remain strong?

A report released Monday by the National Association for Business Economics puts the growth of gross domestic product at 2 percent for this year, the weakest since 2002.

"Based on the economy, I think demand growth will be slower than people think," said Halff, who still has a target price of $73 for crude in the fourth quarter and said he may even raise that to $75.

But it's not just the U.S. economy that influences the price of oil.

"Crude oil is a global market, and we still have strong growth abroad," said Brian Hicks, co-manager of the Global Resources Fund at U.S. Global Investors.

Indeed, while countries like India, China and Brazil still use much less oil than the developed nations, especially on a per capita basis, they are responsible for much of the growth in global demand for crude.

This has led to projected strong demand for crude over the next few years, and concerns that supplies will not be able to keep up.

Already that has created a tight supply and demand scenario, where the difference between what the world produces and what it consumes has narrowed.

That of course magnifies the effects of geopolitical events, as there is less extra oil to cover demand if supplies get disrupted.

Hicks also said the declining value of the U.S. dollar, which oil is priced in, has helped push prices higher. OPEC is less likely to boost production if the value of their product is falling with the dollar. And consumers overseas are less likely to conserve if the price spikes aren't as pronounced.

As for whether speculative investors are driving up the cost of oil, Hicks said that interest in commodities has certainly increased over the last several years. This year alone, an estimated $100 billion was put into commodities funds by everyone from hedge funds to state pension plans.

But he said its impact on prices has been marginal. "There are sound fundamentals behind rising oil prices," he said.  Top of page