A weak dollar is driving investors into hard assets like oil, but high inventories and other weak fundamentals argue against a continued price runup.

Oil has returned to the role it held before last year's price collapse—a sanctuary of choice for investors fleeing the dollar. At least for now, that is.

Over the past week, crude surged through the $80-a-barrel barrier for the first time since September 2008. (The benchmark price of a barrel of crude oil ended Friday, Oct. 23, at $80.50.) This follows a breathtaking, yearlong bout of volatility. Since the summer of last year, oil has rocketed to $147, plunged to $32, and just a week ago traded below $70.

Yet many analysts say oil-market fundamentals are so weak that prices won't rise much higher, and may in fact retreat. "This is a dollar-led rally and unsustainable," says Phil Flynn, an oil analyst with PFGBest Research, a futures brokerage.


Another Safe Haven, Gold, Soars by 20%

The dollar is the main driver behind a 15% increase in oil prices over the past week, analysts say. Since March the dollar has fallen 15% in inflation-adjusted value compared with a basket of currencies of its major trading partners. Traders have sought to cushion the fall in the value of the dollars they are holding by buying futures in traditional safe havens. Mirroring crude's climb, gold has soared this year to more than $1,000 an ounce, or by about 20%. "The steady increase in oil prices means that traders want to hold hard assets," said Lawrence Goldstein, a director at the Energy Policy Research Foundation in Washington.

Few experts are predicting a sudden strengthening of the dollar, so oil prices could stay where they are. But the fundamentals are so weak, analysts say, that the price could rapidly fall back below $80 and even further.

When oil prices rocketed past $140 in 2008, the causes lay mostly with the supply-demand balance: There was virtually no spare production capacity anywhere in the world, so that any supply disruption, such as hurricanes in the Gulf of Mexico and the routine militant attacks in Nigeria, pushed prices up.


Plenty of Production Capacity, Oil in Storage

Observers predicting a price spike have pointed to a drop in global oil exploration and production, saying that when economies rebound there will be a shortage. In the U.S., for instance, exploration is down 27.8% from a year ago, with 309 rigs actively drilling, compared with 428 at this time in 2008, according to the Baker Hughes Rig Count. Abroad, there are 8% fewer rigs drilling than there were a year ago—764, down from 831. Major oil companies such as ExxonMobil (XOM), Chevron (CVX), and BP (BP) continue to spend on exploration, while smaller companies have cut back substantially.

But that is just part of the picture, analysts say. For starters, spare production capacity currently runs about 6.7 million barrels a day, according to the International Energy Agency, with Saudi Arabia accounting for 3.8 million barrels, or 56%, of the total.

In addition, oil storage tanks around the world are overflowing and would have to be drawn down before any big price spike takes place. U.S. crude inventories stand at 339 million barrels, up 27.7% from a year ago, reports the U.S. Energy Information Administration. In addition, since mid-September the Strategic Petroleum Reserve has exceeded 725 million barrels, a 27-year record. In fact, there is such a global glut that there is almost no place on land to put all the oil. An estimated 125 million barrels' worth are floating around on tankers scattered over the globe, according to OPEC. Normally, a negligible amount of oil is being stored offshore in ships.

Refineries, too, can ramp up and produce oil products, analysts say. U.S. refineries are operating at around 80% of capacity, among their lowest rates in two decades. "High inventories and weak market fundamentals might eventually weigh on markets" and push prices lower, said Edward Morse, managing director at Louis Capital Markets, a London-based brokerage. So it's possible that crude isn't such a safe haven after all.




[businessweek]