A perfect storm of events combined to drive oil prices to new highs on Friday. First the numbers, for our cave-bound fans. Oil opened at $128.20, climbed to a record $139.12 all-time high during the day and closed at $138.54 for a record close. That's an 8% jump in just 5 1/2 hours. It was one of those "if only I'd had a crystal ball" days.f

To everyone without that crystal ball, the big jump in oil prices was a scary thing to wake up to with their Saturday morning coffee and newspaper, and even the newspapers seemed a bit confused on where to begin. Here's a recap on some of the competing theories.

Behind The Numbers

First of all, the dollar is weak and getting weaker. The chart below is how the dollar has been shaping up to the euro for the past few months. Not exactly a pretty picture.

Since crude oil is priced in dollars, the price of crude rises in direct relationship to the dollar's decline. Think about it this way, those countries which produce the oil, and the companies in them, have to be able to pay their workers and their bills in local currency, so they have to raise their dollar prices just to stay even. Dollar down = dollar-priced commodities tend to rise.

But we're big believers in simple supply-and-demand charts, so let's look at the supply-shock theory.

First, there are rumors in Nigeria of a strike against Chevron. Not only would it affect existing production, but Chevron is scheduled to bring on-line an additional 250,000 barrels per day on June 15. Even though demand has actually finally started easing in some parts of the world, losing 250K a day of new capacity still matters. Any new capacity that comes on-line will get used, and threats to supply, even rumors of threats, carry weight. Heck, 250K barrels is a quarter of what Senator Schumer is demanding of OPEC.

More disturbing though, is a remark by Israel's deputy minister and transportation minister Shaul Mofaz. In an interview published in an Israeli newspaper and quoted in a Reuters article, he states, "If Iran continues with its programme for developing nuclear weapons, we will attack it. The sanctions are ineffective." Of course, the government was quick to refute Mr. Mofaz's statements, but the damage to oil prices was done.

Evil Speculators

The big enemy in the current debate is definitely that most inscrutable of villains, the speculator, or even the lowly investor who is buying the occasional commodity ETF in their 401(k).

Every pundit, myself included, has discussed the issue of speculation before. But this isn't like the tech bubble, where everyone and their Aunt Mildred was picking stock and investing. Investing in futures is a sophisticated activity, and there are many barriers to entry (margin requirements, portals to trade, etc.). So if the craziness in the oil market was really the result of rogue futures traders, you'd expect it to show up in the volume. But here's the volume of crude oil (CL) contracts traded on NYMEX in the last year:

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