HardAssetsInvestor

Written by Julian Murdoch  |

October 29, 2009

Oil: Supply & Demand? Hardly!

Details

• Awash in oil – so why are prices rising?
• The crude oil-dollar correlation
• Why you should watch the tankers

For most commodities, you can look at the underlying forces driving supply and demand and understand what will move the market. Except, it seems lately, for oil. Prices have risen so far, so fast from their mid-February lows that some investors have started to wonder: Is the price of crude decoupling from supply and demand?

Not quite. But right now, supply and demand only tells part of the story.

Oil Supply And Demand

Globally, we are awash in oil. As reported in the EIA's latest "This Week in Petroleum," crude oil inventories went up yet again this week, gaining 778,000 barrels. While this increase was less than half of the 1.91-million-barrel increase analysts had forecasted, crude oil inventory is still well above the five-year average for this time of year. (Oil still dropped a bit though, due to a huge increase in gasoline inventories when the market had expected a drawdown. See "This Week's Oil Guesses Off The Mark" for more on that story.)

OPEC has publicly stated that they believe inventories in developed OECD countries to be equal to roughly 61 days of demand—a number OPEC is none too happy about. They'd prefer the world to be constantly on the brink of running out (that is, 55 days or less). So with all of this supply, you'd expect to see OPEC talking production cuts—or at least a drop in the price of oil.

Instead, last week the group discussed the need to increase production, so as to keep oil under $80—it seems even OPEC thinks prices are still too high. As OPEC Secretary General Abdalla El-Badri told Bloomberg:

Of course, if the floating stocks (that is, oil stored at sea) remain at current levels and inventories stay full, then apparently OPEC will just sit back and rake in the money.

It's The Dollar, Stupid

So if supply and demand isn't driving oil prices, what is?

It comes back to the strength—or lack thereof—of the U.S. dollar. As OPEC member Qatari Oil Minister Abdullah bin Hamad Al-Attiyah told Bloomberg:

Of course, what he most likely meant to say is that right now, oil has a strong negative correlation with the dollar. Just look at the relationship between oil and the dollar since the beginning of 2007: