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Chicago Tribune: Reasons aplenty to explain record oil price run-up

Bill Barnhart | Market report
September 13, 2007

Now that crude oil futures have hit a milestone, $80 a barrel, expect chatter around the water cooler and urgent remarks by politicians.

“It is a psychological threshold; there is no doubt about it,” said Antoine Halff, head of energy research at Fimat USA.

What follows are some talking points you can use to contribute to or at least evaluate the inevitable reactions:

– Oil prices have been rising for several years, as industrial use expands globally and more people drive more cars more. A new tropical storm in the Gulf of Mexico, sabotage affecting Mexican oil output and a refinery disruption at BP’s Alaskan operations sparked the latest move.

Tuesday’s announcement by OPEC of increased production had little effect.

“The market issued a stern rebuke,” said Mike Fitzpatrick, a vice president in energy trading at MF Global. “It’s clearly not going to be enough to turn prices around.”

– U.S. oil inventories have been bleeding for several weeks, according to weekly reports by the Energy Department. Supplies fell 7 million barrels in the latest report, which like recent reports was worse than expected.

“Since late June, crude stocks have dropped by 31 million barrels, which is about twice as fast as in the same time of year for the last five years,” said Halff.

A major factor behind the supply drop is a shift in the pricing of oil futures. Oil futures for delivery in later months are selling for less than the current price. That’s a reversal of a trend earlier this year in which oil for delivery in outlying months was more expensive.

The shift means it doesn’t pay to hold oil in inventory, said Howard Simons, market strategist at Bianco Research.

– The price margin between crude oil and products refined from crude oil, including gasoline, has been rising for several years. As a result, oil companies have a greater incentive to refine as much oil as possible, Simons said.

“The rising refining margins are a signal that you can buy crude at $80 and turn it into $95 of refined products, and the people who are buying them are getting some economic value out of them,” he said.

A shortage of refining capacity prevents greater output of refined products from reducing prices. Still, consumers have been willing to forego other spending in order to fill their tanks.

“Until we see a narrowing of refined margins, we are not going to be at risk economically or in financial markets,” Simons said.

“It’s not the high oil prices that cause economic stress or inflation. It would be if they were high and you weren’t getting your money’s worth.”

– Higher oil prices, which are denominated in U.S. dollars, have less of an effect in Europe, where the dollar stands at record lows against the euro. But in Japan, with a cheap yen, higher oil prices hurt.

– Despite higher refining margins, the recent run-up in crude oil prices has not been matched by higher prices for oil company equities. Oil stocks, relative to oil prices, spiked in early 2002 but declined by the end of that year and remained fairly stable, according to Bespoke Investment Group. Recently, oil company stock prices have been falling relative to oil prices.

The effect of higher oil prices is more apparent in the recent trend in airline stocks, which had rallied in August with a brief decline in oil prices.

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