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Washington Post: Taking Cues From Fed, Speculators Bid Up Oil

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Speculation caused oil prices to reach record highs after the Federal Reserve’s interest rate cut eased concerns about a U.S. economic slowdown. (By Hasan Jamali — Associated Press)

By Steven Mufson
Washington Post Staff Writer
Saturday, September 22, 2007; Page D01

Federal Reserve Chairman Ben S. Bernanke may have cooled off the credit crisis by cutting interest rates, but he may also have heated up oil prices this week.

For seven consecutive business days, crude oil prices have hit new highs. Even after dropping slightly yesterday, crude oil on the New York Mercantile Exchange finished the week at $81.62 a barrel, up a third since Jan. 1 and not far short of the inflation-adjusted peak set in January 1981, when Saddam Hussein’s Iraq was at war with Iran.

Though gasoline prices haven’t matched earlier levels, new price increases could come soon. AAA said that the nationwide average price of regular unleaded gasoline was holding steady at $2.80 a gallon, up 34 cents from a year ago but still 43 cents below its peak, on May 24.

The fuel for the latest surge in petroleum prices has been renewed speculation by investors and hedge funds after the Federal Reserve’s cut in interest rates eased concerns about an economic slowdown. For every percentage-point increase in gross domestic product, oil consumption in the United States, the world’s biggest oil market, grows from a quarter to a third of a percent.

Lower interest rates have also undercut an already weakened dollar, which reached $1.41 against the euro. Since crude oil is priced in dollars, a weak dollar makes oil cheaper abroad and high prices in dollars more sustainable.

Oil prices this week drew strength from other areas, too. Comments by the French foreign minister, Bernard Kouchner, fanned fears of war with Iran over its refusal to open its nuclear program to international scrutiny. Last weekend, Kouchner warned Western nations to “prepare for the worst,” though he told Washington Post editors yesterday that he favored giving the head of the International Atomic Energy Agency some time to negotiate with Iran.

To top it off, nearly two-thirds of the oil output in the Gulf of Mexico, or more than 800,000 barrels a day, was idled on Thursday as an approaching storm prompted the evacuation of offshore oil facilities, the Minerals Management Service said.

Unlike the rise in oil prices in the spring, this spike is taking place when energy demand usually hits a lull, between summer driving and winter heating seasons. Moreover, the price rise has picked up momentum despite an increase in output of half a million barrels a day by the Organization of the Petroleum Exporting Countries.

“This time it’s just speculation,” Peter C. Fusaro, chairman of Global Change Associates and a consultant on energy hedge funds, said of the price increase. “There’s a large bet out there that prices will continue to trend higher. But it’s detached from fundamentals because there’s no shortage of oil.”

“It’s a big gambling hall,” said Fadel Gheit, an oil analyst at Oppenheimer. “Though oil prices may still go higher, a correction is inevitable. The only question is when and how much.”

Gheit said oil prices were inflated by as much as $30 a barrel. He also argued that while commercial inventories were modest, a buildup of government-held stocks had made demand seem stronger than it actually is.

Still, many analysts said that oil prices would remain high over the longer term because of restricted access to the world’s biggest reserves in Russia and the Middle East and because oil consumption in the United States, China and the Middle East continues to rise despite high prices.

Last week, Goldman Sachs raised its forecast for crude prices to $85 a barrel, and said there was “a high risk of a spike above $90” a barrel. The October futures contract on the Nymex reached a record $83.90 on Thursday, its last day of trading. The peak monthly cost of crude oil to U.S. refiners was an inflation-adjusted $92.91 a barrel in January 1981, according to the Energy Department’s Energy Information Administration.

Royal Dutch Shell showed its confidence in the strength of the domestic gasoline market yesterday by announcing the biggest U.S. refinery project in three decades. The $7 billion expansion project would add 325,000 barrels a day of capacity at the Port Arthur, Tex., refinery that operates through Motiva Enterprises, a joint venture between the company’s Shell Oil unit and Saudi Aramco, the Saudi state oil company. The new facility will be able to handle relatively cheap low-quality crude oils, such as those from Alberta tar sands, new low-grade Saudi production or Venezuela.

“In spite of the high [gasoline] prices, we have still seen growth in the United States,” said Rob Routs, executive director of downstream at Royal Dutch Shell. He said that the United States has been importing about 1 million barrels a day of refined products, so that additional refinery capacity would “give security of supply” and “a good opportunity to cover the growth that is going to take place over the coming years.”

Even if gasoline demand remains healthy from an oil company point of view, many economists warn that high oil prices could hurt the U.S. economy by fueling inflation, pinching consumer spending and siphoning money into the coffers of foreign oil producers. With those producers inclined to convert some of those dollars into other currencies, that could further weaken the U.S. currency — and make it harder for the Fed to cut again.

“I don’t know any other economy in modern history that showed resilience and strength while its currency sank to record levels,” said Gheit. “Something has to give.”

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