Bears Baffled by Oil Highs

THE WALL STREET JOURNAL: Bears Baffled by Oil Highs

By GREGORY MEYER
April 21, 2008; Page C10

As crude-oil prices edge further into uncharted territory, life as a bear has become lonelier than ever.

Benchmark crude futures have registered an electric performance so far this year and now — near $117 a barrel — hover well above some of the highest near-term forecasts. The speed of the ascent has caught many market participants off guard and forced banks and brokerages to repeatedly revise their oil-price outlook upward.

Yet some analysts continue to warn that oil prices are teetering close to a steep fall — at least back near $80 a barrel. For these observers who see the world’s oil supply-and-demand balance loosening and weighing on prices, the red-hot rally is nothing short of astonishing.

“I personally think this is the mother of all bubbles,” said Michael Lynch, president of Strategic Energy & Economic Research Inc., a consulting firm in Amherst, Mass. He expects prices to pull back to $80 a barrel by late June, and in the long run step down to $50 as pent-up supply in Iraq, Nigeria, Venezuela and other underproducing exporters starts to flow.

For Tim Evans, an energy analyst and inveterate bear at Citigroup in New York, that bubble is “still expanding,” filled with sentiment that seems to ignore signs of what he views as a supply surplus through the end of this year.

“There’s no supply-demand deficit,” Mr. Evans said.

The case for lower oil prices is straightforward: The prospect of a deep U.S. recession or even a marked period of slower economic growth in the world’s top energy consumer making a dent in energy consumption. Year to date, oil demand in the U.S. is down 1.9% compared with the same period in 2007, and high prices and a weak economy should knock down U.S. oil consumption by 90,000 barrels a day this year, according to the federal Energy Information Administration.

The benchmark crude futures contract on the New York Mercantile Exchange first touched $100 a barrel on Jan. 2 and has marched higher since then. Nymex crude has risen 22% this year and 91% since the start of 2007, settling at $116.69 a barrel Friday after touching a record intraday high of $117.

The International Energy Agency, the Paris-based energy watchdog of the world’s richest nations, earlier this month lowered its forecast for world oil demand growth by 460,000 barrels a day and now envisions demand will total 87.2 million barrels a day this year, nearly 1.3 million barrels a day more than last year. The IEA also sees supply from outside the Organization of Petroleum Exporting Countries growing by 815,000 barrels a day, the strongest growth since 2004, leading bears to contend the world is amply supplied.

The bulk of the oil market doesn’t seem bothered by this argument. Buyers have been emboldened by what they see as faltering supply, with OPEC members holding oil production steady and supply from outside the cartel growing but not as quickly as originally expected.

While the Federal Reserve’s aggressive interest-rate easing cycle is aimed at stimulating the economy at a dangerous impasse, the oil market has taken its monetary policy cues squarely from the weak dollar. As fears gather that the rate cuts are leaving the U.S. economy extremely vulnerable to inflation, the rise in the price of oil is also seen by some as an early harbinger of those gathering price pressures, reminiscent of the commodity price spike in the early 1970s.

Mr. Lynch at Strategic Energy argues the dynamics of supply and demand justify a price of $30-$40 a barrel, while jitters in unstable exporting regions might reasonably double that price.

“But $114? I mean, the run-up in price we’re seeing in the last six weeks or so has happened while the fundamentals have, generally speaking, gotten bearish,” he said.

Even with red flags on the horizon and oil prices shattering predictions, the rally has generated a sort of self-fulfilling momentum.

“We’re stuck in this rut of an upward market until something major changes in the macro picture,” said Adam Robinson, an energy research analyst at Lehman Brothers. After revising up, Lehman sees the Nymex benchmark crude averaging $89 a barrel this quarter and $93 in 2008.

To Mr. Evans of Citigroup, those factors are already here. Higher prices are sowing the seeds of their own collapse, he says, as consumers start cutting back and producers search for oil that once was too costly to extract. By his reckoning, oil should be trading between $70 and $80 a barrel.

“We don’t need any further evidence for this market to turn lower,” he said.

Write to Gregory Meyer at [email protected]

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