Oil Prices Inflate As Speculators Bet On Stimulus

Oil prices are racing higher as investors bet that central bank cash will soon boost a market afraid of Middle East war and worried about North Sea supplies, but the rally looks increasingly inflated by speculative guesswork.

Oil is up almost a third in six weeks at a time when the world economy, and hence fuel demand, are extremely weak.

Oil prices assume the U.S. Federal Reserve will soon launch a new round of quantitative easing to stimulate the economy, or that bellicose rhetoric between Israel and Iran will lead to conflict, or that North Sea production problems will be long-lasting.

But none of these factors is a safe bet and if they were removed, the price of oil could fall quite sharply.

“The market is decoupling from fundamentals,” said Carsten Fritsch, an analyst at Germany’s Commerzbank in Frankfurt. “Much of the strength is based on factors – such as more U.S. economic stimulus – that are far from guaranteed.”

Brent crude oil hit $115 per barrel on Monday, its highest for three months and up 30 per cent since the end of June. Oil hit an all-time high of $147 in mid-2008 just before the onset of the credit crisis, which sent prices down to $36 just six month later.

Oil prices are now well above the $50-$80 per barrel cost of production from most of the world’s newest oilfields, a level believed to be a natural floor for oil prices.

One spur for prices has been concern over a fall in North Sea output due to planned maintenance, which will help cut production in September by 17 per cent from a dozen British and Norwegian crude oil streams.

For a short period, the North Sea oil spot market could be squeezed if demand for some grades outstrips supply, traders say, but maintenance work is likely to be completed fairly quickly and supplies will then resume.

HOSTILE RHETORIC

The oil market has also been strengthened by hostile rhetoric from Iran.

Washington has tightened sanctions on Iran and sought to increase international diplomatic pressure to curb Tehran’s nuclear ambitions.

Iranian leaders have talked of closing the Strait of Hormuz at the head of the Gulf, through which around a fifth of global sea-borne oil exports flow, if they are ever attacked.

However, with U.S. aircraft carriers within striking distance, Hormuz could not be closed for long, and it almost certainly would not suit Iran to try to close the strait, through which its oil and other exports also pass.

“Iran is not about to close Hormuz,” said Samuel Ciszuk, Middle East analyst for KBC Energy Economics. “Fear of war between Iran and Israel has been greatly overstated.”

But while Middle East tensions may be providing largely psychological support for oil, action by the U.S. central bank could have a dramatic impact on oil’s supply and demand balance.

Since late 2008, the Federal Reserve has bought $2.3 trillion in long-term securities in a drive to spur growth and revive the economy, indirectly pumping billions into assets markets and injecting huge liquidity into oil and commodities.

During the first round of quantitative easing from November 2008 to March 2010, oil more than doubled, and in the course of QE2, the second round between November 2010 and March 2011, it rose by a third.
Bank of America Merrill Lynch say monetary easing of $600 billion in September could push commodity prices sharply higher.

“Oil prices would likely increase by 14 per cent on a third round of QE,” the Merrill Lynch strategists said in a note.