Is Crude Oil Really Worth $80?

Remember the times when crude oil was trading around $30 - why, say $40 even? Now, don't go scratching your head thinking that must have been the good ol' days when Carter was president or was it Nixon? It was much more recent, in 2005. Before Katrina,that is.

What Katrina left behind was a trail of destruction across the Gulf Coast, damaging the ports and refining infrastructure. And oil jumped up to nearly the same levels as it is trading now. However, what is easily forgotten is that post 9/11, the war in Iraq and later Katrina, there has been no significant source of disruption or veritable threat to interruption of supply. And while most of the oil infrastructure that was damaged is now up and running, it begs a question why then did oil jump to its highest ever levels, by first breaching the $80 mark last week and sustaining the increase over a whole week of trading to close at over $83 on 9/19.

As per the industry analysts and based on the timing of the first spike past $80 last week, it was certainly prompted by a decision of the OPEC, or the Organization of Petroleum Exporting Countries, most of whom are from the Middle East, led by Saudi Arabia. The decision was to increase the supply by 500,000 kilo barrels per day, which the market (meaning the Big Oil companies, oil traders, and speculative investment funds) believed was not sufficient to meet the growth expected for the next year.

Now, without coming across as too much of a skeptic in commodity futures markets, I do think that there needs to be a relook at the dynamics of this whole demand and supply expectations process. The announcement, which was eagerly anticipated for well over a week by everyone in the energy market, did nothing to categorically say that production will not be increased in the future. Keeping supply tight is a good strategy for the OPEC, as demand will then drive prices up, but that is expected. What is not expected, of course, is that an increase in supply , however moderate is shrugged off as being insufficient for the world economy in 2009,citing the usual suspects of double-digit growth of the Chinese and other developing economies.

It is clear to see, that while current supply-demand balances are in manageable shape, an almost maniacal rally of futures buying leaves the near futures price at utterly unbelievable levels. While the market reaction itself raises some eyebrows, the magnitude of the response was fantastically disproportionate. Some may call it panic, some may call it volatility, but at the end of the day, it's just unreasonable. It is perhaps not as mysterious as it might appear, if only we do not discount the possibility of the common man being led a long winding, greasy garden path.

A theory often used when trying to explain murder mysteries is called cue bono, or who stands to gain? It may well be handy to explain this situation then. So, who stands to gain if oil goes above $80 or even $100. Quite simply, anyone with a barrel of crude oil in his hand. But, on a more grim note, it is Big Oil, many of whom posted their obscenely huge and biggest ever profits ever. Don't let them explain to you how their expenses are also increasing proportionately. Yes, they do hand-out a good chunk of their profits to their shareholders as dividend bonuses, but where does the money come from in the first instance. Why don't they reinvest some of that into building more refineries, and add to the supply capacity, which would ostensibly aid in reducing gas prices? Guess what, there have been no new oil refineries built in the US since 1976, and elsewhere in the world too. Amidst all the talk of growth in demand no less. Go figure. In essence, money flows from the pockets of gasoline guzzling American citizens, and some of it comes back oil-stained back into a few who decided to partake in a bit of the orgy.

But that's not all. Who else is at the party? Big Finance. The large speculators, who do not have a commercial or hedging interest in the crude futures market, but only a purely monetary motivation. It is their movement to the long side or the short side on an aggregate basis that contributes greatly to the direction crude takes in the first place, which they claim to successfully predict and make profits from. Excuse me, while I yawn and rub my eyes. It all doesn't add up. Or, actually it adds up very well, in the boardrooms of Big Finance on Wall Street.

And all this is not entirely unknown to the regulatory powers that be, either. In fact the role of speculative investors in the futures markets has been under scrutiny for many years now. But leaving aside the dirty financial discussions, here is a simple series of questions that can be ultimately self-revealing. Which are the corporations that have made the most profits in the period past Katrina? You will find the tech-startups like the Googles of the world, but guess the other Big names can be left as an exercise for the meticulous reader. In fact a recent survey whose results were posted on CNNMoney, the top few fastest growing companies in the last year were profiled. Again, more than half of the companies involved with oil, or with metal and mining, in one way or the other.

So, what next from here. Given that there are many political angles to the whole industry that have been carefully avoided in this article, together with the suspicious spurts of price increases, it is anybody's guess which way crude is headed over all. But does it mean that crude is necessarily worth $80 a barrel, either now or in the near term? Far from it. A lot of the $80 is fluff that some people thought they could do with.The demand and supply situation has certainly not shifted so alarmingly from October 2005 to September 2007 to justify on purely economic factors this nearly 100% price escalation.Clearly, there is more than that meets the eye. In fact there is a lot that already meets the eyes of the authorities that matter - the SEC,the Congress and the rest - but will the hands act? Where crude goes from here will not depend on supply or demand as much as it depends on the above question.