Rising Oil Prices: Fundamentals and Geopolitical Risk

Oil prices are climbing again. Since bottoming in late-2008, amid the depths of the financial crisis, crude has nearly doubled. Yet oil is still far below the record higher of $145/barrel reached in July 2008.

Even with today’s price spike to nearly $90, we’re a long way from the former peak. But triple-digit prices may be coming, advises a new report from Bernstein Research, and Mideast political turmoil is only part of the story.

“With confidence toward economic growth on the rise, industrial-linked commodities have soared in anticipation of tightening supply/demand dynamics, following several years of underinvestment,” Bernstein analyst Scott Gruber writes today in a report titled “Is There a Case for $125 Oil?” He goes on to opine that industrial commodities, much like gold, “should rise in an environment of currency debasement, as long as there is underlying economic growth to support demand.” Judging by recent market action, it’s hard to argue. No wonder, then, that Gruber describes his thesis as “alive and well.” He continues:

No industrial commodity offers the depth and liquidity of the crude market. Thus, it is not surprising to see material funds flowing into crude futures, likely originating from both active and passive investors. Open interest on the NYMEX and ICE combined is up 16% year over year, and now eclipses the peak in 2008 by 17%

Fundamentals may fall short of bullish expectations, depending on what happens next with the global economy, but there’s also geopolitical risk to consider. In particular, the rioting in Egypt has clearly caught the attention of investors and speculators the world over. True, Egypt isn’t much of an oil producer to the world in terms of exports (it largely consumes what it produces), but the potential for cross-border reverberations in the oil-rich Middle East is considerable. It was political trouble in nearby Tunisia, after all, that seemed to spill over to Egypt. “If this can happen in Egypt, there is no reason that it can’t occur in Libya or Saudi Arabia,” John Kilduff, a partner at Again Capital LLC, an energy-focused hedge fund, tells Bloomberg.

“People are concerned that this could change the face of the Middle East, and no one knows what direction that might take,” opines oil analyst Phil Flynn of PFGBest Research Chicago via the LA Times. “Will it be liberal and democratic or will it be fundamentalist and Islamic?”

Fundamentals are critical in the long run for oil prices, of course, and that surely plays a role in the recent rise. But there’s a new factor in town, albeit one that’s no stranger to higher prices in the annals of energy markets: fear.

About James Picerno 894 Articles

James Picerno is a financial journalist who has been writing about finance and investment theory for more than twenty years. He writes for trade magazines read by financial professionals and financial advisers.

Over the years, he’s written for the Wall Street Journal, Barron’s, Bloomberg, Dow Jones, Reuters.

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