Some big voices on Wall Street think so, predicting the oil market could
tilt sharply south soon if the U.S. dollar strengthens and demand for crude
oil weakens in some key consuming countries. Tightness on the supply side
could also ease, they say, as some big refineries and new oil fields come
onstream over the next few months and the outlook for the Chinese economy
clouds over.


But don’t count on a price plunge just yet. While oil has eased off its
record of just over $133 nearly two weeks ago, to $124.31 currently, there
are still strong reasons to believe that the benchmark U.S. crude could
hover at about $120 a barrel well past summer.

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At issue are deep disagreements over what is driving the run-up in oil

In the search for scapegoats, many on Capitol Hill in the U.S. and elsewhere
are now blaming oil-futures speculators, noting the vast cash inflows into
commodity index funds. But those skeptical of a sharp price fall point to a
raft of continued gloomy news on the fundamental supply-and-demand side,
arguing that an already tight market isn’t likely to loosen for months.

Like the Dot-Com Boom?

The bearish argument has grown increasingly loud over the past week. Lehman
Brothers on Friday compared the rally to the one-upmanship of the dot-com
boom: Wall Street analysts have repeatedly raised their price forecasts as
oil prices have soared, driving new investor flows that have pushed prices
to still-higher levels, leading to still-higher price forecasts. Lehman sees
the “classic ingredients of an asset bubble,” with financial investors
driven by a “herd” instinct and chasing past performance.

Hedge-fund manager George Soros also has chimed in. “We are currently
experiencing the bursting of a housing bubble and, at the same time, a rise
in oil and other commodities which has some of the earmarks of a bubble,” he
said Tuesday in prepared testimony before the U.S. Senate. Mr. Soros
cautioned, though, that a crash in oil markets was “not imminent.”

Economists who have cited the dollar’s fall as a key factor in the rising
price of oil now argue that that linkage is set to reverse. With the dollar
now showing signs of strength, and the fears of inflation ebbing, oil prices
also should fall, they say. Federal Reserve Chairman Ben Bernanke’s comment
Tuesday that further interest-rate cuts are unlikely gave the dollar another
upward jolt.

To back its dot-com analogy, Lehman Brothers cites evidence that
institutional investors, including sovereign-wealth funds, have been
increasing their exposure to commodities. The investment house calculates
that from January 2006 to mid-April 2008, more than $90 billion of
incremental investor flows was devoted to assets under management by
commodity indexes. It said for every $100 million in new inflows, the price
of West Texas Intermediate, the U.S. benchmark, increased by 1.6%.

Yet others dispute the view that the run-up in crude oil is investor-driven.
“This is the price you get if supply doesn’t expand for five years and
demand continues to grow as it has done for the last four to five years,”
says Paul Horsnell, an analyst with Barclays Capital in London. Prices will
“continue testing upward” unless the supply-and-demand picture changes
substantially, he says.

Others have also disputed the evidence that investors are driving up the
price of crude.

In written testimony to the U.S. Senate last month, Jeffrey Harris, chief
economist of the Commodity Futures Trading Commission, said that while
futures-contract prices for WTI have more than doubled during the past 14
months, managed-money positions, as a fraction of the overall market, have
changed very little.

“Speculative position changes have not amplified crude-oil futures price
changes,” he wrote. “More specifically, the recent crude-oil price increases
have occurred with no significant change in net speculative positions.” He
also said there was no evidence that position changes by speculators
“precede price changes” for crude-oil-futures contracts.

Seeking Their Footing

Mr. Horsnell and others contend that after their precipitous rise to $133,
oil prices are now seeking a new equilibrium. Even the normally bearish
Energy Department doesn’t see prices falling far soon. Guy Caruso, head of
the department’s Energy Information Administration, cited continued tight
global supplies Monday when he predicted that oil will stay above $100 a
barrel through 2009.

The main factor cited for sustained high prices is the surprisingly steep
fall so far this year in production from some of the world’s key exporters,
particularly Mexico, Russia and Venezuela. The big producers within the
Organization of Petroleum Exporting Countries have largely held their output
steady since late last year.

Despite declining demand in the U.S., the thirst for petroleum products —
above all diesel — continues apace in much of the developing world.

China’s Needs

Rocked by the recent earthquake, China is now scrounging for all available
sources of diesel to power thousands of generators that have taken the place
of downed power plants. Surging domestic demand among Persian Gulf countries
also continues to nibble away at available oil exports.

“What will turn this around is a real change in what has pushed this up in
the first place, which would be a notable shift on the supply-demand front,”
said Mr. Horsnell. “So far, we aren’t seeing that.”

Lehman is in the camp that expects the supply-demand balance to change in
the coming months. New Saudi oil production should come onstream soon, as
well as big new refineries that will ease bottlenecks and bring greater
competition in oil-products markets. Russia is enacting tax breaks that many
hope will lift stagnant oil production.

Meanwhile, oil-demand growth is expected to ease in fuel-hungry China, as
the economic slowdown in its Western export markets takes hold. China also
has been stockpiling fuel in the run-up to the Olympics, and with the Games
over, imports might slow.

All this could “set the stage for a significant correction” in the oil
price, says Michael Waldron, an analyst with Lehman. Yet even he predicts
that may not happen before the end of the year.

Write to Guy Chazan at <mailto:[email protected] com> [email protected] com and
Neil King Jr. at <mailto:[email protected] com> [email protected] com


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