Business Blog: Hoover’s Business Insight Zone

Markets behave rationally in many respects, but in many cases they behave a lot less mathematically than they would if human actors weren’t the ones participating in them. Rationally, mathematically, you’d expect investors to hold onto their stocks (or pork bellies or whatever) for as long as they think prices will continue to go up. In practice, though, traders know that markets — that is, other traders — are fickle, and so they often sell parts of their holdings when certain price points are reached. This is common when market indices test new highs, or when indices pass certain round numbers.

Despite any considerations like this, oil futures have hit record highs above the round number of $85/barrel, and they seem to be holding steady. We live in interesting times.

Immediate causes for $85 oil:

• Tensions between Turkey and Kurdistan. Given the size of the Kurdish population spread across northern Iraq, northwestern Iran, and southeastern Turkey — and especially given the geopolitical instability of the whole region — I’m afraid we can expect this to get worse, not better, before it’s all said and done.
• Trouble in Kurdistan is only the latest in a long string of issues, as this quote from an industry watcher indicates: “Trouble keeps brewing and we have not had a relief in tensions in any part of the world for years,” Person said in emailed comments. “If it isn’t one thing, it’s another, from pipeline disruptions in Alaska, hurricanes in the Gulf region, continued Middle East tensions, rebels in Nigeria, or heightened tensions in Venezuela — the oil market has seen it all in just these past two years.”

But does the situation really call for $85 oil? The Times of London thinks not:

US motorists key to long-term oil prices

…A military threat from Turkey is a new piece of excitement but it is not the underlying story about oil which is as bearish as it is bullish, depending on which statistic you favour. Oil stocks in the West have been shrinking. Inventories held by OECD countries are down from 54.2 days supply in the second quarter to 53.8 days and the Centre for Global Energy Studies reckons they will fall below 53 days in the final quarter of this year. These sound like small adjustments but in the world of oil futures trading, it is these tiny adjustments in supply and demand which cause violent price swings….

My take: The long-term consumption habits of US motorists certainly have an impact on the price of oil, but the sensitivity of the futures market to developments in Kurdistan (or Nigeria, or particular fields in the Gulf of Mexico, etc.) shows just how tight the overall supply-and-demand picture is. Long-term trends — especially industrial and consumer growth in India, China, and the peaceful states of the Middle East — point to sustained higher demand. Any number of indicators point to constrained supply. That’s a recipe for historically high prices. I don’t think that recipe’s going to change anytime soon.