Oil prices flirt with $60

Crude oil prices have been creeping higher of late, rising from recent lows in the mid $30 per barrel range to within a whisker of $60 per barrel. What gives? I mean, isn’t the US in its worst recession since the the 1930s, and the contraction, though slowing, continues. Supply and demand, right?

The chart provided by the Energy Information Administration shows US supplies are well above the normal range for this time of year. Moreover, since the beginning of 2008, domestic production is up 3.6% versus the same period a year ago and demand is down close to 6%!

We can’t discount what’s happening around the world, and much of the global economy remains mired in a recession. Hence, basic economics and the law of supply and demand suggest crude prices should be flirting with recent lows.

So what’s up? In my mind, a few things. First, the collapse in crude from $145 per barrel to $32 was probably a bit overdone. Go back to the panic selling of late last year, and hedge funds and speculators were quickly unwinding positions to raise cash.

Stocks, commodities, including oil, were being dumped. We are seeing some recovery from those lows, signaling the selling was probably a bit overdone.

But I don’t think that explains everything. China’s economy has been showing signs of life, and surveys that measure manufacturing are now in the plus column for the Asian giant. It’s difficult to say how much China puts into its own reserves in the event of a disruption of supplies, but growth in its economy is supporting demand for oil.

I want to take a closer look at this in another day but falling prices have also started to dampen activity in the oil fields, which in turn will limit future gains in supply.

And we can’t discount speculators. Look back at last year. A US recession was being birthed and crude rose from $80 per barrel to $147. At the time, well-respected analysts debated whether or not the increase was a reflection of the fundamentals or a bubble brought on by speculators. It’s clear now that the latter argument took the prize in the debate.

So a good part of the rise is also likely coming from those who suspect a bottom in US economic activity is in sight, i.e., specualtors may once again be testing the waters. One of my concerns, however, is that the upward creep in gasoline prices is taking money away from consumers at a time when the extra cash could go along way in supporting spending.

I don’t believe the sizable jump in gasoline prices is enough to derail a recovery at this time, but the economy remains extremely fragile.