SCDigest editorial staff

The News: Oil prices broke the $70 per barrel barrier this week, topping out in mid-week at $72 before falling slightly thereafter. This continued price rise in the cost of oil, which ultimately drives increases in transportation and logistics costs, comes despite the fact the oil inventories in the U.S. are at eight-year highs.

The Impact: In addition to planning for further increases in transportation costs, freight rates and fuel surcharges, these latest dynamics show that models carriers and shippers may use to forecast fuel costs could be obsolete as supply and demand dynamics are trumped by commodity futures traders.

The Story: Oil prices went to over $70 per barrel this week and diesel and other fuel costs continue to soar, threatening still more upward pressure on logistics/ transportation and many commodity prices. Many experts, however, are observing that the traditional role of supply and demand in determining prices is not working as usual in the oil market.

In the past, upward oil price pressure was accompanied by inventory shortages that caused supply-demand imbalances. This week’s run-up, however, is occurring as oil inventories in the U.S. at least by some reports are at their highest levels in eight years.

So with ample supply, why is a barrel of oil at $72?

The answer appears to be that what is driving the price of oil more than ever is not the demand for oil by actual users and consumers, but demand for oil as a commodity by “futures” traders and other investors.

In short, the traditional connection between oil inventories and price per barrel price no longer really exists. With billions of investor money pouring into oil futures, traders are driving up the price of oil regardless of what’s actually happening with supply.

This means in part that the way cargo carriers and shippers may have modeled likely oil price changes or expectations in the past are no longer relevant. While slowing demand and/or rising supply inevitably will have some impact to the cost of fuel for transportation, the connection is perhaps the most tenuous it has ever been.

What is also happening is that prices for oil in the future, based on commodities trading, are often many dollars higher than the price for oil delivered right now. What that means, experts say, is that is pays oil companies and refiners to hold oil off of the market to await higher prices later, which then also contributes to upward price pressure. That reward for holding oil inventories may largely explain the eight year high in U.S. oil inventory numbers. Holding oil is a better use of cash for refiners with a guaranteed profit based on futures contracts than is holding cash.

The good news is that this “speculative” oil price scenario, with prices somewhat decoupled in the short term from supply and demand, means that a dramatic retreat in prices could also occur, if speculators sense problems and quickly pull out of the market.

That could leave a reverse scenario, with current prices well above futures prices six-months out. Some experts say this could lead to a rapid $20-30 drop in the price per barrel.

Does the price of oil make any sense to you? Is the uncoupling of the price from true supply and demand for certain periods causing too much volatility? Let us know your thoughts.

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