Why Oil Is on the Rise Again


"Prices have doubled since February, but that's probably not the end of it."

Ask a group of oil analysts about the recent surge in crude costs and the consensus is: Prices have run up too far, too fast and they aren't supported by the fundamentals.

Ask them about where prices will be two years from now, however, and the majority will offer this prediction: A lot higher.

Oil shot past $70 a barrel last week, and the swiftness of that move has observers wondering if we're headed toward even more dramatic price gains.

To understand the odds of oil moving back above $100, it helps to first examine the reasons that the price has rebounded so strongly in recent weeks.

Much of the recent rally actually has nothing to do with the oil market's current supply-and-demand situation.

"Considering that supply seems ample and demand is weak, the fact that oil is going up looks kind of weird," says Adam Sieminski, chief energy economist at Deutsche Bank. "But those factors are being overwhelmed by. . .relief that we're not going to have the Great Depression. A lot of money is coming out of mattresses."

That inflow is lifting stocks and commodities alike. Morgan Stanley found that the correlation between crude oil prices and equities has recently been at a record high—with both rising strongly on the hope that the economic cycle has already bottomed. They also found that the inverse correlation between a weakening U.S. dollar and rising crude prices was also closing in on a record high.

Concerns about the ballooning U.S. deficit have caused investors to begin fleeing the dollar. The U.S. dollar index has dropped 9% since March. As it falls, oil prices are rising. If it falls further, they'll rise higher.

Just how high oil prices go from here—and how fast they get there—will ultimately depend on producers' ability to meet future demand.

There are signs of demand recovery in Asia. China's crude consumption averaged 7.6 million bpd in April—the highest level on record. Goldman Sachs was confident enough of a demand rebound to come out in early June with a price target of $85 a barrel for West Texas Intermediate crude by the end of 2009 and $95 by the end of 2010.

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