Prices and production

Oil prices are having another spectacular week. Starting at $68 a barrel on Monday, prices reached an inter-day high of $71.79 on Wednesday before settling at $71.33. A combination of fundamentals and financial developments is behind the move. US crude stockpiles fell 4.4 million barrels, and gasoline inventories fell by an unexpected 1.6 million barrels last week. This is the fourth stock draw-down in five weeks giving the markets a reason other than hopes for a rebound to run up prices.

Although demand for gasoline increased slightly last week, most of the inventory decline is due to lower imports as refiners work off unusually large stockpiles. Crude inventories are now only 11 percent higher than the five-year average vs. 27 percent higher a few weeks ago.

Weakness in the dollar, fear of inflation, and hopes for an economic recovery remain major factors in determining the course of oil prices. This week rising interest rates are a major contributor to higher prices as investors seek hedges against inflation.

Kuwait’s oil minister said OPEC will not consider increasing production until prices get back to $100 a barrel. This is the first mention of $100 oil in many months although several financial firms have issued reports talking about oil rising to $85 or $95 when the global economy starts to recover.

Gas prices

US gasoline prices rose another 10 cents a gallon to a nationwide average of $2.62 last week, up almost a dollar a gallon from December. Prices are over $2.90 a gallon in California and Michigan; the latter is having refining problems. Despite the increase, gasoline prices are actually lagging behind crude which has doubled since December, suggesting that still higher prices may be imminent. Last summer motorists were spending about $1.5 billion a day to fill their tanks. By December this had fallen to $600 million as the price of gasoline fell from a national average of $4.11 to $1.62. Now the daily cost has risen to the vicinity of $1 billion.

This situation is starting to raise alarms. For every 10 cents a gallon gasoline that prices increase, consumers have $40 million a day or $1.3 billion a month less to spend on other things. Price increases in the last 5 months have reduced consumer spending power by $400 million a day as gasoline consumption during the period remained reasonably steady. The damage done by increasing gasoline prices is gradual and no particular price, such as $3 a gallon, is the point at which serious economic problems begin.

Our economic situation is turning into a maze of interconnected feedbacks. Government efforts to bail out and stimulate the economy have led to a massive increase in borrowing and now increasing interest rates. This in turn has caused investors to seek the safety of oil, thereby driving up gasoline prices, which could choke off the rebound the government was trying to foster in the first place.