Low US oil inventories and lack of spare OPEC capacity behind recent spikes in oil price

Alliance Trust says that a drop in US stores of oil as winter approaches along with oil group OPEC’s lack of spare capacity are the two most immediate reasons for the sudden jump in oil prices that have moved close to the $100-a-barrel mark.

Since July oil prices have gone from $73 a barrel to $94 a barrel and worsening political tensions involving oil producing countries such as Nigeria and Iran are likely to keep prices high.

Angus McPhail, Global Oil and Natural Resources Analyst, said, “There has been no respite in the tight balance between supply and demand. The main reason for this recent spike is that US inventory positions have fallen to a three-year low precisely as winter approaches. This fact, combined with OPEC’s low spare capacity position, is why oil prices have increased rapidly since July. Moving into winter in the Northern Hemisphere when demand for oil seasonally increases means that the prospect of US$100 per barrel remains very real. This is true even though OPEC has increased production by 500,000 barrels a day, and there has been some additional incremental production coming from non-OPEC producers.”

McPhail said that there were other factors adding to the rising oil price but not all have equal weight. He said that the role of speculators had not increased notably. “Hedge funds are using oil and other commodities as a form of asset class to make money, however, according to the US Commodity Futures Trading Commission, the share of non-commercial positions in crude oil stood at only 9%. When oil stood at US$40 per barrel the level of speculation was the same as it is today,” McPhail said.

He said that while some attribute the moves in the oil price to dollar weakness this was a lesser factor.

“A range of commodities do exhibit a correlation to the US dollar with gold having the strongest correlation, but for oil this is a weaker link that is muddied by the strong effect of geopolitical concerns.”

McPhail believes that the long-term average of oil will remain around $60 a barrel or more for at least the next three years because of many factors underpinning the price including the lack of investment in oil development over the recent years and a range of political risks that mean there is more pressure for it to stay high, than drop below its long-term average of $41 a barrel.

He singles out Nigeria and Iran as the largest of these. In Nigeria there are ongoing hostilities between rebels and the federal government, as well as the ongoing production stoppages in the Niger delta onshore and in shallow water. The Nigerian government have also sent out the wrong message to international oil companies in that they are hoping to alter the oil taxation regime in a way that will lessen incentives for companies to implement projects awaiting approval that would last beyond 2010.

McPhail said that Iran was a risk too because there had been a distinct hardening of the US position, through the imposing of UN trade sanctions, as well as the US Senate’s decision to pass a resolution labelling an arm of the Iranian military as a terrorist organisation, which gives the US a defacto authorisation to use military force against Iran. The gradual ramp up in pressure against Iran and the increasing international polarisation of opinion regarding policy towards Iran imply there is an increasingly serious risk of military activity.