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Supply Fears, Speculators Pumping Up Oil Prices

Investors are seeking big returns amid growing demand and threats to global production.

April 24, 2006|Ronald D. White | Times Staff Writer

It took the worst hurricane season in official memory to drive oil prices last year to new heights.

Last week, without a storm in sight, price records tipped over like an oil rig in Category 5 winds.

This time, petroleum markets are being buffeted by the fear that world oil production might be disrupted. And the rally is being fed by investment funds seeking hefty gains.

In Iran, the world's fourth-largest oil exporter, a nuclear development program is drawing the West's ire. In Nigeria, rebels have forced a 25% reduction in crude output and are threatening more. On the Gulf Coast, oil pumping and fuel refining still haven't recovered from hurricane damage.

At the same time, worldwide demand for all things petroleum shows little sign of weakening after the last few years of torrid growth. Neither does the interest of investors such as hedge funds and mutual funds, which have been funneling billions of dollars into oil and other commodities.

Taken separately, these and other market undercurrents lack the dramatic punch of nature's force. But together, said John Kilduff, senior vice president of energy risk management at New York commodities trader Fimat USA Inc., "It's a parade of horribles ... both real and imagined."

On the New York Mercantile Exchange, light sweet crude closed Friday at a record $75.17 a barrel, up 8.4% in a week that featured four record-setting days. Before this run-up, the record stood at $69.81 a barrel, reached Aug. 30 as markets awoke to Hurricane Katrina's destruction along the Gulf Coast, a key oil production and refining region.

Retail gasoline prices have been jumping, too. On Sunday, California's average price for a gallon of self-serve regular reached a record $3.105, AAA said. The U.S. average stood at $2.90 a gallon, short of the record $3.057.

In an energy futures market wracked with concern that oil demand might outstrip supplies -- traders call it petronoia -- threats alone were enough to ignite prices.

Iran's president, Mahmoud Ahmadinejad, said Wednesday that "the global oil price has not reached its real value yet," raising the prospect that he might be willing to use his country's crude as a weapon.

Meanwhile, Nigerian insurgents rejected the government's plans to redress grievances in the impoverished Niger River Delta region. The militants exploded a car bomb inside a military base late Wednesday, the first major attack in two months.

Turmoil in other oil-producing hotspots, including Venezuela and Chad, is adding to the market volatility.

"This global tension, led by the stalemate between Iran and the U.S., could lead to oil prices about $80. People are really afraid that something is going to happen and soon," said Fadel Gheit, senior energy analyst at Oppenheimer & Co. If conflict breaks out in any of these spots, oil could top $100 a barrel, he said.

All of these simmering problems might not pack such a wallop if worldwide demand hadn't been growing so furiously over the last two years, led by China and India. The unexpected leap in consumption has left oil-producing countries with little extra crude available to make up for disruptions. Members of the Organization of the Petroleum Exporting Countries have spare capacity of about 1.5% of demand, compared with about 5% of demand historically, Citigroup Smith Barney oil analyst Doug Leggate estimated in a report last week to clients.

Oil and natural gas production in the Gulf of Mexico is still recovering from last year's hurricane destruction. About 22% of gulf oil output and 13% of natural gas production was unavailable as of Wednesday, the federal Minerals Management Service said.

In addition, some Gulf Coast refineries remain hobbled by hurricane damage and others are in the middle of longer-than-usual annual tuneups. Many refiners put off their regularly scheduled maintenance last year to rebuild supplies after the hurricanes. The American Petroleum Institute said that U.S. refiners operated at 86.7% of capacity in March, down from 90.2% during the same month in 2005.

Although gasoline prices have caught motorists' attention, they haven't reined in their driving.

Americans have been burning significantly more gasoline -- 9.1 million barrels a day more over the last four weeks compared with the same period last year -- at a time when the nation's fuel supplies are below average, said Phil Flynn, senior market analyst at Alaron Trading Corp.

The oil market's strength also reflects the influx over the last two years of speculators seeking higher returns than the stock market has provided.

Such noncommercial investors, who are looking to take home big profits rather than an actual barrel of oil, make up about 55% of the market, analysts said. Hedge funds and pension funds hold $150 billion to $175 billion in commodities investments, up from about $25 billion at the end of 2003, Fimat's Kilduff said.

"This market has been driven by speculation," Gheit of Oppenheimer said.

"In the old days we used to react. Now the market is taking a step forward. People polish their crystal balls, go to the Internet and the rumors fly across the globe in seconds," he said. "Forget about what happened yesterday. Tell me what will happen tomorrow."

Even so, many analysts said a reduction in oil prices was possible, if certain things came about.

Flynn of Alaron Trading made this list: "Something where Iran was able to back down from their threats, find some middle ground. We need the Nigerian oil production coming back online and we need a very calm and cool hurricane season. These are the things we need to bring these prices down."

Tom Kloza, chief oil analyst at Oil Price Information Service, thinks the rally's end may be in sight.

"The issue of oil prices and the possibility of supply problems has displaced politics, pop culture and global calamities, and taken over the front page," Kloza said. "That is often a sign that a rally is in its most mature stage."

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