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Oil closes above $70 for the first time in 2009

Some analysts question whether the economy is strong enough to justify oil at $70. Others say that if it rises above $80, the burdensome cost to consumers will cause demand -- and oil prices -- to fall.

June 10, 2009|Gail MarksJarvis

Oil closed above $70 a barrel for the first time this year Tuesday, and its swift surge from the $30s over just a few weeks is conjuring up images of its meteoric and economy-crippling rise to more than $140 last summer.

In 2008, nothing seemed capable of stopping oil's climb, and investors kicked themselves for missing out on prices that flirted with $150. But for those who want to bet on another doubling of prices soon, analysts are warning caution.

Some question whether the economy is strong enough to justify oil at $70. Others worry that if oil -- which gained $1.92 to close at $70.01 -- climbs above $80, the burdensome costs to businesses and consumers will weaken the economy, cause demand to drop and push oil prices back down.

"Investors have made a lot of mistakes investing in energy funds," said Morningstar analyst Michael Herbst. "They flood in during rallies when they should be doing just the opposite. Oil is very volatile and not easy to predict."

Oil shares have rallied sharply along with the price of crude since the stock market hit bottom in early March, but experts say it would probably take a continued run-up in oil prices for the stocks to move higher.

It's not just individual investors who struggle to get it right. Last summer, Goldman Sachs estimated that oil could go to $200 a barrel for the year. Instead, it plunged as the recession gripped the economy. Recently, the New York investment bank estimated oil could go to $85 by the end of this year.

Analysts are struggling to determine just what has pushed oil to $70 in such a short time.

"It seems to us that the oil market has mostly responded to improving expectations concerning the timing of the recovery more than to an actual pickup in demand," said Merrill Lynch global economist Riccardo Barbieri. "Inventories are high and OPEC is sitting on ample spare capacity."

Beyond speculative trading, oil is driven largely by supply and demand. So if there is plenty of oil stockpiled, there is no fundamental reason for prices to skyrocket. In fact, if a lot of oil is sitting in tanks and there is little demand for it, the price could be positioned to fall.

That's a possibility Douglas Hepworth is taking seriously. He's the research director of Gresham, a New York commodities investment manager, and he says he doesn't bet on prices. But if he were pushed, he'd be inclined to bet on oil at $50 versus $140, he said.

"In the U.S., oil demand looks very frail," said Merrill Lynch commodities strategist Francisco Blanch. In the Asia Pacific area, "demand has nose-dived as a result of the dramatic contraction in Japanese industry activity." Europe is also weak.

Not all analysts think oil is poised for a fall. Barclays analyst Costanza Jacazio thinks oil at $70 is a fair price despite the economy's weaknesses.

She said oil plunged last year simply because there was no clarity over how troubled the economy would become. Now, there are early signs suggesting that conditions will start improving.

But, she said, there still is no expectation for tremendous growth, Jacazio said. Rather, OPEC seems to be positioned to hold back supplies so they don't overwhelm demand, and OPEC leaders have stated that $75 seems like a fair price.

"So investors have more confidence in the price target, and prices have moved toward that," Jacazio said.

Barclays is expecting oil to remain in a range of $70 to $80 for six months and then to rise gradually as the economy improves in 2010 and 2011. The Britain-based investment bank is forecasting $137 by 2015.

The conditions that drove oil over $140 last summer seem far off now. Experts are unsure when the economy will emerge from recession, and slow growth is expected over the next several years.

"If the world is growing at 5%, there is not enough oil, and if it is growing at 1%, there is too much," Hepworth said.

He thinks oil prices have been skewed lately by trading activities that link a weakening dollar to rising oil prices. Meanwhile, as the economy improves and demand rises for energy, the supply concerns of 2008 could eventually return.

But for now, Hepworth said that scenario appeared to be a distant concern.


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