High price, low demand creates a dangerous oil market

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When has the oil market been the most dangerous? Well, from a GDP perspective, you have to say in the summer of 2008, when the leverage bubble sent oil to the truly dizzying height of $147.27 per barrel -- an impossible price that choked off any momentum the U.S. economy had, and help drive it into the current recession.

Others may cite the world's first two oil shocks, in 1973-74 and 1979-80, which were followed by U.S. recessions (imagine that!), as other periods when the oil market was most dangerous.

Still, energy traders today might cite the current oil market. Oil is flirting with $60 per barrel despite the fact that the price is well above what most sector analysts consider a price justified by fundamentals.

Oil market ignores high inventories

For example, the Organization for Economic Cooperation and Development said OECD nations now have an enormous 61.6-day supply of oil in storage tanks, compared to the normal 50-day supply. Combine the above with flat-to-declining gasoline demand in the United States and very low oil demand growth in emerging markets and it points to an oil price drop. It has not occurred. After a one-month battle over $50, oil has surged to about $60 as if the U.S. and global economies were expanding and not in recessions. Just a scant three months ago in February, oil was trading at about $38: the price has risen about 55 percent since then - a massive move in a robust economy, let alone during a global recession.

The move has confounded the oil bears and gladdened the hearts of the oil bulls who were daring enough to put the trade on.

What's behind the disconnect between oil's price and its price? Some economists point to the weakening dollar, but the dollar hasn't fared that badly since February: it weakened about seven percent versus the British pound and about four percent versus the euro. Economists say the more likely driver of oil is the prospect of a U.S. and global economic recovery. The oil market is looking right past three-year-high oil inventories to a time when emerging markets in China, India, Latin America, and Eastern Europe, will be growing in unison again, which would substantially increase demand for oil.

Nevertheless, the oil market "has to be considered a dangerous one, right now," says economist Peter Dawson. "One side is going to be very wrong and lose a lot of money. Based on oil supply, the price of oil should be around $40-45, unless the U.S. and global economies are about set to recover in a quarter," Dawson told DailyFinance Tuesday. "If the latter is the case, then that would justify oil at $60 per barrel."

Oil Analysis: It's a survival of the fittest struggle in the oil market between the bulls and bears. In addition to economist Dawson's point about one side losing a lot of money, another point is also certain: oil will not stay at this level. It will either rise to $65-70 on further evidence of a recession bottom in the U.S. and global economies, or it will fall back to levels justified by really high inventories, if future economic data suggests a recession through the end of 2009.
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