Oil races to $68, ignoring bloated inventories

It was Scottish poet Robert Burns who first wrote that the best laid plans of mice and men often go awry.

Surely he was a soothsayer predicting the fate of the oil bears in the early 21st century. The world is awash in oil, with inventories so high that global storage tanks are limiting the ability of both oil producing nations and oil companies to stockpile oil, Bloomberg News reported. But the oil market has basically ignored that sloshy reality for the last three months. During that March-May period oil persistently trended higher, from about $37 to $66 per barrel -- up a remarkable 78 percent. On Monday, the first day of June, oil shot up another $1.98 to $68.29 per barrel, before pulling back slightly to trade about $67.75 at mid-day.

Rise blindsides the oil bears

What has caused oil's seemingly paradoxical rise? Three factors, economists say. First, there are signs -- Fed Chair Ben Bernanke calls them "green shoots" -- that the U.S. recession is bottoming. Chief among the green shoots: housing starts appear to have bottomed, and jobless claims apparently have peaked.

Second, a flight out of the dollar and into potentially higher-returning investments has caused the dollar to fall versus the world's other major currencies, and when that occurs, oil, which is priced in dollars, generally rises.

Third, China's manufacturing sector continued to expand in May, Reuters reported Monday, and if that pattern continues oil demand will increase in Asia, further supporting oil prices.

The other major energy commodities also rose Monday. Heating oil surged 5 cents to $1.72 per gallon, unleaded gasoline added 2 cents to $1.91 per gallon, and natural gas gained 24 cents to $4.08 per million BTUs.

Economic Analysis: The rally has crushed the oil bears, many of whom had stops tripped at $65 per barrel. Further, provided the U.S. and global economies continue to show signs of an approaching recovery, a sustained oil price in the $55-70 range is not unreasonable, with some oil experts seeing a $75-85 oil price in 2010. Still, investors need to keep in mind the demand destruction and GDP-lessening impact of high oil prices. Stagnant median incomes have already reduced disposable incomes in the U.S., and sustained high oil and gasoline prices will reduce them even more, creating another unwanted headwind for the U.S. economy.
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