As oil nears $70, OPEC worries about a price collapse

Ah, it's summer time. Families on vacation at the beach, office workers sneaking away early on Friday afternoon to hit the shore, and teenagers hanging out at the neighborhood ice cream parlor. Time to relax.

Well, OPEC is not relaxing. This summer, the oil cartel is concerned about a substantial drop in the price of oil in the weeks ahead. That's correct: OPEC is concerned about prices plummeting.

The price of oil has risen 20 percent in two weeks to over $68 per barrel. It shows no sign of a sustained easing, despite the global recession, and yet producers of 40 percent of the world's oil are fearing a price collapse. Is OPEC disconnected from reality or are they on to something?

U.S. inventories of key fuels such as diesel and heating oil are at 24-year highs, according to data compiled by the U.S. Energy Information Agency. Meanwhile gasoline demand remains flat to barely rising, on a year-over-year basis. Demand for all of the above has been hurt by the recession, and OPEC fears if demand soon doesn't materialize to use the record-high stored oil, a major price break to the downside will ensue.

And if the green shoots wilt . . .

When people see that the green shoots of recovery have been overly optimistic regarding the expansion's arrival, "this distillate overhang will be a main factor pushing prices down," a senior OPEC delegate said in The Wall Street Journal (subscription required). OPEC meets next to discuss production on September 9.

But don't mention oil's record inventories to American motorists: they've seen little relief at the gas pump. True, gas prices have retreated from last year's truly dizzying $4 per gallon heights during the leveraging boom, but prices have risen more than $1 per gallon since December 2008 and are still about $2.30 per gallon for unleaded regular in most regions of the nation. Travel to a high-cost city (New York, Los Angeles, San Francisco), and the price quickly tops $2.70. In other words, so far record inventories have failed to spark a major price-break, and as a result high gasoline and diesel prices are further pinching consumers' budgets -- removing valuable cash that otherwise would likely strengthen the economic recovery.

If OPEC and University of Calgary economics professor Philip Verleger -- who says could hit a low $20 per barrel amid on an oil glut -- are correct, oil's big swoon will likely start in the months ahead, as gasoline demand drops as the U.S. summer driving season ends.

Meanwhile, the oil bulls will continue to let the facts speak for themselves: oil recently tested and sustained support at $60 per barrel earlier in July, after holding support at $40 over throughout Q1 earlier this year. The bulls say those two supports, plus oil's latest technically bullish sign -- the 50-day moving average crossing above the 200-day moving average, a 'golden cross,' -- provide evidence that an oil bottom is in place, and prices are likely to rise in the months ahead as more recovery-confirming data is released. The bulls add that oil's status as an inflation hedge and as an alternative asset further supports prices.

Oil Analysis: Oil's flirting with $70 and OPEC is expressing concern about a price collapse. The oil bears have continually argued that oil's inventory build justifies a much lower price for oil, particularly when both the U.S. and global economies are in recession. But since 2005, some factor has kept oil's price at lofty levels -- geopolitical risk, oil as an inflation hedge, oil as an asset play, and most recently, the prospect of increased demand during a probable global economic recovery in Q3/Q4. Moreover, oil bears have been creamed recently by this market. True, oil's supply/demand fundamentals dictate a considerably lower price for oil, but up until now, this has been a market that has largely ignored or been decoupled from fundamentals. Until fundamentals become the dominant factor, it's hard to see oil's price collapsing.
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