Crude awakening: Oil tops $71 on recovery sentiment
One key driver in oil's $2.13 rise to $71.58 on Monday at mid-day? The Institute for Supply Management's manufacturing index, which rose in July to an 11-month high of 48.9. Readings above 50 signal an expansion; below 50, a contraction. The index hit a low of 32.9 in December 2008. Moreover, the index's new orders component, an indicator of future demand, rose to 55.3 in July from 49.2 in June.
Oil bulls see recovery ahead
The manufacturing statistic further supports the argument that the long U.S. recession is starting to bottom, with a continued pick-up in factory activity expected, implying an increase oil use -- and that's more than enough to have the oil market's bulls hit the 'buy' button.
Another factor that worked in the bulls favor Monday? Two economists. First, former U.S. Federal Reserve Chairman Alan Greenspan told ABC's George Stephanopolis Sunday, "I'm pretty sure we've already seen the bottom. In fact, if you look at the weekly production figures for various different industries, it's clear that we've turned, perhaps in the middle of last month, the middle of July." That sparked enthusiasm in Europe's equity and commodity markets, hours before markets in the United States opened.
Second, Economist Nouriel 'Dr. Doom' Roubini -- the New York University professor who two years ago accurately predicted the global financial crisis -- is now less pessimistic, at least regarding commodity prices, particularly oil. "As the global economy goes toward growth as opposed to a recession, you are going to see further increases in commodity prices especially next year," Roubini told Bloomberg News Monday. "There is now potentially light at the end of the tunnel."
However, investors should be careful to note that Roubini did not make any reference to a recovery. Roubini sees an increase in commodity prices, which is better than declining commodity prices that are so characteristic of recessions (and worse), and deflation. Nevertheless, the Greenspan / Roubini one-two punch was more than enough to shift oil's narrative back to the future demand'scenario and away from record-high oil inventories.
The other major energy commodities surged Monday on renewed bullish sentiment. Gasoline jumped five cents to $2.06 per gallon. Heating oil increased four cents to $1.87 and natural gas climbed 27 cents to $3.93 per million BTUs equivalent (MMBtu).
Further, the move above $70 per barrel will likely gladden the hearts of OPEC members. The cartel, which accounts for about 40 percent of the world's oil production, had eyed addition production cuts in September to counter record oil inventories created by the recession, and thwart a potential collapse in oil prices. However, with oil above or near $70, there will be little need for OPEC to cut production to support prices: more than likely, members will keep production the same to take advantage of oil's high price and collect increased revenue.
However, the news for U.S. motorists is not good. Drivers had hoped to see a 30-cent decline in gasoline prices on oil's decline this summer, something that would help disposable income-strapped citizens. It never occurred. Average U.S. unleaded gasoline dropped about 15-20 cents, to about $2.45 per gallon, and have since risen to an average of $2.54 per gallon since late July.
Economic Analysis: What does the renewed bullish sentiment and oil's rise above $70 mean for U.S. investors? It's a good news - bad news data point.
In general, a belief that oil demand will increase points to increasing industrial, commercial, and residential demand, and that's good news for the U.S. economy. Institutional investors, sensing that excesses in the U.S. and global economies (except the U.S. housing sector) have been worked off, argue that manufacturers can think in terms of increasing production to meet an upturn in demand. That's good news for corporate revenue, earnings, and for U.S. stocks.
However, if oil demand increases too much, it will send oil back to uncomfortable levels again, above $80 and then $90 per barrel. A price that high will depress U.S. GDP growth below where it would be if prices were lower, due to the enormous amount of oil Americans use. Every $1 per barrel rise in oil decreases U.S. GDP by $100 billion per year and every one cent increase in gasoline decreases U.S. consumer disposable income by $600 million per year. So while firm oil prices point to a recovering economy, too high oil prices put the energy problem -- and its drag on U.S. GDP, front-and-center again -- all the more reason for the United States to continue to increase energy efficiency throughout the economy.