Oil: It’s Back To Supply And Demand

The speculators who bid up the market last year are in retreat. So much for the new reality

Last July, when crude oil was surging toward $80 a barrel, the talk of a new reality in the energy markets hit a fever pitch. Some said China and India would so voraciously suck up supplies that we might never see $50 a barrel again. Others noted that the nations that make up OPEC had finally figured out how to put the screws to the West for good, emboldening Iran and Venezuela to send prices higher with a mere rattle of their sabers. The “multi-decade supertrend” mantra echoed through the canyons of Wall Street.

Then oil crashed, touching $50 in January, 35% off its peak. Since July, in fact, crude has underperformed the stock market by 48 percentage points. All this while China’s oil-thirsty economy remains white-hot, Iran is barring nuclear inspectors, Venezuela is booting foreign oil investors, and Russia is putting the energy squeeze on neighbors.

So what happened? Call it a return to normalcy. The speculators and latecomers who bought into the new-paradigm argument suddenly turned tail–and traditional drivers of the oil market reemerged in force.

The biggest: old-fashioned supply and demand. Last week, prices fell when the Energy Dept. said it had tallied just under 322 million barrels of domestic crude oil stockpiles, a 6.8 million-barrel increase for the week and 9.3% more than the five-year average. Then, on Jan. 23, prices rose after the U.S. announced plans to double the size of the strategic petroleum reserve during the next few decades–promising, in essence, to take supply off the market. But that wasn’t enough to demoralize the oil bears, who growled the very next day after another report showed brimming stockpiles. The upshot: The self-correcting forces of Economics 101 still apply to oil. “Cycles come and cycles go,” says Oppenheimer & Co. (OPY ) oil analyst Fadel Gheit. “This is a commodity. There is no physical reason for it to have gone to $80.” Gheit and others say the true supply-demand equilibrium for oil is closer to $45 a barrel.

Business Week