Crude prices remain high despite supply glut

Abu Dhabi: Last week crude oil prices maintained most of their gains over previous weeks with local benchmarks selling at a premium to New York's light sweet.

On trading Monday and Tuesday, prices fell back as expected, reflecting commercial short hedging in futures contracts as shown by the previous week's Commitments of Traders report of the Commodity Futures Trading Commission. But by Wednesday prices had recovered and remained range-bound in choppy trading until settling just below $70 per barrel on Friday.

The local Dubai Mercantile Exchange's benchmark Oman heavy sour closed on Thursday at $69.72, down slightly from the previous week's closing price of $70.91. The New York Mercantile Exchange's nearby benchmark West Texas Intermediate closed Friday at $69.41, down from the previous week's $72.25. New York heating oil finished the week at $1.79 per gallon, down from $1.83.

Based on the fundamentals of supply and demand pundits say current crude price gains are not justified. Crude stocks going into the summer driving season are at multi-year highs in North America; the world oil balance shows a surplus of over three to four million barrels per day of production available for market demand and rising. Yet prices still climb. Some reasons for this could include unanticipated stores of fund money moving into commodity markets and the world financial circulatory system beginning to function once again, with increasing money transaction cycles multiplying the monetary base. This is welcome news, but could quickly transform current price deflation into inflation in a matter of just a few months. Knowing this, traders are moving aggressively into commodity markets, which are known as a hedge against inflation. But this endangers the recovery. With crude prices increasing and the recession not even over, such aggressive buying presages even more rapid price increases, which could choke off the recovery.

Even with strong recessionary undercurrents, commodity prices have possibly failed to cheapen enough to sustain a broad based economic recovery, resulting in expected large wealth transfers between "new economy" and "old economy" regions.

Only New York natural gas is bucking this upward price trend being pegged by current and future fundamentals of supply gains overtaking expected demand increases.

The nearby natural gas futures closed out the week at $4.06 per million British thermal units, about where it was on April 1. Natural gas's crude barrel equivalent bargain cost is signalling that the price relationship to crude will break down further unless yet-to-be-devised LNG futures markets can create a super-regional trading arena.

- The writer is Associate Professor of Economics and petroleum market behaviour at the Petroleum Institute in Abu Dhabi.