ECONOMY IN CRISIS – Institutions put their funds in oil – Safer than greenbacks or stocks
For once, you can’t blame high gasoline prices on supply and demand.
Instead, blame the falling dollar.
Analysts cite the greenback’s demise as one of the main reasons oil prices have hit record heights this month, briefly topping $111 per barrel Monday on the New York Mercantile Exchange. The crude oil bull market has, in turn, driven up gasoline prices nationwide, even though the United States currently has plenty of gas.
Americans are now paying an average of $3.28 for a gallon of regular — $3.63 in California — in part because the dollar has sunk so low. How can the decline of a currency have such a dramatic effect on the amount you pay for fuel?
Oil is traded in dollars. A weak dollar means that foreign investors can buy more oil, which helps drive up the price. And huge institutional investors start buying oil as a safe place to put their money, safer than the dollar or the stock market.
"Oil is the new gold," said James Burkhard, director of global oil market analysis at the Cambridge Energy Research Associates consulting firm. "Oil has some intrinsic value, and that value remains even if the dollar depreciates."
For weeks now, oil industry analysts have watched in amazement as oil’s price kept climbing, even though government statistics showed that the country had ample supplies of oil and gasoline on hand. Gloomy news about the economy should have pulled oil down, because demand for petroleum usually slumps in a recession. But the bull market barely shrugged.
"If you look at the run-up we’ve had for the last $20 or so, there’s no other explanation for it," said Michael Lynch, president of the Strategic Energy & Economic Research consulting firm. "You have days when there’s absolutely no news — except the dollar going down — and oil will still go up $3."
Role of big investors
The role of big investors in this year’s price spike infuriates some consumer advocates. Investors such as hedge funds may view oil as nothing more than a financial asset, but to the rest of the country, it’s fuel. The mercantile exchange didn’t even start selling crude oil futures — the most common form of oil investment — until 1983.
"We’re taking a financial instrument that barely existed 20 years ago and allowing it to drive a stake through the heart of our economy," said Judy Dugan, research director for the Foundation for Taxpayer and Consumer Rights.
Sooner or later, analysts say, the fundamental issues of oil supply and demand should bring oil prices down. Some wondered on Monday if that moment had finally come. As news of the Bear Stearns fire sale reverberated through financial markets, oil prices dropped more than $8 from their morning high. But by the end of the trading day, oil had regained almost half of that loss. It closed at $105.68, down 4.1 percent for the day.
"At some point, the fundamentals have to reassert themselves," Burkhard said. "At some point, this has to stop, unless the dollar is in a terminal freefall."
On Monday, the dollar hit a record low against the euro in midday trading, with a euro worth $1.59.
Whether or not traders start focusing more on supply and demand, Burkhard and others don’t see oil prices going back to where they were at this time last year — about $57 per barrel.
Even if the United States slides into a serious recession and drags the world with it, the global economy will still use vast quantities of oil. Demand is still growing in China, although not at the torrid pace of a few years ago.
Plus, the Organization of the Petroleum Exporting Countries has shown no interest in letting prices fall very far. The cartel controls a big enough portion of the world’s oil fields that it can throttle back production to shore up prices if needed.
"OPEC has the means and the will to defend prices," said David Kirsch, director of market intelligence for the PFC Energy consulting firm. "I think OPEC has gotten used to $80 oil."
The greenback swoon
Why has the dollar sunk so low? The U.S. economy has been losing steam since last year’s mortgage meltdown.
That lessens interest in the dollar among large institutional investors. And because the weakening economy hurts stocks as well, many investors don’t want too much of their money tied up in the stock market.
In contrast, oil looks like a good bet. People have to use it, in large quantities, all the time. Its value has more than tripled in five years, making some people quite rich.
"If you do need to park some money, oil is a pretty good place to go," Kirsch said. "They’re chasing returns, and quite frankly there aren’t a lot of places for them to go."
Because oil has traditionally been sold in dollars, investors in the rest of the world can buy more of it when the dollar slides. That tugs prices upward. And OPEC members will be more willing to push for a higher price, knowing that the dollars they receive aren’t worth as much as before.
This can turn into a vicious cycle. Rising energy prices force consumers and businesses to cut back their spending, further weakening the economy. That hurts the dollar even more.
"It’s almost a self-fulfilling prophecy," said Larry Harding, president of the High Street Partners consulting firm, which helps companies expand overseas. "As the price of oil goes up, the market perception that things are getting worse further drives the dollar down."
The weak economy and high fuel prices have already started eroding demand for oil and gasoline in the United States. Gas sales slipped 0.8 percent in the past month compared with the same period of 2007, according to the federal government. But so far, that hasn’t caused oil prices to fall.