Why oil prices are stubbornly high

Drivers have been paying about 10 cents more for a gallon of gas since Dec. 31.

Toru Hanai/Reuters
Gold: It hit a high on Wednesday. Investors are pumping money into commodities such as gold and oil, which drives up their prices.
SOURCE: Energy Information Administration/Rich Clabaugh–STAFF

It's the New Year's event few consumers want to see: higher bills at the gas pump.

But since the crystal ball fell at Times Square, the price of oil has hovered close to the $100-a-barrel level, despite some predictions it will fall in 2008. With oil up, the price of gasoline has risen 10 cents a gallon since Dec. 31, according to GasPriceWatch.com.

Among the reasons that energy analysts cite for crude oil's strong showing so far:

•US inventories are now at a three-year low. This is prompting some analysts to call for the Energy Department to stop putting oil into the nation's Strategic Petroleum Reserve (SPR) so the oil instead can be used in the marketplace.

•Trouble is brewing in the Nigerian oil patch. Hope that Nigeria's politicians could smooth over problems in sharing the oil wealth are fading amid reports of continued unrest and possible future attacks on the oil infrastructure, analysts say.

•Nervous investors are continuing to pump money into commodities, such as gold, silver, and oil, which drives up their prices. A weak dollar also tends to drive up oil prices.

"We have a little bit of an oil bubble right now," says Phil Flynn, vice president of energy research at Alaron Futures and Options in Chicago. "It could go back to $100 a barrel because it's so close right now, but I think the price is acting very top-heavy."

Some energy traders would not be surprised to see the price of oil remain relatively strong in the first quarter. "We'll see spates of rallies, but the first quarter will be the high point for energy," says John Kilduff, a New York-based trader at MF Global, a large futures broker.

Year-end, inventories tend to be low

Although oil inventories are low, some energy analysts expect them to be restocked this year. Oil companies normally try to reduce their inventories at year-end, says Rick Mueller of Energy Security Analysis Inc. of Wakefield, Mass. "But there is no question: We are at the lower end of the comfort zone," he says.

Oil inventories are down 60 million barrels since July, Mr. Mueller says. "It's a disturbing trend," he says.

On Wednesday, the Energy Information Administration reported that crude-oil inventories fell 6.8 million barrels for the week ending Jan. 4 – the eighth consecutive week they have dropped. One trader blamed bad weather around the Houston ship channel last week. He expected an adjustment next week. Nonetheless, the price of oil jumped on the news.

Part of the reason for the decline in inventories: The price of oil for next December on the New York Mercantile Exchange, a futures market, is about $3 a barrel lower than the price of oil today. "It does not pay to hold inventory," says Lucian Pugliaresi, president of Energy Policy Research Foundation Inc. in Washington. "That indicates the market is perceiving the fundamentals of supply and demand will lead to a lower price in the future."

With inventories relatively low and prices relatively high, some energy traders wonder why the United States is continuing to add to the SPR. Every day, the US adds 90,000 barrels of oil to the underground storage facilities in Louisiana. It stockpiles the oil from the petroleum companies in lieu of collecting taxes from them on oil produced from fields in the Gulf of Mexico.

The SPR is now stocked with 696 million barrels of oil, close to its capacity. "When oil is close to $100 a barrel, it is beyond comprehension why we are still adding to the SPR," says Mr. Kilduff. "It is basically full, and we're adding to it at the top of the market, which is making matters worse."

Iran and Nigeria factors

The oil markets are also trying to assess some geopolitical concerns. For example, energy analysts thought relations between the US and Iran had improved. Then, on Sunday, five Iranian boats confronted a US Navy flotilla in the Strait of Hormuz, according to the Pentagon. President Bush assailed the Iranians for a "provocative" act. "It was just a little incident, but combined with Bush's rhetoric, it revived concerns," says Kilduff.

Analysts had also thought the Nigerian government had been successful in soothing unrest in the oil-producing delta area. "The vice president was from the region, and things appeared to be improving there," says Mueller. "But now, there are some reports that the rebels are planning larger attacks on the oil infrastructure."

Nigeria is the eighth-largest oil producer in the world and an important supplier to the US.

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