Oil Prices Rise Despite Oversupply, and OPEC Wins

Posted by Michael Hoven on March 15, 2010 at 12:38 pm

Qatar is one OPEC member that produces more oil than its OPEC quota allows, but excess production has not brought down oil prices. (image: dubainews.biz)

Oil futures prices have rallied lately, which might lead some to think that the demand for oil must be greater than the supply of oil. On the contrary, oil producers like OPEC are trying to gauge whether there is too much oil on the market. If prices were determined by supply and demand, then the prospect of too much oil would bring prices down; however, as Reuters reported on Thursday, oil prices have risen despite plentiful supplies, demonstrating (again) that the fundamentals of supply and demand have a limited influence on the price of oil.

David Hufton, an oil trader with the firm PVM, puts it another way: “Anybody who still believes that oil futures prices are a reflection of the true state of the physical market is living in a time warp.”

Neither Hufton nor Reuters emphasized the point, but many careful observers of the oil market agree with Hufton that supply and demand do not determine oil prices, and place responsibility for higher prices on speculators who treat oil as a financial rather than a physical asset. Whether you believe speculators perform a useful function—by anticipating future changes in the supply of or demand for oil—or not, their influence in oil markets moves the emphasis away from the physical market.

Who benefits from this? OPEC does, says Reuters. OPEC members are now routinely surpassing their production quotas. According to an energy adviser with PFC Energy, Paul Tossetti, “If you get on the ground and look at the fundamentals, you see too much crude oil production by OPEC.” But OPEC hasn’t suffered from this oversupply, since physical supply hasn’t dragged down oil prices. When OPEC meets this Wednesday, all expectations are for them to maintain their current production targets, even as member nations violate those targets. And why would OPEC try to curb production? If they can produce more and sell it at the same (or higher) prices, then added production only further boosts their profit.

For consumers of heating oil and other oil products, it can be frustrating to pay more for oil now because traders expect oil demand to rise in the future, but that’s what has been happening. While supply and demand can still have an impact on oil prices—the collapse of crude prices from $147 a barrel to $33 a barrel in 2008 was attributed to the recession, which choked off oil demand as the economy contracted—consumers are often at the mercy of investors who are more concerned with the value of the dollar than with how much heating oil people are using. The Commodity Futures Trading Commission (CFTC) has proposed new rules to try to limit the impact that speculators have on the market, but they may not be stringent enough to affect oil prices.

If supply and demand gained a more decisive role in determining oil prices, whether through CFTC regulation or otherwise, consumers would reap the benefits of lower oil prices—at least for now, when there is no shortage of oil supply. However, some oil analysts, like Jeff Rubin, think that significantly higher oil prices are inevitable in the next few years, because supply will be unable to keep up with demand.

So while prices determined by supply and demand are not necessarily low prices, they do give consumers a fighting chance for fair prices. It’s hard to imagine a scenario in which speculators keep oil prices artificially low. If consumers bear the burden when supplies are low and demand is high, they should catch a break when there’s more oil on the market than anyone wants.